Fin 331 Test #3
Vara Technologies' is expected to pay a dividend of $2.00 per share one year from today. Vara's required rate of return is rs = 11%. What would Vara's price be if the expected growth rate were g = 0%?
$18.18
Calvert Industries invests a large sum of money in R&D; as a result, it retains and reinvests all of its earnings. In other words, Calvert doesn't pay any dividends and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing Calvert's stock. The pension fund manager has estimated Calvert's free cash flows for the next 3 years as follows: $1.2 million, $2.5 million, and $4.1 million. After the third year, free cash flow is projected to grow at a constant 5%. Calvert's WACC is 10%, the market value of its debt and preferred stock totals $10.9256 million, and it has 2.5 million shares of common stock outstanding. What is an estimate of Calvert's price per share?
$24
Vara Technologies' is expected to pay a dividend of $2.00 per share one year from today. Vara's required rate of return is rs = 11%. If the expected growth rate is 5%, at what price should the stock sell?
$33.33
Silva Motors just paid a dividend of $2.00, i.e., D0 = $2.00. The dividend is expected to grow by 100% during Year 1, by 50% during Year 2, and then at a constant rate of 5% thereafter. If Silva's required rate of return is rs = 12%, what is the value of the stock today?
$80.10
Investment X has a 25% chance of producing a 20% return, a 50% chance of producing a 15% return, and a 25% chance of producing a return of -5%. What's Investment X's coefficient of variation?
0.85
A 2-stock portfolio that contains $40,000 of GE stock with a beta of 1.25 and $60,000 of Duke Energy stock with a beta of 0.60 would have a beta of 0.86. What would be the portfolio's beta, if the owner rebalanced the portfolio so that it contained $80,000 of GE and $20,000 of Duke Energy stock?
1.12
Suppose a stock has a beta of 1.3, the risk-free rate is 6.0%, and the market risk premium is 4.5%. If the stock's beta falls to 1.0 but the other two variables remain unchanged, by how much would the stock's required rate of return decline?
1.35%
Investment X has a 25% chance of producing a 20% return, a 50% chance of producing a 15% return, and a 25% chance of producing a return of -5%. What is X's expected return?
11.25%
Investors expect Bae Corporation to pay a dividend of D1 = $1.50 and to grow at a constant rate of 7% per year. The stock sells at a price of $25. What is Bae's expected total rate of return?
13%
Investors expect Bae Corporation to pay a dividend of D1 = $1.50 and to grow at a constant rate of 7% per year. The stock sells at a price of $25. What is Bae's expected dividend yield?
6%
Investors expect Bae Corporation to pay a dividend of D1 = $1.50 and to grow at a constant rate of 7% per year. The stock sells at a price of $25. What is Bae's expected capital gains yield?
7%
Investment X has a 25% chance of producing a 20% return, a 50% chance of producing a 15% return, and a 25% chance of producing a return of -5%. What's Investment X's standard deviation?
9.6%
If a firm goes bankrupt and must be liquidated, and if less money is available than the balance sheet values of bonds, preferred stock, and common equity, then some security holders will receive less than the book values of their investments. The priority system under our bankruptcy laws allocates funds first to preferred stock because of its preference, then to bonds, and then to common stockholders (only if there are funds left over after paying preferred stockholders and bondholders). True or false?
False
The actual values of the expected rate of return, the required rate of return, and the realized rate of return must be identical for financial markets to operate.
False
The capital gains yield is calculated as the dollar amount of the year's dividend payments divided by the current stock price.
False
The higher the positive correlation between two assets' returns, the greater is the risk reduction from holding them in a portfolio. True or false?
False
The realized rate of return is denoted simply as a lower-case r. It represents a statistical calculation of what will happen with the stock's future return.
False
The required rate of return is denoted simply as a lower-case r with a straight line on top. This rate of return doesn't represent speculation about a stock's future return but represents the actual return you receive from the stock.
False
A stock with a Beta of more than one:
Has experienced price changes that are more volatile than the over market
The Beta of a stock measures:
How the stock price moves relative to the rest of the market.
The weights in the expected rate of return calculation must sum to equal:
One
The risk-free rate is 3%, and the market risk premium is 4%. Stock A has a beta of 1.2, and Stock B has a beta of 0.8. Assume that investors become less willing to take on risk (i.e., they become more risk averse), so the market risk premium rises from 4% to 6%. Assume that the risk-free rate remains constant. What effect will this have on the required rates of return on the two stocks?
RA= 10.2% RB= 7.8%
The risk-free rate is 3%, and the market risk premium is 4%. Stock A has a beta of 1.2, and Stock B has a beta of 0.8. What is the required rate of return on each stock?
RA= 7.8% RB= 6.2%
In calculating the expected rate of return, the expected returns in each state are weighted by:
The probability of that state occurring.
A stock's price is simply the current market price, and it is easily observed for publicly traded companies. By contrast, intrinsic value, which represents the "true" value of the company's stock, cannot be directly observed and must instead be estimated. True or false?
True
Betas can be found by plotting stocks' returns on the vertical axis and the returns on an index like the S&P 500 on the horizontal axis, and then calculating the slope of the resulting regression line. This slope is the stock's beta coefficient. The steeper the slope, the larger the beta and the riskier the stock. True or false?
True
Firms can use different classes of common stock to meet specific needs of the company. Founders' shares are one such class. They are shares owned by the firm's founders that enable them to maintain control over the company without having to own a majority of stock. True or false?
True
If all investors were completely indifferent to risk, i.e., if they had no aversion to risk at all, then the SML would plot as a horizontal line. True or false?
True
If two assets are held in a portfolio, the assets will generally be less risky than if they were held in isolation. True or false?
True
If two assets are perfectly positively correlated, then their returns will move up and down exactly in sync with one another. True or false?
True
In response to concerns about the CAPM's validity, some researchers have developed models that include more explanatory variables than just beta. While these models are promising, the basic CAPM is still the most widely used method for estimating required rates of returns on stocks. True or false?
True
Is the following statement true or false? There is a fundamental trade-off between risk and return: to entice investors to take on more risk, you have to provide them with higher expected returns.
True
People differ with regard to their willingness to bear risks. However, if two stocks have the same expected rate of return, then most individuals would prefer the less risky to the more risky stock. This is called risk aversion. True or false?
True
Preferred stock is a "hybrid" security. Preferreds typically pay a fixed dividend, so they are a fixed-income security like a bond. However, the directors can omit the preferred dividend without throwing the company into bankruptcy. True or false?
True
Proxy fights are attempts by a person or group that wants to take over control of a firm by getting the firms' stockholders to give their voting proxies to the new group. True or false?
True
Suppose the standard deviation of expected returns for a given corporate project is quite high, and the project's returns are also highly correlated with returns on the firm's other assets. This suggests that the project is quite risky. However, if the project is not perfectly positively correlated with returns on other stocks in the market, then the project's true risk to stockholders might not be very large. True or false?
True
The Security Market Line (SML) shows the relationship between stocks' required rates of return (measured on the vertical axis) and their betas (measured on the horizontal axis). The vertical axis intercept is the required rate of return on a riskless asset, and the required rate of return associated with b = 1.0 is the required rate of return on "the market." The difference between the required rate of return on the market and that on the riskless asset (rM - rRF) is defined as the "market risk premium." The steeper the SML, the larger the market risk premium, and the greater the average investor's aversion to risk. True or false?
True
The capital gains yield is the annual percentage of a stock's change in price.
True
The coefficient of variation is a better measure of risk if one is comparing assets that have substantially different expected returns, because it shows the amount of risk per unit of expected return. True or false?
True
The dividend yield is the percentage of how much of the stock's return is received as dividends.
True
The dividend yield, the capital gains yield, and the total return are three key components of the Discounted Dividend Model.
True
The preemptive right is the right of current stockholders to buy new shares in an amount that will maintain their proportionate ownership in the firm. True or false?
True
The probability distribution for a stock would list the stock's set of possible returns and the probability of each return. We could use this data to find both the stock's expected rate of return and the standard deviation of that return, which is one measure of risk. True or false?
True
The required return represents the return an investor requires to invest in the stock; the expected return is based on a statistical calculation of what will happen with the future value of the stock; and the realized rate of return is the actual, historic return earned on the stock.
True
The total return is equal to the dividend yield plus the capital gains yield.
True
The value of a share of common stock depends on the cash flows it is expected to provide, and those flows consist of two elements: (1) the dividends the investor receives each year while he or she holds the stock and (2) the price received when the stock is sold. The final price includes the original price paid plus an expected capital gain. True or false?
True
The value of a share of stock can be estimated by using the PV of future dividends. An alternative valuation procedure, called the "corporate valuation model," calls for finding the expected future free cash flows, discounting those cash flows at the weighted average cost of capital, summing the PVs of the free cash flows, subtracting the market values of debt and preferred to calculate the value of the common equity, and then dividing by the number of shares outstanding to find the value of a share of common stock. In theory, the two methods should produce the same stock price. Is this statement true or false?
True
To estimate the value of a nonconstant growth stock, we can estimate the value of each dividend during the period of nonconstant growth, find the PVs of these dividends, find the value of the stock at the horizon date, find the PV of the horizon value, and then sum these PVs to find the value of the stock today. True or false?
True
Diversification is a fundamental investment tool. Which of the following is a key to diversification?
Variety—Invest in a wide range of financial products. Correlation—Look at investments that are not closely correlated, meaning that their values don't tend to move in the same direction at the same time.
Which of the following relationships would induce someone to purchase stock?
r hat > r
