Corporations Multiple Choice Final

If you want to value a firm but don't want to explicitly forecast its dividends, share repurchases, or its use of debt, what is the simplest model for you to use? A) Discounted free cash flow model B) Dividend discount model C) Enterprise value model D) Total payout model

A

The firm's unlevered (asset) cost of capital is: A) the weighted average of the equity cost of capital and the debt cost of capital. B) the weighted average of the levered cost of capital and the equity cost of capital. C) the debt cost of capital minus the equity cost of capital. D) the unlevered beta minus the cost of capital.

A

Which of the following is NOT a diversifiable risk? A) The risk that oil prices rise, increasing production costs B) The risk of a product liability lawsuit C) The risk that the CEO is killed in a plane crash D) The risk of a key employee being hired away by a competitor

A

Which of the following is NOT a way that a firm can increase its dividend? A) By increasing its retention rate B) By decreasing its shares outstanding C) By increasing its earnings (net income) D) By increasing its dividend payout rate

A

Which of the following statements is FALSE? A) FV = PV/(1+r)^n B) PV = C) FV = Cn × (1 + r)n D) Most investment opportunities have multiple cash flows that occur at different points in time.

A

Which of the following statements is FALSE? A) If a bond trades at a premium, its yield to maturity will exceed its coupon rate. B) A bond that trades at a premium is said to trade above par. C) When a coupon-paying bond is trading at a premium, an investor's return from the coupons is diminished by receiving a face value less than the price paid for the bond. D) Holding fixed the bond's yield to maturity, for a bond not trading at par, the present value of the bond's remaining cash flows changes as the time to maturity decreases.

A

Which of the following types of risk doesn't belong? A) Idiosyncratic risk B) Undiversifiable risk C) Market risk D) Systematic risk

A

Which of the following types of risk doesn't belong? A) Market risk B) Unique risk C) Idiosyncratic risk D) Unsystematic risk

A

Which of the following statements is FALSE? A) We should use the general dividend discount model to value the stock of a firm with rapid or changing growth. B) As firms mature, their growth slows to rates more typical of established companies. C) The dividend discount model values the stock based on a forecast of the future dividends paid to shareholders. D) The simplest forecast for the firm's future dividends states that they will grow at a constant rate, g, forever.

A) A multistage model should be used

Which of the following statements is FALSE? A) Because investors are risk averse, they will demand a risk premium to hold unsystematic risk. B) Over any given period, the risk of holding a stock is that the dividends plus the final stock price will be higher or lower than expected, which makes the realized return risky. C) The risk premium for diversifiable risk is zero, so investors are not compensated for holding firm-specific risk. D) Because investors can eliminate firm-specific risk "for free" by diversifying their portfolios, they will not require a reward or risk premium for holding it.

A) Because investors are risk averse, they will demand a risk premium to hold systematic risk.

Which of the following statements is FALSE? A) Fluctuations of a stock's returns that are due to firm-specific news are common risks. B) The volatility in a large portfolio will decline until only the systematic risk remains. C) When we combine many stocks in a large portfolio, the firm-specific risks for each stock will average out and be diversified. D) The risk premium of a security is determined by its systematic risk and does not depend on its diversifiable risk

A) Fluctuations of a stock's returns that are due to firm-specific news are not common risks.

The geometric average annual return on Stock A from 2000 to 2009 is closest to: A) 12.4% B) 16.7% C) 13.2% D) 17.8%

A) Geometric Average = blank - 1=blank - 1 = 1.124476 - 1 = 0.124476

Francisco d'Anconia is considering an investment opportunity that costs $10,000 today and will pay $11,500 in two years. The IRR of this opportunity is closest to: A) 7.25% B) 7.50% C) 10.00% D) 15.00%

A) IRR= blank - 1= .072381

Which of the following statements is false regarding profitable and unprofitable growth? A) If a firm wants to increase its share price, it must cut its dividend and invest more. B) If the firm retains more earnings, it will be able to pay out less of those earnings, which means that the firm will have to reduce its dividend. C) A firm can increase its growth rate by retaining more of its earnings. D) Cutting the firm's dividend to increase investment will raise the stock price if, and only if, the new investments have a positive NPV.

A) This will only increase the share price if the reinvested money is invested in positive NPV projects.

Assuming the appropriate YTM on the SASE bond is 7.5%, then the price that this bond trades for will be closest to: A) $1,045 B) $691 C) $1,000 D) $957

A)FV= 1000 I= 3.75 (7.5/2) PMT= 40 (80/2) N= 30 (15 × 2) Compute PV= 1044.57

SASE industries is seeking to raise capital from a large group of investors to fund a new project. Suppose that the efficient portfolio has an expected return of 14% and a volatility of 20%. Sisyphean's new project is expected to have a volatility of 40% and a 70% correlation with the efficient portfolio. The risk-free rate is 4%. 7) The beta for SASE's new project is closest to: A) 1.25 B) 1.40 C) 0.70 D) 1.75

B

Which of the following statements is FALSE? A) Bonds are a securities sold by governments and corporations to raise money from investors today in exchange for promised future payments. B) By convention the coupon rate is expressed as an effective annual rate. C) Bonds typically make two types of payments to their holders. D) The time remaining until the repayment date is known as the term of the bond.

B

Which of the following statements is FALSE? A) The amount of each coupon payment is determined by the coupon rate of the bond. B) Prior to its maturity date, the price of a zero-coupon bond is always greater than its face value. C) The simplest type of bond is a zero-coupon bond. D) Treasury bills are U.S. government bonds with a maturity of up to one year.

B

Which of the following statements is FALSE? A) The total payout model allows us to ignore the firm's choice between dividends and share repurchases. B) By repurchasing shares, the firm increases its share count, which decreases its earnings and dividends on a per-share basis. C) The total payout model discounts the total payouts that the firm makes to shareholders, which is the total amount spent on both dividends and share repurchases. D) In the dividend discount model we implicitly assume that any cash paid out to the shareholders takes the form of a dividend

B) By repurchasing shares, the firm decreases its share count, which increases its earning and dividends on a per-share basis

The SASE Company has a bond outstanding with a face value of $1000 that reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate for this bond is 8% and that the coupon payments are to be made semiannually. How much will each semiannual coupon payment be? A) $60 B) $40 C) $120 D) $80

B) Coupon = (coupon rate × face value)/number of coupons per year= (.08 × 1000)/2 = $40

Nielson Motors has a share price of $25 today. If Nielson Motors is expected to pay a dividend of $0.75 this year, and its stock price is expected to grow to $26.75 at the end of the year, then Nielson's dividend yield and equity cost of capital are: A) 3.0% and 7.0% respectively. B) 3.0% and 10.0% respectively. C) 4.0% and 6.0% respectively D) 4.0% and 10.0% respectively

B) Dividend Yield = $0.75/$25 = .03 or 3% Equity cost of capital = 0.75/25.00 + (26.75 - 25.00)/25.00 = .03 + ..07 = .10 or 10%

Suppose that in the coming year, you expect Exxon-Mobil stick to have a volatility of 42% and a beta of 0.9, and Merck's stock to have a volatility of 24% and a beta of 1.1. The risk free interest rate is 4% and the market's expected return is 12%. The cost of capital for a project with the same beta as Exxon Mobil's stock is closest to: A) 11.6% B) 11.2% C) 12.8% D) 7.6%

B) E[R] =Rf+Beta× Risk Premium = .04 + .9× (.12 - .04) = .112

Suppose that in the coming year, you expect Exxon-Mobil stick to have a volatility of 42% and a beta of 0.9, and Merck's stock to have a volatility of 24% and a beta of 1.1. The risk free interest rate is 4% and the market's expected return is 12%. The cost of capital for a project with the same beta as Merck's stock is closest to: A) 11.2% B) 12.8% C) 12.4% D) 11.6%

B) E[R] =Rf+Beta× Risk Premium = .04 + 1.1 × (.12 - .04) = .128

Which of the following statements is FALSE? A) When an investment is risky, there are different returns it may earn. B) In finance, the variance of a return is also referred to as its volatility. C) The expected or mean return is calculated as a weighted average of the possible returns, where the weights correspond to the probabilities. D) The variance is a measure of how "spread out" the distribution of the return is.

B) In finance, the standard deviation of a return is also referred to as its volatility.

Nielson Motors is considering an opportunity that requires an investment of $1,000,000 today and will provide $250,000 one year from now, $450,000 two years from now, and $650,000 three years from now. If the appropriate interest rate is 10%, then the NPV of this opportunity is closest to: A) ($88,000) B) $88,000 C) $300,000 D) $1,300,000

B) NPV = -1,000,000 + 250,000/(1.10)^1+ 450,000/(1.10)^2+ 650,000/(1.10)^3= 87,528.17

You expect KT Industries (KTI) will have earnings per share of $3 this year and expect that they will pay out $1.50 of these earnings to shareholders in the form of a dividend. KTI's return on new investments is 15% and their equity cost of capital is 12%. The expected growth rate for KTI's dividends is closest to: A) 6.0% B) 7.5% C) 4.5% D) 3.0%

B) g= retention rate × return on new investment = (3.00-1.50) / 3.00 × 0.15 = 0.075 or 7.5%

The equity cost of capital for "Meenie" is closest to: A) 4.50% B) 7.50% C) 9.30% D) 9.75%

B) rMeenie= 3% + 0.75(9% - 3%) = 7.5%

If you want to value a firm that consistently pays out its earnings as dividends, the simplest model for you to use is the: A) enterprise value model. B) total payout model. C) dividend discount model. D) discounted free cash flow model.

C

If you want to value a firm that has consistent earnings grow, but varies how it pays out these earnings to shareholders between dividends and repurchases, the simplest model for you to use is the: A) enterprise value model. B) dividend discount model. C) total payout model. D) discounted free cash flow model

C

In practice which market index is most widely used as a proxy for the market portfolio in the CAPM? A) Dow Jones Industrial Average B) Wilshire 5000 C) S&P 500 D) U.S. Treasury Bill

C

The difference between the weighted-average cost of capital (WACC) and the pre-tax (unlevered) WACC is: A) the weighted-average cost of capital is based on the after-tax cost of equity and the pre-tax WACC is based on the after-tax cost of debt. B) the weighted-average cost of capital multiplies the cost of equity and the cost of debt by (1-tax rate) and the pre-tax WACC does not. C) the weighted-average cost of capital multiplies the cost of debt by (1-tax rate) and the pre-tax WACC does not. D) the weighted-average cost of capital multiplies the component costs of equity and debt by their weight in the capital structure, and the pre-tax WACC does not.

C

The volatility of the market portfolio is 10%, the expected return on the market is 12%, and the risk-free rate of interest is 4%. The beta for Taggart Transcontinental is closest to: A) 0.75 B) 0.80 C) 1.00 D) 1.10

C

Which of the following statements is FALSE? A) Bond prices converge to the bond's face value due to the time effect, but simultaneously move up and down due to unpredictable changes in bond yields. B) As interest rates and bond yields fall, bond prices will rise. C) Bonds with higher coupon rates are more sensitive to interest rate changes. D) Shorter maturity zero coupon bonds are less sensitive to changes in interest rates than are longer-term zero coupon bonds.

C

Which of the following statements is FALSE? A) The bond certificate typically specifies that the coupons will be paid periodically until the maturity date of the bond. B) The bond certificate indicates the amounts and dates of all payments to be made. C) The only cash payments the investor will receive from a zero coupon bond are the interest payments that are paid up until the maturity date. D) Usually the face value of a bond is repaid at maturity

C

Which of the following statements is FALSE? A) The long-run growth rate gFCF is typically based on the expected long-run growth rate of the firm's revenues. B) Because the firm's free cash flow is equal to the sum of the free cash flows from the firm's current and future investments, we can interpret the firm's enterprise value as the total NPV that the firm will earn from continuing its existing projects and initiating new ones. C) If the firm has no debt then rwacc = the risk-free rate of return. D) When using the discounted free cash flow model, we forecast the firm's free cash flow up to some horizon, together with some terminal (continuation) value of the enterprise.

C) If the firm has no debt then rwacc= the cost of equity

Nielson Motors is considering an opportunity that requires an investment of $1,000,000 today and will provide $250,000 one year from now, $450,000 two years from now, and $650,000 three years from now. The Internal Rate of return of this project is closest to: A) 10.2% B) 12.2% C) 14.2% D) 16.2%

C) NPV = 0 = -1,000,000 + 250,000/(1.142)1+ 450,000/(1.142)2+ 650,000/(1.142)3

You are considering purchasing a new home. You will need to borrow $250,000 to purchase the home. A mortgage company offers you a 15 year fixed rate mortgage (180 months) at 9% APR (0.75% month). If you borrow the money from this mortgage company, your monthly mortgage payment will be closest to: A) $2,585 B) $660 C) $2,535 D) $1,390

C) PV = 250000 I= 0.75 N= 180 FV = 0 Compute payment = $2535.67

If the current rate of interest is 8%, then the present value of an investment that pays $1000 per year and lasts 20 years is closest to: A) $18,519 B) $45,761 C) $9,818 D) $20,000

C) PV = C/r (1 - (1 + r)-N

You have an $8,000 balance on your credit card, which charges 12% interest annually (1% per month). If you can afford to pay $100 per month, how many months will it take to pay the credit card in full? A) 170 months B) 14 months C) 162 months D) You will never get the card paid off at that rate.

C) PV= 8000 FV= 0 I= 1 PMT= -100 Compute N= 161.75

Which of the following statements is FALSE? A) Beta measures the sensitivity of a security to market wide risk factors. B) Volatility measures total risk, while beta measures only systematic risk. C) The beta is the expected percentage change in the excess return of the market portfolio for a 1% change in the excess return of a security. D) Utilities tend to be stable and highly regulated, and thus are insensitive to fluctuations in the overall market.

C) The beta is the expected percentage change in the excess return of a security fora 1% change in the excess return of the market portfolio.

The equity cost of capital for "Miney" is closest to: A) 6.30% B) 7.50% C) 9.30% D) 9.75%

C) rMiney= 3% + 1.05(9% - 3%) = 9.3%

Which of the following is NOT a systematic risk? A) The risk that oil prices rise, increasing production costs B) The risk that the Federal Reserve raises interest rates C) The risk that the economy slows, reducing demand for your firm's products D) The risk that your new product will not receive regulatory approval

D

Which of the following statements is FALSE? A) Because interest rates may be quoted for different time intervals, it is often necessary to adjust the interest rate to a time period that matches that of our cash flows. B) The effective annual rate indicates the amount of interest that will be earned at the end of one year. C) The annual percentage rate indicates the amount of simple interest earned in one year. D) The annual percentage rate indicates the amount of interest including the effect of compounding.

D

Suppose a five-year bond with a 7% coupon rate and semiannual compounding is trading for a price of $951.58. Expressed as an APR with semiannual compounding, this bonds yield to maturity (YTM) is closest to: A) 7.0% B) 7.5% C) 7.8% D) 8.2%

D PMT = 35, FV = 1000, PV = -951.58, N = 10, Compute I = 4.099949 × 2 =8.199898%

Which of the following statements is FALSE? A) Estimating dividends, especially for the distant future, is difficult. B) A firm can only pay out its earnings to investors or reinvest their earnings. C) Successful young firms often have high initial earnings growth rates. D) According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the growth rate.

D) According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital adjusted by the growth rate.

Which of the following statements regarding growing annuities is FALSE? A) A growing annuity is a stream of N growing cash flows, paid at regular intervals. B) We assume that g < r when using the growing annuity formula. C) PV of a growing annuity = C × D) A growing annuity is like a growing perpetuity that never comes to an end.

D) An annuity does end.

Which of the following statements is FALSE? A) Beta is the expected percent change in the excess return of the security for a 1% change in the excess return of the market portfolio. B) Beta represents the amount by which risks that affect the overall market are amplified for a given stock or investment. C) It is common practice to estimate beta based on the historical correlation and volatilities. D) Beta measures the diversifiable risk of a security, as opposed to its market risk, and is the appropriate measure of the risk of a security for an investor holding the market portfolio.

D) Beta measures the nondiversifiable risk of a security

Assume that the risk-free rate of interest is 3% and you estimate the market's expected return to be 9%. Which firm has the highest cost of equity capital? A) Eenie B) Meenie C) Miney D) Moe

D) Cost of capital is measured using the CAPM and is a linear function of beta. Therefore, the firm with the highest beta (Moe) has the highest cost of equity capital.

Which of the following statements is FALSE? A) Beta differs from volatility. B) The risk premium investors can earn by holding the market portfolio is the difference between the market portfolio's expected return and the risk-free interest rate. C) Stocks in cyclical industries, in which revenues tend to vary greatly over the business cycle, are likely to be more sensitive to systematic risk and have higher betas than stocks in less sensitive industries. D) If we assume that the market portfolio (or the S&P 500) is efficient, then changes in the value of the market portfolio represent unsystematic shocks to the economy.

D) If we assume that the market portfolio (or the S&P 500) is efficient, then changes in the value of the market portfolio represent systematic shocks to the economy.

An independent film maker is considering producing a new movie. The initial cost for making this movie will be $20 million today. Once the movie is completed, in one year, the movie will be sold to a major studio for $25 million. Rather than paying for the $20 million investment entirely using its own cash, the film maker is considering raising additional funds by issuing a security that will pay investors $11 million in one year. Suppose the risk-free rate of interest is 10%. What is the NPV of this project if the film maker invests his own money and does not issue the new security? What is the NPV if the film maker issues the new security? A) $1.7 million; $1.7 million B) $1.7 million; $2.7 million C) $2.7 million; $1.7 million D) $2.7 million; $2.7 million

D) NPV(no security)= -20+25/ 1.1= 2.7mil; NPV(w/ Security) -10+(25-11)/1.1=2.7mil

Which of the following statements is FALSE? A) Future dividend payments and stock prices are not known with certainty; rather these values are based on the investor's expectations at the time the stock is purchased. B) The capital gain is the difference between the expected sale price and the purchase price of the stock. C) The sum of the dividend yield and the capital gain rate is called the total return of the stock. D) We divide the capital gain by the expected future stock price to calculate the capital gain rate

D) The capital gains rate is the capital gain divided by the current stock price

Which of the following statements is FALSE? A) We must discount the cash flows from stock based on the equity cost of capital for the stock. B) The dividend yield is the percentage return the investor expects to earn from the dividend paid by the stock. C) The firm might pay out cash to its shareholders in the form of a dividend. D) The dividend yield is the expected annual dividend of a stock, divided by its expected future sale price.

D) The dividend yield is the annual dividend divided by the current price.

Which of the following statements is FALSE? A) Firm specific news is good or bad news about the company itself. B) Firms are affected by both systematic and firm-specific risk. C) When firms carry both types of risk, only the firm-specific risk will be diversified when we combine many firms' stocks into a portfolio. D) The risk premium for a stock is affected by its idiosyncratic risk.

D) The risk premium for a stock is affected by its systematic risk

Which of the following statements is FALSE? A) The standard deviation is the square root of the variance. B) Because investors dislike only negative resolutions of uncertainty, alternative measures that focus solely on downside risk have been developed, such as the semi-variance and the expected tail loss. C) While the variance and the standard deviation are the most common measures of risk, they do not differentiate between upside and downside risk. D) While the variance and the standard deviation both measure the variability of the returns, the variance is easier to interpret because it is in the same units as the returns themselves.

D) While the variance and the standard deviation both measure the variability of the returns, the standard deviation is easier to interpret because it is in the same units as the returns themselves

Which of the following statements is FALSE? A) The firm's weighted average cost of capital (WACC) denoted rwacc is the cost of capital that reflects the risk of the overall business, which is the combined risk of the firm's equity and debt. B) Intuitively, the difference between the discounted free cash flow model and the dividend-discount model is that in the divided-discount model the firm's cash and debt are included indirectly through the effect of interest income and expenses on earnings in the dividend-discount model. C) We interpret rwacc as the expected return the firm must pay to investors to compensate them for the risk of holding the firm's debt and equity together. D) When using the discounted free cash flow model we should use the firm's equity cost of capital.

D) You would use the firm's weighted average cost of capital

Your firm is planning to invest in a new power generation system. Galt Industries is an all equity firm that specializes in this business. Suppose Galt's equity beta is 0.75, the risk-free rate is 3%, and the market risk premium is 6%. If your firm's project is all equity financed, then your estimate of your cost of capital is closest to: A) 5.25% B) 6.00% C) 6.75% D) 7.50%

D) ri= rrf+β(rm- rrf) = .03 + .75(.06) = .075 or 7.5%