Final Exam

In an efficient market, the cost of equity for a highly risky firm:

increases in direct relation to the stock's systematic risk.

Electronic Products has 22,500 bonds outstanding that are currently quoted at 101.6. The bonds mature in 8 years and pay an annual coupon payment of $90. What is the firm's aftertax cost of debt if the applicable tax rate is 34 percent?

$1,016 = $90 ×({1 − [1 / (1 + RD )^8]} / RD) + $1,000 / (1 + RD)^8 RD = 8.714 percent Aftertax cost of debt = 8.714 percent ×(1 − .34) = .0575, or 5.75 percent

Sugar Cookies will pay an annual dividend of $1.23 a share next year. The firm expects to increase this dividend by 8 percent per year the following four years and then decrease the dividend growth to 2 percent annually thereafter. Which one of the following is the correct computation of the dividend for Year 7?

($1.23) × (1.08)^4 × (1.02)^2

The common stock of Federal Logistics is selling for $57.56 per share. The company pays a constant annual dividend and has a total return of 10.13 percent. What is the amount of the dividend?

D = .1013 × $57.56 = $5.83

Which one of the following statements is true? -The current yield on a par value bond will exceed the bond's yield to maturity. -The yield to maturity on a premium bond exceeds the bond's coupon rate. -The current yield on a premium bond is equal to the bond's coupon rate. -A premium bond has a current yield that exceeds the bond's coupon rate. -A discount bond has a coupon rate that is less than the bond's yield to maturity.

A discount bond has a coupon rate that is less than the bond's yield to maturity.

Which one of the following portfolios will have a beta of zero?

A portfolio comprised solely of U.S. Treasury bills

Sweet Treats pays a constant annual dividend of $2.38 a share and currently sells for $52.60 a share. What is the rate of return?

R = $2.38 / $52.60 = .0452, or 4.52 percent

Which statement is correct?

An underpriced security will plot above the security market line

American Hat has $1,000 face value bonds outstanding with a market price of $1,150. The bonds pay interest semiannually, mature in 8 years, and have a yield to maturity of 5.98 percent. What is the current yield?

Current yield = (2 × $41.83) / $1,150 Current yield = .0728. or 7.28 percent

Dee's Dress Emporium has 50,000 shares of common stock outstanding at a price of $27 a share. It also has 1000 shares of preferred stock outstanding at a price of $20 a share. There are 800bonds outstanding that have a semiannual coupon payment of $25. The bonds mature in four years, have a face value of $1,000, and sell at 97 percent of par. What is the capital structure weight of the common stock?

Common stock = 50,000 × $27 = $1,350,000 Preferred stock = 1000 × $20 = $20,000 Debt = 800 × (.97 × $1,000) = $776,000 Value = $1,350,000 + 20,000 + 776,000 = $2,146,000 Weight of common stock = $1,350,000 / $2,146,000 = .6291, or 62.91 percent

An unexpected decrease in market interest rates will cause a:

Coupon bond's yield to maturity to decrease

A bond has a par value of $1,000, a current yield of 6.25 percent, and semiannual interest payments. The bond quote is 100.8. What is the amount of each coupon payment?

Coupon payment = [.0625 × (1.008 × $1,000)] / 2 = $31.50

Mary owns 100 shares of stock. Each share entitles her to one vote per open seat on the board of directors. Assume there are three open seats in the current election and Mary casts all 300 of her votes for a single candidate. What is the term used to describe this type of voting?

Cumulative

Braxton's Cleaning Company stock is selling for $32.60 a share based on a rate of return of 13.8 percent. What is the amount of the next annual dividend if the dividends are increasing by 2.4 percent annually?

D1 = $32.60 × (.138 − .024) = $3.72

The price of a stock at Year 3 can be expressed as:

D4 / (R - g).

You are buying a bond at a clean price of $1,140. The bond has a face value of $1,000, a coupon rate of 3.8 percent, and pays interest semiannually. The next coupon payment is one month from now. What is the dirty price of this bond?

Dirty price = $1,140 + [(.038 × $1,000) / 2 × 5/6] Dirty price = $1,155.83

Which term best refers to the practice of investing in a variety of diverse assets as a means of reducing risk?

Diversification

Given the following information, what is the standard deviation of the returns on a portfolio that is invested 40 percent in Stock A, 35 percent in Stock B, and the remainder in Stock C?

E(RNormal) = (.40 × .189) + (.35 × .102) + (.25 × .121) = .14155 E(RRecession) = (.40 × .057) + (.35 × .085) + (.25 × .093) = .0758 E(RPortfolio) = (.07 × .14115) + (.93 × .0758) = .0804 Variance = .07(.14155 − .0804)2 + .93(.0758 − .0804)2 = .000281 Standard deviation = .000281.5 = .0168, or 1.68 percent (See notebook for detailed solution)

What is the principal amount of a bond that is repaid at the end of the loan term called?

Face Value

A company originally issued bonds that were rated investment grade. These bonds have now been downgraded to junk status. These bonds are referred to as:

Fallen angels

Crabby Shores stock is expected to return 15.7 percent in a booming economy, 9.8 percent in a normal economy, and 2.3 percent in a recession. The probabilities of an economic boom, normal state, or recession are 15 percent, 73 percent, and 12 percent, respectively. What is the expected rate of return on this stock?

How to solve: Multiply the probability of state by the stock return, then add all together. =0.0979 -> 9.79%

A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, an aftertax cost of debt of 5.2 percent, and a tax rate of 35 percent. Given this, which one of the following will increase the firm's weighted average cost of capital?

Increasing the firm's beta

The written agreement that contains the specific details related to a bond issue is called the bond:

Indenture

Unsystematic risk can be defined by all of the following except:

Market risk

The Impulse Shopper recently paid an annual dividend of $1.13 per share. The company just announced that it is suspending all dividend payments on its common stock for the next five years. After that, the company expects to pay $.50 a share at the end of each year. At a required return of 18 percent, what is this stock worth today?

P0 = ($.50/.18) / (1 + .18)^5 = $1.21

Great Lakes Steel Supply is losing significant market share and thus its managers have decided to decrease the firm's annual dividend. The last annual dividend was $1.30 per share but all future dividends will be decreased by 2.75 percent annually. What is a share of this stock worth today at a required return of 15.5 percent?

P0 = {$1.30 × [1 + (−.0275)]} / [.155 − (−.0275)] = $6.93

Clock and Cane Company. has 6.8 percent, semiannual coupon bonds on the market with twelve years left to maturity. If the bond currently sells for $989.45, what is its YTM?

PV = $989.45 = [(.068 × $1,000) / 2] × {(1 - {1 / [1 + (r / 2)]^24}) / (r / 2)} + $1,000 / [1 + (r / 2)]^24 r = .0693, or 6.93 percent

What is the beta of the following portfolio? Stock | Value | Beta W | $32,960 | .76 X | 15,780 | 1.31 Y | 8,645 | 1.49 Z | 19,920 | .00

Portfolio value = $32,960 + 15,780 + 8,645 + 19,920 = $77,305 βP = ($32,960 / $77,305)(.76) + ($15,780 / $77,305)(1.31) + ($8,645 / $77,305)(1.49) + ($19,920 / $77,305)(0) = .76

Kate could not attend the last shareholders' meeting and thus she granted the authority to vote on her behalf to the managers of the firm. Which term applies to this granting of authority?

Proxy

KellyAnne Public Relations just paid an annual dividend of $1.27 on its common stock and increases its dividend by 3.4 percent annually. What is the rate of return on this stock if the current stock price is $38.56 a share?

RE=D1/P0 + g RE=1.31318/38.56 +.034 RE=.068055 RE=6.81%

Fire Hydrant Pet Supply just paid its first annual dividend of $0.75 a share. The firm plans to increase the dividend by 2.9 percent per year indefinitely. What is the firm's cost of equity if the current stock price is $16.90 per share?

RE=D1/P0 +g RE=0.77175/16.9 +.029 RE=.074666 RE=7.47%

The common stock of Serenity Homescapes has a beta of 1.21 and a standard deviation of 17.8 percent. The market rate of return is 13.5 percent and the risk-free rate is 3.2 percent. What is the cost of equity for this firm?

RE=Rf + β × (E(RM)−Rf) RE=.032+1.21×(.135−.032) RE=.1566 RE=15.66%

The 5.25 percent preferred stock of Robert Bruce Security is selling for $50.26 a share. What is the firm's cost of preferred stock if the tax rate is 21 percent and the par value per share is $100?

Rp = (.0525 × $100) / $50.26 = .1045, or 10.45 percent

A stock has a beta of 1.32 and an expected return of 12.8 percent. The risk-free rate is 3.6 percent. What is the slope of the security market line?

Slope = (.128 − .036) / 1.32 = .0697, or 6.97 percent

For a risky security to have a positive expected return but less risk than the overall market, the security must have a beta:

That is > 0 but < 1

You own a $58,600 portfolio comprised of four stocks. The values of Stocks A, B, and C are $11,200, $17,400, and $20,400, respectively. What is the portfolio weight of Stock D?

WeightD = ($58,600 − 11,200 − 17,400 − 20,400) / $58,600 = .1638, or 16.38 percent

Spartans has 6.5 percent bonds outstanding that mature in 18 years. The bonds pay interest semiannually and have a face value of $1,000. Currently, the bonds are selling for $985 each. What is the firm's pretax cost of debt?

YTM = 3.32205 × 2 = 6.64% (Use calculator) N = 36 PV = -985 PMT = 32.50 FV = 1000 CPT I/Y

The market-required rate of return on a bond that is held for its entire life is called the:

Yield to maturity

A stock has paid dividends of $1.70, $1.85, $2.00, $2.20, and $2.50 over the past five years, respectively. What is the average capital gains yield?

g = [($1.85 − 1.70) / $1.70 + ($2.00 − 1.85) / $1.85 + ($2.20 − 2.00) / $2.00 + ($2.50 − 2.20) / $2.20] / 4 = .1014, or 10.14 percent

All else constant, the weighted average cost of capital for a risky, levered firm will decrease if:

the firm's bonds start selling at a premium rather than at a discount