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Unformatted text preview: ./ W Name . Exam 2 342 Spring 06 WWW l. The cost of preferred stock is computed the same as:
A. the pretax cost of debt. KP :_ B. an annuity. ‘ 9,4
. the aftertax cost of debt.
a perpetuity. . an irregular growth common stock. 2. The primary purpose of portfolio diversiﬁcation is to:
A. increase returns and risks.
. eliminate all risks.
eliminate assetspeciﬁc risk. . eliminate systematic risk.
E. lower both returns and risks. 3. Risk that affects a large number of assets, each to a greater or lesser degree, is called risk.
A. idiosyncratic B. diversiﬁable
© systematic D. assetspeciﬁc E. total 4. Your best friend works in the ﬁnance ofﬁce of the Delta Corporation. You are aware that this friend trades
Delta stock based on information he overhears in the ofﬁce. You know that this information is not known to the
general public. Your friend continually brags to you about the proﬁts he earns trading Delta stock. Based on this information, you would tend to argue that the ﬁnancial markets are at best form efﬁcient.
A. weak )Z semiweak
C. semistrong @ strong . perfect
5. A security that is fairly priced will have a return that lies
A. below . on or below
on D. on or above
E. above the Security Market Line. 6. The excess return earned by an asset that has a beta of 1.0 over that earned by a riskfree asset is referred to
as the:
A. market rate of return.
' B) market risk premium.
@ systematic return.
. total return. E. real rate of return. r______________________—————————, 13. Daniel's Enterprises has a beta of 1.98 and a growth rate of 12 percent. The stock is currently selling for $12
a share. The overall stock market has an 11 percent rate of return and a risk premium of 8 percent. What IS the required rate of return on Daniel's Enterprises stock? g. 6.: “‘28 (2M 2” .03 + met. 09‘) :
16.67 percent 9 :7, 1213K : . 05 { 8‘ 54
18.84 percent P0 7 ‘2' 213g : 03 E. 19.06 percent FEE C 14. Kurt‘s Adventures, Inc. stock is quite cyclical. In a boom economy, the stock is expected to return 30
percent in comparison to 12 percent in a normal economy and a negative 20 percent in a recessionary period.
The probability of a recession is 15 percent. There is a 30 percent chance of a boom economy. The remainder of
the time the economy will be at normal levels. What is the standard deviation of the returns on Kurt's Adventures, Inc. stock? M L Q. g. p (2 3;»: i) [7 (2  P: ) 2 A. 10.05 percent boom .3 7?? .7767 “.7171” W B. 12.60 percent NopM 33$ .12 .0140 v . 00w ' ooomqg @15.83percent Qeg _\S ,2 103 g 3215 'olga D. 17.46 percent , v,— ' “SWWM' E.25.04percent ‘2 = "2‘0 .025 "—7 €72
. I10 : ‘8 15. Martha' 5 Interiors has a current beta of 1.2. The market risk premium is 6 percent and the riskfree rate of
return is 4 percent. By how much will the cost of equity increase if the company completes an acquisition such
that their company beta rises to 1.4? A. 0.12 percent 6 : [,2 0.24 percent a .
C.1.20percent ~O4+ iZkOb) ~ .112
D.2.40percent [04+l'4(,Ob):_ [ E. 2.47 percent 16. Which one of the following is a correct statement concerning risk premium?
The greater the volatility of returns, the greater the risk premium.
)XThe lower the volatility of returns, the greater the risk premium.
Q.’ The lower the average rate of return, the greater the risk premium.
D. The risk premium is not correlated to the average rate of return.
E. The risk premium is not affected by the volatility of returns. 17. Jack's Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar
characteristics are yielding 8.5 percent. The company also has 4 million shares of common stock outstanding.
The stock has a beta of 1.1 and sells for $40 a share. The US. Treasury bill is yielding 4 percent and the market
risk premium is 8 percent. J ack's tax rate is 35 percent. What is J ack‘s weighted average cost of capital? A. 7.10 percent {4 P 1* OUT \10 LU€ W 9.) 93% ‘t B. 7.39 percent W L: mo 80,000 000 ’ 3 3
© 10.38 percent d ” ammo ' ' D. 10.65 percent 6 . i 223 40 4,000,000 1000050190 . m E. 11.37 percent K€:.O4+ 1.1605) :. [26
Katwdl‘di‘wte; eweka
: 1%3XOESXAﬂS) H0111?) ) 24. The weighted average cost of capital for a ﬁrm is the:
discount rate which the ﬁrm should apply to all of the projects it undertakes.
@overall rate which the ﬁrm must earn on its existing assets to maintain the value of its stock. C. rate the ﬁrm should expect to pay on its next bond issue.
D. maximum rate which the ﬁrm should require on any projects it undertakes.
E. rate of return that the ﬁrm's preferred stockholders should expect to earn over the long term. 2 . The pretax cost of debt for a ﬁrm: a
A is equal to the yield to maturity on the outstanding bonds of the ﬁrm.
fis equal to the coupon rate of the outstanding bonds of the ﬁrm.
,Q./is equivalent to the current yield on the outstanding bonds of the ﬁrm.
D. is based on the yield to maturity that existed when the currently outstanding bonds were originally issued. %has to be estimated as it cannot be directlyobserved in the market. 26.alse If investors are unable to beat the market using all information, including insider information,
thent e market is efﬁcient in the Strong form. A risk premium.
. geometric premium.
C. excess return.
D. average return.
E. variance. § The excess return required from a risky asset over that required from a riskfree asset is called the: 28. The Abco Co. maintains a debtequity ratio of .70 and has a tax rate of 39 percent. The ﬁrm does not issue
preferred stock. The cost of equity is 12 percent and the aftertax cost of debt is 5 percent. What is Abco's weighted average cost of capital? 1 7
A. 8.8percent i we“? SQ ZE' z "' Total 3 D‘iE
(.1, A)“ t \O i; m _ 8.9 percent 1 a. w
9.1 percent (3 .3 . I2 2 l 7
D. 9.3 percent
E.9.5percent 1/!1(‘OS)+,Q/n(l§2>:foq’ 29. A portfolio is: A a group of assets, such as stocks and bonds, held as a collective unit by an investor.
B. the expected return on a risky asset. C. the expected return on a collection of risky assets. D. the variance of returns for a risky asset. E. the standard deviation of returns for a collection of risky assets. 30. Martin Industries just paid an annual dividend of $1.20 a share. The market price of the stock is $26.60 and
the growth rate is 4 percent. What is the ﬁrm's cost of equity? A. 8.38 percent \
B. 8.51percent Fe “— “l'ZUJF‘O‘U «g. . QC;
. 8.57 percent 74:, “to
(I; 8.69 percent
. 8.74 percent /______________________._____i Draw a box around your ﬁnal answers. 36. Bendix Corp has asked you to calculate their cost of capital. You are given the following information:
The company has 8,000,000 shares of common stock outstanding. This stock is presently priced at $40
per share. The yearend dividend is expected to be $2. The dividends have been growing at a rate of 7%
annually. The company also has a bond issue outstanding. The bonds will mature in 15 years and have a
coupon of 81/2 % with interest payments made semiannually. These bonds are presently priced at
$1095. There are 270,000 of these bonds outstanding. There are 1,500,000 shares of preferred stock
outstanding. This stock is priced at $65 per share and has a required return of 9%. The riskless rate is
5%, the market risk premium is 9% and the company has a corporate tax rate of 40%. What is the company’s cost of capital? I [15]
K is, ,2 it 0ng \JaLue Emmy/H»
d 514 tOQS Ito/ow 206,030,000 ,415 mm
p %m tag \.SO0,000 91,500,090 . I31 U D/po
e .120 40 BIOOOICM 320,060,000 .449 , 9
1I3Ii30,000 ‘ a
Kq:\Nd\<d(\' C§+WPKPfWeK /
/ / ‘ N /2 3
Ka:(.4ISI.O LOU—,4) + (.m H 44] ,2) /_, ta 1,0l84 Jr .0308 «0839 @5193 37. The market risk premium is 11% and the variance of market returns is .00575. Bombay Ginners returns are perfectly positively correlated with those of the market and BeefEatery Ginners returns have a covariance with
the market equal to .305. What is the beta of the market? [5] M042 K2"? V—lSK pQQrm‘Ja/t : . l l
93" 1 .0031; 6 :gw : —. 305 :"“:;j5§ /
8M .0135 /Lv’ 38. Given the following information on the two stocks, RF I and EH, calculate the required
portfolio consisting of 5,000 shares of RFI and 10,000 shares of BJI. The stocks’ returns coefﬁcient of 0.8. — E(R)
158% I 33
16 122% a. Beta of the portfolio
@:.%2(s.a")+,k01(\_23 2894 *7.an 21.40 b. Expected return of the portfolio 1" MW” / EU?) : 393) 4"  .14; '3 f‘ “2' . lg‘i c. Standard deviation of the portfolio. ‘
"a 2 e 1 {W A?” “8: + \N 329: 1” ﬁlm ii A “type F» 9g ,5
{(321 231+ (whim rztzavlm tel€143] :LOﬂrO‘lZero’HT/Z 31. The BetrBilt Company has a sixyear bond outstanding with a 5 percent coupon. Interest payments are
paid semiannually. The face amount of the bond is $1,000. This bond is currently selling for 98 percent of its
face value. What is the company's pretax cost of debt? A. 4.72 percent PV 3  QED
B. 5.31 percent FV 3 [000
C 5.35 percent N: \2
@539 percent pMT = ZS E. 5.42 percent 32. Blackwater Adventures has a bond issue outstanding that matures in sixteen years. The bonds pay interest
semiannually. Currently, the bonds are quoted at 103 percent of face value and carry a 9 percent coupon. The
ﬁrm's tax rate is 34 percent. What is the ﬁrm's aftertax cost of debt? .5.19 percent N:g2
5.71 percent pv :  1030
C. 7.86 percent FV 2 1000 D. 8.65 percent
E. 11.41 percent 33. A stock with an actual return that lies above the security market line:
A. has more systematic risk than the overall market. has more risk than warranted based on the realized rate of return.
C. has yielded a higher return than required for the level of risk assumed.
D. has less systematic risk than the overall market.
E. has yielded a return equivalent to the level of risk asSumed. 34. The hypothesis that market prices reﬂect all available information of every kind is called form
efﬁciency. A open
@ trong
C. semistrong D. weak
E. stable 35. The capital structure weights used in computing the weighted average cost of capital are:
A. constant over time provided that the debtequity ratio changes in unison with the market values.
B. based on the face value of the ﬁrm's debt. computed using the book value of the longterm debt and the shareholder's equity.
based on the market value of the ﬁrm's debt and equity securities.
E. limited to the ﬁrm's debt and common stock. +£0.14 « Wire P______—____________________________—i, 18. Watson's Automotive has a $400,000 bond issue outstanding that is selling at 102 percent of face value.
Watson's also has 4,500 shares of preferred stock and 21,000 shares of common stock outstanding. The
preferred stock has a market price of $44 a share compared to a price of $21 a share for the common stock.
What is the weight of the debt as it relates to the ﬁrm's weighted average cost of capital? A. 38percent d 408,000 39 percent ,3.
C. percent 9 4 101 8; O
D. 41 percent 3 1.1000 5 li 441,000
E. 42 percent “04.1, 000 19. The standard deviation for a set of stock returns can be calculated as the:
A. positive square root of the average return.
. average squared difference between the actual return and the average return.
épositive square root of the variance.
D. average return divided by N minus one, where N is the number of returns. E. variance squared. 20. If the ﬁnancial markets are efﬁcient, then investors should expect their investments in those markets to:
X earn extraordinary returns on a routine basis.
. generally have positive net present values.
@generally have zero net present values.
D. produce arbitrage opportunities on a routine basis.
)Zproduce negative returns on a routine basis. 21. Which one of the following would tend to indicate that a portfolio is being effectively diversiﬁed?
A. an increase in the portfolio beta
B. a decrease in the portfolio beta
C. an increase in the portfolio rate of return
. an increase in the portfolio standard deviation
@a decrease in the portfolio standard deviation 22. Nuvo, Inc. stock has a beta of .86 and an expected return of 10.5 percent. The riskfree rate of return is 3.2
percent and the market rate of return is 11.2 percent. Which one of the following statements is true given this
information? ‘ . The return on Nuvo stock will graph below the Security Market Line. ‘/ , 5101' 09) 1’. C’s :.
E Nuvo stock is underpriced. , lO 0 <3
. The expected return on Nuvo stock based on the Capital Asset Pricing Model is 9.88 percent. D. Nuvo stock has more systematic risk than the overall market.
ﬁ/Nuvo stock is correctly priced. 23. Your portfolio is comprised of 30 percent of stock X, 50 percent of stock Y, and 20 percent of stock Z.
Stock X has a beta of .64, stock Y has a beta of 1.48, and stock Z has a beta of 1.04. What is the beta of your
portfolio? X ‘7’ X
A. 1.01 .A . x ,.
31.05 34.104 ) +2“ 1,481+ .22., Luci ) . 1.09 1.14 E. 1.18 ___________________________.__..___—————f, 7. Your ﬁrm uses both preferred and common stock as well as longterm debt to ﬁnance its operations. Which
one of the following will increase the capital structure weight of the debt, all else equal?
an increase in the market price of the common stock I >
an increase in the number of shares of preferred stock outstanding
C. an increase in the quoted price of the ﬁrm's bonds as a percentage of face value D. the exercise of warrants by company employees
E. the conversion of convertible bonds into equity shares 8. The Auto Group has 1,200 bonds outstanding that are selling for $980 each. The company also has 7,500
shares of preferred stock at a market price of $40 each. The common stock is priced at $32 a share and there are
32,000 shares outstanding. What is the weight of the preferred stock as it relates to the ﬁrm's weighted average costofcapital? d, “200 VJng aqm : "HWOOO ZOO/ow w \Z/
A. 10 percent P‘ 1800 Sim}. E 30023103 O 2 ' SOC/GOO .
12 percent e “32,000 3110591 22  ‘10 HJU C. 14 percent , 2 . $00; 000 D. 16 percent
E. 18 percent 9. The common stock of Big Birds Unlimited has a required return of 8 percent and a growth rate of 4 percent.
The last annual dividend was $.60 a share. What is the current price of this stock?
A . $7.50
$7.80 .Ioot\+ .04)
c. $10.00 . 06‘
D. $15.00
B. $15.60 10. Insider trading does not offer any advantages if the ﬁnancial markets are:
A. weak form efﬁcient.
B. semiweakform efﬁcient. C. semistrongform efﬁcient.
. strongform efﬁcient.
inefﬁcient. 11. The amount of systematic risk present in a particular risky asset, relative to the systematic risk present in an
verage risky asset, is called the particular asset's:
beta coefﬁcient.
_B. reward—torisk ratio.
C. total risk. D. diversiﬁable risk.
E. Treynor index. 12. You have a $1,000 portfolio which is invested in stocks A and B plus a riskfree asset. $400 is invested in
stock A. Stock A has a beta of 1.3 and stock B has a beta of .7. How much needs to be invested in stock B if
you want a portfolio beta of .90? ' 3' $368 .15.. B m s K mes.
. $482 400 34 3 S 7
$543 Wei)?" .‘l . $58 , 023‘!
E. $600 5 ‘5 g ‘1 0 [q it .4 X13) i (S‘lz‘X .1 “2 ...
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