FIN3403 - Module 4
A firm is considering investing in a new project with an upfront cost of $400 million. The project will generate an incremental free cash flow of $50 million in the first year and this cash flow is expected to grow at an annual rate of 3% forever. If the firm's WACC is 12%, what is the value of this project? A. $155.6 million B. $555.6 million C. $583.3 million D. $183.3 million
A. $155.6 million Value of project = FCF0 + FCF1 / (WACC - g)
A stock market comprises 4600 shares of stock A and 2000 shares of stock B. Assume the share prices for stocks A and B are $25 and $35, respectively. What is the capitalization of the market portfolio? A. $185,000 B. $157,250 C. $175,750 D. $203,500
A. $185,000
A stock market comprises 4700 shares of stock A and 2300 shares of stock B. Assume the share prices for stocks A and B are $25 and $30, respectively. What proportion of the market portfolio is comprised of stock A? A. 63.0% B. 62.0% C. 61.3% D. 79%
A. 63.0%
For each 1% change in the market portfolio's excess return, the investment's excess return is expected to change by ________ due to risks that it has in common with the market. A. beta B. alpha C. 0% C. 1.5%
A. beta
Bear Stearns' stock price closed at $98, $103, $58, $29, $4 over five successive weeks. The weekly standard deviation of the stock price calculated from this sample is ________. A. $34.37 B. $42.96 C. $49.40 D. $30.07
B. $42.96
Suppose you invest in 100 shares of Harley-Davidson (HOG) at $40 per share and 230 shares of Yahoo (YHOO) at $25 per share. If the price of Harley-Davidson increases to $50 and the price of Yahoo decreases to $20 per share, what is the return on your portfolio? A. 12.25% B. -1.54% C. -10.50% D. -5.20%
B. -1.54%
Suppose you invested $93 in the Ishares High Yield Fund (HYG) a month ago. It paid a dividend of $0.53 today and then you sold it for $94. What was your dividend yield and capital gains yield on the investment? A. 0.54%, 1.13% B. 0.57%, 1.08% C. 0.57%, 1.13% D. 1.08%, 1.18%
B. 0.57%, 1.08% dividend yield =0.53/94 cap gain = 94-93 capital gain yield = 1/93
A portfolio comprises Coke (beta of 1.4) and Wal-Mart (beta of 0.8). The amount invested in Coke is $20,000 and in Wal-Mart is $30,000. What is the beta of the portfolio? A. 1.20 B. 1.04 C. 1.35 D. 1.25
B. 1.04
Verano Inc. has two business divisions-a software product line and a waste water clean-up product line. The software business has a cost of equity capital of 10% and the waste water clean-up business has a cost of equity capital of 7%. Verano has 50% of its revenue from software and the rest from the waste water business. Verano is considering a purchase of another company in the waste water business using equity financing. What is the appropriate cost of capital to evaluate the business? A. 10.0% B. 7.0% C. 8.5% D. 9.0%
B. 7.0%
Assume Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its current capital structure has a 25% weight in equity, 10% in preferred stock, and 65% in debt. The cost of equity capital is 13%, the cost of preferred stock is 9%, and the pretax cost of debt is 8%. What is the weighted average cost of capital for Ford if its marginal tax rate is 40%? A. 6.91% B. 7.27% C. 8.00% D. 8.36%
B. 7.27%
Demand Cash Flow Weak $25,000 Expected $35,000 Strong $45,000 Suppose the above company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company uses no leverage, what is expected return to equity holders? A. 9.33% B. 8.0% C. 12.1% D. 11.6%
B. 8.0%
A firm requires an investment of $18,000 and will return $25,000 after one year. If the firm borrows $10,000 at 6%, what is the return on levered equity? A. 96% B. 80% C. 64% D. 112%
B. 80%
Assume JUP has debt with a book value of $20 million, trading at 120% of par value. The bonds have a yield to maturity of 7%. The firm's book value of equity is $16 million, and it has 2 million shares trading at $19 per share. The firm's cost of equity is 12%. What is JUP's WACC if the firm's marginal tax rate is 35%? A. 10.03% B. 9.12% C. 9.57% D. 7.29%
B. 9.12%
Suppose you invested $60 in the Ishares Dividend Stock Fund (DVY) a month ago. It paid a dividend of $0.63 today and then you sold it for $65. What was your return on the investment? A. 6.57% B. 9.38% C. 10.32% D. 7.51%
B. 9.38% total return = (selling price - purchase price + dividend received)/ purchase price
Leverage is the amount of ________ on a firm's balance sheet. A. equity B. debt C. preferred stock D. retained earnings
B. debt
Companies that sell household products and food have very little relation to the state of the economy because such basic needs do not go away. These stocks tend to have ________ betas. A. high B. low C. negative D. infinite
B. low
Fluctuations of a stock's return that are due to market-wide news representing common risk is the ________. A. idiosyncratic risk B. systematic risk C. unique risk D. unsystematic risk
B. systematic risk
A firm will give a one-time cash flow of $24,000 after one year. If the project risk requires a return of 10%, what is the levered value of the firm with perfect capital markets? A. $26,181.8 B. $17,454.55 C. $21,818.18 D. More information is needed
C. $21,818.18 =24000/(1+0.1)
The book value of a firm's equity is $100 million and its market value of equity is $200 million. The face value of its debt is $50 million and its market value of debt is $60 million. What is the market value of assets of the firm? A. $150 million B. $160 million C. $260 million D. $250 million
C. $260 million
Amazon.com stock prices gave a realized return of 5%, -5%, 11%, and -11% over four successive quarters. What is the annual realized return for Amazon.com for the year? A. 2.91% B. 1.46% C. -1.46% D. 0.00%
C. -1.46% =(1+0.05)*(1-0.05)*(1+0.11)*(1-0.11)=0.98543 =0.98543-1
Assume Time Warner shares have a market capitalization of $40 billion. The company is expected to pay a dividend of $0.25 per share and each share trades for $40. The growth rate in dividends is expected to be 7% per year. Also, Time Warner has $20 billion of debt that trades with a yield to maturity of 9%. If the firm's tax rate is 40%, what is the WACC? A. 5.85% B. 6.54% C. 6.88% D. 7.57%
C. 6.88%
Suppose you invest in 220 shares of Johnson and Johnson (JNJ) at $70 per share and 240 shares of Yahoo (YHOO) at $20 per share. If the price of Johnson and Johnson increases to $80 and the price of Yahoo decreases to $18 per share, what is the return on your portfolio? A. 12.77% B. 9.37% C. 8.51% D. 10.22%
C. 8.51% (new investment - old)/old
Consider two firms, Firm X and Firm Y, that have identical assets that generate identical cash flows. Firm Y is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. Firm X has 2 million shares outstanding and $12 million in debt at an interest rate of 5%. According to MM Proposition I, the stock price for Firm X is closest to ________. A. $12.00 B. $24.00 C. $8.00 D. $6.00
D. $6.00
The average annual return for the S&P 500 from 1886 to 2018 is 9.5%, with a standard deviation of 18%. Based on these numbers, what is a 95% confidence interval for 2019's returns? A. -11.5%, 30.5% B. -16.5%, 35.5% C. -13.25%, 22.75% D. -26.5%, 45.5%
D. -26.5%, 45.5%
The beta of the market portfolio is ________. A. 0 B. -1 C. 2 D. 1
D. 1
Treasury bill returns are 4%, 3%, 2%, and 5% over four years. The standard deviation of returns of Treasury bills is ________. A. 1.55% B. 1.03% C. 0.90% D. 1.29%
D. 1.29%
IBM expects to pay a dividend of $5 next year and expects these dividends to grow at 7% a year. The price of IBM is $90 per share. What is IBM's cost of equity capital? A. 3.77% B. 5.02% C. 7% D. 12.56%
D. 12.56% Cost of equity = (Div1/Pe) + g
Your estimate of the market risk premium is 6%. The risk-free rate of return is 4%, and General Motors has a beta of 1.6. According to the Capital Asset Pricing Model (CAPM), what is its expected return? A. 14.3% B. 12.2% C. 12.9% D. 13.6%
D. 13.6% = (Beta*MRP)+RF
Your retirement portfolio comprises 200 shares of the S&P 500 fund (SPY) and 100 shares of iShares Barclays Aggregate Bond Fund (AGG). The price of SPY is $134 and that of AGG is $110. If you expect the return on SPY to be 10% in the next year and the return on AGG to be 8%, what is the expected return for your retirement portfolio? A. 8.48% B. 123.30% C. 9.89% D. 9.42%
D. 9.42%
To attract capital from outside investors, a firm must offer potential investors an expected return that is commensurate with the level of risk that they can bear. True / False
True
When we combine stocks in a portfolio, the amount of risk that is eliminated depends on the degree to which the stocks face common risks and move together. True / False
True
Big Cure and Little Cure are both pharmaceutical companies. Big Cure presently has a potential "blockbuster" drug before the Food and Drug Administration (FDA) waiting for approval. If approved, Big Cure's blockbuster drug will produce $1 billion in net income for Big Cure. Little Cure has ten separate, less important drugs before the FDA waiting for approval. If approved, each of Little Cure's drugs would produce $50 million in net income. The probability of the FDA approving a drug is 50%.What is the expected payoff for Little Cure's ten drugs? A. $250 million B. $1 billion C. $50 million D. $0
A. $250 million
UPS, a delivery services company, has a beta of 1.4, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 4% and the market risk premium is 6%. What is the expected return on a portfolio with 50% of its money in UPS and the balance in Wal-Mart? A. 10.9% B. 10.4% C. 12.0% D. 13.1%
A. 10.9% Beta % UPS 1.4 0.5 Walmart 0.9 0.5 Portfolio Beta SUMProduct=1.15 MRP 0.06 RF 0.04 Er 0.109 = (Portfolio Beta*MRP)+RF
Assume preferred stock of Ford Motors pays a dividend of $4 each year and trades at a price of $35. What is the cost of preferred stock capital for Ford? A. 11.4% B. 12.6% C. 13.7% D. 14.9%
A. 11.4%
Your estimate of the market risk premium is 7%. The risk-free rate of return is 4%, and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM), what is its expected return? A. 13.8% B. 10.4% C. 11.7% D. 13.1%
A. 13.8%
SIROM Scientific Solutions has $10 million of outstanding equity and $5 million of bank debt. The bank debt costs 5% per year. The estimated equity beta is 2. If the market risk premium is 9% and the risk-free rate is 3%, compute the weighted average cost of capital if the firm's tax rate is 30%. A. 15.17% B. 15.93% C. 16.68% D. 17.44%
A. 15.17%
Outstanding debt of Home Depot trades with a yield to maturity of 7%. The tax rate of Home Depot is 35%. What is the effective cost of debt of Home Depot? A. 4.55% B. 5.01% C. 5.46% D. 5.69%
A. 4.55%
Assume JUP has debt with a book value of $24 million, trading at 120% of par value. The firm has book equity of $28 million, and 2 million shares trading at $20 per share. What weights should JUP use in calculating its WACC? A. 41.86% for debt, 58.14% for equity B. 37.67% for debt, 62.33% for equity C. 33.49% for debt, 66.51% for equity D. 29.30% for debt, 70.70% for equity
A. 41.86% for debt, 58.14% for equity
A portfolio has three stocks — 240 shares of Yahoo (YHOO), 150 Shares of General Motors (GM), and 40 shares of Standard and Poor's Index Fund (SPY). If the price of YHOO is $30, the price of GM is $30, and the price of SPY is $130, calculate the portfolio weight of YHOO and GM. A. 42.6%, 26.6% B. 23.4%, 49.3% C. 12.8%, 16.0% D. 40.5%, 28.0%
A. 42.6%, 26.6%
Your retirement portfolio comprises 100 shares of the Standard & Poor's 500 fund (SPY) and 100 shares of iShares Barclays Aggregate Bond Fund (AGG). The price of SPY is $118 and that of AGG is $97. If you expect the return on SPY to be 11% in the next year and the return on AGG to be 6%, what is the expected return for your retirement portfolio? A. 8.74% B. 10.06% C. 7.43% D. 7.87%
A. 8.74%
An all-equity firm had a dividend expense of $30,000 last year. The market value of the firm is $900,000 and the dividend is expected to increase at 6% each year. What is the cost of equity for this firm? A. 9.53% B. 10.01% C. 10.96% D. 11.44%
A. 9.53% =(30000*1.06/900000)+0.06
A stock market comprises 2100 shares of stock A and 2100 shares of stock B. The share prices for stocks A and B are $25 and $15, respectively. What proportion of the market portfolio is comprised of each stock? A. Stock A is 62.5% and Stock B is 37.5%. B. Stock A is 37.5% and Stock B is 62.5%. C. Stock A is 50% and Stock B is 50%. D. Stock A is 200% and Stock B is 100%.
A. Stock A is 62.5% and Stock B is 37.5%.
You expect General Motors (GM) to have a beta of 1.5 over the next year and the beta of Exxon Mobil (XOM) to be 1.9 over the next year. Also, you expect the volatility of General Motors to be 50% and that of Exxon Mobil to be 35% over the next year. Which stock has more systematic risk? Which stock has more total risk? A. XOM, GM B. GM, XOM C. GM, GM D. XOM, XOM
A. XOM, GM
The Tradeoff Theory suggests that ________. A. a firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress B. differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries C. with higher costs of financial distress, it is optimal for a firm to choose higher leverage D. there is no rational explanation for why firms choose debt levels that are too low to fully exploit the debt tax shield
A. a firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress
The risk that is linked across outcomes is called ________. A. common or systematic risk B. uncorrelated risk C. diversifiable risk D. independent risk
A. common or systematic risk
A firm's ________ ratio is the fraction of the firm's total value that corresponds to debt. A. debt to value B. liabitlity C. equity to debt D. debt to equity
A. debt to value
As we increase the number of stocks in a portfolio, the standard deviation of returns of the portfolio ________. A. decreases B. doubles C. remains unchanged D. increases
A. decreases
A financial manager makes a choice of the amount and source of capital based on how the choice will impact the ________. A. firm value B. Revenue C. Face value of bonds D. depreciation
A. firm value
MM Proposition I states that in a perfect capital market the total value of a firm is equal to the market value of the ________ generated by its assets. A. free cash flows B. earnings after taxes C. cash flows before taxes D. earnings after interest
A. free cash flows
By adding leverage, the returns on a firm are split between debt holders and equity holders, but equity holder risk increases because ________. A. interest payments have first priority B. interest payments can be rolled over C. dividends are paid first D. debt and equity have equal priority
A. interest payments have first priority
It is not correct to discount the cash flows of a levered firm with the cost of equity of the unlevered firm because ________. A. leverage increases the risk of the equity of the firm B. leverage decreases the risk of equity of the firm C. leverage changes the unlevered cost of equity D. cost of debt decreases in this setting
A. leverage increases the risk of the equity of the firm
Diversification reduces the risk of a portfolio because ________, and some of the risks are averaged out of the portfolio. A. stocks do not move identically B. stocks have common risks C. stocks are fully predictable D. stocks are not affected by the market
A. stocks do not move identically
Many financial managers use market risk premiums that are closer to 5%, which is lower than historical averages, because ________. A. the return investors require as compensation for taking on the risk of investing in equity markets has diminished over a period of time B. investors require a higher risk premium for holding risky securities than in the past C. investors require a supernormal risk premium for holding risky securities as compared with the past D. investors require the same premium for holding risky securities as in the past
A. the return investors require as compensation for taking on the risk of investing in equity markets has diminished over a period of time
Equity in a firm with no debt is called _______ A. unlevered equity B. Levered equity C. risk-free equity D. prefered equity
A. unlevered equity
While ________ seems to be a reasonable measure of risk when evaluating a large portfolio, the ________ of an individual security does not explain the size of its average return. A. volatility, volatility B. mode, mean return C. the mean return, standard deviation D. mode, volatility
A. volatility, volatility
A firm's overall cost of capital that is a blend of the costs of the different sources of capital is known as the firm's ________. A. weighted average cost of capital B. cost of equity infusion C. cost of debt D. cost of preferred stock
A. weighted average cost of capital
Your estimate of the market risk premium is 6%. The risk-free rate of return is 4% and General Motors has a beta of 1.4. What is General Motors' cost of equity capital? A. 11.2% B. 12.4% C. 11.8% D. 13.0%
B. 12.4%
A firm has a market value of equity of $40,000 and a total market value of $48,000. The unlevered cost of equity is 16%, and the firm was able to borrow the $8,000 at 7%. Based on this information, what is the firm's levered cost of equity capital? A. 8.9% B. 17.8% C. 24.9% D. 21.4%
B. 17.8% re = ru + (D/E)(ru-rd)
The S&P 500 index delivered a return of 10%, 15%, 15%, and -30% over four successive years. What is the arithmetic average annual return for four years? A. 3.00% B. 2.50% C. 3.50% D. 2.25%
B. 2.50% =(10+15+15-30)/4
A firm requires an investment of $25,000 and will return $36,500 after 1 year. If the firm borrows $20,000 at 7%, what is the return on levered equity? A. 162% B. 202% C. 242% D. 302%
B. 202% cost: 25000 borrow: 20000 equity: 5000 kd: .07 cf: 36500 debt repayment: 21400 ncf: 15100 roe: nfc/equity
A firm requires an investment of $20,000 and will return $26,500 after one year. If the firm borrows $6000 at 7%, what is the return on levered equity? A. 61% B. 43% C. 35% D. 52%
B. 43%
Assume the market value of Fords' equity, preferred stock, and debt are$6 billion, $2 billion, and $13 billion, respectively. Ford has a beta of 1.7, the market risk premium is 8%, and the risk-free rate of interest is 3%. Ford's preferred stock pays a dividend of $4 each year and trades at a price of $30 per share. Ford's debt trades with a yield to maturity of 8.0%. What is Ford's weighted average cost of capital if its tax rate is 30%? A. 9.95% B. 9.48% C. 10.43% D. 11.38%
B. 9.48%
Anheuser Busch, a manufacturer of beverages, is planning to purchase Six Flags theme parks. Anheuser Busch should use the ________ to evaluate the business of Six Flags. A. WACC of Anheuser Busch B. WACC of Six Flags C. average market return D. divisional cost of capital
B. WACC of Six Flags
A linear regression to estimate the relation between General Motors' stock returns and the market's return gives the best-fitting line that represents the relation between the stock and the market. The slope of this line is our estimate of ________. A. alpha B. beta C. risk-free rate D. volatility
B. beta
Stocks tend to move together if they are affected by ________. A. company specific events B. common economic events C. events unrelated to the economy D. idiosyncratic shocks
B. common economic events
In general, it is possible to eliminate ________ risk by holding a large portfolio of assets. A. unsystematic and systematic B. unsystematic C. systematic D. market specific
B. unsystematic
If you build a large enough portfolio, you can diversify away all ________ risk, but you will be left with ________ risk. A. diversifiable, unsystematic B. unsystematic, systematic C. systematic, undiversifiable D. undiversifiable, diversifiable
B. unsystematic, systematic
Equity in a firm that also has debt in their capital structure is called ________. A. risk-free equity B. prefered equity C. Levered equity D. unlevered equity
C. Levered equity
Big Cure and Little Cure are both pharmaceutical companies. Big Cure presently has a potential "blockbuster" drug before the Food and Drug Administration (FDA) waiting for approval. If approved, Big Cure's blockbuster drug will produce $1 billion in net income for Big Cure. Little Cure has ten separate, less important drugs before the FDA waiting for approval. If approved, each of Little Cure's drugs would produce $100 million in net income. The probability of the FDA approving a drug is 40%.What is the expected payoff for Big Cure's blockbuster drug? A. $100 million B. $1 billion C. $400 million D. $0
C. $400 million Expected payoff = prob of payoff x amount successful
Greg purchased stock in Bear Stearns and Co. at a price of $88 per share one year ago. The company was acquired by JP Morgan at a price of $11 per share. What is Greg's return on his investment? A. -113.75% B. -96.25% C. -87.50% D. -100.62%
C. -87.50% =(11-88)/88
A portfolio comprises Coke (beta of 1.6) and Wal-Mart (beta of 0.6). The amount invested in Coke is $10,000 and in Wal-Mart is $20,000. What is the beta of the portfolio? A. 0.841 B. 0.030 C. 0.930 D. 0.98
C. 0.930
The price of Microsoft is $37 per share and that of Apple is $43 per share. The price of Microsoft increases to $42 per share after one year and to $47 after two years. Also, shares of Apple increase to $49 after one year and to $59 after two years. If your portfolio comprises 100 shares of each security, what is your portfolio return in year 1 and year 2? Assume no dividends are paid. A. 13.06%, 14.84% B. 10.31%, 18.96% C. 13.75%, 16.48% D. 11.69%, 19.78%
C. 13.75%, 16.48%
Your estimate of the market risk premium is 9%. The risk-free rate of return is 3.8% and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM), what is its expected return? A. 14.8% B. 15.6% C. 16.4% D. 17.2%
C. 16.4%
Suppose that a stock gave a realized return of 20% over a two-year time period and a 10% return over the third year. The geometric average annual return is ________. A. 14.08% B. 8.28% C. 16.57% D. 12.43%
C. 16.57% =(1.2)*(1.2)*(1.1)= 1.584 =1.584^(1/3)
UPS, a delivery services company, has a beta of 1.6, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 6% and the market risk premium is 9%. What is the expected return on a portfolio with 40% of its money in UPS and the balance in Wal-Mart? A. 14.96% B. 15.79% C. 16.62% D. 18.28%
C. 16.62%
A firm has a market value of equity of $30,000 and a total market value of $37,500. The unlevered cost of equity is 16%, and the firm was able to borrow the $7,500 at 8%. Based on this information, what is the firm's levered cost of equity capital? A. 21.6% B. 9.0% C. 18.0% D. 25.2%
C. 18.0%
Suppose you invest in 100 shares of Merck (MRK) at $40 per share and 120 shares of Yahoo (YHOO)at $25 per share. If the price of Merck increases to $45 and the price of Yahoo decreases to $22 per share, what is the return on your portfolio? A. 7.70% B. 4.11% C. 2.00% D. 2.57%
C. 2.00%
The excess return is the difference between the average return on a security and the average return for ________. A. a portfolio of securities with similar risk B. a broad-based market portfolio like the S&P 500 index C. Treasury bills D. Treasury bonds
C. Treasury bills
The relative proportion of debt, equity, and other securities that a firm has outstanding constitute its ________. A. asset ratio B. current ratio C. capital structure D. retained earnings
C. capital structure
Asymmetric information implies that ________ may have better information about a firm's cash flows than other stakeholders. A. suppliers B. creditors C. managers D. debt holders
C. managers
A portfolio of stocks can achieve diversification benefits if the stocks that comprise the portfolio are ________. A. perfectly correlated B. both perfectly correlated and susceptible to common risks only C. not perfectly positively correlated D. susceptible to common risks only
C. not perfectly positively correlated
One of the factors that determine the present value (PV) of financial distress costs is ________. A. employee compensation B. costs of unpaid interest arrears C. probability of financial distress D. loss of dividend payments
C. probability of financial distress
Which of the following investments had the largest fluctuations overall return over the past eighty years? A. Treasury bills B. S&P 500 C. small stocks D. corporate bonds
C. small stocks
The risk premium of a security is determined by its ________ risk and does not depend on its ________ risk. A. diversifiable, undiversifiable B. undiversifiable, diversifiable C. systematic, unsystematic D. systematic, undiversifiable
C. systematic, unsystematic
The ________ of a firm's debt can be used as the firm's current cost of debt. A. current yield B. coupon rate C. yield to maturity D. discount yield
C. yield to maturity
According to researchers Modigliani and Miller, with perfect capital markets, the total value of a firm should not depend on its capital structure. True / False
True
Your investment over one year yielded a capital gains yield of 5% and no dividend yield. If the sale price was $114 per share, what was the cost of the investment? A. $103.14 B. $114.00 C. $119.43 D. $108.57
D. $108.57 =114/(1.05)
Correlation is the degree to which the returns of two stocks share common risks. True/False
True
Assume General Motors has a weighted average cost of capital of 10%. GM is considering investing in a new plant that will save the company $30 million over each of the first two years, and then $25 million each year thereafter. If the investment is $150 million, what is the net present value (NPV) of the project? A. $65.2 million B. -$76.1 million C. -$86.9 million D. $108.7 million
D. $108.7 million
Suppose a project financed via an issue of debt requires six annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 8%, what is the value of the interest rate tax shield? A. $58.25 million B. $34.95 million C. $23.30 million D. $29.12 million
D. $29.12 million PV -> Tax Shield = Tax Rate x PV
You expect General Motors (GM) to have a beta of 1.3 over the next year and the beta of Exxon Mobil (XOM) to be 0.9 over the next year. Also, you expect the volatility of General Motors to be 40% and that of Exxon Mobil to be 30% over the next year. Which stock has more systematic risk? Which stock has more total risk? A. XOM, GM B. XOM, XOM C. GM, XOM D. GM, GM
D. GM, GM Beta = systematic, GM more systematic Volatility = std dev which is total risk, GM more total
Which of the following does a firm consider in the choice of securities issued? A. whether the chosen security will have a fair price in the market B. the tax consequences of the chosen security C. the transactions costs of the chosen security D. all of the above are considered
D. all of the above are considered
Rational investors ________ fluctuations in the value of their investments. A. prefer B. are in favor of C. are indifferent to D. are averse to
D. are averse to
Because investors can eliminate unsystematic risk "for free" by diversifying their portfolios, they ________. A. require a risk premium for bearing it B. do not require a credit spread C. are indifferent about credit spread and risk premium D. do not require a risk premium for bearing it
D. do not require a risk premium for bearing it
Historically, stocks have delivered a ________ return on average compared to Treasury bills but have experienced ________ fluctuations in values. A. lower, higher B. higher, lower C. lower, lower D. higher, higher
D. higher, higher
Aside from direct costs of bankruptcy, a firm may also incur other indirect costs such as ________. A. increase in raw material costs B. loss of dividend receipts C. loss of interest receipts D. loss of customers and loss of suppliers
D. loss of customers and loss of suppliers
Investment cash flows are independent of financing choices in a ________. A. firm with leverage B. market with frictions C. setting with frictions in investment returns D. perfect capital markets
D. perfect capital markets
A portfolio of stocks where each stock has a large component of independent risk but when these such stocks are held in a portfolio the total risk is less is referred to as diversification of risks, because the independent risks are averaged out. True/False
True
