FIN QUIZ 4

Four months ago, you purchased 900 shares of Turicchi Tours stock for $7.68 per share. Last month, you received a dividend payment of $.12 per share. Today, you sold the shares for $9.13 per share. What is your total dollar return on this investment?

$1,413 Total dollar return = ($9.13 − 7.68 + .12)(900) Total dollar return = $1,413

Suppose a stock had an initial price of $30 per share, paid a dividend of $5 per share during the year, and had an ending share price of $33.40. What was the capital gains yield?

11.3% Capital gains yield = ($33.40 − 30)/$30 Capital gains yield = .113, or 11.3%

The Swanson Corporation's common stock has a beta of 1.07. If the risk-free rate is 3.4 percent and the expected return on the market is 11 percent, what is the company's cost of equity capital?

11.53 Here we have information to calculate the cost of equity using the CAPM. The cost of equity is: RE = .034 + 1.07(.11 − .034) RE = .1153, or 11.53%11.53

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?

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

Suppose a stock had an initial price of $74 per share, paid a dividend of $1.65 per share during the year, and had an ending share price of $83. Compute the percentage total return.

14.39% The return of any asset is the increase in price, plus any dividends or cash flows, all divided by the initial price. The return of this stock is: R = [($83 − 74) + 1.65]/$74R = .1439, or 14.39%

Savers has an issue of preferred stock with a stated dividend of $3.85 that just sold for $87 per share. What is the bank's cost of preferred stock?

4.43 The cost of preferred stock is the dividend payment divided by the price, so: RP = $3.85/$87 RP = .0443, or 4.43%

Today, you sold 540 shares of stock and realized a total return of 7.3 percent. You purchased the shares one year ago at a price of $24 per share and have received a total of $86 in dividends. What is your capital gains yield on this investment?

6.64% Capital gains yield = .073 − [($86/540)/$24] Capital gains yield = .0664, or 6.64%

The Tribiani Company just issued a dividend of $2.90 per share on its common stock. The company is expected to maintain a constant 4.5 percent growth rate in its dividends indefinitely. If the stock sells for $56 a share, what is the company's cost of equity?

9.91 With the information given, we can find the cost of equity using the dividend growth model. Using this model, the cost of equity is: RE = [$2.90(1.045)/$56] + .045 RE = .0991, or 9.91%

Of the options listed below, which is the best example of a diversifiable risk?

A firms sales decrease

A stock has had returns of 6 percent, 29 percent, 13 percent, −19 percent, 34 percent, and −2 percent over the last six years.

Arithmetic average return: 10.16% Geometric average return: 8.63% The arithmetic average return is the sum of the known returns divided by the number of returns, so: Arithmetic average return = (.06 + .29 + .13 − .19 + .34 − .02)/6 Arithmetic average return = .1017, or 10.17% Using the equation for the geometric return, we find: Geometric average return = [(1 + R1) × (1 + R2) × ... × (1 + RT)]1/T − 1 Geometric average return = [(1 + .06)(1 + .29)(1 + .13)(1 − .19)(1 + .34)(1 − .02)]1/6 − 1 Geometric average return = .0863, or 8.63% geo: https://goodcalculators.com/geometric-average-return-calculator/

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

Beta

A stock has a beta of 1.15, the expected return on the market is 11.3 percent, and the risk-free rate is 3.6 percent. What must the expected return on this stock be?

Expected return: 12.46% CAPM states the relationship between the risk of an asset and its expected return. CAPM is: E(Ri) = Rf + [E(RM) − Rf] × βi Substituting the values we are given, we find: E(Ri) = .036 + (.113 − .036)(1.15) E(Ri) = .1246, or 12.46%

Of the options listed below, which are examples of diversifiable risk? I. Wildfires damage an entire town II. The federal government imposes a $1,000 fee on all business entities III. Payroll taxes are increased nationally IV. All software providers are required to improve their privacy standards

I and IV only

Which of the following statements regarding a firm's pretax cost of debt is accurate?

It is based on the current yield to maturity of the company's outstanding bonds.

Vanessa purchased a stock one year ago and sold it today for $3.15 per share more than her purchase price. She received a total of $2.60 per share in dividends. Which one of the following statements is correct in relation to this investment?

The capital gains yield is positive.

Brannan Manufacturing has a target debt-equity ratio of .35. Its cost of equity is 11 percent, and its pretax cost of debt is 6 percent. If the tax rate is 21 percent, what is the company's WACC?

WACC: 9.36 Here we need to use the debt-equity ratio to calculate the WACC. Doing so, we find: WACC = .11(1/1.35) + .06(.35/1.35)(1 − .21) WACC = .0938, or 9.38%

Jiminy's Cricket Farm issued a 30-year, 4.5 percent semiannual bond three years ago. The bond currently sells for 104 percent of its face value. The company's tax rate is 22 percent. a. What is the pretax cost of debt? b. What is the aftertax cost of debt? c. Which is more relevant, the pretax or the aftertax cost of debt?

a. 4.25 b. 3.31 c. after tax cost of debt a. The pretax cost of debt is the YTM of the company's bonds, so: P0 = $1,040 = $22.50(PVIFAR%,54) + $1,000(PVIFR%,54) R = 2.125% YTM = 2 × 2.125% YTM = 4.25% b.The aftertax cost of debt is: RD = .0425(1 − .22) RD = .0331, or 3.31% c. The aftertax rate is more relevant because that is the actual cost to the company.

Sunrise, Incorporated, is trying to determine its cost of debt. The firm has a debt issue outstanding with 23 years to maturity that is quoted at 96 percent of face value. The issue makes semiannual payments and has an embedded cost of 5 percent annually. a. What is the company's pretax cost of debt? b.If the tax rate is 21 percent, what is the aftertax cost of debt?

a. 5.30% b. 4.19% The pretax cost of debt is the YTM of the company's bonds, so: P0 = $960 = $25(PVIFAR%,46) + $1,000(PVIFR%,46) R = 2.652% YTM = 2 × 2.652% YTM = 5.30% And the aftertax cost of debt is: RD = .0530(1 − .21) RD = .0419, or 4.19%

Tencent Corporation has a target capital structure of 70 percent common stock, 5 percent preferred stock, and 25 percent debt. Its cost of equity is 11 percent, the cost of preferred stock is 5 percent, and the pretax cost of debt is 6 percent. The relevant tax rate is 23 percent. a.What is the company's WACC? b.What is the aftertax cost of debt?

a. WACC: 9.11% b. cost of debt: 4.62% a. Using the equation to calculate the WACC, we find: WACC = .70(.11) + .05(.05) + .25(.06)(1 − .23) WACC = .0911, or 9.11% b. Since interest is tax deductible and dividends are not, we must look at the aftertax cost of debt, which is: RD = .06(1 − .23)RD = .0462, or 4.62% Hence, on an aftertax basis, debt is cheaper than the preferred stock.

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

beta of 1

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

cost of debt.

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:

cost of equity.

When evaluating any capital project proposal, the cost of capital:

depends upon how the funds raised for that project are going to be spent.

Suppose a stock had an initial price of $74 per share, paid a dividend of $1.65 per share during the year, and had an ending share price of $83. What was the dividend yield and the capital gains yield?

dividend yield: 2.22 capital gains yield: 12.16 The dividend yield is the dividend divided by the beginning of the period price, so: Dividend yield = $1.65/$74 Dividend yield = .0223, or 2.23% And the capital gains yield is the increase in price divided by the initial price, so: Capital gains yield = ($83 − 74)/$74 Capital gains yield = .1216, or 12.16%

If a poorly-diversified portfolio becomes well diversified, we would expect the portfolio's:

standard deviation to decrease.

________ measures total risk, and ________ measures systematic risk.

standard deviation; beta

What are the portfolio weights for a portfolio that has 145 shares of Stock A that sell for $47 per share and 200 shares of Stock B that sell for $21 per share?

stock A: 0.6187 stock B: 0.3812 The portfolio weight of an asset is the total investment in that asset divided by the total portfolio value. First, we will find the portfolio value, which is: Total value = 145($47) + 200($21) Total portfolio value = $11,015 The portfolio weight for each stock is: WeightA = 145($47)/$11,015 = .6187 WeightB = 200($21)/$11,015 = .3813

To determine a firm's cost of capital, one must include:

the returns currently required by both debtholders and stockholders.

Suppose a stock had an initial price of $74 per share, paid a dividend of $1.65 per share during the year, and had an ending share price of $61. a. Compute the percentage total return. b. What was the dividend yield and the capital gains yield?

total return: -15.33% dividend yield: 2.22% capital gains yield: -17.57% Using the equation for total return, we find: R = [($61 − 74) + 1.65]/$74 R = −.1534, or −15.34% And the dividend yield and capital gains yield are: Dividend yield = $1.65/$74 Dividend yield = .0223, or 2.23% Capital gains yield = ($61 − 74)/$74 Capital gains yield = −.1757, or −17.57%

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

unsystematic risk

One year ago, you purchased 100 shares of Bailey Homes stock at a price of $37.78 per share. The company pays a quarterly dividend of $1.85 per share. Today, you sold for the shares for $28.30 per share. What is your total percentage return on this investment?

−5.5% Total percentage return = [$28.30 − 37.78 + (1.85)(4)]/$37.78 Total percentage return = −.055, or −5.5%