Corp. Finance Test 2 Spring 2016

Net present value: A. Is the best method of analyzing mutually exclusive projects B. Is less useful than the internal rate of return when comparing different sized projects C. Is the easiest method of evaluation for nonfinancial managers to use

A

Phillips Equipment has 75,000 bonds outstanding that are selling at par. Bonds w/similar characteristics are yielding 7.5 percent. The company also has 750,000 shares of 6 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $64 a share. The common stock has a beta of 1.21 and sells for $44 a share. The US Treasury bill is yielding 2.3 percent and the return on the market is 11.2 percent. The corporate tax rate is 34 percent. What is the firm's weighted average cost of capital? A. 9.69 percent B. 10.64 percent C. 11.18 percent

A

Stock splits can be used to: A. adjust the market price of a stock so it falls within a preferred trading range B. Decrease the excess cash held by a firm thereby lowering agency costs C. increase the par value while decreasing the market price per share

A

Terry has a portfolio comprised of two individual securities. Which one of the following computations that he might do is NOT a weighted average? A. correlation between the securities B. individual security expected return C. portfolio expected return

A

The cost of preferred stock: A. is equal to the dividend yield B. is equal to the yield to maturity C. is highly dependent on the dividend growth rate

A

The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual return of 12 percent. This stock: A. is underpriced B. Is correctly priced C. Will plot below the security market line

A

The pretax cost of debt: A. is based on the current yield to maturity of the firm's outstanding bonds B. Is equal to the coupon rate on the latest bonds issued by a firm. C. is equivalent to the average current yield on all of a firm's outstanding bonds

A

The systematic risk of the market is measured by: A. A beta of 1.0 B. A beta of 0.0 C. A standard deviation of 1.0

A

Unsystematic risk: A. Can be effectively eliminated by portfolio diversification B. Is compensated for by the risk premium C. Is measured by beta

A

Which form of market efficiency would most likely offer the greatest profit potential to an outstanding professional stock analyst? A. Weak B. Semi weak C. semi strong

A

Which one of the following is least apt to reduce the unsystematic risk of a portfolio? A. Reducing the number of stocks held in the portfolio B. Adding bonds to a stock portfolio C. Adding international securities into a portfolio of US stocks

A

You are considering a project with conventional cash flows, an IRR of 11.63 percent, a PI of 1.04, and NPV of $987, and a payback period of 2.98 years. Which one of the following statements is correct given this information? A. the discounted payback period must be greater than 2.98 years B. the break-even discount rate must be less than 11.63 percent C. the discount rate used in computing the net present value was less than 11.63 percent

A

A reward-to-volatility ratio is useful in: A. measuring the standard deviation of returns B. understanding how returns increase relative to risk increases C. analyzing returns on variable rate bonds

B

A stock has annual returns of 5.4 percent, 12.9 percent, -3.8 percent, and 9.4 percent for the past four years. The arithmetic average of these returns is _____ percent while the geometric average return for the period is _____ percent. A. 4.57; 4.75 B. 5.98; 5.79 C. 6.33; 6.11

B

Aaron owns 1,600 shares of LP Gas stock which he purchased six years ago at a price of $18 a share. Today, these shares are selling for $26 each. Aaron is subject to a tax rate of 20 percent on both his dividend income and his capital gains. From Aaron's prerogative, a stock repurchase today: A. is equivalent to a cash dividend B. is more desirable than a cash dividend in respect to the timing of taxation C. will result in the same tax liability as an equivalent cash dividend

B

Estimates of the rate of return on a security based on the historical arithmetic average tend to _____ returns for the long-term, while estimates using historical geometric average tend to _____ expected return for the short-term. A. Overestimate; overestimate B. Overestimate; underestimate C. Underestimate; overestimate

B

How might a large market risk premium impact people's desire to buy stocks? A. Investors with high risk aversion will be less willing to invest in stocks B. Investors with high risk aversion will be more willing to invest in stocks C. It will only impact the share prices

B

Individual investors who continually monitor the financial markets seeking mispriced securities: A. earn excess profits on all of their investments B. make the markets increasingly more efficient C. Are never able to find a security that is temporarily mispriced

B

Industries that are not closely related to business cycles include: A. Industries that have products with low price elasticities B. industries that have products with high price elasticities C. All industries are closely related to business cycles

B

Leo purchased a stock for $47.10 a share, received a $1.74 dividend per share and sold the shares for $50.10/share. During the time he owned the stock, inflation averaged 3.1 percent. What is his exponential, real rate of return on this investment? A. 6.96 percent B. 6.75 percent C. 7.18 percent

B

Standard deviation is a measure of which one of the following? A. Average rate of return B. Volatility C. Probability

B

The Dry Dock is considering a project with an initial cost of $118,400. The project's cash inflows for years 1 through 3 are $37,200, $54,600, and $46,900, respectively. What is the IRR of this project? A. 8.42 percent B. 8.04 percent C. 7.48 percent

B

Tidewater Fishing has a current beta of 1.08. The market risk premium is 7.9 percent and the risk-free rate of return is 3.2 percent. By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.16? A. .88 percent B. .63 percent C. 2.60 percent

B

To convince investors to accept greater volatility, you must: A. Decrease the risk premium B. Increase the risk premium C. Decrease the real return

B

Two equally weighted investments with a correlation of -1 will have a portfolio standard deviation of: A. -1 B. 0 C. +.5

B

Which one of the following risks is irrelevant to a well-diversified investor? A. systematic risk B. unsystematic risk C. market risk

B

Which one of the following statements is correct concerning a portfolio beta? A. Portfolio betas range between -1.0 and +1.0 B. A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio C. A portfolio beta cannot be computed from the betas of the individual securities comprising the portfolio because some risk is eliminated via diversification

B

A project has a required payback period of three years. Which one of the following statements is correct concerning the payback analysis of this project? A. the cash flows in each of the three years must exceed one-third of the project's initial cost if the project is to be accepted B. the cash flow in year three is ignored C. the cash flow in year two is valued just as highly as the cash flow in year one

C

A project has an initial cash outflow of $39,800 and produces cash inflows of $18,304, $19,516, and $14,280 for years 1 through 3, respectively. What is the NPV at a discount rate of 11 percent? A. $7,675.95 B. -$1,208.19 C. $2,971.13

C

A project has an initial cost of $18,400 and is expected to produce cash inflows of $7,200, $8,99, and $7,500 over the next three years, respectively. What is the discounted payback period if the required rate of return is 12 percent? A. 2.31 years B. 2.45 years C. 2.91 years

C

A stock with a beta of zero would be expected to: A. have a rate of return equal to zero B. have a rate of return equal to the market risk premium C. have a rate of return equal to the risk-free rate

C

An efficient portfolio is a portfolio that does which one of the following? A. offers the highest return for the lowest possible cost B. provides an evenly weighted portfolio of diverse assets C. offers the highest return for a given level of risk

C

As long as the inflation rate is positive, the real rate of return on a security will be _____ the nominal rate of return. A. Greater than B. Equal to C. Less than

C

Assume a project has cash flows of -$51,300, $18,200, $37,300, and $14,300 for years 0 to 3, respectively. What is the profitability index given a required return of 12.5 percent? A. .94 B. .98 C. 1.09

C

Elias is a risk-averse investor. David a less risk-averse investor than Elias. Therefore, A. for the same risk, David requires a higher rate of return than Elias B. for the same return, Elias tolerates higher risk than David C. for the same return, David tolerates higher risk than Elias

C

Fashion Wear has bonds outstanding that mature in 12 years, pay interest annually, and have a coupon rate of 7.5 percent. These bonds have a face value of $1,000 and a current market price of $1,060. What is the company's aftertax cost of debt if its tax rate is 35 percent? A. 6.85 percent B. 6.50 percent C. 4.39 percent

C

Financial risk is: A. The risk inherent in a firm's operations B. A type of unsystematic risk C. Dependent upon a firm's capital structure

C

If the variability of the returns on large-company stocks were to decrease over the long-term, you would expect which one of the following to occur as a result? A. Increase in the risk premium B. Increase in the average long-term rate of return C. Decrease in the 68 percent probability range of returns

C

If two assets have a zero correlation, their returns will: A. always move in the same direction by the same amount B. always move in the same direction but not necessarily by the same amount C. move randomly and independently of each other

C

Inside information has the least value when financial markets are: A. weak form efficient B. semi strong form efficient C. Strong form efficient

C

Suppose you borrow at the risk-free rate an amount equal to your initial wealth and invest in a portfolio with an expected return of 16% and a standard deviation of returns of 20%. The risk-free asset has an interest rate of 4%; calculate the expected return on the resulting portfolio: A. 20% B. 32% C. 28%

C

The Boat Works has decided to take the company public by offering a total of 150,000 shares of common stock to the public. The firm has hired an underwriter who arranges a firm commitment underwriting and suggests an initial selling price of $22 a share with a spread of 8 percent. As it turns out, the underwriters only sell 122,400 shares. How much cash will the firm receive from its first public offering? A. $2,727,200 B. $3,074,400 C. $3,036,000

C

The Downtowner has 950,000 shares of common stock outstanding valued at $38 a share along with 40,000 bonds selling for $1,020 each. What weight should be given to the debt when the firm computes its weighted average cost of capital? A. 46.67 percent B. 55.05 percent C. 53.06 percent

C

The dividend growth model cannot be used to compute the cost of equity for a firm that: A. reduces its dividend on a regular basis B. has a dividend payout ratio of 100 percent C. Has a retention ratio of 100 percent

C

The information content of a dividend increase generally signal that: A. The firm has a one-time surplus of cash B. The firm has few, if any, net present value projects to pursue C. Management believes earnings growth will be strong going forward

C

The interest tax shield is a key reason why: A. The required rate of return on assets rises when debt is added to the capital structure B. The value of an unlevered firm is equal to the value of a levered firm C. The net cost of debt to a firm is generally less than the cost of equity

C

The internal rate of return is: A. the discount rate that makes the NPV of a project equal to the initial cash outlay B. equivalent to the discount rate that makes the NPV equal to one C. tedious to compute without the use of either a financial calculator or a computer

C

The profitability index is most closely related to which one of the following? A. Payback B. Discounted payback C. Net present value

C

The value of a firm is maximized when the: A. Cost of equity is maximized B. Tax rate is zero C. Weighted average cost of capital is minimized

C

Underwriters generally: A. Pay a spread to the issuing firm B. Provide only best efforts underwriting in the US C. Accept the risk of selling the new securities in exchange for the gross spread

C

What is market capitalization? A. The total owner's equity in a firm B. The total marketable assets of a firm C. Shares outstanding multiplied by the market value of the stock

C

Which of the following yields on a stock can be negative? A. Dividend yield B. Capital gains yield C. capital gains yield and total return

C

Which one of the following has the greatest tendency to increase the percentage of debt included in the optimal capital structure of a firm? A. Exceptionally high depreciation expenses B. Very low marginal tax rate C. Low probability of financial distress

C

Which one of the following is most indicative of a totally efficient stock market? A. Extraordinary returns earned on a routine basis B. Positive net present values on stock investments over the long-term C. Zero net present values for all stock investments

C

Which one of the following is the best example of a diversifiable risk? A. Interest rates increase B. Energy costs increase C. A firm's sales decrease

C

Which one of the following statements best defines the efficient market hypothesis? A. Efficient markets limit competition B. Security prices in efficient markets remain steady as new information becomes available C. All securities in an efficient market are zero net present value investments

C

Which one of the following statements related to risk is correct? A. the beta of a portfolio must increase when a stock with a high standard deviation is added to the portfolio B. every portfolio that contains 25 or more securities is free of unsystematic risk C. The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio

C

Which two methods of project analysis are the most biased towards short-term projects? A. Net present value and internal rate of return B. Internal rate of return and profitability index C. Payback and discounted payback

C

You are aware that your neighbor trades stocks based on confidential information he overhears at his workplace. This information is not available to the general public. This neighbor continually brags to you about the profits he earns on these trades. Given this, you would tend to argue that the financial markets are at best _____ form efficient. A. Weak B. Strong C. Semi Strong

C