BADM 710 Test 2

What is the value of a 20-year, zero-coupon bond with a face value of $1,000 when the market required rate of return is 9.6 percent, compounded semiannually? A) $153.30 B) $192.40 C) $195.26 D) $168.31 E) $172.19

A) $153.30 1. FV: $1,000 2. Coupon Rate: 0.0% 3. Number of compounding periods per year: 2 4. PMT: $1,000 * (0/2) = 0 5. Number of Years to Maturity = 5 years 6. Number of compounding periods till maturity (NPER): Number of compounding periods per year *Number of years to maturity (3*20) = 40 7. Market rate of return/Required rate of return: 9.60% 8. Market rate of return/Required rate of return per period (RATE) = Market rate of return/Required rate of return / Number of compounding periods per year = (9.60%/2) = 4.60% 9. Zero coupon bond valuePV(RATE,NPER,PMT,FV)*-1 = 153.30

Last week, Railway Tours paid its annual dividend of $1.20 per share. The company has been reducing the dividends by 10 percent each year. What is the value of this stock at a discount rate of 13 percent? A) $4.70 B) $3.71 C) $8.31 D) $36.00 E) $27.00

A) $4.70 P0 = D1/(ke-g) Where P0 is the price Ke is the required return 13.00% g is the growth rate -10.00% D1 is dividend at end of year = 1.20 *.90 1.08 P0 = 1.08/(13%-(-10%) P0 = 1.08/(23%) P0 = $4.70

A firm offers a 10-year, zero coupon bond with a face value of $1,000. What is the current market price if the yield to maturity is 7.6 percent, given semiannual compounding? A) $474.30 B) $473.26 C) $835.56 D) $919.12 E) $1,088.00

A) $474.30

You invested in long-term corporate bonds and earned 6.1 percent. During that same time period, large-company stocks returned 12.6 percent, long-term government bonds returned 5.7 percent, U.S. Treasury bills returned 4.2 percent, and inflation averaged 3.8 percent. What average risk premium did you earn? A) 1.9% B) 2.3% C) 1.3% D) .4% E) 6.5%

A) 1.9% Average risk premium earned = Return from investment - Risk-free return ( treasury bills) = 6.1% - 4.2% = 1.9%

Engine Builders stock sells for $24.20 a share. The firm just paid an annual dividend of $2 per share and has a long-established record of increasing its dividend by a constant 2.5 percent annually. What is the market rate of return on this stock? A) 10.97% B) 14.41% C) 10.70% D) 12.34% E) 11.46%

A) 10.97% R = (D x (1+g) / P) + g = ($2 x (1+2.5%) / $24.20) + 2.5% ($2.05 / $24.20) + 2.50% = 0.0847 + 0.025 =0.1097 or 10/97

BCD shares are currently selling for $27.38 each. You bought 200 shares one year ago at $26.59 and received dividend payments of $1.27 per share. What was your percentage capital gain for the year? A) 2.97% B) 3.21% C) 7.75% D) -2.89% E) 7.52%

A) 2.97% Percentage capital gain for the year = ($ 27.38 - $ 26.59) / $ 26.59 x 100 = 2.97%

BPJ stock is expected to earn 14.8 percent in a recession, 6.3 percent in a normal economy, and lose 4.7 percent in a booming economy. The probability of a boom is 20 percent while the probability of a normal economy is 55 percent. What is the expected rate of return on this stock? A) 6.23% B) 6.72% C) 6.81% D) 7.60% E) 8.11%

A) 6.23% Probability of recession=(100-20-55)=25% expected rate of return on this stock=Respective returns*Respective probabilities =(14.8*0.25)+(6.3*0.55)-(4.7*0.2) =6.23%(Approx)

A corporate bond has a coupon of 7.5 percent and pays interest annually. The face value is $1,000 and the current market price is $1,108.15. The bond matures in 14 years. What is the yield to maturity? A) 6.31% B) 7.82% C) 8.00% D) 8.04% E) 8.12%

A) 6.31% Coupon = 7.5% = $ 75 (i.e., $ 1000 * 7.5%) Face Value = $ 1000 Price of the Bond = $ 1108.15 Years to maturity = 14 Years Yield to Maturity = [Coupon + (Face Value - Price)/n] / (Face Value + Price)/2 Yield to Maturity = [75 + (1000 - 1108.15)/14] / [1000 + 1108.15]/2 Yield to Maturity = (75 - 7.725) / 1054.075 Yield to Maturity = 67.275/1054.075 Yield to Maturity = 0.0631 or 6.31% Therefore the right option is (a) 6.31%

Which one of the following is a correct statement concerning risk premium? A) The greater the volatility of returns, the greater the risk premium. The lower the volatility of returns, the greater the risk premium. The lower the average rate of return, the greater the risk premium. The risk premium is not correlated to the average rate of return. The risk premium is not affected by the volatility of returns.

A) The greater the volatility of returns, the greater the risk premium.

The CAPM has an advantage over DDM because the CAPM: A) explicitly adjusts for risk. B) applies to firms that pay dividends. C) is more simplistic. D) specifically considers a firm's degree of operating leverage. E) ignores changes in the overall market over time.

A) explicitly adjusts for risk.

Standard deviation measures _____ risk while beta measures ____ risk. A) total; systematic B) nondiversifiable; diversifiable C) unsystematic; total D) unsystematic; systematic E) total; unsystematic

A) total; systematic

Aspens is preparing a bond offering with a coupon rate of 5.5 percent. The bonds will be repaid in 10 years. The company plans to issue the bonds at par value and pay interest semiannually. Which one of the following statements is correct? A) The bonds will pay 19 interest payments and one principal payment. B) The bonds will initially sell at a discount. C) At maturity, the bonds will pay a final payment of $1,055. D) The bonds will pay ten equal coupon payments. E) At issuance, the bond's yield to maturity is 5.5 percent.

Answer is the bond's yield to maturity is 5.5 percent. Explnation:A bond's coupon rate is equal to its yield to maturity if its purchase price is equal to its par value. For example , Par value of bond is $ 1000, Terminal value =$ 1000, coupon rate=5.5% YTM formula ={Interest +Terminal value -Face value)/No of years to maturity}/Initial investment ={1000*5.5% +(1000-1000)/10 }/1000 =(1000*5.5%+0)/1000 =1000*5.5%/1000 YTM =5.5%

What would be the maximum an investor should pay for the common stock of a firm that has no growth opportunities but pays a dividend of $1.36 per year? The required rate of return is 12.5 percent. A) $9.52 B) $10.88 C) $11.24 D) $10.64 E) $11.47

B) $10.88 We need to compute this using dividend discount model also known as gordans formula Po = Dividend in next year /(Ke - G) Ke = required rate of return Po= price of the stock ready to pay at time T0 G = growth hence Po = 1.36/12.5% since no growth rate Therefore Maximum an investor should pay Price = $10.88

You bought 360 shares of stock at a total cost of $7,754.40. You received a total of $403.20 in dividends and sold your shares for $19.98 a share. What was your total rate of return? A) 3.67% B) -2.04% C) -1.29% D) 7.24% E) 5.38%

B) -2.04% Selling price = 360*19.98 = 7192.80 Profit % = (7192.80 + 403.20 - 7754.40)/7754.40 Profit % = -2.04%

A 12-year, 5 percent coupon bond pays interest annually. The bond has a face value of $1,000. What is the percentage change in the price of this bond if the market yield rises to 6 percent from the current level of 5.5 percent? A)-5.28% B) -4.26% C) -2.38% D) 1.13% E) 4.13%

B) -4.26%

There is a 15 percent probability the economy will boom; otherwise, it will be normal. Stock G should return 15 percent in a boom and 8 percent in a normal economy. Stock H should return 9 percent in a boom and 6 percent otherwise. What is the variance of a portfolio consisting of $3,500 in Stock G and $6,500 in Stock H? A) .000209 B) .000247 C) .002098 D) .037026 E) .073600

B) .000247

Zoom stock has a beta of 1.46. The risk-free rate of return is 3.07 percent and the market rate of return is 11.81 percent. What is the amount of the risk premium on Zoom stock? A) 8.09% B) 12.76% C) 9.59% D) 10.25% E) 17.24%

B) 12.76% Beta, B = 1.46 Return on Market, Rm = 11.81% Risk Free Rate, Rf = 3.07% Risk Premium = Beta(Rm-Rf) Risk Premium = 1.46(11.81% - 3.07%) Risk Premium = 1.46 * 8.74% Risk Premium = 12.76%

A stock was priced at $23.08, $24.15, $23.99, and $24.26 at end of Years 1 to 4, respectively, The annual dividend is constant at $.20 a share. What is the geometric average return on this stock? A) 3.27% B) 2.52% C) 2.56% D) 2.48% E) 3.31%

B) 2.52% Geometric Average Return = (1.0087 x 1.0083 x 1.0083 x 0.958) ^1/4-1 = 2.52%

You have a sampling of returns for the Malta Stock Fund. The returns are 7.25 percent, 5.63 percent, 12.56 percent, and 1.08 percent. What is the average arithmetic return and variance of this sampling? A) 6.57%; .00287 B) 6.63%; .00225 C) 6.65%; .00215 D) 6.63%; .00287 E) 6.65%; .00215

B) 6.63%; .00225 Average arithematice return = Sum of all the stocks returns / Number of years Average return of the sampling = ( 7.25% + 5.63% + 12.56% + 1.08% ) / 4 = 6.63%

A bond with a face value of $1,000 that sells for less than $1,000 in the market is called a _____ bond. A) Par B) discount C) Premium D) Zero Coupon E) Floating rate

B) discount

The beta of a firm is more likely to be high under which two conditions? A) high cyclical business activity and low operating leverage B) high cyclical business activity and high operating leverage C) low cyclical business activity and low financial leverage D) low cyclical business activity and low operating leverage E) low financial leverage and low operating leverage

B) high cyclical business activity and high operating leverage

Norris Co. has developed an improved version of its most popular product. To get this improvement to the market, will cost $48 million and will return an additional $13.5 million for 5 years in net cash flows. The firm's debt-equity ratio is .25, the cost of equity is 13 percent, the pretax cost of debt is 9 percent, and the tax rate is 30 percent. What is the net present value of this proposed project? A) $1,306,411 B) $1,102,459 C) $1,077,180 D) $1,214,318 E) $989,760

C) $1,077,180

City Movers announced that its next annual dividend will be $.40 a share. The following dividends will be $.60, and $.75 a share annually for the following two years, respectively. After that, dividends are projected to increase by 3.5 percent per year. How much is one share of this stock worth at a rate of return of 12 percent? A) $8.45 B) $6.84 C) $7.87 D) $8.06 E) $7.03

C) $7.87 At the end of year 3, the value of share = D1 / (Re - G) = $0.75 x 1.035 / (0.12 - 0.035) = $9.13 1 0.40 0.8929 0.3571 2 0.60 0.7972 0.4783 3 0.75 0.7118 0.5338 3 9.13 0.7118 6.4986 Price 7.8678

Jack's Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding 8.6 percent. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. Treasury bill is yielding 4 percent and the market risk premium is 8 percent. Jack's tax rate is 34 percent. What is Jack's weighted average cost of capital? A) 10.10% B) 11.39% C) 10.43% D) 10.65% E) 11.47%

C) 10.43% Debt Number of bond = 80,000 Face value = $1,000 Market value of long term debt = ($1,000 × 80,000) = $80,000,000 YTM of Bond = 8.60%. Tax rate is 34%. So, cost of after tax is calculated below: After tax cost per debt = 8.60% × (1 - 34%) = 5.676% After tax cost of debt is 5.676%. EQUITY Number of share outstanding = 4,000,000 Price of stock = $40 Market value of equity = $40 × 4,000,000 = $160,000,000 Risk free rate = 4.00% Market return = 8.00% Beta = 1.10 Cost of common Equity is calculated below using CAPM formula: Cost of common Equity = Risk free rate + Risk Premium× Beta = 4.00% + 8.00% × 1.1 = 4.00% + 8.80% = 12.80% Cost of common Equity is 12.80%. Value of total capital = $80 million + $160 million = $240 million Weight of debt = 33.33% Weight of equity = 66.67% Now WACC is calculated below: WACC = (66.67% × 12.80%) + (33.33% × 5.676%) = 8.53% + 1.892% = 10.43 WACC of company is 10.43%.

The stock of Martin Industries has a beta of 1.43. The risk-free rate of return is 3.6 percent and the market risk premium is 9 percent. What is the expected rate of return? A) 11.32% B) 14.17% C) 16.47% D) 17.48% E) 18.03%

C) 16.47% Expected rate of return = Risk-free rate + Beta(Market risk premium) = 3.6% + 1.43(9%) = 3.6% + 12.87% = 16.47%

One year ago, you purchased 300 shares of IXC stock at a price of $22.05 per share, received $460 in dividends over the year, and today sold all of your shares for $29.32 per share. What was your dividend yield? A) 5.23% B) 5.87% C) 6.95% D) 1.92% E) 2.48%

C) 6.95% Dividend per share = 460 / 300 =1.53333 Dividend Yield = Dividend / Price 1.53333 / 22.05 0.069539 =6.59%

Allison's wants to raise $12.4 million to expand its business. To accomplish this, it plans to sell 25-year, $1,000 face value, zero-coupon bonds. The bonds will be priced to yield 6.5 percent, with semiannual compounding. What is the minimum number of bonds Allison's must sell to raise the $12.4 million it needs? A)59,864 B) 52,667 C) 61,366 D) 60,107 E) 60,435

C) 61,366

The returns on a portfolio over the last five years were: --5.2 percent, 21.6 percent, 4.5 percent, 11.7 percent, and 5.9 percent. What is the standard deviation of these returns? A) 8.82% B) 9.21% C) 9.86% D) 9.08% E) 9.73%

C) 9.86% Average return=(Total returns/Total time period) =(-5.2+21.6+4.5+11.7+5.9)/5=7.7% REturn (REturn-Mean)^2 -5.2 (-5.2-7.7)^2=166.41 21.6 (21.6-7.7)^2=193.21 4.5 (4.5-7.7)^2=10.24 11.7 (11.7-7.7)^2=16 5.9 (5.9-7.7)^2=3.24 Total 389.1% Hence SD=[Total of (REturn-mean)^2/(Time period-1]^(1/2) =9.86%(Approx).

Which one of these factors generally has the greatest impact on a firm's PE ratio? A) required rate of return B) current dividends C) future opportunities D) the overall risk level of the current firm E) depreciation method used by the firm

C) future opportunities

Assume you are using the dividend growth model to value stocks. If you expect the market rate of return to increase across the board on all equity securities, then you should also expect the: A) market values of all stocks to increase. B) market values of all stocks to remain constant as the dividend growth will offset the increase in the market rate. C) market values of all stocks to decrease. D) stocks that do not pay dividends to decrease in price while the dividend-paying stocks maintain a constant price. E) dividend growth rates to increase to offset this change.

C) market values of all stocks to decrease

For a multi-product firm, if a project's level of risk differs from that of the overall firm, then the: A) CAPM can no longer be used to estimate the cost of equity as beta no longer applies. B) project should be discounted using the overall firm's beta. C) project should be discounted using a beta commensurate with the project's risks. D) project should be discounted at the market rate. E) project should be discounted at the T-bill rate.

C) project should be discounted using a beta commensurate with the project's risks.

As we add more diverse securities to a portfolio, the ____ risk of the portfolio will decrease while the _____ risk will not. A) total; unsystematic B) systematic; unsystematic C) total; systematic D) systematic; total E) unsystematic; total

C) total; systematic

A stock with an actual return that lies above the security market line has: A) more systematic risk than the overall market. B) more risk than warranted based on the realized rate of return. C) yielded a higher return than expected for the level of risk assumed. D) less systematic risk than the overall market. E) yielded a return equivalent to the level of risk assumed.

C) yielded a higher return than expected for the level of risk assumed.

Upland Motors recently paid a $1.48 per share annual dividend. Dividends are expected to increase by 2.5 percent annually. What is one share of this stock worth today if the appropriate discount rate is 14 percent? A) $12.87 B) $13.04 C) $14.16 D) $13.19 E) $12.25

D) $13.19 Po = D1 / (r-g) Po = $1.48*1.025 / (14%-2.5%) Po = $1.517 / 11.5% Po = 13.19

Alpha Industries is going to pay $.35, $.50, and $.80 a share over the next three years, respectively. After that, the company has stated that the annual dividend will be $1.25 per share indefinitely. What is this stock worth today at a discount rate of 13.45 percent? A) $6.20 B) $9.48 C) $10.88 D) $7.61 E) $5.06

D) $7.61 Cash Inflows (Dividend) 1.00 0.8814 0.3500 0.31 Cash inflows (Dividend) 2.00 0.7769 0.5000 0.39 Cash inflows (Dividend) 3.00 0.6848 0.8000 0.55 Cash inflows (Price) = 1.25/13.45% 3.00 0.6848 9.2937 6.36 Current Price of Stock 7.61

The variance of Stock A is .0036, the variance of the market is .0059, and the covariance between the two is .0026. What is the correlation coefficient? A) .8776 B) .1224 C) .5010 D) .5642 E) .4918

D) .5642 Correlation co-efficient = Covariance÷(Standard deviation of market×Standard deviation of Stock A ) = 0.0026/(0.0036×0.0059)^0.50 = 0.5642

HNT is an all-equity firm with a beta of .88. What will the firm's equity beta be if the firm switches to a debt-equity ratio of .35? A) .880 B) 8.567 C) .972 D) 1.188 E) 1.204

D) 1.188

A portfolio consists of three stocks. There are 540 shares of Stock A valued at $24.20 share, 310 shares of Stock B valued at $48.10 a share, and 200 shares of Stock C priced at $26.50 a share. Stocks A, B, and C are expected to return 8.3 percent, 16.4 percent, and 11.7 percent, respectively. What is the expected return on this portfolio? A) 12.50% B) 11.67% C) 12.78% D) 12.47% E) 11.87%

D) 12.47%

Bikes and More just announced its next annual dividend will be $2.42 a share and all future dividends will increase by 2.5 percent annually. What is the market rate of return if this stock is currently selling for $22 a share? A) 13.62% B) 13.84% C) 13.58% D) 13.50% E) 13.46%

D) 13.50% Current Price = D1 / Ke - g D1 - Expected Dividend Next Year Ke - Market rate of return g - growth rate Hence, 22 = 2.42 / (Ke - 0.025) or, 22Ke =2.42 + 0.55 or, Ke = 2.97 / 22 = 0.135 Hence, market rate of return is 13.5%

The risk-free rate of return is 3.68 percent and the market risk premium is 7.84 percent. What is the expected rate of return on a stock with a beta of 1.32? A) 9.17% B) 9.24% C) 13.12% D) 14.03% E) 14.36%

D) 14.03% Required return (CAPM) = Rf+β×Rp Rf is risk free return β is beta of the security Rp is risk premium = 3.68%+1.32×7.84% = 14.03%

Sound Systems (SS) has 200,000 shares of common stock outstanding at a market price of $37 a share. SS recently paid an annual dividend in the amount of $1.20 per share. The dividend growth rate is 4 percent. SS also has 4,500 bonds outstanding with a face value of $1,000 per bond that are selling at 99 percent of par. The bonds have a 6 percent coupon and a 6.7 percent yield to maturity. If the tax rate is 34 percent, what is the weighted average cost of capital? A) 5.33% B) 5.87% C) 6.49% D) 6.26% E) 7.28%

D) 6.26%

A corporate bond with a face value of $1,000 matures in 4 years and has a coupon rate of 6.25 percent. The current price of the bond is $932 and interest is paid semiannually. What is the yield to maturity? A)9.05% B) 6.67% C) 8.58% D) 8.28% E) 7.92%

D) 8.28%

Six months ago, you purchased 100 shares of stock in ABC at a price of $43.26 a share. The stock pays a quarterly dividend of $.10 a share. Today, you sold all of your shares for $46.71 per share. What is your holding period total return? A)8.24% B) 7.81% C) 7.97% D) 8.44% E) 8.90%

D) 8.44% Total Return = (Total dividend + Capital gain) / Stock price at the beginning = ($0.10 x 2 quarters) + ($46.71 - $43.26) / $43.26 = $0.20 + $3.45 / $43.26 = 0.0844 or 8.44%

The economy has a 10 percent chance of booming, 60 percent chance of being normal, and 30 percent chance of going into a recession. A stock is expected to return 16 percent in a boom, 11 percent in a normal, and lose 8 percent in a recession. What is the standard deviation of the returns? A) 5.80% B) 7.34% C) 8.38% D) 9.15% E) 9.87%

D) 9.15% a. chance * expected return b. expected return - total expected return c. expected return - total expected return * expected return - total expected return d. expected return - total expected return * expected return - total expected return * chance 1. 10% 16 a. 1.6 b. 10.20 c. 104.04 d. 10.404 2. 60% 11 a. 6.6 b.5.20 c. 27.04 d. 16.224 3. 30% -8 a.-2.4 b.-13.80 c. 190.44 d. 57.132 total expected return a. 5.8 d. 83.76 standard deviation root over of expected return - total expected return * expected return - total expected return * chance standard deviation = root over of 83.76 standard deviation = 9.15%

Peter's Audio has a yield to maturity on its debt of 7.8 percent, a cost of equity of 12.4 percent, and a cost of preferred stock of 8 percent. The firm has 105,000 shares of common stock outstanding at a market price of $22 a share. There are 25,000 shares of preferred stock outstanding at a market price of $45 a share. The bond issue has a total face value of $1.5 million and sells at 98 percent of face value. If the tax rate is 34 percent, what is the weighted average cost of capital? A) 9.04% B) 8.54% C) 8.69% D) 9.22% E) 9.45%

D) 9.22%

All else constant, a coupon bond that is selling at a premium, must have: A) a coupon rate that is equal to the yield to maturity. B) a market price that is less than par value. C) semiannual interest payments. D) a yield to maturity that is less than the coupon rate. E) a coupon rate that is less than the yield to maturity.

D) a yield to maturity that is less than the coupon rate.

The _____ premium is that portion of the bond yield that represents compensation for potential difficulties that might be encountered should the bond holder wish to sell the bond prior to maturity. A) default risk B) taxability C) infaltion D) liquidity E) interest rate risk

D) liquidity

Tin Roof's net cash flows for the next three years are projected at $72,000, $78,000, and $84,000, respectively. After that the cash flows are expected to increase by 3.2 percent annually. The aftertax cost of debt is 6.2 percent and the cost of equity is 11.4 percent. What is the value of the firm if it is financed with 40 percent debt and 60 percent equity? A) $1,215,650 B) $1,328,141 C) $1,461,439 D) $1,575,941 E) $1,279,623

E) $1,279,623

Rosita's announced that its next annual dividend will be $1.65 a share and all future dividends will increase by 2.5 percent annually. What is the maximum amount you should pay to purchase a share of this stock if you require a 12 percent rate of return? A) $13.75 B) $17.80 C) $15.46 D) $16.94 E) $17.37

E) $17.37 Po = D1 / (r-g) $1.65/ (12%-2.5%) $1.65 / 9.5% Po= $17.37

Hu's has 25,000 shares of common stock outstanding with a beta of 1.4, a market price of $32 a share, and a dividend yield of 5.7 percent. Dividends increase by 4.2 percent annually. The firm also has $450,000 of debt outstanding that is selling at 102 percent of par that has a yield to maturity of 6.8 percent. The tax rate is 35 percent. The firm is considering a project that has the same risk level as the firm's current operations, an initial cost of $328,000 and cash inflows of $52,500, $155,000, and $225,000 for Years 1 to 3, respectively. What is the NPV of the project? A) $48,515 B) $61,492 C) $46,511 D) $57,006 E) $32,899

E) $32,899