Fin 316 Final

The payback period is the period of time it takes an investment to generate sufficient cash flows to:

recover the investment's initial cost.

Diversifying a portfolio across various sectors and industries will tend to:

reduce the firm-specific risk.

Any financial benefit derived from the interest tax shield accrues to the:

shareholders

Which of the following investment decision rules can choose among mutually exclusive investments?

NPV

The weighted average cost of capital is defined as the weighted average of a firm's:

cost of equity and its aftertax cost of debt.

The IRR decision rule states that a project should be accepted if its IRR:

exceeds the required rate

The change in a firm's future cash flows that results from adding a new project are referred to as _____ cash flows.

incremental

Which one of the following is the best example of systematic risk?

inflation exceeding market expectations

The discount rate that causes the net present value of a project to equal zero is called the:

internal rate of return

One advantage of debt financing over equity financing is:

tax deductible interest.

According to the trade-off theory, the capital structure is a trade-off between:

tax savings and financial distress costs.

Interest Rate Tax Shield

the gain to investors from the tax deductibility of interest payments

Sibling Incorporated has a beta of 1.0. If the expected return on the market is 12%, what is the expected return on Sibling Incorporated's stock?

12%

Most of the beneficial effects of diversification will have been received by the time a portfolio of common stocks contains about _____ stocks.

20

You purchased land 3 years ago for $60000 and believe its market value is now $90000. You are considering building a hotel on this land instead of selling it. To build the hotel, it will initially cost you $150000, an expense that you plan to depreciate straight line over the next three years. Wells Fargo offered you a loan for $60,000 at an 8% interest rate to be repaid over the next 4 years. You anticipate that the hotel will earn revenues of $165000 each year, while expenses will be a mere $30000 each year. The initial working capital requirement will be $7000 which will be recovered in the last year. The tax rate is 35%. Your estimated cost of capital is 10%. What is the net present value of this project?

$20,000.38

What is the equivalent annual cost for a project that requires a $40,000 investment at time-period zero, and a $10,000 annual expense during each of the next 4 years, if the opportunity cost of capital is 10%?

$22,618.83

Junior's has a new project in mind that will increase accounts receivable by $50,000, increase accounts payable by $14,000, increase fixed assets by $25,000, and decrease inventory by $9,000. What is the amount the firm should use as the initial cash flow attributable to net working capital when it analyzes this project?

$27,000

A 5-year project is expected to generate revenues of $90000, variable costs of $35000, and fixed costs of $15000. The annual depreciation is $8000 and the tax rate is 35 percent. What is the annual operating cash flow?

$28,800

Fun Land is considering adding a miniature golf course to its facility. The course would cost $68,000, would be depreciated on a straight line basis over its 4-year life, and would have a zero salvage value. The estimated income from the golfing fees would be $48,000 a year with $7,500 of that amount being variable cost. The fixed cost would be $8,600. In addition, the firm anticipates an additional $12,000 in revenue from its existing facilities if the course is added. The project will require $4,000 of net working capital, which is recoverable at the end of the project. What is the net present value of this project at a discount rate of 8 percent and a tax rate of 25 percent?

$54,068.43

What is the net present value of a project with the following cash flows if the discount rate is 9 percent? Year 0: $-12750 Year 1: $2050 Year 2: $1800 Year 3: $1775 Year 4: $0

-$7,983.62

A U.S. Treasury bill has a beta of _____ while the overall market has a beta of _____.

0; 1

What are two advantages of going public?

1. Liquidity 2. Better access to capital

What is the beta of a portfolio with an expected return of 10% if Treasury bills yield 2% and the market risk premium is 8%?

1.00

The company cost of capital for a firm with a 65/35 debt/equity split, 8% after-tax cost of debt, 15% cost of equity, and a 35% tax rate would be:

10.45%

A company you are researching has common stock with a beta of 1.51. Currently, Treasury bills yield 3%, and the market portfolio offers an expected return of 12%. The company finances 40% of its assets with debt that has a yield to maturity of 6%. The firm also uses preferred stock to finance 10% of its assets. The preferred stock has a current price of $12 per share and pays a level $1 dividend. The firm is in the 35% tax bracket. What is the weighted average cost of capital?

10.69%

Given the following information, what is the standard deviation for this stock? (Hint: you'll need to find the expected return first) Probabilities: Recession:0.3 Normal:0.5 Boom:0.2 Returns: Recession:-10% Normal:12% Boom:16%

10.71%

The common stock of Pittsburgh Steel Products has a beta of 1.5 and a standard deviation of 14.25 percent. The market rate of return is 10 percent and the risk-free rate is 3.5 percent. What is the cost of equity for Pittsburgh Steel Products?

13.25%

What return on equity do investors seem to expect for a firm with a $55 share price, an expected dividend of $5.50, a beta of .9 and a constant growth rate of 5.5%?

15.50%

You own a portfolio that is invested 30 percent in stock A, 45 percent in stock B, and the remainder in stock C. The expected returns on these stocks are 15.31 percent, 17.9 percent, and 13.82 percent, respectively. What is the expected return on the portfolio?

16.1%

A company you are researching has common stock with a beta of 1.5. Currently, Treasury bills yield 4%, and the market portfolio offers an expected return of 13%. What is the required return on this common stock?

17.5%

According to CAPM estimates, what is the cost of equity for a firm with beta of 1.5 when the risk-free interest rate is 6% and the expected return on the market portfolio is 15%?

19.5%

You are considering investing in a project with the following possible outcomes: Calculate the expected rate of return and standard deviation of returns for this investment, respectively. Probabilities: Boom:0.15 Normal:0.4 Decline:0.25 Depression:0.2 Returns: Boom:12% Normal:7% Decline:1% Depression:-8%

3.25%, 6.61%

Over the past six years, a stock had annual returns of 2 percent, -5 percent, 6 percent, 3 percent, 3 percent, and -2 percent, respectively. What is the standard deviation of these returns?

3.97%

What is the percentage return on a stock that was purchased for $50.00, paid a $3.00 dividend after one year and was then sold for $49.00?

4%

What is the after tax cost of debt on a $550000 loan given a 10% interest rate and 32% tax bracket?

6.8%

The stock of Uptown Men's Wear is expected to produce the following returns given the various states of the economy. What is the expected return on this stock? Probabilities: Recession:0.4 Normal:0.4 Boom:0.2 Returns: Recession:-11% Normal:12% Boom:23%

5%

You own a portfolio that has 45% invested in asset A, and 55% invested in asset B. Asset A's standard deviation is 10% and asset B's standard deviation is 12%. The correlation coefficient between the two assets is -0.58. The expected return on the portfolio is 12%. What is the portfolio standard deviation?

5.4%

The preferred stock of Nadine Fashions pays an annual dividend of $2.25 a share and sells for $38.75 a share. The tax rate is 32 percent. What is the firm's cost of preferred stock?

5.81%

Calculate the weighted average cost of capital for the following firm: it has $600000 in debt, $400000 in common stock and $200000 in preferred stock. It has a 4% cost of debt, 14% cost of common stock, 12% cost of preferred stock and a 34% tax rate.

7.99%

Last week, Lester's Electronics paid an annual dividend of $2.25 on its common stock. The company has a longstanding policy of increasing its dividend by 3.5 percent annually. This policy is expected to continue. What is the firm's cost of equity if the stock is currently selling for $40.95 a share?

9.19%

The difference between beta and standard deviation is best described as:

Beta measures the risk investors are compensated for, while standard deviation measures both systematic and unsystematic risk.

In a best-efforts IPO, the underwriter guarantees that all stock will be sold.

FALSE

What would you recommend to an investor who is considering an investment which, according to its beta, plots below the security market line (SML)?

Don't invest; risk is high relative to return.

Woven Goods is considering adding a new line of baskets to its product line-up. Which of the following are relevant cash flows for this project? I. increased revenue from existing goods if these baskets are added to the lineup II. revenue from the new line of baskets III. money spent to date investigating the availability of woven baskets IV. cost of expanding the showroom to make space for the new baskets

I, II, and IV only

Which of the following statements are correct? I. The risk-free rate of return has a zero risk premium. II. The reward for bearing risk is called the standard deviation. III. Based on historical returns, there are rewards for bearing risk. IV. In general, the higher the risk, the higher the expected return.

I, III, and IV only

What is the typical relationship between the standard deviation of an individual common stock and the standard deviation of a diversified portfolio of common stocks?

Individual stock's standard deviation will be higher.

What is the process called for selling stock to the public for the first time?

Initial Public Offering (IPO)

What will happen to the expected return on a stock with a beta of 1.5 and a market risk premium of 9% if the Treasury bill yield increases from 3% to 5%?

The expected return will increase by 2.0%.

You are considering a new investment which is expected to earn 12%. The beta of this new investment is 0.6. Treasury Bills are earning 3%, and the S&P 500 is expected to earn 10%. Which one of the following statements is correct?

The new investment is underpriced.

If the market portfolio is expected to offer returns of 16%, then what can be said about a portfolio expected to return 13%?

The portfolio's beta is less than 1.0.

Which of the following best describes a firm commitment IPO?

The underwriter purchases the entire issue at a small discount and then resells it at the offer price.

A typical measure for the risk-free rate of return is the:

US Treasury Bill rate

The return on which one of the following is used as the risk-free rate of return?

US Treasury bills

A project you are evaluating has an IRR of 10%. The project's required return has been measured to be 16%. Therefore:

You should reject the project.

A sunk cost is:

a cost that has already been incurred and cannot be recouped.

Which one of the following indicates a project has a required return that exceeds its internal (or actual) rate of return?

a negative NPV

Which one of the following portfolios has the least amount of systematic risk?

a portfolio consisting of various US Treasury bills

Investment projects that plot above the security market line would be considered to have:

a positive NPV.

Systematic risk is:

a risk that affects a large number of assets.

The difference between an IPO and a secondary offering is that:

additional, non-outstanding shares are issued in an IPO.

The most valuable alternative that is forfeited if a particular investment is undertaken is called:

an opportunity cost

Which one of the following best exemplifies unsystematic risk?

an unexpected increase in the sales of a firm

Do public or private companies have more access to larger amounts of capital?

public

The amount of systematic risk present in a particular risky asset relative to that in an average risky asset (or the market in general) is called the:

beta coefficient

Stock returns can be explained by the stock's _________ and the stock's __________.

beta; unique risk

Capital structure decisions refer to the:

blend of equity and debt used by the firm.

According to pecking order theory, managers will often choose to finance with:

debt rather than new equity, to avoid reduced share price.

As the debt to equity ratio decreases when debt is not risk free:

debtholders demand a lower expected return.

MM's proposition II states that the:

expected return on equity increases as financial leverage increases.

The "trade-off theory" of capital structure suggests that:

firms with higher risk should use less debt.

What does going public do for private equity investors?

gives them the ability to diversify

If the slope of the line measuring a stock's historic returns against the market's historic returns is positive, then the stock:

has a positive beta.

A proposed project will increase a firm's accounts receivables. This increase:

is a cash outflow at time zero and a cash inflow at the end of the project.

A net present value of zero implies that an investment:

is earning a return that exactly matches the requirement.

The cost of preferred stock:

is equal to the stock's dividend yield.

The NPV rule states that you should accept an investment if the NPV:

is postive

A firm has a cost of equity of 10 percent, a cost of preferred of 9 percent, and an aftertax cost of debt of 5 percent. Given this, which one of the following will decrease the firm's weighted average cost of capital?

issuing new debt

A firm's capital structure is represented by its mix of:

liabilities and equity.

The lower the standard deviation of a security, the _____ the expected rate of return and the _____ the risk.

lower; lower

MM Proposition I states that a firm's value is unaffected by its:

mixture of debt and equity.

The slope of the security market line equals:

the market risk premium.

The concept of investing in a variety of diverse assets to reduce risk is referred to as:

the principle of diversification.

Payback ignores the:

time value of money.

Costs of financial distress are costs arising from bankruptcy or distorted business decisions before bankruptcy.

true

Studies have shown that, on average, new security issues are:

under priced

The goal of diversification is to eliminate:

unsystematic risk

Standard deviation measures the _____ of a security's returns over time.

volatility

All else constant, an increase in a firm's cost of debt:

will result in an increase in the firm's cost of capital.