Financial Management Final Exam

rate of return on a perpetuity.

The cost of preferred stock is equivalent to the:

RE = .01 + 1.2(.085) RE = .112, or 11.2%

Kelley Couriers just paid its annual dividend of $5.25 per share. The stock has a market price of $58.25 and a beta of 1.2. The return on the U.S. Treasury bill is 1 percent and the market risk premium is 8.5 percent. What is the cost of equity?

6.68% RE = $.95/$43.50 + .045 RE = .0668, or 6.68%

Montez Supply is expected to pay an annual dividend of $.95 per share next year. The market price of the stock is $43.50 and the growth rate is 4.5 percent. What is the cost of equity?

capital asset pricing model

The ________ explains the relationship between the expected return on a security and the level of that security's systematic risk.

eliminate asset-specific risk.

The most important reason to diversify a portfolio is to:

14.2% E(r) = .035 + 1.43(.075) E(r) = .142, or 14.2%

The risk-free rate of return is 3.5 percent, the inflation rate is 2.9 percent, and the market risk premium is 7.5 percent. What is the expected rate of return on a stock with a beta of 1.43?

5.59% E(r) = .14(.12) + .65(.065) + .21(−.015)E(r) = .0559, or 5.59%

You recently purchased a stock that is expected to earn 12 percent in a booming economy, 6.5 percent in a normal economy, and lose 1.5 percent in a recessionary economy. The probability of a booming economy is 14 percent while the probability of a normal economy is 65 percent. What is your expected rate of return on this stock?

Standard deviation; beta

________ measures total risk, and ________ measures systematic risk.

WACC = (1/1.62)(.163) + (.62/1.62)(.0521)WACC = .1206, or 12.06%

Kelso's has a debt-equity ratio of .62 and a tax rate of 21 percent. The firm does not issue preferred stock. The cost of equity is 16.3 percent and the aftertax cost of debt is 5.21 percent. What is the weighted average cost of capital?

52.18% Portfolio weightC = [400($39.80)]/[650($15.82) + 320($11.09) + 400($39.80) + 100($7.60)] Portfolio weightC = .5218, or 52.18%

You own the following portfolio of stocks. What is the portfolio weight of Stock C?

beta of 1

A ________ is the market's measure of systematic risk.

5.55% E(RP) = .15(.2000) + .65(.1215) + .20(−.1075)E(RP) = .0875, or 8.75% RPP = .0875 − .032RPP = .0555, or 5.55%

A portfolio is invested 45 percent each in Stock A and Stock B, and 10 percent in Stock C. The expected T-bill rate is 3.2 percent. What is the expected risk premium on the portfolio?

WACC = .113 = (1/1.62)RE + (.62/1.62)(.063) RE = .1440, or 14.40%

Dee's Toys has a target debt-equity ratio of .62. Its WACC is 11.3 percent and the tax rate is 21 percent. What is the cost of equity if the aftertax cost of debt is 6.3 percent?

.004682 E(r) = .74(.093) + .26(−.063)E(r) = .0524, or 5.24% σ2 = .74(.093 − .0524)2 + .26(−.063 − .0524)2σ2 = .004682

If the economy is normal, Taeana Wear stock is expected to return 9.3 percent. If the economy falls into a recession, the stock's return is projected at a negative 6.3 percent. The probability of a normal economy is 74 percent. What is the variance of the returns on this stock?

11.1% E(r) = .019 + 1.34(.069) E(r) = .111, or 11.1%

The stock of Rullo Rigs has a beta of 1.34. The risk-free rate of return is 1.9 percent, the inflation rate is 2.2 percent, and the market risk premium is 6.9 percent. What is the expected rate of return on this stock?

8.5% Risk premium = 1.31(.08 − .015) Risk premium = .085, or 8.5%

The stock of Yakir Development has a beta of 1.31. The risk-free rate of return is 1.5 percent and the market rate of return is 8 percent. What is the risk premium on this stock?

RP = $2.60/$23.85 RP = .1090, or 10.90%

Walker Systems has an issue of preferred stock outstanding with a stated annual dividend of $2.60 that just sold for $23.85 per share. What is the bank's cost of preferred stock?

E = 165,000($33) = $5,445,000P = 15,000($43) = $645,000D = 1.01($750,000) = $757,500V = $5,445,000 + 645,000 + 757,500V = $6,847,500WACC = ($5,445,000/$6,847,500)(.147) + ($645,000/$6,847,500)(.089) + ($757,500/$6,847,500)(.083)(1 − .21)WACC = .1325, or 13.25%

Wayco Industrial Supply has a pretax cost of debt of 8.3 percent, a cost of equity of 14.7 percent, and a cost of preferred stock of 8.9 percent. The firm has 165,000 shares of common stock outstanding at a market price of $33 per share. There are 15,000 shares of preferred stock outstanding at a market price of $43 per share. The bond issue has a face value of $750,000 and a market quote of 101. The company's tax rate is 21 percent. What is the weighted average cost of capital?

1.10 ValuePortfolio = $6,000 + 17,900 + 2,750 ValuePortfolio = $26,650 βPortfolio = ($6,000/$26,650)(1.37) + ($17,900/$26,650)(.95) + ($2,750/$26,650)(1.48) βPortfolio = 1.10

What is the beta of the following portfolio?

cost of debt.

Wright Market Research is able to borrow money at a rate of 6.8 percent per year. This interest rate is called the:

1.08 E(Ri) = .065 = .011 + βi(.05) βi = 1.08

A stock has an expected return of 6.5 percent, the risk-free rate is 1.1 percent, and the market risk premium is 5 percent. What is the stock's beta?

unsystematic risk

An investor who owns a well-diversified portfolio would consider ________ to be irrelevant.

D = .974($380,000) = $370,120P = 2,600($61) = $158,600E = 37,500($19) = $712,500V = $370,120 + 158,600 + 712,500V = $1,241,220WE = $712,500/$1,241,220WE = .5740, or 57.40%

Florida Groves has a $380,000 bond issue outstanding that is selling at 97.4 percent of face value. The firm also has 2,600 shares of preferred stock valued at $61 per share and 37,500 shares of common stock valued at $19 per share. What weight should be assigned to the common stock when computing the weighted average cost of capital?

RE = {[$1.25(1.065)]/$48.75} + .065 RE = .0923, or 9.23%

Gabaldon Group has a stock price of $48.75, a beta of 1.3, and just paid an annual dividend of $1.25 per share. The dividend growth rate is expected to be 6.5 percent per year. What is the estimated cost of equity using the dividend discount model? Multiple Choice

RP = .06($100)/$49 RP = .1224, or 12.24%

Grill Works has 6 percent preferred stock outstanding that is currently selling for $49 per share. The market rate of return is 14 percent and the tax rate is 21 percent. What is the cost of preferred stock if its stated value is $100 per share?

WACC = .46(.158) + .05(.083) + .49(.068)WACC = .1102, or 11.02%

Mullineaux Corporation has a target capital structure of 46 percent common stock, 5 percent preferred stock, and the balance in debt. Its cost of equity is 15.8 percent, the cost of preferred stock is 8.3 percent, and the aftertax cost of debt is 6.8 percent. What is the WACC given a tax rate of 23 percent?

Beta

Of the options listed below, which is the best measure of systematic risk?

cost of equity

Okonjo Economics has a debt-equity ratio of .38. All of the firm's outstanding shares were purchased by a small number of investors. The return these investors require is called the:

RE = .022 + 1.32(.106 − .022) = .13288, or 13.288%RP = (.055)($100)/$64 = .08594, or 8.594%E = 75,000($41) = $3,075,000P = 48,000($64) = $3,072,000D = 6,500(.965)($1,000) = $6,272,500V = $3,075,000 + 3,072,000 + 6,272,500V = $12,419,500WACC = ($3,075,000/$12,419,500)(.13288) + ($3,072,000/$12,419,500)(.08594) + ($6,272,500/$12,419,500)(.067)(1 − .21)WACC = .0809, or 8.09%

Phillips Equipment has 6,500 bonds outstanding that are selling at 96.5 percent of par. Bonds with similar characteristics are yielding 6.7 percent, pretax. The company also has 48,000 shares of 5.5 percent preferred stock and 75,000 shares of common stock outstanding. The preferred stock sells for $64 per share. The common stock has a beta of 1.32 and sells for $41 per share. The preferred stock has a stated value of $100. The U.S. Treasury bill is yielding 2.2 percent and the return on the market is 10.6 percent. The corporate tax rate is 21 percent. What is the weighted average cost of capital?

D = 13,000($1,008) = $13,104,000E = 168,000($53) = $8,904,000V = $13,104,000 + 8,904,000V = $22,008,000WD = $13,104,000/$22,008,000WD = .5954, or 59.54%

The Downtowner has 168,000 shares of common stock outstanding valued at $53 per share along with 13,000 bonds selling for $1,008 each. What weight should be given to the debt when the company computes its weighted average cost of capital?

($.66 − .58)/$.58 = .13793($.72 − .66)/$.66 = .09091($.75 − .72)/$.72 = .04167g = (.13793 + .09091 + .04167)/3g = .09017RE = [$.75(1.09017)]/$10.08 + .09017RE = .1713, or 17.13%

The Shoe Outlet has paid annual dividends of $.58, $.66, $.72, and $.75 per share over the last four years, respectively. The stock is currently selling for $10.08 per share. What is the cost of equity?

The actual expected stock return indicates the stock is currently overpriced.

The common stock of Alpha Manufacturers has a beta of 1.24 and an actual expected return of 13.25 percent. The risk-free rate of return is 3.7 percent and the market rate of return is 11.78 percent. Which one of the following statements is true given this information?

4.66% E(r) = .22(−.05) + .63(.07) + .15(.09)E(r) = .0466, or 4.66%

The common stock of Hall & Byrd is expected to lose 5 percent in a recession, earn 7 percent in a normal economy, and earn 9 percent in a booming economy. The probability of a boom is 15 percent while the probability of a recession is 22 percent. What is the expected rate of return on this stock? Multiple Choice

.001051 E(r) = .11(.135) + .63(.08) + .26(.025)E(r) = .0718, or 7.18% σ2 = .11(.135 − .0718)2 + .63(.08 − .0718)2 + .26(.025 − .0718)2 σ2 = .001051

The rate of return on the common stock of Kang Distribution is expected to be 13.5 percent in a boom economy, 8 percent in a normal economy, and only 2.5 percent in a recessionary economy. The probabilities of these economic states are 11 percent for a boom and 26 percent for a recession. What is the variance of the returns on this common stock?

10.96% E(RP)Boom = (.19 + .13 + .07)/3E(RP)Boom = .13, or 13% E(RP)Normal = (.15 + .05 + .13)/3E(RP)Normal = .11, or 11% E(RP)Bust = (−.29 − .14 + .22)/3E(RP)Bust = −.07, or −7% E(RP)Boom = .25(.13) + .72(.11) + .03(−.07)E(RP)Boom = .1096, or 10.96%

What is the expected return of an equally weighted portfolio comprised of the following three stocks?

7.86% Portfolio value = 1,400($15.57) + 2,800($57.08) + 3,600($27.75) Portfolio value = $21,798 + 159,824 + 99,900 Portfolio value = $281,522 E(r) = ($21,798/$281,522)(−.02) + ($159,824/$281,522)(.11) + ($99,900/$281,522)(.05) E(r)= .0786, or 7.86%

What is the expected return on this portfolio?

I, II, and III only

Which of the following statements are accurate? I. Diversifiable risks can be essentially eliminated by investing in 30 unrelated securities. II. There is no reward for accepting diversifiable risks. III. Diversifiable risks are generally associated with an individual firm or industry. IV. Beta measures diversifiable risk.

55.88% .102 = .117x + .083(1 − x)x = .5588, or 55.88%

You have a portfolio consisting solely of Stock A and Stock B. The portfolio has an expected return of 10.2 percent. Stock A has an expected return of 11.7 percent while Stock B is expected to return 8.3 percent. What is the portfolio weight of Stock A?

1.56 βPortfolio = 1.24 = (.06)(0) + (.40)(1) + (.54βB) βB = 1.56 The beta of a risk-free asset is zero. The beta of the market is 1.

Your portfolio has a beta of 1.24. The portfolio consists of 6 percent U.S. Treasury bills, 40 percent Stock A, and 54 percent Stock B. Stock A has a risk level equivalent to that of the overall market. What is the beta of Stock B?