MOS 3310 Quiz 4
TRUE/FALSE QUESTIONS
1) When inflation is expected to be low, the risk premium on common stocks is expected to be low.
Correct Answer – TRUE
2) Market risk can be eliminated in a stock portfolio through diversification.
Correct Answer – FALSE
3) The risk that remains in a stock portfolio after efforts to diversify is known as unique risk.
Correct Answer – FALSE
4) Treasury bills have a Beta of zero.
Correct Answer – TRUE
5) The security market line plots the historic relationship between returns on an individual stock and the market portfolio.
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6) The company cost of capital is the expected rate of return that investors demand from the company’s assets and operations.
7) Assuming a project has the same risk and financing as the firm, it will have a positive NPV if its rate of return is greater than the firm’s WACC.
8) There are two costs of debt finance. The explicit cost of debt is the rate of interest that bondholders demand. But there is also an implicit cost, because over-borrowing increases the required rate of return to equity.
MULTIPLE CHOICE QUESTIONS (please show calculations for your answers)
9) If when a coin is tossed the observance of a head rewards you with a dollar and the observance of a tail costs you fifty cents, how much would you expect to gain after twenty tosses?
A. $5.00
B. $7.50
C. $10.00
D. $15.00
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10) An investor receives a 15 percent total return by purchasing a stock for $40 and selling it after one year with a 10 percent capital gain. How much was received in dividend income during the year?
A. $2.00
B. $2.20
C. $4.00
D. $6.00
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11) The covariance of two stocks was calculated at -.01733. If the standard deviation of the first stock is .106 and .164 for the second, determine the correlation.
A. -.997
B. -.887
C. -.687
D. -.587
12) If a stock is purchased for $25 per share and held one year, during which time a $3.50 dividend is paid and the price climbs to $28.25, the nominal rate of return is:
A. 13.00 percent.
B. 14.00 percent.
C. 23.01 percent
D. 27.00 percent.
13) Calculate the real rate of interest if the nominal rate of interest is 8.65% and the inflation rate is 2.24%.
A. 9.50%
B. 8.49%
C. 7.38%
D. 6.27%
14) If a two-stock portfolio is equally invested in stocks with Betas of 1.4 and 0.7, then the portfolio Beta is:
A. 0.70.
B. 1.05.
C. 1.40.
D. 2.10
15) What rate of return should an investor expect for a stock that has a Beta of 0.8 when the market is expected to yield 14% and Treasury bills offer 6%?
A. 9.2%
B. 11.2%
C. 12.4%
D. 12.8%
16) A stock with a Beta greater than 1.0 would be termed:
A. an aggressive stock, expected to increase more than the market increases.
B. a defensive stock, expected to decrease more than the market increases.
C. an aggressive stock, expected to decrease more than the market increases.
D. a defensive stock, expected to increase more than the market decreases.
17) A considerable scattering in the plot of points representing the historic returns of a stock versus the returns on the market indicates the:
A. high Beta of the stock.
B. unique risk of the stock.
C. changes in market risk premium over time.
D. current underpricing of the stock.
18) What will happen to a stock that offers a lower risk premium than predicted by the CAPM?
A. its Beta will increase.
B. its Beta will decrease.
C. its price will decrease until yield is increased.
D. its price will increase until the yield is reduced.
19) The slope of the security market line equals:
A. one.
B. beta.
C. the market risk premium.
D. the expected return on the market portfolio
20) What dividend is paid on preferred stock if investors require a 9% rate of return and the stock has a market value of $54.00 per share and a book value of $50.00 per share?
A. $2.92
B. $4.50
C. $4.68
D. $4.86
21) The company cost of capital, pretax for a firm with a 60/40 debt/equity split, 8% cost of debt, 15% cost of equity, and a 35% tax rate would be:
A. 7.02%
B. 9.12%
C. 10.80%
D. 13.80%
22) What is the WACC for a firm with 40% debt, 20% preferred stock and 40% equity if the respective costs for these components are 6% after-tax, 12% after-tax, and 18% before- tax? The firm’s tax rate is 35%.
A. 9.48%
B. 11.16%
C. 12.00%
D. 15.60%
23) If a firm wishes to undertake a project with a different risk than its own, what is the best way by which to estimate the project’s beta?
A. a company in the same business as the firm.
B. a risk adjustment made to the firm’s beta.
C. a company in the same business as the project.
D. management approximation.
24) Free cash flow is defined as:
A. debt at zero percent interest.
B. cash flow that is not required for investing in fixed assets only.
C. cash flow that is not required for investing in working capital only.
D. cash flow that is not required for investing in either fixed assets or working capital.
25) A proposed project has a positive NPV when evaluated at the company cost of capital. If the firm employs debt in its capital structure, will the project remain acceptable after evaluation with the WACC?
A. Yes, using the WACC will increase the NPV.
B. No, using the WACC will decrease the NPV.
C. the project may now become unacceptable.
D. there will be no change in the project’s NPV.
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