FINA 320 Quiz 5

(Mock Quiz) Although non-systematic risk is present in differing amounts, individual stocks are:

exposed to differing amounts of systematic risk also

(Quizlet) What are risk premiums?

extra return for taking on the risk

(Mock Quiz) The ___ the beta coefficient the ___ the expected return, on average.

higher; higher

(Quizlet) Portfolio diversification is the ___ in ___ different asset classes or sectors

investment; several

(Quizlet) Investment with a high variance has a higher chance of ___ return

lower, negative

(Sample Quiz) The slope of an asset's security market line is the ___

market risk premium

(Sample Quiz) Regarding diversification, ____

most of the benefits are realized without about 20 to 30 stocks

(Mock Quiz) The standard deviations of individual stocks are generally higher than the standard deviation of the market portfolio because individual stocks:

none of the above

(Quizlet) If we are looking at a project that does ___. have the same risk as the firm, then we need to determine the appropriate discount rate for that project

not

(Quizlet) Portfolio variance is ___ the weighted average of the variance of each of the stock in the portfolio

not

(Quizlet) The cost of the debt is ___ the coupon rate

not

(Mock Quiz) If a security plots below the security market line, it is:

offering too little return to justify its risk

(Homework)When firms develop a WACC for individual projects based on the cost of capital for other firms in similar lines of business as the project, the firm is utilizing a:

pure play approach

(Mock Quiz) The major benefit of diversification is to:

reduce the expected risk

(Quizlet) The objective of diversification is to ____ the risk (or return variance) of a portfolio ___ an equivalent reduction in expected returns

reduce; without

(Quizlet) Which of the following regarding systematic risk statements is not true?

risk factors that affect a small number of assets

What does beta < tell us?

risk is less systematic risk than the overall market

(Quizlet) What does beta of 1 tell us?

risk is the same systematic risk as overall market

(Sample Quiz) Over the past 75 years, which of the following investments has provided the largest average return?

small company stocks

(Quizlet) The ___ of returns is a measure of total risk

standard variation

(Quizlet) Which of the following statements regarding systematic risk is not true?

the expected return on a risky asset depends only on that asset's systematic risk since unsystematic risk cannot be diversified away

(Sample Quiz) The standard deviation for historical stock returns can be calculated as:

the positive square root of the variance

(Quizlet) What is the security market line?

the relationship between expected return and beta

What does beta > tell us?

the risk is more systematic risk than the overall market

Variance and standard deviation measure the ___

volatility of returns

(Homework & Quiz) All else the same, a higher corporate tax rate ____.

will decrease the WACC of a firm with some debt in its capital structure

(Homework) Suppose a stock had an initial price of $69 per share, paid a dividend of $1.95 per share during the year, and had an ending share price of $53. b. What was the capital gain yield for the year?

-23.19%

(Quiz & Mock Quiz) Determine the value of Coldron shares. The last dividend paid was $3.20, and dividends are expected to grow at 4% indefinitely. Coldron has a beta of 0.9, the risk free rate is 3 percent and the risk premium is 7 percent. (round to the nearest cent)

$62.79

(Homework) Suppose a stock had an initial price of $69 per share, paid a dividend of $1.95 per share during the year, and had an ending share price of $53. c. What is the percentage total return for the year?

-20.36

(Quizlet) The type of risk that can be diversified away is called

-Diversifiable risk -Unique risk -Idiosyncratic risk All of the above

(Quizlet) The cost of equity is the ___ by equity investors given the risk of the cash flows from the firm

-investment required -return required -risk required All of the above

(Homework) You own a portfolio that is 50 percent invested in Stock X, 30 percent in Stock Y, and 20 percent in Stock Z. The returns on these stocks are 10 percent, 18 percent, and 13 percent respectively. What is the return on the portfolio?

.1300

(Quiz) The beta of an investment in U.S. Treasury bills is:

0.0

(Sample Quiz) A company's zero coupon bond issue matures in 16 years and has a yield to maturity of 10.60%. Each zero has a face value of $1,000 and there are 4,000 of the bonds outstanding. If the market values the equity at $1,800,000, what capital structure weight for debt would you use in calculating the WACC, assuming the firm's only debt consists of the zeros?

0.299

(Sample Quiz) What is the beta for a portfolio equally weighted in four assets: A, the market portfolio; B, which has half the risk of A; C, which has twice the risk of A; and D, which is risk-free?

0.875

(Quiz & Mock Quiz) Assume a portfolio is made up of the following three stocks: expected return %, required return %, investment amount $,stock beta X, 9%, 12%, $20,000, 1.40 Y, 6%, 5%, $40,000, 1.10 Z, 2%, 6%, $140,000, .80 Selecting the closest answer, the beta for this portfolio is:

0.92

(Homework & Quiz) Stock in Parrothead Industries has a beta of 1.10. The market risk premium is 8 percent, and T-bills are currently yielding 5.5 percent. Parrothead's most recent dividend was $2.20 per share, and dividends are expected to grow at a 5 percent annual rate indefinitely. If the stock sells for $32 per share, what is your best estimate of Parrothead's cost of equity?

13.26%

(Sample Quiz) Security, Return, Standard Deviation, Beta A, 16%, 20%, 1.2 B, 12%, 25%, 0.8 Risk-free asset, 4%, ?, ? What is the value of systematic risk (as measured beta) for a portfolio with 2/3 of the funds invested in A and 1/3 of the funds invested in B?

1.067

(Homework) You own a stock portfolio invested 25 percent in Stock Q, 20 percent in Stock R, 15 percent in Stock S, and 40 percent in Stock T. The betas for these four stocks are .9, 1.4, 1.1 and 1.8, respectively. What is the portfolio beta?

1.39

(Homework) Given the following information for Dunhill Power Co. find the WACC. Assume the company's tax rate is 35 percent. Debt: 3,000 8 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 103 percent of par; the bonds make semiannual payments. Common Stock: 90,000 shares outstanding, selling for $45 per share; the beta is 1.20. Preferred Stock: 13,000 shares of 7 percent preferred stock outstanding, currently selling for $108 per share. The preferred stock has a par value of $100. Market: 8 percent market risk premium and 6 percent risk-free rate.

10.27%

(Quiz) Calculate the risk premium on stock C given the following information: risk-free rate = 5%, market return = 13%, stock C beta = 1.3

10.4%

(Homework) A stock has an expected return of 10 percent, its beta is .9 and the risk-free rate is 6 percent. What must the expected return on the market be?

10.45

(Sample Quiz) What is the expected return on Asset A if it has a beta of 0.6, the expected market return is 15%, and the risk-free rate is 6%?

11.4%

(Homework) Titan Mining Corporation has 8 million shares of common stock outstanding, 5 million shares of preferred stock outstanding, and 100,000 units of 9 percent semiannual bonds outstanding, par value $1,000 each. The preferred stock pays a dividend of $6 per share. The common stock currently sells for $32 per share and has a beta of 1.15, the preferred stock currently sells for $67 per share, and the bonds have 15 years to maturity and sell for 91 percent of par. The market risk premium is 10 percent, T-bills are yielding 5 percent, and Titan Mining's tax rate is 35 percent. b. If Titan Mining is evaluating a new investment project that has the same risk as the firm's typical project, what rate should the firm use to discount the project's cash flow?

11.48%

(Sample Quiz & Quiz) Security, Return, Standard Deviation, Beta A, 16%, 20%, 1.2 B, 12%, 25%, 0.8 Risk-free asset, 4%, ?, ? What is the portfolio expected return and the portfolio beta if you invest 35% in A, 45% in B, and 20% in the risk-free asset?

11.8%; 0.78

(Quiz) What is the after-tax cost of preferred stock that sells for $10.00 per share and offers $1.20 annual dividend when the tax rate is 35%?

12%

(Homework) In the previous problem, suppose the most recent dividend was $4 and the dividend growth rate is 6 percent. Assume that the overall cost of debt is the weighted average of that implied by the two outstanding debt issues. Both bonds make semiannual payments. The tax rate is 35 percent. What is the company's WACC?

12.13%

(Mock Quiz) Given the following information, what is the WACC? Common Stock: 1 million shares outstanding, $40 per share, $1 par value, beta = 1.3 Bonds: 10,000 bonds outstanding, $1,000 face value each, 8% annual coupon (paid annually), 22 years to maturity, market price = $1,101.23 per bond Market Risk Premium = 8.6%, risk-free rate = 4.5%, marginal tax rate = 34%

13.30%

(Quiz) What is the standard deviation of a portfolios returns if the mean return is 15%, the variance of returns is 0.0184, and there are three stocks in the portfolio?

13.56%

(Homework) Suppose a stock had an initial price of $69 per share, paid a dividend of $1.95 per share during the year, and had an ending share price of $53. a. What was the dividend yield for the year?

2.83%

(Homework) Suppose Massey Ltd. just issued a dividend of $.68 per share on its common stock. The company paid dividends of $.40, $.45, $.52, and $.60 per share in the last four years. If the stock currently sells for $12, what is your best estimate of the company's cost of equity capital?

20.66%

(Homework) Both assets A and B plot on the SML. Asset A has an expected return on 15% and a beta of 1.7, and asset B has an expected return of 12% and a beta of 1.1. What is the risk-free rate of return?

6.5%

(Quiz) Company X has 2 million shares of common stock outstanding at a book value of $2.00 per share. The stock trades for $3.00 per share. It also has $2 million in face value of debt that trades at 90% of par. What is the weight on debt for WACC purposes? (round to the nearest one tenth of a percentage)

23.1%

(Sample Quiz) Given the following information, what is your best estimate for the firm's cost of equity on January 2, 2003, if the stock sells for $42 on that day? Date, Dividend 12/31,97, $1.50 12/31/98, $1.73 12/31/99, $2.01 12/31/00, $2.34 12/31/01, $2.71 12/31/02, $3.17

24.91%

(Mock Quiz) An investor is considering investing in Tawari Company for one year. He expects to receive $2 in dividends over the year and feels he can sell the stock for $30 at the end of the year. To realize a return on the investment over the years 14%, the price the investor would pay for the stock today is closest to:

28

(Mock Quiz) You want to create a portfolio equally as risky as the market (i.e., a portfolio with beta equals 1), and you have $1,000,000 to invest. The portfolio contains stocks A, B, C and risk free. Given this information, find how much must you investment in Stock C. Round your answer to the nearest dollar. (NOTE: do NOT include the dollar sign in your answer) Asset, Investment, Beta Stock A, $200,000, .70 Stock B, $250,000, 1.10 Stock C, ?, 1.60 Risk-free asset, ?, ?

365,625

(Mock Quiz) Ferryville Radar Technologies has five-year, 7.5% bonds outstanding that trade at a yield to maturity of 6.8%. The company's marginal tax rate is 35%. Ferryville plans to issue new five-year notes to finance an expansion. Ferryville's after-tax cost of debt capital is closest to:

4.42%

(Quiz) A firm sold a 10-year bond issue 3 years ago. The bond has a 6.45% annual coupon and a $1,000 face value. The coupons are paid annually. If the current market price of the bond is $951.64 and the tax rate is 35%, what is the after-tax cost of debt? (round to the nearest hundredth percent?)

4.77%

(Homework) Jiminy's Cricket Farm issued a 30-year, 9 percent annual coupon bond 8 years ago. The bond makes coupon payments semiannually. The par value of the bond is $1,000. The bond currently sells for 105 percent of its face value. The company's tax rate is 35 percent. b. What is the after-tax cost of debt?

5.52%

(Quiz) What is the total return to an investor who buys a bond for $1,100 when the bond has a 9% coupon rate and 5 years remaining until maturity, then sells the bond after 1 year for $1,085?

6.82%

(Homework) Your firm has preferred stock outstanding that pays a current dividend of $3.00 per year and has a current price of $39.50. You anticipate the economy will grow steadily at a rate of 3.00% per year for the foreseeable future. What is the market required rate of return on your firm's preferred stock?

7.60%

(Sample Quiz) Asset A has an expected return of 14.5% and a beta of 1.15. The risk-free rate is 5%. What is the market risk premium?

8.26%

(Homework) Jiminy's Cricket Farm issued a 30-year, 9 percent annual coupon bond 8 years ago. The bond makes coupon payments semiannually. The par value of the bond is $1,000. The bond currently sells for 105 percent of its face value. The company's tax rate is 35 percent. a What is the pretax cost of debt?

8.49%

(Quiz & Mock Quiz) The weighted-average cost of capital, after tax, for a firm with a 65/35 debt/equity split, 8% cost of debt, 15% cost of equity, and a 35% tax rate would be:

8.63%

(Quiz & Homework) Mr. Malone wants to change the overall risk of his portfolio. Currently, his portfolio is a combination of risky assets with a beta of 1.25 and an expected return of 14%. He will add a risk-free asset (U.S. Treasury bill) to his portfolio. If he wants a beta of 1.0, what percent of his wealth should be in the risky portfolio? Round your answer to the nearest percent. (NOTE: enter your answer as percent without the percentage sign. For example, if your answer is 5.45%, enter 5)

80

(Sample Quiz) Billick Brothers is estimating its WACC. The company has collected the following information: -Its capital structure consists of 40 percent debt and 60 percent common equity -The company has 20-year bonds outstanding with a 9 percent annual coupon that are trading at par -The company's tax rate is 40 percent -The risk-free rate is 5.5 percent -The market risk premium is 5 percent -The stock's beta is 1.4 What is the company's WACC?

9.66%

(Homework) Which of the following would likely have the greatest amount of systematic risk?

A portfolio half invested in the market portfolio and half invested in stocks with betas = 1.50

(Quiz) A stock investor owns a diversified portfolio of 15 stocks. What will be the likely effect on portfolio return standard deviation from adding one more stock?

A slight decrease will occur

(Homework & Quiz) Takelmer Industries has a different WACC for each of three types of projects. Low-risk projects have an 8% WACC, average-risk projects a 10% WACC, and high-risk projects a 12% WACC. Which of the following projects do you recommend that the firm accept? Project, Level of Risk, IRR A, Low, 9.50% B, Average, 8.50% C, Average, 7.50% D, Low, 9.50% E, High, 14.50% F, High, 17.50% G, Average, 11.50%

A, D, E, F, and G

(Sample Quiz) Security, Return, Standard Deviation, Beta A, 16%, 20%, 1.2 B, 12%, 25%, 0.8 Risk-free asset, 4%, ?, ? Which of A and B has the least total risk? The least systematic risk?

A; B

(Homework) An all-equity firm is considering the following projects: Project W: beta .70, expected return 11% Project X: beta .95, expected return 13% Project Y: beta 1.05, expected return 14% Project Z: beta 1.60, expected return 16% The T-bill rate is 5 percent, and the expected return on the market is 12 percent. Assume the company's overall WACC is 12%. b. Which projects should be accepted?

Accept: X, Y, Z Reject: Z

(Homework) Which of the following is false concerning diversification? Assume that the securities being considered for selection into a portfolio are not perfectly correlated.

As more securities are added to the portfolio, the systematic risk of the portfolio declines

(Sample Quiz & Quiz) Bradshaw Steel has a capital structure with 30 percent debt (all long-term bonds) and 70 percent common equity. The coupon rate on the company's long-term bonds is 8 percent and the bond is sell at a premium. The firm estimates that its overall composite WACC is 10 percent. The risk-free rate of interest is 5.5 percent, the market risk premium is 5 percent, and the company's tax rate is 40 percent. Bradshaw uses the CAPM to determine its cost of equity. What is the beta on Bradshaw's stock?

Cannot be solved because not enough information is provided

(Quiz & Mock Quiz) Which of the following would decrease a portfolio's systematic risk?

Common stock with positive beta is sold and replaced with Treasury bills

(Homework) Titan Mining Corporation has 8 million shares of common stock outstanding, 5 million shares of preferred stock outstanding, and 100,000 units of 9 percent semiannual bonds outstanding, par value $1,000 each. The preferred stock pays a dividend of $6 per share. The common stock currently sells for $32 per share and has a beta of 1.15, the preferred stock currently sells for $67 per share, and the bonds have 15 years to maturity and sell for 91 percent of par. The market risk premium is 10 percent, T-bills are yielding 5 percent, and Titan Mining's tax rate is 35 percent. a. What is the firm's market value capital structure?

D/V = .1334 P/V = .4912 E/V = .3754

(Sample Quiz & Mock Quiz) Ed Lawrence has $100,000 invested. Of that, $300,000 is invested in IBM stock, $25,000 is invested in T-bills, and the remainder is invested in corporate bonds. Which of the following is true regarding his portfolio?

Ed has 30% of his portfolio invested in stocks

(Sample Quiz) Which of the following would be considered an example of systematic risk?

Greater new jobless claims than expected

(Homework) Filer Manufacturing has 8.2 million shares of common stock outstanding. The current share price is $52, and the book value per share is $5. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $70 million, an 8 percent coupon, and sells for 104 percent of par. The second issue has a face value of $50 million, a 7.5 percent coupon, and sells for 97 percent of par. The first issue matures for 10 years, the second in 6 years. (assume each unit of bond has a face value of $1,000) a. What are the Filer's capital structure weights on book value basis?

In terms of book value, 25.47% of the capital is composed of equity and the remaining 74.53% is composed of debt

(Homework) Filer Manufacturing has 8.2 million shares of common stock outstanding. The current share price is $52, and the book value per share is $5. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $70 million, an 8 percent coupon, and sells for 104 percent of par. The second issue has a face value of $50 million, a 7.5 percent coupon, and sells for 97 percent of par. The first issue matures for 10 years, the second in 6 years. (assume each unit of bond has a face value of $1,000) b. What are Filer's capital structure weights on a market value basis?

In terms of market value, 77.85% of the capital is composed of equity and the remaining 22.15% is composed of debt

(Quiz) A firm is considering an investment in a project whose risk is greater than the current risk of the firm, based on any method for assessing risk. In evaluating this asset, the decision maker should:

Increase the cost of capital used to evaluate the project to reflect the projects higher risk

(Homework) A firm that uses its WACC as a cutoff without consideration of project risk:

Likely will see its WACC rise over time

(Quiz & Mock Quiz) What is the expected yield on the market portfolio at a time when Treasury bills yield 6% and a stock with a beta of 1.4 is expected to yield 18%?

None of the above

(Sample Quiz) An investment earned the following for the returns 1998 through 2001: 30%, 40%, 15%, and 7%. What is the variance of returns for this investment?

None of the above (the correct answer is 0.0219)

(Homework) An all-equity firm is considering the following projects: Project W: beta .70, expected return 11% Project X: beta .95, expected return 13% Project Y: beta 1.05, expected return 14% Project Z: beta 1.60, expected return 16% The T-bill rate is 5 percent, and the expected return on the market is 12 percent. Assume the company's overall WACC is 12%. c. Which projects would be incorrectly accepted or rejected if the firm's overall cost of capital were used as a hurdle rate

Project W would be incorrectly rejected; project Z would be incorrectly accepted

(Homework) An all-equity firm is considering the following projects: Project W: beta .70, expected return 11% Project X: beta .95, expected return 13% Project Y: beta 1.05, expected return 14% Project Z: beta 1.60, expected return 16% The T-bill rate is 5 percent, and the expected return on the market is 12 percent. Assume the company's overall WACC is 12%. a. Which projects have a higher expected return than the firm's 12 percent cost of capital?

Projects X, Y and Z

(Homework) Standard deviation is one of the most common measures of ____.

Return volatility

(Sample Quiz & Mock Quiz) The principle of diversification tells us that:

Spreading an investment across many diverse assets will eliminate some of the risk

(Quiz) Which of the following risks would be classified as a non-systematic risk for an auto manufacturer?

Steel prices

(Homework) Stock A has a beta coefficient of 0.9, and stock B has a beta coefficient of 1.2. Which of the following statements is false regarding these two stocks?

Stock A necessarily must have a lower standard deviation of returns than stock B

(Homework) You have $10,000 to invest in a stock portfolio. Your choices are Stock X with a return of 15 percent and Stock Y with a return of 10 percent. If your goal is to create a portfolio with a return of 13.5 percent, how much money will you invest in Stock X? In Stock Y?

Stock X = $7,000 Stock Y = $3,000

(Homework & Mock Quiz) The relevant risk for the fair market pricing of financial securities is the ___.

Systematic risk

(Quiz) Assume that the Security Market Line (SML) is based on a risk free rate of 5% and a market return of 11%. What will happen to the SML if the forecast of risk-free rate increases and investors become more risk averse?

The SML will shift p and have a steeper slope

(Mock Quiz) Which of the following is true regarding the WACC?

The WACC is the required return on any investment a firm makes that has a level of risk equal to that of present operations

(Homework) Jiminy's Cricket Farm issued a 30-year, 9 percent annual coupon bond 8 years ago. The bond makes coupon payments semiannually. The par value of the bond is $1,000. The bond currently sells for 105 percent of its face value. The company's tax rate is 35 percent. c. Which is more relevant, the pretax or the after-tax cost of debt? Why?

The after-tax rate is more relevant because that is the actual cost to the company

(Homework) Which of the following is false regarding the estimation of a firm's cost of equity capital?

The cost of equity is equal to the weighted average cost of capital

(Homework) Which of the following describes a stock that plots above the security market line?

The expected return of the stock is too high

(Quiz) What is the typical relationship between the return standard deviation of an individual common stock and the return standard deviation of a diversified portfolio of common stocks?

The individual stock's return standard deviation is higher

(Homework) Filer Manufacturing has 8.2 million shares of common stock outstanding. The current share price is $52, and the book value per share is $5. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $70 million, an 8 percent coupon, and sells for 104 percent of par. The second issue has a face value of $50 million, a 7.5 percent coupon, and sells for 97 percent of par. The first issue matures for 10 years, the second in 6 years. (assume each unit of bond has a face value of $1,000) c. Which are more relevant, the book or market value weights? Why?

The market value weights are more relevant

(Quiz) If the market portfolio is expected to offer returns of 16%, then what can be said about a portfolio expected to return 13%?

The portfolio's beta is less than 1.0

(Homework & Quiz) Which of the following is false regarding risk and return?

The reward for bearing risk is known as the standard deviation

(Sample Quiz) Which of the following is false regarding risk and return?

The reward for bearing risk is known as the standard deviation

(Mock Quiz) Which of the following statement about equity beta is true?

The slope of the security market line measures a security's beta (non-diversifiable Risk) and beta can change whenever there is a change in investors expectations of inflation and/or their degree of risk aversion

(Homework & Mock Quiz) The type of risk that we can diversify away is ___

Unsystematic risk

(Quizlet) Which of the following is not a disadvantage of SML?

applicable to all companies, as long as we can compute beta

(Quizlet) Using the WACC as our discount rate is only appropriate for projects that ___ risk as the firm's current operations

are the same

(Quizlet) We can use the individual costs of capital that we have computed to get our ___ cost of capital for the firm

average

(Homework & Mock Quiz) The cost of debt capital for a firm ____

can be estimated even if the firm's bonds are not publicly traded, by looking at the yield to maturity on bonds outstanding from peer group firms with similar ratings and maturity

(Quizlet) A stock has been held for one year, during which time its dividend yield was greater than its capital gains yield. For this stock, the percentage return is:

cannot be determined

(Homework)___ refers to the way a company finances itself through some combinations of loans, bond sales, preferred stock sales, common stock sales, and retention of earnings.

capital structure

(Quizlet) What is a portfolio?

collection of assets

(Quizlet) The ___ is the required return on our ___

cost of debt; company's debt

(Quizlet) Which are considered to be risk free

coupon bonds

Julius, Inc. is in a 40% marginal tax bracket. The firm can raise as much capital as needed in the bond market at a cost of 10% yield to maturity. The preferred stock has a fixed dividend of $4.00. The price of preferred stock is $31.50. The after-tax costs of debt and preferred stock are closest to:

debt: 6%, preferred stock: 12.27%

(Sample Quiz) Suppose that the Federal Reserve takes actions that cause the risk-free rate to fall. All else the same, we would expect a firm's cost of equity to ___.

decrease if we are using the SML

(Quizlet) Risk premium of market portfolio; the ____ between the market return and the return on risk-free Treasury bills.

difference

(Quizlet) Which of the following is not a disadvantage of the dividend growth model?

does not require additional training to ensure proper integration

(Mock Quiz) A stock's risk premium is equal to the:

expected market risk premium times beta

(Quizlet) The risk-return trade-off for a portfolio is measured

expected return and standard deviation