FIN 3601 Final Exam

Which one of the following sets of dividend payments best meets the definition of two-stage growth as it applies to the two-stage dividend growth model? A. No dividends for five years, then increasing dividends forever B. $1 per share annual dividend for two years, then $1.25 annual dividends forever C. Decreasing dividends for six years followed by one final liquidating dividend payment D. Dividends payments that increase by 2, 3, and 4 percent respectively for three years followed by a constant dividend thereafter E. Dividend payments that increase by 10 percent per year for five years followed by dividends that increase by 3 percent annually thereafter

Dividend payments that increase by 10 percent per year for five years followed by dividends that increase by 3 percent annually thereafter

Which one of the following applies to the dividend growth model? A. An individual stock has the same value to every investor. B. Even if the dividend amount and growth rate remain constant, the value of a stock can vary. C. Zero-growth stocks have no market value. D. Stocks that pay the same annual dividend will have equal market values. E. The dividend growth rate is inversely related to a stock's market price.

Even if the dividend amount and growth rate remain constant, the value of a stock can vary

True or False. Suppose you are the president of a small, publicly-traded corporation. Since you believe that your firm's stock price is temporarily depressed, all additional capital funds required during the current year will be raised using debt. In this case, the appropriate marginal cost of capital for use in capital budgeting during the current year is the after-tax cost of debt.

False

True or False. The before-tax cost of debt, which is lower than the after-tax cost, is used as the component cost of debt for purposes of developing the firm's WACC.

False

True or False. The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

False

An increase in which of the following will increase the current value of a stock according to the dividend growth model? I. dividend amount II. number of future dividends, provided the current number is less than infinite III. discount rate IV. dividend growth rate A. I and II only B. III and IV only C. I, II, and III only D. I and IV only E. I, II, III, and IV

I and IV only

The dividend growth model: I. assumes that dividends increase at a constant rate forever. II. can be used to compute a stock price at any point in time. III. can be used to value zero-growth stocks. IV. requires the growth rate to be less than the required return. A. I and III only B. II and IV only C. I, III, and IV only D. I, II, and IV only E. I, II, III, and IV

I, II, III, and IV

At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset? I. asset's standard deviation II. asset's beta III. risk-free rate of return IV. market risk premium A. I and III only B. II and IV only C. III and IV only D. I, III, and IV only E. I, II, III, and IV

II and IV only

Reyes has a dividend yield of 5.4 percent and a total return for the year of 4.8 percent. Which one of the following must be true? A. The dividend must be constant. B. The stock has a negative capital gains yield. C. The capital gains yield must be zero. D. The required rate of return for this stock increased over the year. E. The firm is experiencing supernormal growth.

The stock has a negative capital gains yield

True or False. Because of differences in the expected returns on different investments, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.

True

True or False. If a firm's marginal tax rate is increased, this would, other things held constant, lower the cost of debt used to calculate its WACC.

True

True or False. Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

True

True or False. Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky.

True

True or False. The cost of debt, rd, is normally less than cost of equity rs, so rd(1 - T) will normally be much less than rs. Therefore, as long as the firm is not completely debt financed, the weighted average cost of capital (WACC) will normally be greater than rd(1 - T).

True

In the constant-growth dividend valuation model, the required rate of return must be _______ the dividend growth rate in order for the formula price to be meaningful. A) equal to B) proportional to C) less than D) greater than

greater than

The two-stage dividend growth model evaluates the current price of a stock based on the assumption a stock will: A. pay an increasing dividend for a period of time and then cease paying dividends altogether. B. increase the dividend amount every other year. C. pay a constant dividend for the first two quarters of each year and then increase the dividend the last two quarters of each year. D. grow at a fixed rate for a period of time after which it will grow at a different rate indefinitely. E. pay increasing dividends for a fixed period of time, cease paying dividends for a period of time, and then commence paying increasing dividends for an indefinite period of time.

grow at a fixed rate for a period of time after which it will grow at a different rate indefinitely

According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the: A. amount of total risk assumed and the market risk premium B. market risk premium and the amount of systematic risk inherent in the security C. risk free rate, the market rate of return, and the standard deviation of the security D. beta of the security and the market rate of return E. standard deviation of the security and the risk-free rate of return.

market risk premium and the amount of systematic risk inherent in the security

National Trucking has paid an annual dividend of $1 per share on its common stock for the past 15 years and is expected to continue paying a dollar per share long into the future. Given this, one share of the firm's stock is: A. basically worthless as it offers no growth potential. B. equal in value to the present value of $1 paid one year from today. C. priced the same as a $1 perpetuity. D. valued at an assumed growth rate of 1 percent. E. worth $1 per share in the current market.

priced the same as a $1 perpetuity.

For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure. A. rs > rd > WACC B. rs > WACC > rd C. WACC > rs > rd D. rd > rs > WACC E. WACC > rd > rs

rs > WACC > rd

Total risk is measured by _____ and systematic risk is measured by _____. A. beta; alpha B. beta; standard deviation C. alpha; beta D. standard deviation; beta E. standard deviation; variance

standard deviation; beta

Everything else being equal a higher corporate tax rate... A. will decrease the WACC of a firm with some debt in its capital structure B. will not affect the WACC of a firm with debt in its capital structure C. will increase the WACC of a firm with debt and equity in its capital structure D. will decrease the WACC of a firm with only equity in its capital structure

will decrease the WACC of a firm with some debt in its capital structure

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 D. A portfolio of U.S. Treasury bills will have a beta of +1.0 E. The beta of a market portfolio is equal to zero

A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting? A.Long-term debt B.Accounts payable C.Retained earnings D.Common stock E.Preferred stock

Accounts payable

What is the model called that determines the market value of a stock based on its next annual dividend, the dividend growth rate, and the applicable discount rate? A. Maximal growth model B. Constant growth model C. Capital pricing model D. Realized earnings model E. Realized growth model

Constant growth model

A decrease in which of the following will increase the current value of a stock according to the dividend growth model? A. Dividend amount B. Number of future dividends, provided the total number of dividends is less than infinite C. Dividend growth rate D. Discount rate E. Both the discount rate and the dividend growth rate

Discount rate

Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept? A. Division B project with a 13% return B. Division B project with a 12% return C. Division A project with an 11% return D. Division A project with a 9% return E. Division B project with an 11% return

Division A project with an 11% return

True or False. Portfolio A has only one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

False

Which one of the following statements is correct? A. Stocks can only be assigned one dividend growth rate. B. Preferred stocks generally have variable growth rates. C. Dividend growth rates must be either zero or positive. D. All stocks can be valued using the dividend discount models. E. Stocks can have negative growth rates.

Stocks can have negative growth rates

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant? A. The required return on Portfolio P would increase by 1%. B. The required return on both stocks would increase by 1%. C. The required return on Portfolio P would remain unchanged. D. The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%. E. The required return for Stock A would fall, but the required return for Stock B would increase.

The required return on Portfolio P would increase by 1%

Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur? A. The required return on a stock with beta = 1.0 will not change. B. The required return on a stock with beta > 1.0 will increase. C. The return on "the market" will remain constant. D. The return on "the market" will increase. E. The required return on a stock with a positive beta < 1.0 will decline.

The required return on a stock with a positive beta < 1.0 will decline

True or False. Diversification will normally reduce the riskiness of a portfolio of stocks.

True

The primary purpose of portfolio diversification is to: A. increase returns and risks B. eliminate all risks C. eliminate asset-specific risk D. eliminate systematic risk E. lower both returns and risks

eliminate asset-specific risk

The dividend growth model: A. assumes dividends increase at a decreasing rate. B. only values stocks at Time 0. C. cannot be used to value constant dividend stocks. D. can be used to value both dividend-paying and non-dividend-paying stocks. E. requires the growth rate to be less than the required return.

requires the growth rate to be less than the required return