Cost of Capital and Capital Structure (chap 15-17)

If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to:

-Reject some positive NPV projects -Accept some negative NPV projects -Favor high risk projects over lo risk projects -Increase it overall level of risk overtime

Which one of the following earned the highest risk premium over the period 1926-2019?

Small Company Stocks

A company that has a(n) ________ would be most likely to have a high percentage of debt in its optimal capital structure. Choose ALL the correct answers. exceptionally high level of depreciation expense

low probability of financial distress

Based on the capital asset pricing model, which one of the following must increase the expected return on an individual security, all else held constant?

A decrease in the risk-free rate given a security beta of 1.06

Which one of the following had a zero standard deviation of returns for the period of 1926-2019?

All of the listed security types had a standard deviation of returns in excess of zero percent.

Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Ignore taxes. Select ALL the correct answers.

At the break-even EBIT, there is no advantage to debt.

The aftertax cost of debt:

Has a greater effect on a firm's cost of capital when the debt-equity ratio is higher

Which of the following statements are true of a well-diversified portfolio's expected return? Assume that all portfolio weights are positive. Choose ALL the correct answers.

I. It cannot exceed the expected return of the best performing security in the portfolio. II. It must be equal to or greater than the expected return of the worst performing security in the portfolio. III. It is independent of the unsystematic risks of the individual securities held in the portfolio.

With respect to returns, which one of the following statements is accurate?

Over time, the average unexpected return will be zero.

Shoe Box Stores is currently an all-equity firm with 25,000 shares of stock outstanding. Management is considering changing the capital structure to 35 percent debt. The interest rate on the debt would be 8 percent. Ignore taxes. Jamie owns 600 shares of Shoe Box Stores stock that is priced at $22 a share. What should Jamie do if she prefers the all-equity structure but Shoe Box Stores adopts the new capital structure?

Since the firm is using 35 percent leverage, Jamie can offset the firm's leverage by selling shares and loaning out 35 percent of her investment at 8 percent interest. Number of shares to be sold = 600 shares × .35 = 210 shares

The U.S. Securities and Exchange Commission periodically charges individuals with insider trading and claims those individuals have made unfair profits. Given this, you would be most apt to argue that the markets are less than _____ form efficient.

Strong

The common stock of Alpha Manufacturers has a beta of 1.24 and an actual expected return of 13.25 percent. The risk-free rate of return is 3.7 percent and the market rate of return is 11.78 percent. Which of the following statements is true given this information (choose ALL the correct answers)?

The actual expected stock return indicates the stock is currently overpriced.

Assume a stock experiences an actual return that is above the security market line. An analyst can safely conclude that the stock has (choose ALL the correct answers):

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

Stock Alpha has a beta of .79 and a reward-to-risk ratio that is less than the reward-to-risk ratio of Stock Omega. Omega has a beta of 1.12. This information implies that (choose ALL the correct answers): Alpha is riskier than Omega and both stocks are fairly priced.

either Alpha is overpriced or Omega is underpriced or both.

Asset-specfic risk

risk that affects a very small number of assets, unsystematic risk

Portfolio Beta

the weighted average of the betas for each asset in the portfolio

Portfolio expected return

the weighted average of the expected returns for each asset in the portfolio