MGMT 109 Quiz 3

The beta of the market portfolio is

+1.0

By combining lending and borrowing at the risk-free rate with efficient portfolios, we can

- extend the range of investment possibilities - change the set of efficient portfolios from being curvilinear to a straight line - provide a higher expected return for any level of risk, except for the tangential portfolio and the risk-free asset.

How can an investor earn more than the return generated by the tangency portfolio and still stay on the security market line?

Borrow at the risk-free rate and invest in the tangency portfolio.

Which of the following lists events in chronological order from earliest to latest?

Declaration date, ex-dividend date, record date

A Wall Street Journal quotation for a company has the following values: Div: $1.12, PE: 18.3, Close: $37.22. Calculate the approximate dividend payout ratio for the company.

EPS = 37.22 / 18.3 Div Payout = 1.12 / 2.03 - 55%

Suppose the beta of Amazon is 2.2, the risk-free rate is 5.5 percent, and the market risk premium is 8 percent. Calculate the expected rate of return for Amazon.

Expected Rate = RFR + B(Risk Premium) 5.5 + 2.2(8) 23.1%

The company cost of capital is the correct discount rate for any project undertaken by the company. T/F

False

If a firm uses the same company cost of capital for evaluating all projects, which situation(s) will likely occur? I) The firm will reject good low-risk projects; II) The firm will accept poor high-risk projects; III) The firm will correctly accept projects with average risk

I, II, III

The dividend-irrelevance proposition of Miller and Modigliani depends on the following relationship between investment policy and dividend policy:

Investment policy is independent of dividend policy.

Assume the following data: EBIT = 400; Net income = 100; Average equity = 1000. Calculate the ROE (return on equity).

ROE = NI / Equity = 100 / 1,000 10%

Petersen Company has a capital budget of $1.0 million. The company wants to maintain a target capital structure which is 40% debt and 60% equity. The company forecasts its net income this year will be $400,000. If the company follows the residual distribution model and pays all distributions as dividends, what will be its ultimate payout ratio?

The capital budget is 60% x 1.0 million =$600,000. With only $400,000 of income, the payout ratio would be 0%. All is needed for the capital budget.

The capital asset pricing model (CAPM) states which of the following?

The expected risk premium on an investment is proportional to its beta.

Most firms have long-run target dividend payout ratios. T/F

True

The market value of Charcoal Corporation's common stock is $20 million, and the market value of its risk-free debt is $5 million. The beta of the company's common stock is 1.25, and the market risk premium is 8 percent. If the Treasury bill rate is 5 percent, what is the company's cost of capital? (Assume no taxes.)

WACC = [(E/V) x Re] + [(D/V) x Rd x (1-T) Re = Rf + B(risk premium) Re = 5 + (1.25 x 8) = 15% Rd = 5% Value = 20 + 5 = 25 WACC = [(20/25) x 0.15] + [(5/25)x0.05] 13%

The market value of Charter Cruise Company's equity is $15 million and the market value of its debt is $5 million. If the required rate of return on the equity is 20 percent and that on its debt is 8 percent, calculate the company's cost of capital. (Assume no taxes.)

WACC = [(E/V) x Re] + [(D/V) x Rd x (1-T) Value = $15mil + $5 mil = $20 mil [(15/20) x 0.2] + [(5/20) x 0.08 x (1-0)] 17%

The M&M Company is financed by $4 million (market value) in debt and $6 million (market value) in equity. The cost of debt is 5 percent and the cost of equity is 10 percent. Calculate the weighted average cost of capital. (Assume no taxes.)

WACC = [(E/V) x Re] + [(D/V) x Rd x (1-T)] WACC = [(4/10) x 5] + [(6/10) x 10] 8%

Suppose a firm sets aside assets to protect particular investors. These assets are called

collateral

Using a company's cost of capital to evaluate a project is

correct for projects that have average risk compared to the firm's other assets.

Which of these dates, when arranged in chronological order, occurs last?

dividend payment date

Firms can pay out cash to their shareholders in the following way(s):

dividends and share repurchases

Even if both dividends and capital gains are taxed at the same ordinary income tax rate, the effect of each type of tax is different because:

dividends are taxed when distributed, while capital gains are deferred until the stock is sold

The cost of capital is the same as the cost of equity for firms that are financed

entirely by equity.

The main advantage of debt financing for a firm is that

interest expenses are tax deductible.

If a bond is junior or subordinated, it

must give preference to senior creditors in the event of default.

When a company sells an entire issue of securities to a small group of institutional investors like life insurance companies, pension funds, and so forth, it is called a(an)

private placement

Generally, underwriters provide the following services to the issuing firm:

provide advice, buy some or all of the new issue, and resell the issue to the public

When a firm improves (lowers) its days of inventory it generally:

releases cash locked up in inventory

When comparing levered vs. unlevered capital structures, leverage works to increase EPS for high levels of operating income because interest payments on the debt

stay fixed, leaving more income to be distributed over fewer shares.

Dividend policy changes are decided and announced by

the board of directors.

The law of conservation of value implies that

the value of any asset is preserved regardless of the nature of the claims against it

An analyst computes a beta coefficient with a low standard error. This implies that

this particular beta is more reliable than most

An analyst should evaluate each project at its own opportunity cost of capital. The true cost of capital depends on the particular use of that capital. T/F

true

Generally, initial public offerings (IPOs) are

underpriced

Financial leverage increases the expected return and risk of the shareholder. T/F

TRUE

Investors require higher returns on levered equity than on equivalent unlevered equity. T/F

TRUE