FIN 310 Chapter 11-12 KU

A firm has a cost of equity of 13 percent, a cost of preferred of 11 percent, and an aftertax cost of debt of 6 percent. Given this, which one of the following will increase the firm's weighted average cost of capital? A. Increasing the firm's tax rate B. Issuing new bonds at par C. Redeeming shares of common stock D. Increasing the firm's beta E. Increasing the debt-equity ratio

D.

Based on the capital asset pricing model, investors are compensated based on which of the following? I. market risk premium II. portfolio standard deviation III. portfolio beta IV. risk-free rate A. I and III only B. II and IV only C. I, II, and III only D. I, III, and IV only E. I, II, III, and IV

D.

Portfolio diversification eliminates which one of the following? A. Total investment risk B. Portfolio risk premium C. Market risk D. Unsystematic risk E. Reward for bearing risk

D.

Standard deviation measures _____ risk while beta measures _____ risk. A. systematic; unsystematic B. unsystematic; systematic C. total; unsystematic D. total; systematic E. asset-specific; market

D.

Assume you own a portfolio of diverse securities which are each correctly priced. Given this, the reward-to-risk ratio: A. for the portfolio must equal 1.0. B. for the portfolio must be less than the market risk premium. C. for each security must equal zero. D. of each security is equal to the risk-free rate. E. of each security must equal the slope of the security market line.

E.

The beta of a risky portfolio (assuming no borrowing or shortselling) cannot be less than _____ nor greater than _____. A. 0; 1 B. 1; the market beta C. the lowest individual beta in the portfolio; market beta D. the market beta; the highest individual beta in the portfolio E. the lowest individual beta in the portfolio; the highest individual beta in the portfolio

E.

Boone Brothers remodels homes and replaces windows. Ace Builders constructs new homes. If Boone Brothers considers expanding into new home construction, it should evaluate the expansion project using which one of the following as the required return for the project? A. Boone Brothers' cost of capital B. Ace Builders' cost of capital C. Average of Boone Brothers' and Ace Builders' cost of capital D. Lower of Boone Brothers' or Ace Builders' cost of capital E. Higher of Boone Brothers' or Ace Builders' cost of capital

B.

Which one of the following describes systemic risk? A. Risk that affects a large number of assets B. An individual security's total risk C. Diversifiable risk D. Asset specific risk E. Risk unique to a firm's management

A.

Old Town Industries has three divisions. Division X has been in existence the longest and has the most stable sales. Division Y has been in existence for five years and is slightly less risky than the overall firm. Division Z is the research and development side of the business. When allocating funds, the firm should probably: A. require the highest rate of return from division X since it has been in existence the longest. B. assign the highest cost of capital to division Z because it is most likely the riskiest of the three divisions. C. use the firm's WACC as the cost of capital for division Z as it provides analysis for the entire firm. D. use the firm's WACC as the cost of capital for divisions A and B because they are part of the revenue-producing operations of the firm. E. allocate capital funds evenly amongst the divisions to maintain the current capital structure of the firm.

B.

Which one of the following is an example of systematic risk? A. Major layoff by a regional manufacturer of power boats B. Increase in consumption created by a reduction in personal tax rates C. Surprise firing of a firm's chief financial officer D. Closure of a major retail chain of stores E. Product recall by one manufacturer

B.

Which one of the following is the slope of the security market line? A. Risk-free rate B. Market risk premium C. Beta coefficient D. Risk premium on an individual asset E. Market rate of return

B.

Which one of the following statements is correct, all else held constant? A. Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred. B. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options. C. The aftertax cost of debt increases when the market price of a bond increases. D. If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC. E. WACC is only applicable to firms that issue both common and preferred stock.

B.

All else constant, which of the following will increase the ahertax cost of debt for a firm? I. increase in the yield to maturity of the firm's outstanding debt II. decrease in the yield to maturity of the firm's outstanding debt III. increase in the firm's tax rate IV. decrease in the firm's tax rate A. I only B. I and III only C. I and IV only D. II and III only E. II and IV only

C.

Which one of the following best exemplifies unsystematic risk? A. Unexpected economic collapse B. Unexpected increase in interest rates C. Unexpected increase in the variable costs for a firm D. Sudden decrease in inflation E. Expected increase in tax rates

C.

Which one of the following terms best refers to the practice of investing in a variety of diverse assets as a means of reducing risk? A. Systematic B. Unsystematic C. Diversification D. Security market line E. Capital asset pricing model

C.

Which of the following are weaknesses of the dividend growth model? I. market risk premium fluctuations II. lack of dividends for some firms III. reliance on historical beta IV. sensitivity of model to dividend growth rate A. II only B. I and II only C. I and III only D. II and IV only E. I, II, III, and IV

D.

Which one of the following represents the rate of return a firm must earn on its assets if it is to maintain the current value of its securities? A. Cost of equity B. Internal rate of return C. After tax cost of debt D. Weighted average cost of capital E. Debt-equity ratio

D.

A firm uses its weighted average cost of capital to evaluate the proposed projects for all of its varying divisions. By doing so, the firm: A. automatically gives preferential treatment in the allocation of funds to its riskiest division. B. encourages the division managers to only recommend their most conservative projects. C. maintains the current risk level and capital structure of the firm. D. automatically maximizes the total value created for its shareholders. E. allocates capital funds evenly amongst its divisions.

A.

The security market line is a linear function which is graphed by plotting data points based on the relationship between which two of the following variables? A. Risk-free rate and beta B. Market rate of return and beta C. Market rate of return and the risk-free rate D. Risk-free rate and the market rate of return E. Expected return and beta

E.

Which one of the following represents the amount of compensation an investor should expect to receive for accepting the unsystematic risk associated with an individual security? A. Security beta multiplied by the market rate of return B. Market risk premium C. Security beta multiplied by the market risk premium D. Risk-free rate of return E. Zero

E.

Which one of the following is the pre-tax cost of debt? A. Average coupon rate on the firm's outstanding bonds B. Coupon rate on the firm's latest bond issue C. Weighted average yield-to-maturity on the firm's outstanding debt D. Average current yield on the firm's outstanding debt E. Annual interest divided by the market price per bond for the latest bond issue

C.

Ted is trying to decide what cost of capital he should assign to a project. Which one of the following should be his primary consideration in this decision? A. Amount of debt used to finance the project B. Use, or lack thereof, of preferred stock to finance the project C. Mix of funds used to finance the project D. Risk level of the project E. Length of the project's life

D.

The cost of preferred stock: A. increases when a firm's tax rate decreases. B. is constant over time. C. is unaffected by changes in the market price. D. is equal to the stock's dividend yield. E. increases as the price of the stock increases.

D.

The risk premium for an individual security is based on which one of the following types of risk? A. Total B. Surprise C. Diversifiable D. Systematic E. Unsystematic

D.

The systematic risk principle states that the expected return on a risky asset depends only on which one of the following? A. Unique risk B. Diversifiable risk C. Asset-specific risk D. Market risk E. Unsystematic risk

D.