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Terms in this set (26)
A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?
- If market interest rates decline, the price of the bond will also decline.
- The bond is currently selling at a price below its par value.
- The bond's current price is higher than its face value.
- The bond should currently be selling at its par value.
-If market interest rates remain unchanged, the bond's price one year from now will be higher than it is today.
The bond's current price is higher than its face value.
Which of the following events would make it more likely that a company would call its outstanding callable bonds?
- The company's bonds are downgraded.
- Market interest rates rise sharply.
- Market interest rates decline sharply.
- The company's financial situation deteriorates significantly.
- Inflation increases significantly.
Market interest rates decline sharply.
Assume that interest rates on 20-year Treasury and corporate bonds with different ratings, all of which are noncallable, are as follows:
T-bond = 7.72% A = 9.64%
AAA = 8.72% BBB = 10.18%
The differences in rates among these issues were most probably caused primarily by:
- Real risk-free rate differences.
-Tax effects.
- Default risk.
- Maturity risk differences.
- Inflation differences.
Default risk.
Taggart Inc.'s stock has a 50% chance of producing a 36% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return? Do not round your intermediate calculations.
- 15.86%
- 15.71%
- 15.40%
- 12.01%
- 14.01%
15.40%
Measures a stock's market risk, and shows a stock's volatility relative to the market.
- Indicates how risky a stock is if the stock is held in a well-diversified portfolio.
- A portfolio's beta is the weighted average of the betas of the assets in the portfolio.
- If beta = 1.0, the security is just as risky as the average stock.
- If beta > 1.0, the security is riskier than average.
- If beta < 1.0, the security is less risky than average.
- Most stocks have betas in the range of 0.5 to 1.5.
A portfolio's beta is the weighted average of the betas of the assets in the portfolio.
You have the following data on three stocks:
Stock Standard Deviation Beta
A 20% 0.59
B 10% 0.61
C 12% 1.29
If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.
- A; A.
- A; B.
- B; A.
- C; A.
- C; B.
B; A.
Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.
- Stock A would be a more desirable addition to a portfolio then Stock B.
- In equilibrium, the expected return on Stock B will be greater than that on Stock A.
- When held in isolation, Stock A has more risk than Stock B.
- Stock B would be a more desirable addition to a portfolio than A.
- In equilibrium, the expected return on Stock A will be greater than that on B.
In equilibrium, the expected return on Stock A will be greater than that on B.
For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?
- The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation.
- The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation.
- The beta of the portfolio is less than the weighted average of the betas of the individual stocks.
- The beta of the portfolio is equal to the weighted average of the betas of the individual stocks.
- The beta of the portfolio is larger than the weighted average of the betas of the individual stocks.
The beta of the portfolio is equal to the weighted average of the betas of the individual stocks.
Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?
- Adding more such stocks will reduce the portfolio's diversifiable, risk.
- Adding more such stocks will increase the portfolio's expected rate of return.
- Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk.
- Adding more such stocks will have no effect on the portfolio's risk.
- Adding more such stocks will reduce the portfolio's market risk but not its diversifiable risk.
Adding more such stocks will reduce the portfolio's diversifiable, risk.
If a stock's dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.
- The expected return on the stock is 5% a year.
- The stock's dividend yield is 5%.
- The price of the stock is expected to decline in the future.
- The stock's required return must be equal to or less than 5%.
- The stock's price one year from now is expected to be 5% above the current price.
The stock's price one year from now is expected to be 5% above the current price.
A share of common stock just paid a dividend of $1.00. If the expected long-run growth rate for this stock is 5.4%, and if investors' required rate of return is 14.2%, what is the stock price?
- $12.70
- $11.98
- $14.61
- $10.66
- $12.10
$11.98
Molen Inc. has an outstanding issue of perpetual preferred stock with an annual dividend of $2.00 per share. If the required return on this preferred stock is 6.5%, at what price should the stock sell?
- $30.77
- $32.92
- $38.15
- $23.38
- $27.38
$30.77
The Francis Company is expected to pay a dividend of D1 = $1.25 per share at the end of the year, and that dividend is expected to grow at a constant rate of 6.00% per year in the future. The company's beta is 1.70, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is the company's current stock price?
- $13.44
- $12.93
- $17.01
- $14.80
- $18.03
$17.01
Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept?
- A Division B project with a 13% return.
- A Division B project with a 12% return.
- A Division A project with an 11% return.
- A Division A project with a 9% return.
- A Division B project with an 11% return.
A Division A project with an 11% return.
Several years ago the Jakob Company sold a $1,000 par value, noncallable bond that now has 20 years to maturity and a 7.00% annual coupon that is paid semiannually. The bond currently sells for $875, and the company's tax rate is 40%. What is the component cost of debt for use in the WACC calculation? Do not round your intermediate calculations.
- 4.58%
- 4.97%
- 3.78%
- 4.92%
- 5.87%
4.97%
You were hired as a consultant to Giambono Company, whose target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 12.00%. The firm will not be issuing any new stock. What is its WACC?
- 8.93%
- 7.59%
- 6.96%
- 7.68%
- 6.69
8.93%
Teall Development Company hired you as a consultant to help them estimate its cost of capital. You have been provided with the following data: D1 = $1.45; P0 = $19.00; and g = 6.50% (constant). Based on the DCF approach, what is the cost of equity from retained earnings?
- 10.88%
- 15.26%
- 14.41%
- 13.00%
- 14.13%
14.13%
Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 0.70. Based on the CAPM approach, what is the cost of equity from retained earnings?
- 9.25%
- 7.00%
- 8.47%
- 7.08%
- 7.78%
7.78%
Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?
- A project's IRR increases as the WACC declines.
- A project's NPV increases as the WACC declines.
- A project's MIRR is unaffected by changes in the WACC.
- A project's regular payback increases as the WACC declines.
- A project's discounted payback increases as the WACC declines.
A project's NPV increases as the WACC declines.
Which of the following statements is CORRECT?
- The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.
- The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR.
- The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate.
- The NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period.
- The IRR method does not consider all relevant cash flows, particularly cash flows beyond the payback period.
The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.
Which of the following statements is CORRECT?
- The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
- The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
- The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
- The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
- The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.
- The longer a project's payback period, the more desirable the project is normally considered to be by this criterion.
- One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money.
- If a project's payback is positive, then the project should be rejected because it must have a negative NPV.
- The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.
- If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time.
One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money.
The relative risk of a proposed project is best accounted for by which of the following procedures?
- Adjusting the discount rate upward if the project is judged to have above-average risk.
- Adjusting the discount rate upward if the project is judged to have below-average risk.
- Reducing the NPV by 10% for risky projects.
- Picking a risk factor equal to the average discount rate.
- Ignoring risk because project risk cannot be measured accurately.
Adjusting the discount rate upward if the project is judged to have above-average risk.
Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects?
- Project A, which has average risk and an IRR = 9%.
- Project B, which has below-average risk and an IRR = 8.5%.
- Project C, which has above-average risk and an IRR = 11%.
- Without information about the projects' NPVs we cannot determine which one or ones should be accepted.
- All of these projects should be accepted as they will produce a positive NPV.
Project B, which has below-average risk and an IRR = 8.5%.
Langston Labs has an overall (composite) WACC of 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Langston evaluates low-risk projects with a WACC of 8%, average-risk projects at 10%, and high-risk projects at 12%. The company is considering the following projects:
Project Risk Expected Return
- High 15%
- Average 12%
- High 11%
- Low 9%
- Low 6%
A, B, and D
Which of the following statements is CORRECT?
- Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset.
- Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.
- Corporations must use the same depreciation method for both stockholder reporting and tax purposes.
- Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV.
- Using accelerated depreciation rather than straight line normally has the effect of slowing down cash flows and thus reducing a project's forecasted NPV.
Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV.
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