1. A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = ?5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?
The constant growth model cannot be used because the growth rate is negative.
The company’s dividend yield 5 years from now is expected to be 10%.
The company’s expected stock price at the beginning of next year is $9.50.
The company’s expected capital gains yield is 5%.
The company’s current stock price is $20.
1. Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?
Variance; correlation coefficient.
Coefficient of variation; beta.
Standard deviation; correlation coefficient.
1. Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?
A project’s NPV increases as the WACC declines.
A project’s discounted payback increases as the WACC declines.
A project’s MIRR is unaffected by changes in the WACC.
A project’s IRR increases as the WACC declines.
A project’s regular payback increases as the WACC declines.
1. Which of the following risk types can be diversified by adding stocks to a portfolio?
Non diversifiable risks.
1. Firms that make investment decisions based upon the payback rule may be biased towards rejecting projects:
with early cash inflows.
With short lives.
With long lives.
Those with negative NPVs.
None of above.
1. When a project’s internal rate of return equals its opportunity cost of capital, then:
The net present value will be negative.
The net present value is a linear combination of MIRR and IRR.
The net present value will be positive.
The project has no cash inflows.
The net present value will be zero.
1. When hard rationing exists, projects may be evaluated by the use of ?
borrowing rather than lending projects.
Modified payback period.
A profitability index.
1. Because of its age, your car costs $3000 annually in maintenence expense. You could replace it with a newer vehicle costing $6000. Both vehicles would be expected to last 4 more years. If your opportunity cost is 10% what should be the maximum annual maintenance expense be on the newer vehicle to justify the purchase ? (Hint : EAC on the new vehicle should not exceed $3000)
1. Taggart Inc.’s stock has a 50% chance of producing a 39% 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?
1. Tom O’Brien has a 2-stock portfolio with a total value of $100,000. $35,000 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio’s beta?
1. Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. You are in the process of buying 1,000 shares of Alpha Corp at $10 a share and adding it to your portfolio. Alpha has an expected return of 22.5% and a beta of 1.80. The total value of your current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Alpha stock?
14.82% and 1.25
12.15% and 1.26
13.49% and 1.11
11.18% and 1.06
10.69% and 1.03
1. Cooley Company’s stock has a beta of 1.20, the risk-free rate is 2.25%, and the market risk premium is 5.50%. What is the firm’s required rate of return?
1. Roenfeld Corp believes the following probability distribution exists for its stock. What is the coefficient of variation on the company’s stock?
State of the Economy Probability of State Occurring Stock’s Expected Return
Boom 0.29 25%
Normal 0.50 15%
Recession 0.21 5%
1. You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio’s beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.25. What will the portfolio’s new beta be?
1. Returns for the Dayton Company over the last 3 years are shown below. What’s the standard deviation of the firm’s returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.)
1. A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is r = 10.5%, and the expected constant growth rate is g = 7.2%. What is the stock’s current price?
1. If D = $2.25, g (which is constant) = 3.5%, and P = $60, what is the stock’s expected dividend yield for the coming year?
1. Bay Manufacturing is expected to pay a dividend of $1.25 per share at the end of the year (D = $1.25). The stock sells for $21.50 per share, and its required rate of return is 10.5%. The dividend is expected to grow at some constant rate, g, forever. What is the equilibrium expected growth rate?
1. Molen Inc. has an outstanding issue of perpetual preferred stock with an annual dividend of $8.00 per share. If the required return on this preferred stock is 6.5%, at what price should the stock sell?
1. The Francis Company is expected to pay a dividend of D = $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 1.15, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is the company’s current stock price?
1. Nachman Industries just paid a dividend of D0 = $1.25. Analysts expect the company’s dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The required return on this low-risk stock is 9.00%. What is the best estimate of the stock’s current market value?
1. A company’s perpetual preferred stock currently sells for $125.00 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm’s cost of preferred stock?
1. 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 16.75%. The firm will not be issuing any new stock. What is its WACC?
1. Anderson Systems is considering a project that has the following cash flow and WACC data. What is the project’s NPV? Note that if a project’s projected NPV is negative, it should be rejected.
Year 0 1 2 3
Cash flows -$1,000 $500 $500 $500
1. Daves Inc. recently hired you as a consultant to estimate the company’s WACC. You have obtained the following information. (1) The firm’s noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,250.00. (2) The company’s tax rate is 40%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock’s beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common stock. What is its WACC?
1. Warr Company is considering a project that has the following cash flow data. What is the project’s IRR? Note that a project’s projected IRR can be less than the WACC or negative, in both cases it will be rejected.
Year 0 1 2 3 4
Cash flows -$1,150 $400 $400 $400 $400
1. Taggart Inc. is considering a project that has the following cash flow data. What is the project’s payback?
Year 0 1 2 3
Cash flows -$800 $500 $500 $500
1. Ehrmann Data Systems is considering a project that has the following cash flow and WACC data. What is the project’s MIRR? Note that a project’s projected MIRR can be less than the WACC (and even negative), in which case it will be rejected.
Year 0 1 2 3
Cash flows -$1,000 $450 $450 $450
1. Fernando Designs is considering a project that has the following cash flow and WACC data. What is the project’s discounted payback?
Year 0 1 2 3
Cash flows -$650 $500 $500 $500
1. Francis Inc.’s stock has a required rate of return of 10.25%, and it sells for $35.00 per share. The dividend is expected to grow at a constant rate of 6.00% per year. What is the expected year-end dividend, D ?
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