FINA 320 Quiz 5

The ______ the beta coefficient the _____ the expected return, on average

higher, higher

The slope of an asset's security market line is the ___

market risk premium

Standard deviation is one of the most common measures of

return volatility

A stock has been held for one year, during which time its dividend yield was greater than its capital gains yield. For this stock the percentage returns...

cannot be determined

The cost of preferred stock is equal to the preferred stock dividend:

divided by the market price

Gary bought a share of stock for $15.75 that paid a dividend of $0.45 and sold three months later for $18.65. What were his dollar return and percentage return?

$3.35; 21.27%

The beta of an investment in U.S. Treasury bills is:

0

What is the value of systematic risk ( measured by beta) for a portfolio with 2/3 of the funds invested in A and 1/3 invested in B?

1.067

Which of the following would likely have the greatest amount of systematic risk?

A portfolio half invested in the market portfolio and half invested in stocks with betas = 1.50

A stock investor owns a diversified portfolio of 15 stocks. What will be the likely effect on portfolio return standard deviation from adding one more stock?

A slight decrease will occur

The cost of debt capital for a firm ________.

Can be estimated even if the firm's bonds are not publicly traded, by looking at the yield to maturity on bonds outstanding from peer group firm's with similar ratings and maturity

The weighted average of betas of all individual assets is:

Exactly 1

Which of the following would be considered an example of systematic risk?

Greater unemployment rate than expected.

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

Invest; return in high relative to risk

What will happen to a stock that offers a lower risk premium than predicted by the CAPM?

Its price will decrease until the expected return is increased

A firm that uses its WACC as a cutoff without consideration of project risk

Likely will see its WACC rise over time

If treasury bills are yielding 10% at a time when the market risk premium is 6% then the:

Market portfolio should yield 16%

Regarding diversification:

Most of the benefits are realized with 20 to 30 stocks

An investment earned the following returns for the return 1998 through 2001: 30%, 40%, 15%, and 7%. What is the variance of returns for this investment?

None of the above

The standard deviations of individual stocks are generally higher than the standard deviation of the market portfolio because individual stocks:

None of the above

What is the expected yield on the market portfolio at a time when treasury bills yield 6%, and a stock with a beta if 1.4 is expected to yield 18%?

None of the above

If a security plots below the security market line, it is:

Offering to little return to justify its risk

When firms develop a WACC for individual projects based on the cost of capital for other firms in similar lines of business as the project, the firm is utilizing a

Pure play approach

The major benefit of diversification is to:

Reduce the expected risk

Datem Corp. has an expected return of 11%. With a risk-free rate of 3%, a market risk premium of 7% and a beta of 0.8, you can estimate its required return. What is the required return, and would Date plot above or below the security market line (SML)?

Required return = 8.6%, plots above the SML

The principle of diversification tells us that:

Spreading an investment across many diverse assets will eliminate some of the risk.

Which of the following risks would be classified as a non-systematic risk for an auto manufacturer?

Steel prices

Which of the following statements is more likely to be correct concerning the statement, "Stock A has a higher expected return than Stock B"?

Stock A has a higher beta

The relevant risk for the fair market pricing of financial securities is the _________.

Systematic risk

Which of the following is true regarding the WACC?

The WACC is the required return on any investment a firm makes that has a level of risk equal to that of present operations

Which of the following is false regarding the estimation of a firm's cost of equity capital?

The cost of equity is equal to the weighted average cost of capital

The company cost of capital (WACC) may be an inappropriate discount rate for a capital budgeting proposal if:

The proposal has a different degree of risk

Which of the following is false regarding risk and return?

The reward for bearing risk is known as the standard deviations

An investor receives a 15% total return by purchasing a stock for $40 and selling it after one year with a 5% capital gain. How much was received in individual income during the year?

$4.00

Which of the following statements is true for a stock that sells now for $60, pays an annual dividend of $4.00, and experienced a 20% return on investment over the past year? Its price one year ago was:

$53.33

Determine the value of Coldron shares. The last dividend paid was $3.20, and dividends are expected to grow at 4% indefinitely. Coldron has a beta of 0.9, the risk-free rate is 3 percent and the risk premium is 7 percent.

$62.79

What is the approximate Variance of returns if over the last 3 years an investment returned 8.0%, -12%, and 15%

.0196

You own a portfolio that is 50 percent invested in Stock X, 30 percent in Stock Y, and 20 percent in Stock Z. The returns on these three stocks are 10 percent, 18 percent, and 13 percent respectively. What is the return on the portfolio? Round your answer to the nearest basis point, or hundredth of percent. (NOTE: enter your answer as percent without the percentage sign. For example, if your answer is 5.45% enger 5.45)

.1300

An investor divides her portfolio equally into three parts, with one part in treasury bills, one part in a market index, and one part in a diversified portfolio with beta of 1.50. What is the beta of the investor's overall portfolio?

.83

A company's zero coupon bond issue matures in 16 years and has a yield to maturity of 10.60%. Each zero has a face value of $1,000 and there are 4,000 of the bonds outstanding. If the market values the equity at $1,800,000, what capital structure weight for debt would you use in calculating the WACC, assuming the firm's only debt consists of the zeros?

0.299

What should be the beta of a replacement stock if an investor wishes to achieve a portfolio beta of 1.0 by replacing stock C in the following equally weighted portfolio. Stock A -.9beta, stock B-1.1 beta, and stock C is 1.35 beta?

1

Calculate the risk premium on stock C given the following information: risk-free rate=5%, market return=13%, stock C beta=1.3

10.4%

In a year in which common stock offered an average return of 18%, treasury bonds offered 10% and treasury bills offered 7%, the risk premium for common stocks was:

11%

What is the WACC for a firm using 55% equity with a required return of 15%, 35% debt with required return of 8%, 10% preferred with a required return of 10%, and a tax rate of 35%

11.07%

What is the expected return on asset A if it has a beta of 0.6, the expected market return is 15%, and the risk -free rate is 6%?

11.4%

What is the after-tax cost of preferred stock that sells for $10.00 per share and offers a $1.20 annual dividend when the tax rate is 35%?

12%

Treasury bills currently have a return of 2.5%, and the market risk premium is 7%. If a firm has a beta of 1.4, what is its cost on equity?

12.3%

An analyst gathered the following data about a company: Capital structure 30% debt, 20% preferred stock, 50% common stock. Required rate of return 10% for debt, 11% for preferred stock, and 18% for common stock. Assuming a 40% tax rate, what after-tax rate must the company earn on its investments?

13%

Given the following information, what is the WACC? Common stock: 1 million shares outstanding, $40 per share, $1 par value, beta =1.3 Bonds: 10,000 bonds outstanding, $1,000 face value each, 8% annual coupon (paid annually), 22 years to maturity, market price= $1,101.23 per bond Market risk premium= 8.6%, risk-free rate = 4.5%, marginal tax rate= 34%

13.30%

What is the standard deviation of a portfolio's returns if the mean return is 15%, the variance of returns is .0184, and there are three stocks in the portfolio?

13.56%

What is the approximate standard deviation of returns if over the past 4 years an investment returned 8.0%, -12.0%, -12.0%, and 16.0%?

14%

What rate of return should an investor expect for a stock that has a beta of 1.25 when the market is expected to yield 14% and Treasury bills offer 6%?

16.0

Company X has 2 million shares of common stock outstanding at a book value of $2.00 per share. The stock trades for $3.00 per share. It also has $2 million in face value of debt that trades at 90% of par. What is the weight on debt for WACC purposes?

23.1%

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

25

You want to create a portfolio equally as risky as the market (i.e, portfolio with beta equal to 1), and you have $1,000,000 to invest. The portfolio contains stocks A, B, C and a risk free asset. Given this information, find how much must you investment in stock C. Round your answer to the nearest dollar (NOTE: do NOT include the dollar sign in your answer).

365,625. Answer range +/- 5 (365620 - 365630)

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%

Ferryville Radar technologies has five-year, 7.5% bonds outstanding that trade at a yield to maturity of 6.8%. The company's marginal tax rate is 35%. Ferryville plans to issue new five-year notes to finance an expansion. Ferryville's after-tax cost of debt capital is closest to:

4.4

A firm sold a ten-year bond issue 3 years ago. The bond has a 6.45% annual coupon and a $1000 face value. The coupons are paid annually. If the current market price of the bond is $951.64 and the tax rate is 35%, what is the after-tax cost of debt?

4.77%

A company has a bond issue outstanding that has an 8% coupon, pays semiannual interest, matures in 7 years at a face value of $1,000. The bonds currently trade at a price of $940. The company's tax rate is 40% and its stock beta is 1.3. The risk-free rate is 3%, and the risk premium is 7%. For purposes of estimating its weighted average cost of capital, what after-tax cost of debt should the company use?

5.51%

A firm has $100 million in equity and $300 million in debt. The firm recently issued bonds at the market required rate of return of 9% . The firm's beta is 1.125, the risk-free rate is 6% and the expected return in the market is 14%. Assume the firm is at their optimal capital structure and the firm's tax rate is 40% What is the firm's weighted average cost of capital (WACC)?

7.80%

Asset A has an expected return of 14.5% and a beta of 1.15. The risk-free rate is 5%. What is the market risk premium?

8.26%

A company has the following capital structure: Target weights: 30% debt, 20% preferred stock, 50% common equity Tax Rate: 35% The firm can issue $1,000 face value, 7% semi-annual coupon debt with a 15-year maturity for a price of $1,047.46 A preferred stock issue that pays a dividend of $2.80 has a value of $35 per share The company's common shares have a value of $40 and a dividend in year 0 of D0=$3.00 The stock's dividend is expected to grow at a constant rate of 6% per year The company's weighted average cost of capital is closest to:

9.84%

Which of the following events will reduce a company's weighted average cost of capital (WACC)

A reduction in the market risk premium

The managers of Kenforest Grocers are trying to determine the company's optimal capital budget for the upcoming year. Kenforest is considering the following projects: The company estimates that its WACC is 11, All projects are independent. The company adjusts for risk by adding 2 percentage points to the WACC for high-risk projects and subtracting 2 percentage points from the WACC for low-risk projects. Which of the projects will the company accept?

A, B, C, F

Which of A and B have the least total risk? The least Systematic

A;B

Given the following information, what is your best estimate for the firm's cost of equity on January 2, 2012, if the stock sells for $42 on that day?

About 25%

A stock has an expected return of 10 percent, its beta is .9, and the risk-free rate is 6 percent. What must the expected return on the market be? Round your answer to the nearest basis point, or hundredth of percent.

Answer range: +/- .05 (10.40-10.50)

Titan Mining Corporation has 8 million shares of common stock outstanding. 5 million shares of preferred stock outstanding, and 100,000 units of 9 percent semiannual bonds outstanding, par value $1000 each. The preferred stock currently sells for $67 per share, and the bonds have 15 years to maturity and sell for 91 percent of par. The market risk premium is 10 percent, t bills are yielding 5 percent, and titan Mining's tax rate is 35 percent. If Titan Mining is evaluating a new investment project that has the same risk as the firm's typical project, what rate should the firm use to discount the project's cash flows?

Answer range: +/- .05 (11.43-11.53)

Which of the following is false concerning diversification? Assume that securities being considered for the selection into a portfolio are not perfectly correlated

As more securities are added to the portfolio, the systematic risk declines

A company has a target capital structure of 40% debt and 60%equity. The company is a constant growth firm that just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8%. The company/s bonds pay10% coupon (semiannual payment): mature in 20 years, and sell for $849.54. The company's stock beta is 1.2. The company's marginal tax rate is 400%. The risk-free rate is 4%. The market risk premium is 10%. The cost of equity using the capital asset pricing model (CAPM) and the constant growth model is:

CAPM: 16.0%; CGM: 16.0%

Bradshaw Steel has a capital structure with 30% debt (all long-term bonds) and 70% common equity. The coupon rate on the company's long-term bonds is 8% and the bond is sell at a premium. The firm estimates that its overall composite WACC is 10%. The risk-free rate of interest is 5.5%, the market risk premium is 5%, and the company's tax rate is 40%. Bradshaw uses the CAPM to determine its cost of equity. What is the beta on Bradshaw's Stock?

Cannot be solved because not enough information is provided

_______________ refers to the way a company finances itself through some combination of loans, bond sales, preferred stock sales, common stock sales, and retention of earnings.

Capital structure

Which of the following would decrease a portfolio's systematic Risk?

Common stock with positive beta is sold and replaced with Treasury bills.

Which of the following would decrease a portfolio's systematic risk?

Common stock with positive beta is sold and replaced with Treasury bills.

Julias INC. is in a 40% marginal tax bracket The firm can raise as much capital as needed in the bond market at a cost of 10%Yield to maturity The prefered stock has a fixed dividend of $4.00 The price of preferred stock is 31.50 The after tax costs of debt and preferred stock are closest to:

Debt 6% preferred stock 12.7%

Holding all else equal, if the beta of a stock increase the stock's price will

Decrease

Ed Lawrence has invested $100,000. Of that, $13,000 is invested in IBM stock, $25,000 is invested in T-bills, and the remainder is invested in corporate bonds. Which of the following is true regarding his portfolio?

Ed has 30% of his portfolio invested in stocks

If a stock consistently goes down, (up) by 1.6% when the market portfolio goes down (up) by 1.2% then its beta :

Equals 1.33

A stock's risk premium is equal to the:

Expected market risk premium times beta

A firm is considering an investment in a project whose risk is greater than the current risk of the firm, based on any method for assessing risk. In evaluating this asset, the decision maker should

Increase the cost of capital used to evaluate the project to reflect the project's higher risk.

What happens to the expected portfolio returns if the portfolio beta increases from 1.0 to 1.5, the risk free rate decreases from 5% to 4%, and the market risk premium increases from 8% to 9%.

It increases from 13 to 17.5%

Takelmer Industries has a different WACC for each of three types of projects. Low-risk projects have an 8% WACC, average risk projects a 10% WACC, and high-risk projects a 12% WACC. Which of the following projects do you recommend that the firm accept?

Projects A ( Low level of risk, 9.50%), Projects D (Low, 9.50%), Projects E (High, 14.50%), Projects F (High, 17.50%), Projects G (Average 11.50%)

When firm develop a WACC for individual projects based on the cost of capital for other firms in similar lines of business as the project, the firm is utilizing a

Pure play approach

Assume a firm uses a constant WACC to select investment projects rather than adjusting the projects for risk. If so, the firm will tend to:

Reject positive-NPV (profitable), low-risk projects and accept negative-NPV (unprofitable), high-risk projects

At a recent Haggerty Semiconductors Board of Directors meeting, Merle Haggerty was asked to discuss the topic of the company's weighted average cost of capital (WACC). At the meeting Haggerty made the following statements about the company's WACC: Statement 1: A company creates value by producing a higher return on its assets than the cost of financing those assets. As such, the WACC is the cost of financing a firm's assets and can be viewed as the firm's opportunity cost of financing its assets Statement 2: since a firm's WACC reflects the average risk of the projects that make up the firm, it is not appropriate for evaluating all new projects. It should be adjusted upwards for projects with greater-than-average risk and downward for projects with less-than-average risk Are Statement 1 and Statement 2, as made by Haggerty CORRECT

Statement 1: correct; Statement 2: correct

Stock A has a beta coefficient of 0.9, and stock B has a beta coefficient of 1.2. Which of the following statements is false regarding these two stocks?

Stock A necessarily must have a lower standard deviation of returns than stock B.

Assume that the Security Market line (SML) is based on a risk free rate of 5% and a market return of 11%. What will happen to the SML, if the forecast of risk-free rate increases and investors become more risk averse?

The SML will shift up and have a steeper slope

Which of the following describes a stock that plots above the security market line?

The expected return of the stock is too high

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

The individual stock's return standard deviation is higher.

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

The standard deviation for historical stock returns can be calculated as:

The square root of the variance

Which of the following Portfolios might be expected to exhibit less unsystematic risk?

Thirty random stocks; portfolio unknown

The variance of an investment's returns is a measure of the

Volatility of the rates of return

Select the statement that is the most correct:

When calculating the cost of debt; a company needs to adjust for taxes, because interest payments are tax deductible

All else the same, a higher corporate tax rate

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

You have $10,000 to invest in a stock portfolio. Your choices are Stock X with a return of 15 percent and Stick Y with a return of 10 percent. If your goal is to create a portfolio with a return of 13.5 percent, how much money will you invest in Stock X?

X: 7,000 Y: 3,000

An all-equity firm is considering the following projects: The T-Bill rate is 5%, the expected return on the market is 12% The company's WACC is 12% Which project would be incorrectly accepted if overall cost of capital were used as a hurdle rate?

Z

Jiminy's Cricket Farm issued a 30-year, 9 percent annual coupon bond 8 years ago. The bond makes coupon payments semiannually. The par value of the bond is $1,000. The bond currently sells for 105 percent of its face value. The company's tax rate is 35 percent. a. what is the pre-tax cost of debt? b. What is the after-tax cost of debt? c. Which is more relevant? Why?

a. 8.49% b. 5.52% c. After tax rate is more relevant because that is actual cost

Although non-systematic risk is present in differing amounts, individual stocks are:

exposed to differing amounts of systematic risk also.