Test 3 Finance

25. The opportunity cost of capital is equal to:

the return offered by other projects of equal risk.

39. The appropriate opportunity cost of capital is the return that investors give up on alternative investments with:

the same risk.

49. Macro events only are reflected in the performance of the market portfolio because:

the specific risks have been diversified away

26. If two projects offer the same positive NPV, then:

they add the same amount to the value of the firm.

48. The expected return on a security includes a reward for:

time value of money and market risk.

38. The variance of an investment's returns is a measure of the:

volatility of the rates of return.

29. Firms that make investment decisions based on the payback rule may be biased toward rejecting projects:

with long lives.

13. What real rate of return is earned by a one-year investor in a bond that was purchased for $1,000, has an 9% coupon, and was sold for $954 when the inflation rate was 5.40%?

−.95%

10. What is the percentage return on a stock that was purchased for $42.00, paid no dividend after one year, and was then sold for $40.00?

−4.76%

7. What is the equivalent annual cost for a project that requires a $42,000 investment at time-period zero, and a $12,000 annual expense during each of the next 5 years, if the opportunity cost of capital is 12%?

$23,651.21

2. What is the maximum that should be invested in a project at time zero if the inflows are estimated at $105,000 annually for 4 years, and the cost of capital is 8%?

$347,773.32

1. What is the NPV of a project that costs $290,000 and returns $110,000 annually for 4 years if the opportunity cost of capital is 12%?

$44,108.43

9. Which of the following statements is true for a stock that sells now for $50, pays an annual dividend of $3.00, and experienced a 15% return on investment over the past year? Its price one year ago was:

$46.09.

5. If a project's IRR is 12% and the project provides annual cash flows of $18,000 for 6 years, how much did the project cost?

$74,005

3. What is the minimum cash flow that could be received at the end of year 3 to make the following project "acceptable"? Initial cost = $190,000; cash flows at end of years 1 and 2 = $75,000; opportunity cost of capital = 10%.

$79,640

8. The profitability index for a project costing $54,000 and returning $29,000 annually for 3 years at an opportunity cost of capital of 13% is

.268

57. Suppose that the S&P 500, with a beta of 1.0, has an expected return of 13% and T-bills provide a risk-free return of 4%. 1. What would be the expected return and beta of portfolios constructed from these two assets with weights in the S&P 500 of (i) 0; (ii) 0.25; (iii) 0.50; (iv) 0.75; (v) 1.0? 2. How does expected return vary with beta?

1. 0: 4,0 .25: 6.25, .25 .5: 8.5, .5 .75: 10.75, .75 1: 13,1 2. Increases by 9%

55. Figure 12.11 shows plots of monthly rates of return on three stocks versus the stock market index. The beta and standard deviation of each stock is given beside its plot. 1. Which stock is safest for a diversified investor? 2. Which stock is safest for an undiversified investor who puts all her funds in one of these stocks? 3. Consider a portfolio with equal investments in each stock. What would this portfolio's beta have been? 4. Consider a well-diversified portfolio made up of stocks with the same beta as Ford. What are the beta and standard deviation of this portfolio's return? The standard deviation of the market portfolio's return is 20%. 5. What is the expected rate of return on each stock? Use the capital asset pricing model with a market risk premium of 8%. The risk-free rate of interest is 4%.

1. Walmart 2. Pfizer 3. 0.82 4. Beta: 1.31 StDev: 26.20 5. Ford: 14.48 Pfizer: 11.2 Walmart: 6.08

52. If a stock consistently goes down (up) by 1.6% when the market portfolio goes down (up) by 1.2%, then its beta equals:

1.33.

27. According to the NPV rule, all projects should be accepted if NPV is positive when discounted at the:

opportunity cost of capital.

16. If the net present value of a project that costs $20,000 is $5,000 when the discount rate is 10%, then the:

project's rate of return is greater than 10%.

11. What is the approximate standard deviation of returns if over the past 4 years an investment returned 7.0%, -13.0%, -13.0%, and 15.4%?

12.46%

14. What is the variance of return of a three-stock portfolio (with unequal weights 25%, 45%, and 30%) that produced returns of 28%, 33%, and 38%, respectively?

13.69

54. What is the standard deviation of the market portfolio if the standard deviation of a well-diversified portfolio with a beta of 1.25 equals 20%?

16.00%

What is the approximate IRR for a project that costs $120,000 and provides cash inflows of $50,000 for 4 years?

24.1%

32. What is the percentage return on a stock that was purchased for $50.00, paid a $3.00 dividend after one year, and was then sold for $49.00?

4.00%

12. What nominal return was received by an investor when inflation averaged 7.55% and the real rate of return was a negative 2.20%?

5.18%

56. A share of stock with a beta of .75 now sells for $50. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 4%, and the market risk premium is 7%. If the stock is perceived to be fairly priced today, what must be investors' expectation of the price of the stock at the end of the year?

52.63

19. Which of the following changes will increase the NPV of a project?

A decrease in the discount rate

35. Stock A has 10 million shares issued and stock B has 5 million shares issued. What is their relative weighting if both stocks are represented in the S&P 500?

A has twice the weighting, to account for having more shares

23. Which of the following investment criteria takes the time value of money into consideration?

All of these

6. What is the minimum number of years that an investment costing $650,000 must return $78,000 per year at a discount rate of 12% in order to be an acceptable investment?

An infinite number of years

44. Which of the following concerns is likely to be most important to portfolio investors seeking diversification?

Correlation of returns between securities

45. Which of the following risks is most important to a well-diversified investor in common stocks?

Market risk

50. A stock's beta measures the:

sensitivity of the stock's returns to those of the market portfolio.

37. Which of the following guarantees is offered to common stock investors?

No guarantees of any form

33. How is it possible for real rates of return to increase during times when the rate of inflation increases?

Nominal returns increased more than inflation.

30. Which of the following investment decision rules tends to improperly reject long-lived projects?

Payback period

15. Which of the following statements is correct for a project with a positive NPV?

The IRR must be greater than 0.

40. What is the typical relationship between the standard deviation of an individual common stock and the standard deviation of a diversified portfolio of common stocks?

The individual stock's standard deviation will be higher.

18. What should occur when a project's net present value is determined to be negative?

The project should be rejected.

21. Given a particular set of project cash flows, which of the following statements is correct?

There can be more than one IRR for the project.

47. Which of the following risk types can be diversified by adding stocks to a portfolio?

Unique risk

28. When a project's internal rate of return equals its opportunity cost of capital, then:

the net present value will be zero.

17. The decision rule for net present value is to:

accept all projects with positive net present values.

51. A stock with a beta greater than 1.0 would be termed:

an aggressive stock, expected to increase more than the market increases.

34. The Dow Jones Industrial Average is:

an index of 30 major industrial stocks

36. Although Standard and Poor's Composite Index contains a small number of U.S. publicly traded stocks, the Index represents:

approximately 75% of U.S. stocks traded, in value.

43. A firm is said to be countercyclical if its returns:

are better when most firms do poorly.

42. The benefits of portfolio diversification are highest when the individual securities have returns that:

are less than perfectly correlated with the rest of the portfolio.

24. For mutually exclusive projects, the IRR can be used to select the best project:

by calculating the IRR based on incremental cash flows.

46. The risk premium that is offered on common stock is equal to the:

excess of expected return over a risk-free return.

41. The standard deviations of individual stocks are generally higher than the standard deviation of the market portfolio because individual stocks:

have no diversification of risk.

53. If you were willing to bet that the overall stock market was heading up on a sustained basis, it would be more profitable to invest in:

high beta stocks.

22. When projects are mutually exclusive, selection should be made according to the project with the:

highest NPV.

31. The use of a profitability index will always provide results consistent with selecting the project with the:

largest return per dollar invested.

20. If the IRR for a project is 15%, then the project's NPV would be:

negative at a discount rate of 20%.