FIN 300

You want your portfolio beta to be .95. Currently, your portfolio consists of $4,000 invested in Stock A with a beta of 1.26 and $7,000 in Stock B with a beta of .94. You have another $8,000 to invest and want to divide it between an asset with a beta of 1.74 and a risk-free asset. How much should you invest in the risk-free asset?

$4,305

Nelson Paints recently went public by offering 50,000 shares of common stock to the public. The underwriters provided their services in a best efforts underwriting. The offering price was set at $17.50 a share and the gross spread was $2.30. After completing their sales efforts, the underwriters determined that they sold a total of 47,500 shares. How much cash did the company receive from its IPO?

$722,000

Assume a project has cash flows of −$54,300, $18,200, $37,300, and $14,300 for Years 0 to 3, respectively. What is the profitability index given a required return of 12.6 percent?

1.02

A project has cash flows of −$152,000, $60,800, $62,300 and $75,000 for Years 0 to 3, respectively. The required rate of return is 13 percent. What is the profitability index? Should you accept or reject the project based on this index value?

1.02, accept

What is the beta of the following portfolio? StockAmountInvestedSecurityBetaA$14,200 1.39 B$23,900 .98 C$8,400 1.52

1.2

You own a portfolio equally invested in a risk-free asset and two stocks. One of the stocks has a beta of 1.46 and the total portfolio is equally as risky as the market. What is the beta of the second stock?

1.54

A stock had returns of 13 percent, 11 percent, 8 percent, 14 percent, −9 percent, and −5 percent over the past six years. What is the geometric average return for this time period?

4.93 percent

Which one of the following is the best example of a diversifiable risk?

A firm's sales decrease

Roger's Meat Market is considering two independent projects. The profitability index decision rule indicates that both projects should be accepted. This result most likely does which one of the following?

Assumes the firm has sufficient funds to undertake both projects

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk?

Capital asset pricing model

Which one of the following statements is correct concerning the issuance of long-term debt?

Direct placement debt tends to have more restrictive covenants than publicly issued debt.

Blue Stone Builders recently offered to sell 45,000 newly issued shares of stock to the public. The underwriters charged a fee of 8.2 percent and paid Blue Stone Builders the uniform auction price for each of those shares. Which one of the following terms best describes this underwriting?

Dutch auction

Which one of the following statements concerning venture capitalists is correct?

Exit strategy is a key consideration when selecting a venture capitalist.

Generally speaking, which of the following best correspond to a wide frequency distribution?

High standard deviation, large risk premium

Which of the following statements concerning risk are correct? I. Non-diversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for non-diversifiable risk. IV. Diversifiable risks are market risks you cannot avoid.

I and III only

Which one of the following will decrease the net present value of a project?

Increasing the project's initial cost at time zero

In actual practice, managers most frequently use which two types of investment criteria?

Internal rate of return and net present value

Which one of the following is an example of systematic risk?

Investors panic causing security prices around the globe to fall precipitously

Two mutually exclusive projects have an initial cost of $47,500 each. Project A produces cash inflows of $25,300, $37,100, and $22,000 for Years 1 through 3, respectively. Project B produces cash inflows of $43,600, $19,800 and $10,400 for Years 1 through 3, respectively. The required rate of return is 14.7 percent for Project A and 14.9 percent for Project B. Which project(s) should be accepted and why?

Project A, because it has the larger NPV.

You are considering a project with conventional cash flows, an IRR of 11.63 percent, a PI of 1.04, an NPV of $987, and a payback period of 2.98 years. Which one of the following statements is correct given this information?

The discount rate used in computing the net present value was less than 11.63 percent.

Which one of the following is the most likely reason why a stock price might not react at all on the day that new information related to the stock's issuer is released? Assume the market is semistrong form efficient.

The information was expected.

Which one of the following statements related to unexpected returns is correct?

Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term.

Underwriters generally:

accept the risk of selling the new securities in exchange for the gross spread.

The systematic risk of the market is measured by a:

beta of 1

Treynor Industries is investing in a new project. The minimum rate of return the firm requires on this project is referred to as the:

cost of capital.

The IRR that causes the net present value of the differences between two project's cash flows to equal zero is called the:

crossover rate

Roy owns 200 shares of RTF Inc. He has opted not to participate in the current rights offering by this company. As a result, Roy will most likely be subject to:

dilution.

The internal rate of return is defined as the:

discount rate which causes the net present value of a project to equal zero.

A syndicate can best be defined as a:

group of underwriters sharing the risk of selling a new issue of securities.

The dividend growth model:

is only as reliable as the estimated rate of growth.

Net present value:

is the best method of analyzing mutually exclusive projects.

Scott is considering a project that will produce cash inflows of $2,900 a year for 3 years. The required rate of return is 15.4 percent and the initial cost is $6,800. What is the discounted payback period?

never

The weighted average cost of capital for a firm with debt is the:

rate of return a company must earn on its existing assets to maintain the current value of its stock.

The cost of preferred stock is computed the same as the

rate of return on a perpetuity

The Securities and Exchange Commission:

reviews registration statements to ensure they comply with current laws and regulations.

Which one of the following categories of securities had the most volatile annual returns over the period 1926-2016?

small-company stocks

Small-company stocks, as the term is used in the textbook, are best defined as the:

smallest 20 percent of the companies listed on the NYSE.

If a project has a net present value equal to zero, then:

the project earns a return exactly equal to the discount rate.

The intercept point of the security market line is the rate of return which corresponds to:

the risk-free rate.

Standard deviation is a measure of which one of the following?

volatility

The equivalent annual cost method is useful in determining:

which one of two machines should be purchased when the machines are mutually exclusive, have differing lives, and will be replaced at the end of their lives.

You have $21,600 to invest in a stock portfolio. Your choices are Stock X with an expected return of 14.3 percent and Stock Y with an expected return of 8.1 percent. Your goal is to create a portfolio with an expected return of 12.5 percent. All money must be invested. How much will you invest in Stock X?

$15,329

Chelsea Fashions is expected to pay an annual dividend of $1.26 a share next year. The market price of the stock is $24.09 and the growth rate is 2.6 percent. What is the cost of equity?

7.83 percent

Jones & Co. recently went public and received $23.07 a share on their entire offer of 30,000 shares. Keeser & Co. served as the underwriter and sold 28,500 shares to the public at an offer price of $26.50 a share. What type of underwriting was this?

Firm commitment

A stock had annual returns of 5.3 percent, −2.7 percent, 16.2 percent, and 13.6 percent over the past four years. Which one of the following best describes the probability that this stock will produce a return of 20 percent or more in a single year?

Less than 16 percent but more than 2.5 percent

Which of the following are advantages of the payback method of project analysis?

Liquidity bias, ease of use

You are viewing a graph that plots the NPVs of a project to various discount rates that could be applied to the project's cash flows. What is the name given to this graph?

NPV profile

Which one of the following is an example of unsystematic risk?

National decrease in consumer spending on entertainment

Which two methods of project analysis are the most biased towards short-term projects?

Payback and discounted payback

Equity financing of new, non-public companies is broadly referred to as:

Private Equity

Which one of the following is a preliminary prospectus?

Red Herring

What is the form called that is filed with the SEC and discloses the material information on a securities issuer when that issuer offers new securities to the general public?

Registration Statement

JJ's is reviewing a project with a required discount rate of 15.2 percent and an initial cost of $309,000. The cash inflows are $47,000, $198,000, and $226,000 for Years 2 to 4, respectively. Should the project be accepted based on discounted payback if the required payback period is 2.5 years?

Reject; The project never pays back on a discounted basis.

Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly?

Reward-to-risk ratio

Alberto currently owns 2,500 shares of Southern Tools. He has just been notified that the company is issuing additional shares and he is being given a chance to purchase some of these shares prior to the shares being offered to the general public. What is this type of an offer called?

Rights Offer

Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas?

Security market line

Pearson Electric recently registered 180,000 shares of stock under SEC Rule 415. The company plans to sell 100,000 shares this year and the remaining 80,000 shares next year. What type of registration was this?

Shelf registration

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 one of the following statements is true given this information?

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

A project has a net present value of zero. Which one of the following best describes this project?

The project's cash inflows equal its cash outflows in current dollar terms.

Which one of the following risks is irrelevant to a well-diversified investor?

Unsystematic risk

Business Aid is funded by a group of wealthy investors for the sole purpose of providing funding for individuals and small firms that are trying to convert their new ideas into viable products. What is this type of funding called?

Venture capital

Which one of the following statements concerning venture capital financing is correct?

Venture capitalists should have key contacts and financial strength.

A proposed project has an initial cost of $38,000 and cash inflows of $12,300, $24,200, and $16,100 for Years 1 through 3, respectively. The required rate of return is 16.8 percent. Based on IRR, should this project be accepted? Why or why not?

Yes; The IRR exceeds the required return.

The difference between the underwriters' cost of buying shares in a firm commitment and the offering price of those securities to the public is called the:

gross spread.

There are two distinct discount rates at which a particular project will have a zero net present value. In this situation, the project is said to:

have multiple rates of return

To convince investors to accept greater volatility, you must:

increase the risk premium

With firm commitment underwriting, the issuing firm:

knows upfront the amount of money it will receive from the stock offering.

Existing shareholders:

may or may not have a pre-emptive right to newly issued shares.

Assume that last year T-bills returned 2.8 percent while your investment in large-company stocks earned an average of 7.6 percent. Which one of the following terms refers to the difference between these two rates of return?

risk premium

The _____ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly.

risk premium

Which one of the following is a risk that applies to most securities?

systematic

Executive Tours has decided to go public and has hired an investment firm to handle the offering. The investment firm is serving as a(n):

underwriter

An asset has an average return of 10.91 percent and a standard deviation of 20.94 percent. What range of returns should you expect to see with a 95 percent probability?

−30.97% to 52.79%

Assume an investment has cash flows of −$39,700, $21,750, $18,500, and $12,500 for Years 0 to 3, respectively. What is the NPV if the required return is 12.9 percent? Should the project be accepted or rejected?

$2,764.89; accept

HH Companies has identified two mutually exclusive projects. Project A has cash flows of −$40,000, $21,200, $16,800, and $14,000 for Years 0 to 3, respectively. Project B has a cost of $38,000 and annual cash inflows of $25,500 for 2 years. At what rate would you be indifferent between these two projects?

-4.38 percent

The rate of return on the common stock of Lancaster Woolens is expected to be 18 percent in a boom economy, 8 percent in a normal economy, and only 2 percent in a recessionary economy. The probabilities of these economic states are 12 percent for a boom and 10 percent for a recession. What is the variance of the returns on this common stock?

.001524

If the economy is normal, Charleston Freight stock is expected to return 14.3 percent. If the economy falls into a recession, the stock's return is projected at a negative 8.7 percent. The probability of a normal economy is 80 percent. What is the variance of the returns on this stock?

.008464

Kelso's has a debt-equity ratio of .62 and a tax rate of 21 percent. The firm does not issue preferred stock. The cost of equity is 16.3 percent and the aftertax cost of debt is 5.21 percent. What is the weighted average cost of capital?

12.06 percent

Grill Works has 6 percent preferred stock outstanding that is currently selling for $49 a share. The market rate of return is 14 percent and the tax rate is 21 percent. What is the cost of preferred stock if its stated value is $100 per share?

12.24 percent

Colin is analyzing a 3-year project that has an initial cost of $199,800. This cost will be depreciated straight-line to zero over three years. The projected annual net income for the three years is $11,600, $15,900, and $17,200. If the discount rate is 12 percent, what is the average accounting rate of return?

14.91 percent

Thayer Farms stock has a beta of 1.38. The risk-free rate of return is 3.87 percent, the inflation rate is 3.93 percent, and the market risk premium is 9.03 percent. What is the expected rate of return on this stock?

16.33 percent

Suppose you bought a $1,000 face value bond with a coupon rate of 5.6 percent one year ago. The purchase price was $987.50. You sold the bond today for $994.20. If the inflation rate last year was 2.6 percent, what was your exact real rate of return on this investment?

3.65 percent

Galvatron Metals has a bond outstanding with a coupon rate of 5.9 percent and semiannual payments. The bond currently sells for $1,947 and matures in 21 years. The par value is $2,000 and the company's tax rate is 40 percent. What is the company's aftertax cost of debt?

3.68 percent

Jiminy's Cricket Farm issued a 20-year, 7 percent, semiannual bond four years ago. The bond currently sells for 108 percent of its face value. What is the aftertax cost of debt if the company's combined tax rate is 23 percent?

4.78 percent

It is common for venture capitalists to receive at least ___ percent of a start-up company's equity in exchange for the venture capital.

40

The expected return on JK stock is 16.28 percent while the expected return on the market is 11.97 percent. The stock's beta is 1.63. What is the risk-free rate of return?

5.13 percent

Fashion Wear has bonds outstanding that mature in 11 years, pay interest annually, and have a coupon rate of 6.45 percent. These bonds have a face value of $1,000 and a current market price of $994. What is the company's aftertax cost of debt if its tax rate is 21 percent?

5.16 percent

The Downtowner has 168,000 shares of common stock outstanding valued at $53 a share along with 13,000 bonds selling for $1,008 each. What weight should be given to the debt when the company computes its weighted average cost of capital?

59.54 percent

You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 3 percent, -12 percent, 24 percent, 16 percent, and 17 percent. The average inflation rate over this period was 3.4 percent and the average T-bill rate was 5.55 percent. What was the average real return on the company's stock? What was the average nominal risk premium on the company's stock?

6 percent 4 percent Explanation a. To find the average return, we sum all the returns and divide by the number of returns, so: Average return = (.03 - .12 + 0.24 + .16 + .17)/5 Average return = .0960, or 9.60% To calculate the average real return, we can use the average return of the asset, and the average inflation in the Fisher equation. Doing so, we find: (1 + R) = (1 + r)(1 + h) r⎯⎯r¯ = (1.0960/1.034) - 1 r⎯⎯r¯ = .0600, or 6.00% b. The average risk premium is the average return of the asset, minus the average risk-free rate, so, the average risk premium for this asset would be:RP⎯⎯⎯⎯⎯=R⎯⎯⎯−Rf⎯⎯⎯⎯=0.0960 − 0.0560 = 0.0400 or 4.00%RP¯=R¯−Rf¯=0.0960 − 0.0560 = 0.0400 or 4.00%

You bought one of Shark Repellant's 6 percent coupon bonds one year ago for $867. These bonds pay annual payments, have a face value of $1,000, and mature 12 years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 7.4 percent. The inflation rate over the past year was 2.9 percent. What was your total real return on this investment?

6.61 percent

Holdup Bank has an issue of preferred stock with a stated dividend of $7 that just sold for $87 per share. What is the bank's cost of preferred?

8.05 percent

A stock had returns of 5 percent, 14 percent, 11 percent, −8 percent, and 6 percent over the past five years. What is the standard deviation of these returns?

8.44 percent

Jerilu Markets has a beta of 1.09. The risk-free rate of return is 3.18 percent and the market rate of return is 11.27 percent. What is the risk premium on this stock?

8.82 percent

Precision Dyes is analyzing two machines to determine which one it should purchase. The company requires a rate of return of 15 percent and uses straight-line depreciation to a zero book value over the life of its equipment. Ignore bonus depreciation. Machine A has a cost of $462,000, annual aftertax cash outflows of $46,200, and a four-year life. Machine B costs $898,000, has annual aftertax cash outflows of $16,500, and has a seven-year life. Whichever machine is purchased will be replaced at the end of its useful life. Which machine should the company purchase and how much less is that machine's EAC as compared to the other machine's?

A; $24,321.02

You are considering two mutually exclusive projects. Project A has cash flows of −$72,000, $21,400, $22,900, and $56,300 for Years 0 to 3, respectively. Project B has cash flows of −$81,000, $20,100, $22,200, and $74,800 for Years 0 to 3, respectively. Both projects have a required 2.5-year payback period. Should you accept or reject these projects based on payback analysis?

Accept Project A and reject Project B

Isaac has analyzed two mutually exclusive projects that have 3-year lives. Project A has an NPV of $81,406, a payback period of 2.48 years, and an AAR of 9.31 percent. Project B has an NPV of $82,909, a payback period of 2.57 years, and an AAR of 9.22 percent. The required return for Project A is 11.5 percent while it is 12 percent for Project B. Both projects have a required AAR of 9.25 percent. Isaac must make a recommendation and justify it in 15 words or less. What should his recommendation be?

Accept Project B and reject Project A based on the NPVs

With Dutch auction underwriting:

all successful bidders pay the same price per share.

The return earned in an average year over a multiyear period is called the _____ average return.

arithmetic

A stock has had returns of 6 percent, 24 percent, 16 percent, −12 percent, 31 percent, and −6 percent over the last six years. What are the arithmetic and geometric average returns for the stock?

arithmetic Average return: 9.83% Geometric Average Return: 8.73%

Unsystematic risk:

can be effectively eliminated by portfolio diversification.

The standard deviation of a portfolio:

can be less than the standard deviation of the least risky security in the portfolio.

The standard deviation of a portfolio:

can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.

The reward-to-risk ratio for Stock A is less than the reward-to-risk ratio of Stock B. Stock A has a beta of .82 and Stock B has a beta of 1.29. This information implies that:

either Stock A is overpriced or Stock B is underpriced or both.

Assume the market rate of return is 10.1 percent and the risk-free rate of return is 3.2 percent. Lexant stock has 2 percent less systematic risk than the market and has an actual return of 10.2 percent. This stock:

is underpriced.

Estimates of the rate of return on a security based on the historical arithmetic average will probably tend to _____ the expected return for the long-term and estimates using the historical geometric average will probably tend to _____ the expected return for the short-term.

overestimate; underestimate

Which one of the following characteristics is most associated with financing type projects?

prepaid services

The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-free asset is referred to as the:

risk premium.

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

Inside information has the least value when financial markets are:

strong form efficient

Direct business loans typically ranging from one to five years are called:

term loans.

Efficient financial markets fluctuate continuously because:

the markets are continually reacting to new information.

ALUM Inc. uses high-tech equipment to produce specialized products. Each one of its machines costs $1,243,000 to purchase plus an additional $78,000 a year to operate. The machines have a five-year life after which they are worthless. What is the equivalent annual cost of one these machines if the required return is 16.5 percent?

−$462,061.04

What range of returns should you expect to see with a 99 percent probability on an asset that has an average return of 11.33 percent and a standard deviation of 24.88 percent?

−63.31% to 85.97%

The Boat Works decided to go public by offering a total of 135,000 shares of common stock to the public. The company hired an underwriter who arranged a firm commitment underwriting and an initial selling price of $24 a share with a spread of 8.3 percent. As it turned out, the underwriters only sold 122,400 shares to the public. What is the amount paid to the issuer?

$2,971,080

Rosa's has a weighted average cost of capital of 11.73 percent. The cost of equity is 15.8 percent and the pretax cost of debt is 7.6 percent. The tax rate is 21 percent. What is the target debt-equity ratio?

.71

Christina purchased 500 shares of stock at a price of $62.30 a share and sold the shares for $64.25 each. She also received $738 in dividends. If the inflation rate was 3.9 percent, what was her exact real rate of return on this investment?

1.54 percent

The common stock of Jensen Shipping has an expected return of 15.4 percent. The return on the market is 11.2 percent, the inflation rate is 3.1 percent, and the risk-free rate of return is 3.6 percent. What is the beta of this stock?

1.55

Southern Bakeries just paid its annual dividend of $.48 a share. The stock has a market price of $17.23 and a beta of .93. The return on the U.S. Treasury bill is 3.1 percent and the market risk premium is 7.6 percent. What is the cost of equity?

10.17 percent

Judy's Boutique just paid an annual dividend of $2.77 on its common stock. The firm increases its dividend by 3.50 percent annually. What is the company's cost of equity if the current stock price is $40.12 per share?

10.65 percent

Dee's Fashions has a growth rate of 3.2 percent and is equally as risky as the market while its stock is currently selling for $32 a share. The overall stock market has a return of 10.9 percent and a risk premium of 6.8 percent. What is the expected rate of return on this stock?

10.9

Smathers Corp. stock has a beta of 1.19. The market risk premium is 7.40 percent and the risk-free rate is 3.02 percent annually. What is the company's cost of equity?

11.83 percent

The market has an expected rate of return of 12.6 percent. The long-term government bond is expected to yield 4.8 percent and the U.S. Treasury bill is expected to yield 2.7 percent. The inflation rate is 3.2 percent. What is the market risk premium?

9.9 percent

Which one of the following statements is correct concerning market efficiency?

A firm will generally receive a fair price when it issues new shares of stock if the market is efficient.

A stock with an actual return that lies above the security market line has:

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

Assume all stock prices fairly reflect all of the available information on those stocks. Which one of the following terms best defines the stock market under these conditions?

efficient capital market

The average compound return earned per year over a multiyear period is called the _____ average return.

geometric

An asset has an average return of 10.55 percent and a standard deviation of 19.35 percent. What range of returns should you expect to see with a 68 percent probability?

−8.80% to 29.90%