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FIN 100 Principles of Finance complete

The five basic principles of finance include al of the following EXCEPT:
incremental profits determine value
All of the following measure liquidity EXCEPT
operating return on assets
Williams Inc. has a current ratio equal to 3, a quick ratio equal to 1.8, and total current
assets of 6 million. Williams’ inventory balance is:
2,400,000
Benkart Corporation has sales of 5,000,000, net income of 800,000, total assets of
2,000,000 and 100,000 shares of common stock outstanding. If Benkart’s P/E ratio is 12,
what is the company’s current stock price?
$96 per share
A firm that wants to know if it has enough cash to meet its bills would be most likely to
use which kind of ratio?
liquidity
The present value of a single future sum
depends upon the number of discount periods
the 3 basic type of issues addressed by the study of finance are
capital budgeting, capital structure decisions, and working capital management
The present value of 1,000 to be received in 5 years is _____ if the discount rate is
12.78%
$548
You charged 1,000 on your credit card for christmas presents. Your credit card company
charges you 26% annual interest, compounded monthly. If you make the minimum
payments of 25 per month, how long will it take to pay off your balance
94 months
Your company has received a 50,000 loan from an industrial finance company. The
annual payments are 6,202.70. If the company is paying 9 percent interest per year, how
many loan payments must the company make?
15
You have contracted to buy a house for 250,000 paying 30,000 down and taking out a
fully amortizing loan for the balance, at a 5.7% annual rate for 30 years. What will your
monthly payment be if they make equal monthly installments over the next 30 years?
1,277
Stock A’s expected return is
8.2%
Stock W’s standard deviation of returns is
17%
Changes in the general economy, like changes in interest rates or tax laws represent
what type of risk?
market risk
Of the following different types of securities, which is typically considered most risky?
Common stocks of small companies
Which of the following would NOT normally be considered a flotation cost
dividends
The real rate of return is the return earned above the
inflation risk premium
If you were to use the standard deviation as a measure of investment risk, which of the
following has historically been the least risky investment
US Treasury Bill
A typical measure for the risk-free rate of return is the
US Treasury Bill rate
The basic format of an income statement is
Sales – Expenses = Profits
Which of the following bond provisions will make a bond more desirable to investors,
other things being equal?
The bond is convertible
Two consideration that cause corporation’s cost of capital to be different than its
investors’ required returns are
corporate taxes and floatation costs
A firm’s cost of capital is influenced by
capital structure
Shareholder wealth maximization means
maximizing the price of existing common stock.
All of the following statements about balance sheets are true EXCEPT
balance sheets show average asset balances over a one-year period
Which of the following accounts belongs in the equity section of a balance sheet?
retained earnings
Siskiyou, Inc. has total current assets of 1,200,000; total current liabilities of 500,000;
long term assets of 800,000 and long-term debt of 600,000. How much is the firm’s total
equity
900,000
What information does a firm’s statement of cash flows provide to the viewing public?
a report documenting a firm’s cash inflows and cash outflows from operating, financing, and
investing activities for a defined period of time
Investors want a return that satisfies the following expectations:
Both A and B.
In order to reduce agency problems, managers may be provided compensation that
includes:
an option to buy the company’s stock
Investors generally don’t like risk. Therefore, a typical investor
will only take on additional risk if he expects to be compensated in the form of additional return.
The true owners of the corporation are the
common stockholders.
ExxonMobil generates about $50 billion in cash annually from its operations and invests
about half of that on new exploration. Therefore, ExxonMobil is an example of a(n):
savings surplus unit.
Three ways that savings can be transferred through the financial markets include all of
the following except:
indirect transfer using the venture capital firm.
Money market transactions include which of the following?
securities that have a maturity of less than one year
The investment banker performs what three basic functions?
underwriting, distributing, and advising
Which of the following is not a valid theory that attempts to explain the shape of the term
structure of interest rates
the Fisher Effect theory
A corporation’s operating profit margin is equal to
EBIT divided by Sales.
PDQ Corp. has sales of $4,000,000; the firm’s cost of goods sold is $2,500,000; and its
total operating expenses are $600,000. What is PDQ’s EBIT?
$900,000
The two principal sources of financing for corporations are
debt and equity.
All of the following statements about balance sheets are true except:
balance sheets show average asset balances over a one-year period.
Common-sized balance sheets
show each balance sheet account as a percentage of total assets.
You have the choice of two equally risk annuities, each paying $5,000 per year for 8
years. One is an annuity due and the other is an ordinary annuity. If you are going to be
receiving the annuity payments, which annuity would you choose to maximize your
wealth?
the annuity due
Most stocks have betas between
0.60 and 1.60.
) You are considering investing in Ford Motor Company. Which of the following are
examples of diversifiable risk?
II. Risk resulting from uncertainty regarding a possible strike against Ford.
III. Risk resulting from an expensive recall of a Ford product.
Beta is a statistical measure of
the relationship between an investment’s returns and the market return.
You have just purchased a share of preferred stock for $50.00. The preferred stock pays
an annual dividend of $5.50 per share forever. What is the rate of return on your
investment?
.110
Shafer Corporation issued callable bonds. The bonds are most likely to be called if
interest rates decrease.
Put the following in order of their claim on assets of a firm, starting with the LAST to
have a claim: A. Subordinated debentures B. Debentures (unsubordinated)
C. Common Stock D. Preferred stock
Common stock, preffered stock, subordinated, unsubordianted
In an efficient securities market the market value of a security is equal to:
its intrinsic value.
What is the value of a bond that has a par value of $1,000, a coupon of $120 (annually),
and matures in 10 years? Assume a required rate of return of 7.8%.
1,284.38
Finance theory suggests that the current market value of a bond is based upon which of
the following?
The sum of the present value of the bond’s interest payments and the present value of the
principal.
A $1,000 par value 14-year bond with a 10 percent coupon rate recently sold for $965. The
yield to maturity is
10.49%.
What is the expected rate of return on a bond that matures in 5 years, has a par value of
$1,000, a coupon rate of 11.5%, and is currently selling for $982? Assume annual coupon
12.0%
Cumulative preferred stock
requires dividends in arrears to be carried over into the next period.
Many preferred stocks have a provision that entitles a company to repurchase its
preferred stock from their holders at stated prices over a given time period. What is the
name of this provision?
Callable
Many preferred stocks have a feature that requires a firm to periodically set aside an
amount of money for the retirement of its preferred stock. What is the name of this
feature?
sinking fund
Keyes Corporation preferred stock pays an annual dividend of $7 per share. Which of the
following statements is true for an investor with a required return of 9%?
The value of the preferred stock is $77.78 per share
Consider the following four types of payments that could be made by a normal operating
firm: interest, common dividends, income taxes, and preferred dividends. Compared to
the other payments mentioned, where would you rank common dividend payments in
terms of the order of payment if the firm is liquidating?
fourth
An example of the growth factor in common stock is:
retaining profits in order to reinvest into the firm.
A company has preferred stock with a current market price of $18 per share. The
preferred stock pays an annual dividend of 4% based on a par value of $100. Flotation
costs associated with the sale of preferred stock equal $1.50 per share. The company’s
marginal tax rate is 40%. Therefore, the cost of preferred stock is
24.24%.
Due to changes in regulatory requirements, the transactions costs associated with
selling corporate securities increased by $1 per share. This change will
cause the cost of capital to increase.
Chapter 7 Self Test
1. If the market price of a bond decreases, then:
a. The yield to maturity increases
2. If a corporation were to choose between issuing a debenture, a mortgage bond, or a
subordinated debenture, which would have the highest yield to maturity, everything else
equal?
a. The subordinated debenture
3. If market interest rates decline:
a. Investor’s current required rate of return is above the coupon rate of the bond.
4. The yield to maturity on long-term bonds:
a. is equal to the current yield if the bond is selling for face value.
5. A bond will sell at a discount (below par value) if
a. Investor’s current required rate of return is above the coupon rate of the bond.
6. Shafer Corporation issued callable bonds. The bonds are most likely to be called if:
a. Interest rates decrease
7. While checking the Wall Street Journal bond listings you notice that the price of an AT&T
bond is the same as the price of a K-Mart bond. Based on this information you know
that:
a. The bond with the lower coupon rate will have the lower current yield.
8. Zevo Corp. bonds have a coupon rate of 7%, a yield to maturity of 10%, a face value of
$1,000, and mature in 10 years. Which of the following statements is most correct?
a. An investor who purchases the bond today will earn a return of 10% per year if
he holds the bond until it matures
9. Two investors are considering the purchase of Corporation ABC bonds. The bonds are
selling at their par value of $1,000 with a coupon rate of 9%. Investor A decides to buy
the bonds and Investor B does not buy the bonds.
a. Investor A must have a required return less than or equal to 9%.
10. In 1998 Fischer Corp issued bonds with an 8 percent coupon rate, paid annually, and a
$1,000 face value. The bonds mature on March 1, 2023. If an investor purchased one of
these bonds on March 1, 2010, determine the yield to maturity if the investor paid $1,100
for the bond.
a. 6.82%
11. What is the expected rate of return on a bond that matures in 5 years, has a par value of
$1,000, a coupon rate of 11.5%, and is currently selling for $982? Assume annual
coupon payments.
a. 12.0%
12. Assume that Brady Corp. has an issue of 18-year $1,000 par value bonds that pay 7%
interest, annually. Further assume that today’s required rate of return on these bonds is
5%. How much would these bonds sell for today? Round off to the nearest $1.
a. $1,233.79
13. Homer’s Trucking Company bonds have a 11% coupon rate. Interest is paid semiannually.
The bonds have a par value of $1,000 and will mature 8 years from now.
Compute the value of Homer’s Trucking Company bonds if investors’ required rate of
return is 9.5%.
a. 1082.75
14. Podunk Communications bonds mature in 6 1/2 years with a par value of $1,000. They
pay a coupon rate of 9% with semi-annual payments. If the required rate of return on
these bonds is 11% what is the bond’s value?
a. 908.83
15. Bartiromo, Inc. bonds have a 8% coupon rate with semi-annual coupon payments and
$1,000 par value. The bonds have 6 years until maturity, and sell for $925. What is the
current yield for Bartiromo’s bonds?
a. 8.65
b. 4.32
16. Other things being equal, investors will value which of the following bonds the highest?
a. Convertible bonds
17. Cabell Corp. bonds pay an annual coupon rate of 10%. If investors’ required rate of
return is now 12% on these bonds, they will be priced at:
a. A discount to par varlue
18. A bond will sell at a premium (above par value) if:
a. Investor’s current required rate of return is below the coupon rate of the bond.
19. The yield to maturity on a bond is the rate of return that equates the present value of the
bond’s future cash flows with the bond’s
a. Market value
20. Which of the following is NOT a definition of yield to maturity:
a. discount rate that equates present value of future cash flows with a bond’s face
value.
21. Which of the following statements is most correct?
a. If a bond’s yield to maturity exceeds its coupon rate, the bond’s price must be
less than its maturity value.
22. Which of the following statements concerning junk bonds is most correct?
a. Junk bonds have higher interest rates than AAA-rated bonds because of the
higher risk.
23. A corporate bond has a coupon rate of 9%, a face value of $1,000, and matures in 15
years. Which of the following statements is most correct?
a. An investor who buys the bond for $900 will have a yield to maturity on the bond
greater than 9%.
24. A bond’s yield to maturity depends upon all of the following except:
a. The individual investor’s required return
25. Plasma TV Corporation bonds are currently priced at $1,088. They have a par value of
$1,000 and 12 years to maturity. They pay an annual coupon rate of 6%. What is the
yield to maturity on this bond?
a. 5.0%
26. What is the yield to maturity of a bond that pays an 5% coupon rate with annual coupon
payments, has a par value of $1,000, matures in 15 years, and is currently selling for
$769?
a. 7.6%
27. SWH Corporation issued bonds on January 1, 2004. The bonds had a coupon rate of
5.5%, with interest paid semiannually. The face value of the bonds is $1,000 and the
bonds mature on January 1, 2019. What is the yield to maturity for an SWH Corporation
bond on January 1, 2010 if the market price of the bond on that date is $950?
a. 6.23%
28. Swanson, Inc. bonds have a 10% coupon rate with semi-annual coupon payments. They
have 12 and 1/2 years to maturity and a par value of $1,000. Compute the value of
Swanson’s bonds if investors’ required rate of return is 8%.
a. 1156.22
29. SWH Corporation issued bonds on January 1, 2004. The bonds had a coupon rate of
5.5%, with interest paid semiannually. The face value of the bonds is $1,000 and the
bonds mature on January 1, 2019. What is the intrinsic value of an SWH Corporation
bond on January 1, 2010 to an investor with a required return of 7%?
a. 901.08
30. Bartiromo, Inc. bonds have a 4% coupon rate with semi-annual coupon payments and a
$1,000 par value. The bonds have 11 years until maturity, and sell for $1,025. What is
the current yield for Bartiromo’s bonds?
a. 3.90
31. A corporate bond has a coupon rate of 9%, a face value of $1,000, a market price of
$850, and the bond matures in 15 years. Therefore, the bond’s yield to maturity is:
a. 11.1%.
32. A $1,000 par value 14-year bond with a 10 percent coupon rate recently sold for $965.
The yield to maturity is:
a. 10.49%
33. Peerless Securities has an issue of $1,000 par value bonds with 18 years remaining to
maturity. The bonds pay 7.7% interest on a semi-annual basis. The current market price
of the bonds is $1,175. What is the yield-to-maturity of the bonds?
a. 6.09%
34. What is the yield to maturity of a corporate bond with 13 years to maturity, a coupon rate
of 8% per year, a $1,000 par value, and a current market price of $1,250? Assume semiannual
coupon payments.
a. 5.31%
35. Bartiromo, Inc. bonds have a 4% coupon rate with semi-annual coupon payments and a
$1,000 par value. The bonds have 11 years until maturity, and sell for $925. What is the
current yield for Bartiromo’s bonds?
a. 8%
36. If market interest rates decline:
a. Long-term bonds will rise in value more than short-term bonds.
37. A bond will sell at a discount (below par value) if:
a. Investor’s current required rate of return is above the coupon rate of the bond.
Chapter 8 Self-Test
1. Many preferred stocks have a provision that entitles a company to repurchase its
preferred stock from their holders at stated prices over a given time period. What is the
name of this provision?
a. Callable
2. Which of the following features, or benefits, belong to a firm’s common stockholders?
a. Voting rights
b. Limited liability
c. Ownership of the firm
d. All of these
3. How is preferred stock affected by a decrease in the required rate of return?
a. The value of a share of preferred stock increases
4. Which of the following statements concerning the required rate of return on stocks is
true?
a. The higher the risk, the higher the required return, other things being equal.
5. Most preferred stocks have a feature that requires all past unpaid preferred dividend
payments be paid before any common stock dividends can be paid. What is the name of
this feature?
a. Cumulative
6. Many preferred stocks have a feature that requires a firm to periodically set aside an
amount of money for the retirement of its preferred stock. What is the name of this
feature?
a. Sinking fund
7. Preferred stock valuation usually treats the preferred stock as a:
a. Perpetuity
8. Cumulative preferred stock:
a. requires dividends in arrears to be carried over into the next period.
9. Preferred stock is similar to a bond in the following way:
a. both investments provide a stated income stream.
10. Keyes Corporation preferred stock pays an annual dividend of $7 per share. Which of
the following statements is true for an investor with a required return of 9%?
a. The value of the preferred stock is $77.78 per share
11. What is the value of a preferred stock that pays a $4.50 dividend to an investor with a
required rate of return of 10%?
a. 45
12. Bin Restaurant Corp preferred stock has a market price of $14.50. If it has a yearly
dividend of $3.50, what is your expected rate of return if you purchase the stock at its
market price?
a. 24.14%
13. You observe Golden Flashes Common Stock selling for $40.00 per share. The next
dividend is expected to be $4.00, and is expected to grow at a 5% annual rate forever. If
your required rate of return is 12%, should you purchase the stock?
a. Yes, because the present value of the expected future cash flows is greater than
$40.
14. Shara Miselle Co. just paid a dividend of $1.65 (D0) on its common stock. This
company’s dividends are expected to grow at a constant rate of 3% indefinitely. If the
required rate of return on this stock is 11%, compute the current value per share of
Shara Miselle stock.
a. 21.24
15. H. J. Corp.’s common stock paid $2.50 in dividends last year (D0). Dividends are
expected to grow at a 12-percent annual rate forever. If H. J.’s current market price is
$40.00, and your required rate of return is 23 percent, should you purchase the stock?
a. No the stock is overpriced
16. Using the constant growth dividend valuation model and assuming dividends will growth
a constant rate forever, the increase in the value of the stock each year should be equal
to the
a. growth rate in dividends, g.
17. Which of the following statements concerning the constant growth dividend valuation
model is true?
a. The required rate of return must exceed the growth rate.
18. Which of the following changes will make the value of a stock go up, other things being
held constant?
a. The required return decreases
19. Which of the following is not true regarding common stock?
a. Dividend payments, like interest payments, are fixed.
20. If two firms have the same current dividend and the same expected growth rate, their
stocks must sell at the same current price or else the market will not be in equilibrium.
a. False, because the required return could be different
21. All of the following affect the value of a share of common stock except:
a. the stock and paid-in-capital amounts on the balance sheet.
22. CMT, Inc. has an issue of preferred stock whose par value is $500. The preferred stock
pays a 4.5% dividend. If investors require a 5.5% rate of return for these shares, what
price should the preferred stock sell for?
a. $409.09
23. Yanti Corp. preferred stock has a 5% stated dividend percentage, and a $100 par value.
What is the value of the stock if your required rate of return is 6% per year?
a. 83.33
24. Nuray Corp. preferred stock pays a $.50 annual dividend. What is the value of the stock
if your required rate of return is 10%?
a. 5.00
25. The PDQ Company’s common stock is expected to pay a $2.00 dividend in the coming
year. If investors require a 17% return and the growth rate in dividends is expected to be
8%, what will the market price of the stock be?
a. 22.22
26. Kilsheimer Company just paid a dividend of $5 per share. Future dividends are expected
to grow at a constant rate of 7% per year. What is the value of the stock if the required
return is 16%?
a. 59.44
27. Butler Corp paid a dividend today of $5 per share. The dividend is expected to grow at a
constant rate of 6.5% per year. If Butler Corp stock is selling for $50.00 per share, the
stockholders’ expected rate of return is:
a. 16.50
28. Casino Games Company preferred stock pays a perpetual annual dividend of 3.5% of its
$100 par value. If investors’ required rate of return on this stock is 11%, what is the value
per share?
a. 31.82
29. Bell Corp. has a preferred stock that pays a dividend of $2.40. If you are willing to
purchase the stock at $11, what is your required rate of return (round your answer to the
nearest .1% and assume that there are no transaction costs)?
a. 21.8
30. Greenland Airlines has net income of $2 million this year. The book value of Greenland
Airlines common equity is $8 million dollars. The company’s dividend payout ratio is 60%
and is expected to remain this way. What is Greenland Airlines’ internal growth rate?
a. 10%
31. United Financial Corp had a return on equity of 15%. The corporation’s earnings per
share was $6.00, its dividend payout ratio was 40% and its profit-retention rate was
60%. If these relationships continue, what will be United Financial Corp’s internal growth
rate?
a. 8.6
32. Creamy Custard common stock is currently selling for $79.00. It just paid a dividend of
$4.60 and dividends are expected to grow at a rate of 5% indefinitely. What is the
required rate of return on Creamy Custard’s stock?
a. 11.11
33. Baseheart, Inc. expects its current annual $2.50 per share common stock dividend to
remain the same for the foreseeable future. Therefore, the value of the stock to an
investor with a required return of 12% is:
a. 20.83
34. Lily Co.paid a dividend of $5.25 on its common stock yesterday. The company’s
dividends are expected to grow at a constant rate of 8.5% indefinitely. The required rate
of return on this stock is 15.5%. You observe a market price of $78.50 for the stock.
Should you purchase this stock?
a. Yes, the market price is below the intrinsic value of the stock
35. Johnstown Supply Corporation stock is currently selling for $58.00. It is expected to pay
a dividend of $5.00 at the end of the year. Dividends are expected to grow at a constant
rate of 7.5% indefinitely. Compute the required rate of return on Johnstown Supply
Corporation stock.
a. 16.12
36. Lily Co. paid a dividend of $5.25 on its common stock yesterday. The company’s
dividends are expected to grow at a constant rate of 8.5% indefinitely. If the required rate
of return on this stock is 15.5%, compute the current value per share of Lily Co. stock.
a. 81.38
37. ADR Bank preferred stock pays an annual dividend of $2.75 per share. If the stock is
currently selling for $27.50 per share, what is the expected rate of return on this stock?
a. 10.0
Chapter 9 Self Test
1. The average cost associated with each additional dollar of financing for investment
projects is:
a. the marginal cost of capital.
2. Using the weighted average cost of capital as the required rate of return for every project
will:
a. cause a firm to reject projects that should have been accepted and cause a firm
to accept projects that were too risky.
3. Joe’s Discount Club currently has a weighted average cost of capital of 12%. Joe’s has
been growing rapidly over the past several years, selling common stock in each year to
finance its growth. However, due to difficult economic times this year, Joe’s decides to
cut its dividend and increase its retained earnings so that the common equity portion of
its capital structure will include only retained earnings and no new common stock will be
sold. Joe’s weighted average cost of capital this year should be
a. Less than 12%
4. In general, which of the following rankings, from highest to lowest cost, is most
accurate?
a. cost of new common stock, cost of retained earnings, cost of preferred stock,
cost of debt
5. Acme Conglomerate Corporation operates three divisions. One division involves
significant research and development, and thus has a high-risk cost of capital of 15%.
The second division operates in business segments related to Acme’s core business,
and this division has a cost of capital of 10% based upon its risk. Acme’s core business
is the least risky segment, with a cost of capital of 8%. The firm’s overall weighted
average cost of capital of 11% has been used to evaluate capital budgeting projects for
all three divisions. This approach will
a. favor projects in the research and development division because the higher risk
projects look more favorable if a lower cost of capital is used to evaluate them.
6. Interest rate parity exists because
a. there are investors who stand ready to engage in arbitrage.
7. Due to changes in regulatory requirements, the transactions costs associated with
selling corporate securities increased by $1 per share. This change will
a. cause the cost of capital to increase.
8. Which of the following should not be considered when calculating a firm’s WACC?
a. Cost of carrying inventory
9. Which of the following should NOT be considered when calculating a firm’s WACC?
a. After-tax cost of accounts payable
10. A company has preferred stock that can be sold for $21 per share. The preferred stock
pays an annual dividend of 3.5% based on a par value of $100. Flotation costs
associated with the sale of preferred stock equal $1.25 per share. The company’s
marginal tax rate is 35%. Therefore, the cost of preferred stock is:
a. 17.72
11. KayCee Manufacturing Company paid a dividend yesterday of $3.50 per share. The
dividend is expected to grow at a constant rate of 10% per year. The price of KayCee’s
common stock today is $40 per share. If KayCee decides to issue new common stock,
flotation costs will equal $4.00 per share. Kaycee’s marginal tax rate is 35%. Based on
the above information, the cost of retained earnings is:
a. 19.63
12. Cost of new common stock is:
a. 20.09
13. Kelly Corporation will issue new common stock to finance an expansion. The existing
common stock just paid a $1.50 dividend, and dividends are expected to grow at a
constant rate 8% indefinitely. The stock sells for $45, and flotation expenses of 5% of the
selling price will be incurred on new shares. What is the cost of new common stock be
for Kelly Corp.?
a. 11.79
14. Five Rivers Casino is undergoing a major expansion. The expansion will be financed by
issuing new 15-year, $1,000 par, 9% annual coupon bonds. The market price of the
bonds is $1,070 each. Gamblers flotation expense on the new bonds will be $50 per
bond. Gamblers marginal tax rate is 35%. What is the pre-tax cost of debt for the newlyissued
bonds?
a. 8.76
15. Kendall, Inc. has $15 million of outstanding bonds with a coupon rate of 10 percent. The
yield to maturity on these bonds is 12.5 percent. If the firm’s tax rate is 30 percent, what
is relevant cost of debt financing to Kendall, Inc.?
a. 8.75 percent
16. Clothier, Inc. has a target capital structure of 40% debt and 60% common equity, and
has a 40% marginal tax rate. If Clothier’s yield to maturity on bonds is 7.5% and
investors require a 15% return on Clothier’s common stock, what is the firm’s weighted
average cost of capital?
a. 10.80%
17. A U.S. company can borrow 12,000 pounds in Great Britain for 4% interest, paying back
12,480 pounds in one year. Alternatively, the U.S. company can borrow an equivalent
amount of U.S dollars in the United States and pay 8% interest. Assuming capital
markets are efficient, estimate the expected inflation rate in the United States if inflation
in Great Britain is expected to be zero.
a. 3.85
18. Which of the following differentiates the cost of retained earnings from the cost of newlyissued
common stock?
a. The flotation costs incurred when issuing new securities.
19. Why should firms that own and operate multiple businesses that have different risk
characteristics use business-specific, or divisional costs of capital?
a. Not all lines of business have equal risk and it is likely that the firm will accept
projects whose returns are unacceptably low in relation to the risk involved.
20. Which of the following causes a firm’s cost of capital (WACC) to differ from an investor’s
required rate of return on the company’s common stock?
a. The incurrence of flotation costs when new securities are issued.
21. All the following variables are used in computing the cost of debt except:
a. risk-free rate.
22. Higher flotation costs will result in all of the following except:
a. higher cost of retained earnings
23. A firm’s weighted average cost of capital is a function of (1) the individual costs of
capital, (2) the capital structure mix, and (3) the level of financing necessary to make the
investment.
a. True
24. Jiffy Co. expects to pay a dividend of $3.00 per share in one year. The current price of
Jiffy common stock is $60 per share. Flotation costs are $3.00 per share when Jiffy
issues new stock. What is the cost of internal common equity (retained earnings) if the
long-term growth in dividends is projected to be 8 percent indefinitely?
a. 13 percent
25. General Bill’s will issue preferred stock to finance a new artillery line. The firm’s existing
preferred stock pays a dividend of $4.00 per share and is selling for $40 per share.
Investment bankers have advised General Bill that flotation costs on the new preferred
issue would be 5% of the selling price. The General’s marginal tax rate is 30%. What is
the relevant cost of new preferred stock?
a. 10.53
26. Triplin Corporation’s marginal tax rate is 35%. It can issue 10-year bonds with an annual
coupon rate of 7% and a par value of $1,000. After $12 per bond flotation costs, new
bonds will net the company $966 in proceeds. Determine the appropriate after-tax cost
of new debt for Triplin to use in a capital budgeting analysis.
a. 4.87
27. Porky Pine Co. is issuing a $1,000 par value bond that pays 8.5% interest annually.
Investors are expected to pay $1,100 for the 12-year bond. Porky will pay $50 per bond
in flotation costs. What is the after-tax cost of new debt if the firm is in the 35% tax
bracket?
a. 4.70
28. Higgins Office Corp. plans to maintain its optimal capital structure of 40 percent debt, 10
percent preferred stock, and 50 percent common equity indefinitely. The required return
on each component source of capital is as follows: debt–8 percent; preferred stock–12
percent; common equity–16 percent. Assuming a 40 percent marginal tax rate, what
after-tax rate of return must Higgins Office Corp. earn on its investments if the value of
the firm is to remain unchanged?
a. 12.00 percent
29. Asian Trading Company paid a dividend yesterday of $5 per share (D0 = $4). The
dividend is expected to grow at a constant rate of 8% per year. The price of Asian
Trading Company’s stock today is $29 per share. If Asian Trading Company decides to
issue new common stock, flotation costs will equal $2.50 per share. Asian Trading
Company’s marginal tax rate is 35%. Based on the above information, the cost of
retained earnings is:
a. 26.62%
30. A corporate bond has a face value of $1,000 and a coupon rate of 9%. The bond
matures in 14 years and has a current market price of $946. If the corporation sells more
bonds it will incur flotation costs of $26 per bond. If the corporate tax rate is 35%, what is
the after-tax cost of debt capital?
a. 6.56
31. Durocorp has a target capital structure of 30% debt and 70% equity. Durocorp is
planning to invest in a project that will necessitate raising new capital. New debt will be
issued at a before-tax yield of 14%, with a coupon rate of 10%. The equity will be
provided by internally generated funds so no new outside equity will be issued. If the
required rate of return on the firm’s stock is 22% and its marginal tax rate is 35%,
compute the firm’s cost of capital.
a. 18.13
32. Given the following information on S & G Inc.’s capital structure, compute the company’s
weighted average cost of capital.
The company’s marginal tax rate is 40%.
a. 10.6
33. Milton Parker has a capital structure that consists of $7 million of debt, $2 million of
preferred stock, and $11 million of common equity, based upon current market values.
Parker’s yield to maturity on its bonds is 7.4%, and investors require an 8% return on
Parker’s preferred and a 14% return on Parker’s common stock. If the tax rate is 35%,
what is Parker’s WACC?
a. 10.18
Foundations of Finance, 7e (Keown/Martin/Petty)
Chapter 8 The Valuation and Characteristics of Stock
8.1 Learning Objective 1
1) Preferred stock is referred to as a hybrid security because it has many characteristics of both
common stock and bonds.
Answer: TRUE
Keywords: Preferred Stock, Hybrid Security
AACSB: Reflective thinking skills
2) Because most preferred stocks are perpetuities, their value can be determined by dividing the
annual dividend by an investor’s required return.
Answer: TRUE
Keywords: Preferred Stock, Perpetuity, Intrinsic Value
AACSB: Reflective thinking skills
3) In terms of risk, preferred stock is safer than common stock because it has a prior claim on
assets and income.
Answer: TRUE
Keywords: Preferred Stock, Common Stock, Risk
AACSB: Reflective thinking skills
4) Public perception and reputation do not affect stock prices, which are strictly a function of
dividends and required returns.
Answer: FALSE
Keywords: Stock Valuation Reputation
AACSB: Reflective thinking skills
5) A call provision entitles a company to repurchase its preferred stock from holders at stated
prices over a given time period.
Answer: TRUE
Keywords: Preferred Stock, Call Provision
AACSB: Reflective thinking skills
6) For a given constant required rate of return, the greatest portion of a preferred stockholder’s
return comes from increases in the price of preferred stock.
Answer: FALSE
Keywords: Preferred Stock, Capital Gain
AACSB: Reflective thinking skills
7) The amount of the preferred stock dividend is generally fixed either as a dollar amount or as
a percentage of the par value.
Answer: TRUE
Keywords: Preferred Stock Dividend
AACSB: Reflective thinking skills
8) Preferred stock is riskier than long-term debt because its claim on assets and income come
after those of bonds.
Answer: TRUE
Keywords: Claims on Income, Preferred Stock, Long-term Debt
AACSB: Reflective thinking skills
9) A call provision allows the issuing firm the opportunity to avoid rising interest rates by calling
investors and asking for more cash.
Answer: FALSE
Keywords: Call Provision
AACSB: Reflective thinking skills
10) Although under normal operating conditions preferred shareholders do not have voting
rights, protective provision generally allow for voting rights in the event of nonpayment of
preferred dividends.
Answer: TRUE
Keywords: Preferred Stock, Protective Provisions
AACSB: Reflective thinking skills
11) If a firm does not have enough money to pay any common stock dividends, it is technically
in default to the common shareholders.
Answer: FALSE
Keywords: Common Stock Dividends, Default
AACSB: Analytic skills
12) The use of a call provision in addition to a sinking fund can effectively create a maturity date
for preferred stock.
Answer: TRUE
Keywords: Preferred Stock, Call Provision, Sinking Fund, Maturity Date
AACSB: Reflective thinking skills
13) The upper limit on common stock dividends, which is set by the SEC, is generally equal to
the sum of dividends paid on the company’s preferred stock.
Answer: FALSE
Keywords: Dividends, Common Stock
AACSB: Reflective thinking skills
14) A sinking-fund provision allows for the retirement of a portion of preferred stock each year.
Answer: TRUE
Keywords: Sinking Fund, Preferred Stock
AACSB: Reflective thinking skills
15) Two approaches that allow for the retirement of preferred stock are call provisions and
sinking fund provisions.
Answer: TRUE
Keywords: Preferred Stock, Call Provision, Sinking Fund Provision
AACSB: Reflective thinking skills
16) A company’s market capitalization is generally greater than its book value, in part due to its
reputation for being able to deliver growth, attract top talent, and avoid ethical mistakes.
Answer: TRUE
Keywords: Reputation, Book Value, Market Capitalization
AACSB: Reflective thinking skills
17) Preferred stock valuation usually treats the preferred stock as a
A) capital asset.
B) perpetuity.
C) common stock.
D) long-term bond.
Answer: B
Keywords: Preferred Stock, Perpetuity
AACSB: Reflective thinking skills
18) Preferred stock is similar to a bond in the following way
A) preferred stock always contains a maturity date.
B) both investments provide a stated income stream.
C) both contain a growth factor similar to common stock.
D) both provide interest payments.
Answer: B
Keywords: Preferred Stock, Bonds
AACSB: Analytic skills
19) Cumulative preferred stock
A) requires dividends in arrears to be carried over into the next period.
B) has a right to vote cumulatively.
C) has a claim to dividends before bonds.
D) has a higher required return than common stock.
Answer: A
Keywords: Cumulative Preferred Stock
AACSB: Analytic skills
20) How is preferred stock similar to bonds?
A) Dividend payments to preferred shareholders (much like bond interest payments to
bondholders) are tax deductible.
B) Investors can sue the firm if preferred dividend payments are not paid (much like
bondholders can sue for non-payment of interest payments).
C) Preferred stockholders receive a dividend payment (much like interest payments to
bondholders) that is usually fixed.
D) Preferred stock is not like bonds in any way.
Answer: C
Keywords: Preferred Stock, Bonds
AACSB: Reflective thinking skills
21) Most preferred stocks have a feature that requires all past unpaid preferred dividend
payments be paid before any common stock dividends can be paid. What is the name of this
feature?
A) Participating
B) Cumulative
C) Provisional
D) Convertible
Answer: B
Keywords: Preferred Stock, Cumulative, Dividends
AACSB: Reflective thinking skills
22) Many preferred stocks have a provision that entitles a company to repurchase its preferred
stock from their holders at stated prices over a given time period. What is the name of this
provision?
A) Cumulative
B) Putable
C) Callable
D) Convertible
Answer: C
Keywords: Callable Preferred Stock
AACSB: Reflective thinking skills
23) Many preferred stocks have a feature that requires a firm to periodically set aside an
amount of money for the retirement of its preferred stock. What is the name of this feature?
A) Convertible
B) Callable
C) Cumulative
D) Sinking fund
Answer: D
Keywords: Preferred Stock, Sinking Fund
AACSB: Reflective thinking skills
8.2 Learning Objective 2
1) XYZ Corp 8% preferred stock with a par value of $100 and a market price of $150 will pay an
annual dividend this year of $12 per share.
Answer: FALSE
Keywords: Preferred Stock, Dividends, Par Value
AACSB: Analytic skills
2) The YLD% shown in Wall Street Journal stock quotes stands for the stock’s dividend yield
and is calculated by dividing the amount of the dividend by the stock’s opening price on the first
day of the year.
Answer: FALSE
Keywords: Dividend Yield, Stock Quotes
AACSB: Reflective thinking skills
3) A preferred stock that pays an annual dividend of $10, has a par value of $100, and has a
required return of 5% will be valued at $200.
Answer: TRUE
Keywords: Preferred Stock, Valuation
AACSB: Analytic skills
4) Keyes Corporation preferred stock pays an annual dividend of $7 per share. Which of the
following statements is true for an investor with a required return of 9%?
A) The value of the preferred stock is $7 because the dividend is fixed at $7 each year .
B) The value of the preferred stock is $63.00 per share.
C) The value of the preferred stock is $77.78 per share.
D) The value of the preferred stock is $6.30 per share because of the 9% required return.
Answer: C
Keywords: Preferred Stock Valuation
AACSB: Reflective thinking skills
5) Which of the following statements concerning preferred stock is most correct?
A) Preferred stock is valued the same as zero coupon bonds because the cash flow patterns
are similar.
B) If a corporation issues 4% preferred stock with a par value of $100, the dividend will increase
by 4% per year.
C) Preferred stock dividends are typically the same each year, allowing a preferred stock to be
valued as a perpetuity.
D) Preferred stock dividends are calculated as a percentage of common stock dividends,
although the preferred stock dividends must be paid first.
Answer: C
Keywords: Preferred Stock Valuation, Dividends, Perpetuity
AACSB: Reflective thinking skills
6) Nuray Corp. preferred stock pays a $.50 annual dividend. What is the value of the stock if
your required rate of return is 10%?
A) $.05
B) $.50
C) $5.00
D) $50.00
Answer: C
Keywords: Preferred Stock
AACSB: Analytic skills
7) Bell Corp. has a preferred stock that pays a dividend of $2.40. If you are willing to purchase
the stock at $11, what is your required rate of return (round your answer to the nearest .1% and
assume that there are no transaction costs)?
A) 21.8%
B) 11.0%
C) 9.1%
D) 20.1%
Answer: A
Keywords: Preferred Stock, Required Return
AACSB: Analytic skills
8) What is the value of a preferred stock that pays a $4.50 dividend to an investor with a
required rate of return of 10%?
A) $22.22
B) $27.83
C) $45
D) $55.50
Answer: C
Keywords: Preferred Stock Valuation
AACSB: Analytic skills
9) How is preferred stock affected by a decrease in the required rate of return?
A) The value of a share of preferred stock increases.
B) The dividend increases.
C) The dividend decreases.
D) The dividend yield increases.
Answer: A
Keywords: Preferred Stock Valuation, Required Return
AACSB: Reflective thinking skills
10) Casino Games Company preferred stock pays a perpetual annual dividend of 3.5% of its
$100 par value. If investors’ required rate of return on this stock is 11%, what is the value per
share?
A) $35.00
B) $31.82
C) $7.97
D) $3.18
Answer: B
Keywords: Preferred Stock Valuation, Perpetual Dividend
AACSB: Analytic skills
11) CMT, Inc. has an issue of preferred stock whose par value is $500. The preferred stock pays
a 4.5% dividend. If investors require a 5.5% rate of return for these shares, what price should
the preferred stock sell for?
A) $611.11
B) $508.33
C) $409.09
D) $81.82
Answer: C
Keywords: Preferred Stock Valuation
AACSB: Analytic skills
12) Department 65 has an issue of preferred stock that pays a dividend of $4.00. The preferred
stockholders require a rate of return on this stock of 9%. At what price should the preferred
stock sell for? Round off to the nearest $0.10.
A) $36.00
B) $44.40
C) $62.50
D) $88.80
Answer: B
Keywords: Preferred Stock Valuation
AACSB: Analytic skills
13) Positive Tronics Industries preferred stock has a par value of $100 and pays a dividend of
$6.00 per share. It presently sells for $87 per share. What do investors require as a rate of
return on this stock? Round off to the nearest .10%.
A) 14.5%
B) 9.3%
C) 6.9%
D) 6.0%
Answer: C
Keywords: Preferred Stock, Required Return
AACSB: Analytic skills
14) Yanti Corp. preferred stock has a 5% stated dividend percentage, and a $100 par value.
What is the value of the stock if your required rate of return is 6% per year?
A) $83.33
B) $94.05
C) $100.00
D) $30.00
Answer: A
Keywords: Preferred Stock Valuation
AACSB: Analytic skills
15) If Neal O’Danny preferred stock pays an annual dividend of $2.80, and investors require a
9% return, what is the value of O’Danny’s preferred stock today?
Answer: V
p
= Div/R = $2.80/.09 = $31.11
Keywords: Preferred Stock Valuation
AACSB: Analytic skills
8.3 Learning Objective 3
1) The market price of a firm’s common stock equals the sum of all equity accounts as reported
in its balance sheet (common stock + paid-in capital + retained earnings) divided by the number
of shares outstanding.
Answer: FALSE
Keywords: Market Value of Equity
AACSB: Reflective thinking skills
2) Historically, price appreciation, or capital gains yield, has accounted for a greater portion of
returns on common stocks than dividend payments.
Answer: TRUE
Keywords: Dividends, Returns on Common Stock, Price Appreciation
AACSB: Reflective thinking skills
3) Preferred stock is less risky than common stock, but more risky than debt.
Answer: TRUE
Keywords: Preferred Stock, Debt, Common Stock, Required Return
AACSB: Reflective thinking skills
4) Cumulative voting is advantageous to minority shareholders because it may allow them to
elect a member of the board of directors.
Answer: TRUE
Keywords: Cumulative Voting, Minority Shareholders
AACSB: Reflective thinking skills
5) Shareholders, as owners of the corporation, face unlimited liability for the corporation’s debts,
while bondholders, as creditors, may only lose the value of their investment if the company goes
bankrupt.
Answer: FALSE
Keywords: Shareholders, Creditors, Limited Liability
AACSB: Reflective thinking skills
6) Common stock cannot be worth less than its book value.
Answer: FALSE
Keywords: Common Stock, Book Value
AACSB: Reflective thinking skills
7) Convertibility is a common feature of common stock; it allows the common stockholders to
convert their common shares into preferred shares or into bonds.
Answer: FALSE
Keywords: Convertibility
AACSB: Reflective thinking skills
8) Common stockholders demand a return on the price paid for their common stock, but since
retained earnings on the balance sheet are merely “on paper” they do not require a return on
earnings that have been retained.
Answer: FALSE
Keywords: Required Return, Retained Earnings
AACSB: Reflective thinking skills
9) The common stock of a constant-growth firm is valued in the same manner as its preferred
stock.
Answer: FALSE
Keywords: Constant Growth Common Stock Valuation Model, Preferred Stock
AACSB: Reflective thinking skills
10) Common stock does not mature.
Answer: TRUE
Keywords: Common Stock, Maturity Date
AACSB: Reflective thinking skills
11) Bondholders and preferred stockholders can be viewed as creditors, whereas the common
stockholders are the true owners of the firm.
Answer: TRUE
Keywords: Common Stock, Preferred Stock, Bonds
AACSB: Reflective thinking skills
12) If a common stockholder cannot personally attend the meeting of shareholders then their
votes are lost.
Answer: FALSE
Keywords: Voting Rights, Common Stock
AACSB: Reflective thinking skills
13) Under cumulative voting a 10% shareholder will likely be able to elect 10% of the board of
directors.
Answer: TRUE
Keywords: Cumulative Voting, Board of Directors
AACSB: Reflective thinking skills
14) Under majority voting a majority (>50%) shareholder will just be able to elect a simple
majority of the board of directors.
Answer: FALSE
Keywords: Majority Voting, Board of Directors
AACSB: Reflective thinking skills
15) Under majority voting a majority (>50%) shareholder will be able to elect the entire board of
directors.
Answer: TRUE
Keywords: Majority Voting, Board of Directors
AACSB: Reflective thinking skills
16) Preferred stock and common stock issued by the same firm will have the same required
return because the riskiness of the firm’s cash flows is the same for both securities.
Answer: FALSE
Keywords: Preferred Stock, Common Stock, Required Return
AACSB: Reflective thinking skills
17) In theory, shareholders select the board of directors, but in reality, management effectively
selects the directors.
Answer: TRUE
Keywords: Board of Directors, Agency Problems
AACSB: Reflective thinking skills
18) Limited liability for a corporation’s common shareholders is a protective provision that aids
the corporation in raising funds.
Answer: TRUE
Keywords: Limited Liability
AACSB: Reflective thinking skills
19) If a shareholder cannot attend the corporation’s annual meeting, the shares may still be
voted using
A) the preemptive right.
B) a proxy.
C) majority voting rules.
D) the cumulative voting right.
Answer: B
Keywords: Proxy
AACSB: Reflective thinking skills
20) Minority shareholders have a greater chance of electing a member to the board of directors
if the company uses
A) cumulative voting.
B) majority voting.
C) minority voting.
D) proxy voting.
Answer: A
Keywords: Cumulative Voting
AACSB: Analytic skills
21) Preferred stock differs from common stock in that
A) preferred stock usually has a maturity date.
B) preferred stock investors have a higher required return than common stock investors.
C) preferred stock dividends are fixed.
D) common stock investors have a required return and preferred stock investors do not.
Answer: C
Keywords: Preferred Stock, Dividends
AACSB: Reflective thinking skills
22) How is preferred stock similar to common stock?
A) Preferred dividend payments usually have unlimited growth potential.
B) Investors cannot sue a corporation for the non-payment of dividends.
C) Both preferred and common stockholders have voting control of a firm.
D) Preferred stock dividends and common stock dividends are fixed.
Answer: B
Keywords: Preferred Stock, Common Stock
AACSB: Reflective thinking skills
23) Which of the following is not true regarding common stock?
A) Dividends, unlike interest payments, are not tax deductible.
B) Common stock, unlike bond principal, does not mature.
C) Common stockholders are owners of the firm, whereas bondholders are creditors.
D) Dividend payments, like interest payments, are fixed.
Answer: D
Keywords: Common Stock, Dividends
AACSB: Reflective thinking skills
24) Consider the following four types of payments that could be made by a normal operating
firm: interest, common dividends, income taxes, and preferred dividends. Compared to the other
payments mentioned, where would you rank common dividend payments in terms of the order
of payment if the firm is liquidating?
A) First
B) Second
C) Third
D) Fourth
Answer: D
Keywords: Common Stock Dividends
AACSB: Reflective thinking skills
25) Assume that a firm had such serious financial problems that it was about to be liquidated
after a bankruptcy. All of the firm’s assets are about to be sold in order to pay the following
claims against the firm: bondholders, preferred stockholders, common stockholders, and federal
income taxes. Of the claims mentioned, what priority would common stockholders have?
A) First
B) Second
C) Third
D) Fourth
Answer: D
Keywords: Common Stock Claims, Liquidation
AACSB: Reflective thinking skills
26) What provision entitles the common shareholder to maintain a proportionate share of
ownership in a firm?
A) the cumulative feature
B) the convertible feature
C) the proportionality clause
D) the preemptive right
Answer: D
Keywords: Preemptive Right, Common Stock
AACSB: Reflective thinking skills
27) Which of the following features, or benefits, belong to a firm’s common stockholders?
A) limited liability
B) ownership of the firm
C) voting rights
D) all of the above
Answer: D
Keywords: Common Stock, Limited Liability, Voting Rights
AACSB: Reflective thinking skills
28) Who bears the greatest risk of loss of value if a firm should fail?
A) bondholders
B) preferred stockholders
C) common stockholders
D) All of the above bear equal risk of loss.
Answer: C
Keywords: Claims on Assets, Bankruptcy, Risk
AACSB: Reflective thinking skills
8.4 Learning Objective 4
1) The most relevant form of growth for valuing a firm’s common stock is internal growth.
Answer: TRUE
Keywords: Common Stock Valuation, Internal Growth
AACSB: Reflective thinking skills
2) Because common stock represents a residual interest in the corporation, the value of
common stock is equal to the total firm value less the firm’s outstanding debt.
Answer: TRUE
Keywords: Common Stock Valuation, Enterprise Value, Residual Interest
AACSB: Reflective thinking skills
3) An investor’s required rate of return for a common stock can be estimated by summing the
stock’s dividend yield and annual growth rate, assuming the growth rate is constant over time.
Answer: TRUE
Keywords: Required Return, Dividend Yield, Growth Rate, Constant Growth Dividend Valuation
Model
AACSB: Reflective thinking skills
4) Given the constant growth dividend valuation model, the expected percentage growth in
value of a stock is equal to the capital gains yield for that stock.
Answer: TRUE
Keywords: Constant Growth Dividend Valuation Model, Capital Gains Yield
AACSB: Reflective thinking skills
5) If the expected growth rate for dividends is zero, then the value of common stock will be
equal to the current dividend.
Answer: FALSE
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
6) A common stock with an expected dividend growth rate of zero would be valued in the same
way as preferred stock, that is, the expected dividend divided by the required return.
Answer: TRUE
Keywords: Preferred Stock, Constant Growth Dividend Valuation Model
AACSB: Reflective thinking skills
7) In general, common stock and preferred stock are both valued by calculating the present
value of all expected future cash flows, using the required return as the discount rate.
Answer: TRUE
Keywords: Common Stock, Preferred Stock, Valuation, Present Value, Required Return
AACSB: Reflective thinking skills
8) The stock valuation model D
1
/(r
cs
– g) requires the stock to grow at a rate greater than the
required return; otherwise, the stock is worthless.
Answer: FALSE
Keywords: Constant Growth Common Stock Valuation Model
AACSB: Reflective thinking skills
9) The retention ratio is equal to 1 minus the dividend payout ratio.
Answer: TRUE
Keywords: Retention Ratio, Dividend Payout Ratio
AACSB: Reflective thinking skills
10) A firm can increase the growth rate of common stockholders’ investment in the firm by
retaining more earnings or increasing return on equity.
Answer: TRUE
Keywords: Growth Rate, Common Stock, Retained Earnings, Return on Equity
AACSB: Reflective thinking skills
11) Common stock valuation can be based on the present value of future dividends or
alternatively on the present value of the firm’s future quarterly net income.
Answer: FALSE
Keywords: Common Stock, Valuation, Dividends, Net Income
AACSB: Reflective thinking skills
12) The change in the value of a corporation’s common stock as the result of growth is the same
regardless of whether the growth is the result of internal growth or the infusion of new capital.
Answer: FALSE
Keywords: Dividend Valuation Model, Internal Growth
AACSB: Reflective thinking skills
13) United Financial Corp had a return on equity of 15%. The corporation’s earnings per share
was $6.00, its dividend payout ratio was 40% and its profit-retention rate was 60%. If these
relationships continue, what will be United Financial Corp’s internal growth rate?
A) 6.0%
B) 8.6%
C) 9.0%
D) 15.6%
Answer: B
Keywords: Internal Growth Rate, Profit-Retention Rate
AACSB: Analytic skills
14) Baseheart, Inc. expects its current annual $2.50 per share common stock dividend to
remain the same for the foreseeable future. Therefore, the value of the stock to an investor with
a required return of 12% is:
A) $3.00
B) $18.33
C) $20.83
D) $30.00
Answer: C
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
15) Which of the following changes will make the value of a stock go up, other things being held
constant?
A) The required return decreases.
B) The required return increases.
C) In general, investors become more risk averse.
D) The growth rate of dividends decreases.
Answer: A
Keywords: Risk/Return Tradeoff, Required Return, Stock Valuation
AACSB: Analytic skills
16) If two firms have the same current dividend and the same expected growth rate, their stocks
must sell at the same current price or else the market will not be in equilibrium.
A) False, because the required return could be different
B) True, because we are using a dividend valuation model
C) True if markets are semi-strong form efficient
D) True if investors are risk-averse
Answer: A
Keywords: Dividend, Growth Rate, Stock Valuation
AACSB: Analytic skills
17) You are considering the purchase of a common stock that paid a dividend of $2.00
yesterday. You expect this stock to have a growth rate of 15 percent for the next 3 years,
resulting in dividends of D
1
=$2.30, D
2
=$2.645, and D
3
=$3.04. The long-run normal growth rate
after year 3 is expected to be 10 percent (that is, a constant growth rate after year 3 of 10% per
year forever). If you require a 14 percent rate of return, how much should you be willing to pay
for this stock?
A) $89.75
B) $83.65
C) $56.46
D) $62.57
Answer: D
Keywords: Constant Growth, Stock Valuation
AACSB: Analytic skills
18) Which of the following statements concerning the required rate of return on stocks is true?
A) The higher an investor’s required rate of return, the higher the value of the stock.
B) If risk is reduced, the required return will decrease because more investors are risk-averse.
C) The required return on preferred stock is generally higher than the required return on
common stock.
D) The higher the risk, the higher the required return, other things being equal.
Answer: D
Keywords: Required Return, Risk, Stock Valuation
AACSB: Reflective thinking skills
19) Which of the following statements concerning the constant growth dividend valuation model
is true?
A) The required rate of return must exceed the growth rate.
B) The dividend growth rate must be bigger than 8%.
C) The growth rate must increase every year.
D) The required rate of return must be equal to the growth rate for dividends.
Answer: A
Keywords: Required Return, Constant Growth Dividend Valuation Model
AACSB: Reflective thinking skills
20) A small biotechnology research corporation has been experiencing losses for the first three
years of its existence, and thus has a negative balance in retained earnings. The corporation’s
stock price, however, is $1 per share. Which of the following statements is most correct?
A) Investors are irrational to pay $1 per share when earnings per share have been negative for
three years.
B) Investors believe the stock is worth $1 per share because future earnings (and cash flows)
are expected to be positive.
C) The corporation’s accountants must have made a mistake because retained earnings may
not be negative.
D) The required return on the stock will be small because the company has very few assets.
Answer: B
Keywords: Required Return, Retained Earnings
AACSB: Reflective thinking skills
21) A small company struggling to reach profitability just announced a major new government
contract that will validate its technology and generate revenue for the next several years. The
announcement of the contract will
A) cause the stock price to increase because r
cs
(the required return) is likely to increase.
B) cause the stock price to decrease because the government usually pays below market price
for the goods and services it purchases.
C) cause the stock price to increase because r
cs
(the required return) is likely to decrease and g
(the growth rate in future dividends) is likely to increase.
D) have no effect on the stock price because the company has not yet paid any dividends.
Answer: C
Keywords: Required Return, Growth Rate, Stock Valuation
AACSB: Analytic skills
22) Using the constant growth dividend valuation model and assuming dividends will growth a
constant rate forever, the increase in the value of the stock each year should be equal to the
A) growth rate in dividends, g.
B) required return on the stock, r
cs
.
C) dividend yield plus the capital gains yield.
D) dividend yield.
Answer: A
Keywords: Constant Growth Dividend Valuation Model
AACSB: Reflective thinking skills
23) Nogrowth Corporation expects their dividend to stay at $0.50 per share each year into the
foreseeable future. Therefore,
A) the stock will be valued at $0.50 times the number of years an investor plans to keep it.
B) the value of the stock can be estimated as $0.50 divided by an investor’s required rate of
return.
C) the value of the stock can not be determined using the dividend valuation model because the
growth rate is zero.
D) the value of the stock is positive only if the required return is negative
Answer: B
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
24) A financial analyst expects KacieCo. to pay a dividend of $2 per share one year from today,
a dividend of $3 per share in years two, and estimates the value of the stock at the end of year
two to be $22. If your required return on KacieCo stock is 14 %, what is the most you would be
willing to pay for the stock today if you plan to sell the stock in two years?
A) $20.99
B) $26.75
C) $26.90
D) $27.00
Answer: A
Keywords: Stock Valuation, Present Value
AACSB: Analytic skills
25) Kilsheimer Company just paid a dividend of $5 per share. Future dividends are expected to
grow at a constant rate of 7% per year. What is the value of the stock if the required return is
16%?
A) $33.44
B) $55.56
C) $59.44
D) $65.87
Answer: C
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
26) Emery Company just paid a dividend yesterday of $2.25 per share. The company’s stock is
currently selling for $60 per share, and the required rate of return on Emery Company stock is
16%. What is the growth rate expected for Emery Company dividends assuming constant
growth?
A) 9.47%
B) 9.89%
C) 10.87%
D) 11.81%
Answer: D
Keywords: Constant Growth Dividend Valuation Model, Growth Rate
AACSB: Analytic skills
27) J&S Corporation has preferred stock which paid an annual dividend in 2009 of $5 per share.
J&S also has common stock which paid a dividend in 2009 of $5. Which of the following
statements is most correct concerning J&S stock?
A) The price of the preferred stock should equal the price of the common stock since the
dividends are the same.
B) The price of the common stock could be higher than the price of the preferred stock if the
common stock dividends are expected to grow in the future.
C) The price of the preferred stock is expected to be higher than the price of the common stock
because the required return on preferred stock is higher than the required return on common
stock.
D) If the required return on the preferred stock is the same as the required return on the
common stock, then the price of preferred stock should equal the price of the common stock if
markets are efficient.
Answer: B
Keywords: Preferred Stock Valuation, Common Stock Valuation
AACSB: Reflective thinking skills
28) Using the dividend valuation method, an analyst determines the value of Company A’s stock
to be $10 and the value of Company B’s stock to be $14. Based on this information, which of
the following statements is most accurate?
A) Company B must be riskier than Company A, and risk requires a reward.
B) Other things being equal, if Company A and Company B have the same firm value, Company
B must have more debt, thus leveraging its returns for the benefit of shareholders.
C) Other things being equal, if Company A and Company B have the same firm value, Company
A may have more shares of stock outstanding than Company B.
D) Company B’s required rate of return is higher than Company A’s required return.
Answer: C
Keywords: Free Cash Flow Valuation
AACSB: Reflective thinking skills
29) All of the following affect the value of a share of common stock except:
A) the dollar amount of the dividends.
B) investors’ required rate of return.
C) the future growth rate for dividends.
D) the stock and paid-in-capital amounts on the balance sheet.
Answer: D
Keywords: Common Stock Valuation, Balance Sheet, Required Return, Dividends
AACSB: Reflective thinking skills
30) The PDQ Company’s common stock is expected to pay a $2.00 dividend in the coming year.
If investors require a 17% return and the growth rate in dividends is expected to be 8%, what
will the market price of the stock be?
A) $11.76
B) $24.00
C) $23.11
D) $22.22
Answer: D
Keywords: Constant Growth Dividend Valuation Model, Common Stock
AACSB: Analytic skills
31) An example of the growth factor in common stock is:
A) acquiring a loan to fund an investment in Asia.
B) retaining profits in order to reinvest into the firm.
C) issuing new stock to provide capital for future growth.
D) two strong companies merging together to increase their economy of scale.
Answer: B
Keywords: Growth Rate, Common Stock, Retained Profits
AACSB: Reflective thinking skills
32) You are considering the purchase of a share of Edie’s common stock. You expect to sell it at
the end of 1 year for $32.00. You will also receive a dividend of $2.50 at the end of the year.
Edie just paid a dividend of $2.25. If your required return on this stock is 12%, what is the most
you would be willing to pay for it now?
A) $28.57
B) $33.05
C) $20.83
D) $30.80
Answer: D
Keywords: Common Stock Valuation, Dividend, Required Return
AACSB: Analytic skills
33) Lily Co. paid a dividend of $5.25 on its common stock yesterday. The company’s dividends
are expected to grow at a constant rate of 8.5% indefinitely. If the required rate of return on this
stock is 15.5%, compute the current value per share of Lily Co. stock.
A) $81.38
B) $76.43
C) $56.23
D) $43.90
Answer: A
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
34) Lily Co.paid a dividend of $5.25 on its common stock yesterday. The company’s dividends
are expected to grow at a constant rate of 8.5% indefinitely. The required rate of return on this
stock is 15.5%. You observe a market price of $78.50 for the stock. Should you purchase this
stock?
A) No, the market price is above the intrinsic value of the stock.
B) Yes, the market price is below the intrinsic value of the stock.
C) No, the growth rate in dividends is too far below the required return.
D) Yes, but only if you can keep the stock for at least 5 years.
Answer: B
Keywords: Constant Growth Dividend Valuation Model
AACSB: Reflective thinking skills
35) Wallace Industries paid a dividend of $1.65 on its common stock yesterday. The dividends
of Wallace Industries are expected to grow at 9% per year indefinitely. If the risk free rate is 3%
and investors’ risk premium on this stock is 8%, estimate the value of Wallace Industries stock 2
years from now.
A) $106.84
B) $100.43
C) $91.81
D) $54.71
Answer: A
Keywords: Constant Growth Dividend Valuation Model, Required Return, Risk Free Rate, Risk
Premium
AACSB: Analytic skills
36) Greenland Airlines has net income of $2 million this year. The book value of Greenland
Airlines common equity is $8 million dollars. The company’s dividend payout ratio is 60% and is
expected to remain this way. What is Greenland Airlines’ internal growth rate?
A) 6%
B) 9%
C) 10%
D) 15%
Answer: C
Keywords: Sustainable Growth Rate
AACSB: Analytic skills
37) Berberich Corporation net income this year is $800,000. The company generally retains
35% of net income for reinvestment. The company’s common equity currently has a book value
of $5,000,000. They just paid a dividend of $1.37, and the required rate of return on this stock is
12%. Compute the value of this stock if dividends are expected to continue growing indefinitely
at the company’s internal growth rate.
A) $22.61
B) $11.42
C) $15.63
D) $4.35
Answer: A
Keywords: Internal Growth Rate, Constant Growth Dividend Valuation Model
AACSB: Analytic skills
38) Chambers Corporation’s ROE is 20%. Their dividend payout ratio is 70%. The last dividend,
just paid, was $2.00. If dividends are expected to grow by the company’s internal growth rate
indefinitely, what is the current value of Chambers common stock if its required return is 18%?
A) $17.67
B) $16.89
C) $14.92
D) $11.52
Answer: A
Keywords: Internal Growth Rate, Constant Growth Dividend Valuation Model
AACSB: Analytic skills
39) Johnstown Supply Corporation stock is currently selling for $58.00. It is expected to pay a
dividend of $5.00 at the end of the year. Dividends are expected to grow at a constant rate of
7.5% indefinitely. Compute the required rate of return on Johnstown Supply Corporation stock.
A) 12.48%
B) 15.65%
C) 13.64%
D) 16.12%
Answer: D
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
40) Modem Development, Inc. paid a dividend of $5.00 per share on its common stock
yesterday. Dividends are expected to grow at a constant rate of 4% for the next two years, at
which point the stock is expected to sell for $56.00. If investors require a rate of return on
Modem’s common stock of 18%, what should the stock sell for today?
A) $50.22
B) $48.51
C) $44.76
D) $40.22
Answer: B
Keywords: Dividend Valuation Model
AACSB: Analytic skills
41) If you expect NoDiv Corporation to sell for $75 per share in three years while paying no
dividends along the way, and if your required rate of return is 16% per year, how much is the
stock worth today?
A) $42.68
B) $48.05
C) $51.10
D) $74.64
Answer: B
Keywords: Common Stock Valuation, Present Value
AACSB: Analytic skills
42) Creamy Custard common stock is currently selling for $79.00. It just paid a dividend of
$4.60 and dividends are expected to grow at a rate of 5% indefinitely. What is the required rate
of return on Creamy Custard’s stock?
A) 11.11%
B) 11.76%
C) 12.2%
D) 14.21%
Answer: A
Keywords: Required Return, Constant Growth Dividend Valuation Model
AACSB: Analytic skills
43) Modem Development, Inc. paid a dividend of $5.00 per share on its common stock
yesterday. Dividends are expected to grow at a constant rate of 10% for the next two years, at
which point the dividends will begin to grow at a constant rate indefinitely. If the stock is selling
for $50 today and the required return is 15%, what it the expected annual dividend growth rate
after year two?
A) 3.365%
B) 3.878%
C) 4.556%
D) 5.000%
Answer: A
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
44) I Sage, whose common stock is currently selling for $12 per share, is expected to pay a
$1.80 dividend, and sell for $14.40 one year from now. What are the dividend yield, growth rate,
and total rate of return, respectively?
A) 15%20%35%
B) 10%5%15%
C) 15% 12% 27%
D) 20% 15%35%
Answer: A
Keywords: Dividend Yield, Growth Rate, Total Rate of Return
AACSB: Analytic skills
45) Shara Miselle Co. just paid a dividend of $1.65 (D
0
) on its common stock. This company’s
dividends are expected to grow at a constant rate of 3% indefinitely. If the required rate of return
on this stock is 11%, compute the current value per share of Shara Miselle stock.
A) $20.63
B) $21.24
C) $15.00
D) $55.00
Answer: B
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
46) You observe Golden Flashes Common Stock selling for $40.00 per share. The next dividend
is expected to be $4.00, and is expected to grow at a 5% annual rate forever. If your required
rate of return is 12%, should you purchase the stock?
A) Yes, because the present value of the expected future cash flows is greater than $40.
B) No, because the present value of the expected future cash flows is less than $40.
C) Yes, because the present value of the expected future cash flows is less than $40.
D) No, because the present value of the expected future cash flows is greater than $40.
Answer: A
Keywords: Common Stock Valuation, Required Return
AACSB: Reflective thinking skills
47) NewAge, Inc. paid a dividend yesterday of $2 per share. NewAge management expects the
dividend to increase next year to $3 annually. If the dividend is expected to stay at $3 per year
for the foreseeable future, what is the value of the stock to an investor with a required rate of
return of 10%?
A) $7.50
B) $30.00
C) $32.00
D) $50.00
Answer: B
Keywords: Dividend Valuation Model, Zero Growth
AACSB: Analytic skills
48) H. J. Corp.’s common stock paid $2.50 in dividends last year (D
0
). Dividends are expected
to grow at a 12-percent annual rate forever. If H. J.’s current market price is $40.00, and your
required rate of return is 23 percent, should you purchase the stock?
A) No, the percentage return on the stock is too high, thus it is too risky.
B) Yes, the stock is expected to return more than you require.
C) No, the stock is overpriced.
D) Not enough information is given.
Answer: C
Keywords: Constant Growth Dividend Valuation Model, Required Rate of Return
AACSB: Reflective thinking skills
49) Diana Ltd. paid a $2.50 per share dividend yesterday. The dividend is expected to grow at
10 percent per year for the foreseeable future. Diana Ltd. has a beta of 1.6, a standard
deviation of returns of 30 percent, and a required return of 18%. What is the value of a share of
Diana Ltd. common stock?
Answer: D1 = $2.50 * (1.10) = $2.75; P
0
= D
1
/(r
cs
— g) = $2.75/(.18 – .10) = $34.38
Keywords: Constant Growth Dividend Valuation Model
AACSB: Analytic skills
50) You are considering the purchase of Zee Company stock. You anticipate that the company
will pay dividends of $3.50 per share next year and $4.00 per share the following year. You
believe that you can sell the stock for $20.00 per share two years from now. If your required rate
of return is 10 percent, what is the maximum price that you would pay for a share of Zee
Company stock?
Answer: V
C
= $3.50 (PVIF
10%,1)
+ $24.00 (PVIF
10%,2) = $23.02
Keywords: Common Stock Valuation
AACSB: Analytic skills
51) The price of DDS Corporation stock is expected to be $45 in 5 years. Dividends are
anticipated to increase at an annual rate of 10 percent from the most recent dividend of $1.00. If
your required rate of return is 15 percent, how much are you willing to pay for DDS stock?
Answer: The expected cash flows are the future dividends plus the future selling price,
Year D PV @ 15%
1 1.10 .96
2 1.21 .91
3 1.33 .88
4 1.46 .84
5 1.61 .80
$4.39 =PV of dividends only
P = $4.39 + ($68/(1.15^5 = 22.37) = $26.76
Keywords: Common Stock Valuation
AACSB: Analytic skills
8.5 Learning Objective 5
1) The expected rate of return implied by a given market price equals the required rate of return
for investors at the margin.
Answer: TRUE
Keywords: Required Return, Expected Return
AACSB: Reflective thinking skills
2) Butler Corp paid a dividend today of $5 per share. The dividend is expected to grow at a
constant rate of 6.5% per year. If Butler Corp stock is selling for $50.00 per share, the
stockholders’ expected rate of return is
A) 11.50%.
B) 13.56%.
C) 15.49%.
D) 16.50%.
Answer: D
Keywords: Expected Rate of Return, Constant Growth Dividend Valuation Model
AACSB: Analytic skills
3) The expected rate of return on a share of common stock whose dividends are growing at a
constant rate (g) is which of the following, where D
1
is the next dividend and Vc is the current
value of the stock?
A) (D
1
+ g)/Vc
B) D
1
/Vc + g
C) D
1
/g
D) D
1
/g + Vc
Answer: B
Keywords: Constant Growth Dividend Valuation Model, Expected Rate of Return
AACSB: Analytic skills
4) Bin Restaurant Corp preferred stock has a market price of $14.50. If it has a yearly dividend
of $3.50, what is your expected rate of return if you purchase the stock at its market price?
A) 41.43%
B) 19.45%
C) 22.36%
D) 24.14%
Answer: D
Keywords: Preferred Stock, Expected Rate of Return
AACSB: Analytic skills
5) ADR Bank preferred stock pays an annual dividend of $2.75 per share. If the stock is
currently selling for $27.50 per share, what is the expected rate of return on this stock?
A) 2.75%
B) 10.0%
C) 17.5%
D) 27.5%
Answer: B
Keywords: Preferred Stock, Expected Rate of Return
AACSB: Analytic skills
6) H. J. Corp. common stock paid $2.50 in dividends last year (D
0
). Dividends are expected to
grow at a 12-percent annual rate forever. If H. J.’s current market price is $40.00, what is the
stock’s expected rate of return (nearest .01 percent)?
A) 5.50%
B) 11.00%
C) 18.25%
D) 19.00%
Answer: D
Keywords: Constant Growth Dividend Valuation Model, Expected Rate of Return
AACSB: Analytic skills
7) U.S Technologies preferred stock sells for $80 and pays $9 each year in dividends. What is
the expected rate of return?
Answer: r
p
= D/V = $9/805 = .1125 = 11.25%
Keywords: Preferred Stock Valuation, Expected Rate of Return
AACSB: Analytic skills
8) You purchased one share of Sophia Enterprises common stock for $30 today. If the stock
pays a dividend of $6.50 in one year, and sells for $32.50 at that time, what will the dividend
yield, growth rate, and total rate of return be for the year?
Answer: Dividend yield = Div/price = $6.50 / $30 = 21.67%
Growth rate = change in price = ($32.50 – $30) / $30 = 8.33%
Total rate of return = Div. yield + growth rate = 30%
Keywords: Dividend Yield, Growth Rate, Total Rate of Return
AACSB: Analytic skills
9) Tannerly Worldwide’s common stock is currently selling for $48 a share. If the expected
dividend at the end of the year is $2.40 and last year’s dividend was $2.00, what is the rate of
return implicit in the current stock price?
Answer: r
c
= 2.40/48 + (2.40 – 2.00)/2.00 = .05 + .20 = 25%
Keywords: Expected Rate of Return, Dividend Yield, Growth Rate
AACSB: Analytic skills
10) Miller’s preferred stock is selling at $54 on the market and pays an annual dividend of $4.20
per share.
a. What is the expected rate of return on the stock?
b. If an investor’s required rate of return is 9%, what is the value of the stock to that investor?
c. Considering the investor’s required rate of return, does this stock seem to be a desirable
investment?
Answer:
a. R = D/V
R = $4.20/54
R = 7.78%
b. V = D/R
V = $4.20/.09
V = $46.67
No, it is not a desirable investment because the current selling price exceeds the value to the
investor.
Keywords: Preferred Stock Valuation, Expected Rate of Return, Required Rate of Return
AACSB: Analytic skills
11) The common stock of Cranberry Inc. is selling for $26.75 on the open market. Next year’s
dividend is expected to be $3.68, and the growth rate of this company is estimated to be 5.5%.
If Richard Dean, an average investor, is considering purchasing this stock at the market price,
what is his expected rate of return?
Answer:
R = (D/V) + g
R = ($3.68/$26.75) + .055
R = 19.26%
Keywords: Expected Rate of Return, Dividend Yield, Growth Rate
AACSB: Analytic skills
Review Test Submission: Chapter 6: Practice Quiz
User Diana Gutierrez
Course 201515 Winter 2014 FIN_3302 15011:Samuel Penkar – Fully
Online
Test Chapter 6: Practice Quiz
Started 12/27/14 3:31 PM
Submitted 12/27/14 3:35 PM
Status Needs Grading
Attempt Score Grade not available.
Time Elapsed 3 minutes
Results
Displayed
Submitted Answers, Correct Answers
 Question 1
0 out of 1 points
You hold a portfolio with the following securities:
What is the expected return for the market, according to the CAPM?
Correct
Answer: a. 14.0%
 Question 2
1 out of 1 points
A security with a beta of one has a required rate of return equal to the overall market rate of
return.
Correct
Answer: b. true
 Question 3
0 out of 1 points
Most stocks have betas between
Correct
Answer:
1.60.
 Question 4
0 out of 1 points
Assume that you have $165,000 invested in a stock that is returning 11.50%, $85,000
invested in a stock that is returning 22.75%, and $235,000 invested in a stock that is
returning 10.25%. What is the expected return of your portfolio?
Correct
Answer: b. 12.9%
 Question 5
Needs Grading
Discuss whether the standard deviation of a portfolio is, or is not, a weighted average of the
standard deviations of the assets in the portfolio. Fully explain your answer.
Correct Answer:
 Question 6
0 out of 1 points
Beta is a measurement of the relationship between a security’s returns and the general
market’s returns.
Correct
Answer: b. true
 Question 7
1 out of 1 points
An all-stock portfolio is more risky than a portfolio consisting of all bonds.
Correct
Answer: b. true
 Question 8
Needs Grading
Answer the questions below using the following information on stocks A, B, and C.
Assume the risk-free rate of return is 3% and the expected market return is 12%
a. Calculate the required return for stocks A, B, and C.
b. Assuming an investor with a well-diversified portfolio, which stock would the investor want
to add to his portfolio?
c. Assuming an investor who will invest all of his money into one security, which stock will the
investor choose?
Correct Answer:
 Question 9
1 out of 1 points
Changes in the general economy, like changes in interest rates or tax laws represent what
type of risk?
Correct
Answer: b.
risk
 Question 10
0 out of 1 points
Cash flows is the most relevant variable to measure the returns on debt instruments, while
GAAP net income is the most relevant variable to measure the returns on common stock.
Correct
Answer: a. false
 Question 11
0 out of 1 points
Investment A has an expected return of 15% per year, while investment B has an expected
return of 12% per year. A rational investor will choose
Correct Answer:
 Question 12
0 out of 1 points
Portfolio performance is determined mainly by stock selection and market timing, with less
emphasis on asset allocation.
Correct
Answer: a. false
 Question 13
0 out of 1 points
Assume that you have $165,000 invested in a stock whose beta is 1.25, $85,000 invested in
a stock whose beta is 2.35, and $235,000 invested in a stock whose beta is 1.11. What is
the beta of your portfolio?
Correct
Answer: a. 1.37
 Question 14
0 out of 1 points
According to the CAPM, for each unit of Beta an asset’s required rate of return increases by
the market’s return.
Correct
Answer: a. false
 Question 15
0 out of 1 points
Of the following, which differs in meaning from the other three?
Correct Answer:
Saturday, December 27, 2014 3:35:34 PM CST
 Question 1
1 out of 1 points
The minimum rate of return necessary to attract an investor to purchase or hold a security is
referred to as the:
Correct Answer:
 Question 2
0 out of 1 points
An investor currently holds the following portfolio:
If the risk-free rate of return is 4% and the market risk premium is 9%, then the required
return on the portfolio is:
Correct
Answer: c.
 Question 3
0 out of 1 points
Assume that you expect to hold a $20,000 investment for one year. It is forecasted to have a
yearend value of $21,000 with a 30% probability; a yearend value of $24,000 with a 45%
probability; and a yearend value of $30,000 with a 25% probability. What is the expected
holding period return for this investment?
Correct
Answer: c. 23%
 Question 4
Needs Grading
Discuss whether the standard deviation of a portfolio is, or is not, a weighted average of the
standard deviations of the assets in the portfolio. Fully explain your answer.
Correct Answer:
 Question 5
0 out of 1 points
The portfolio beta is simply the sum of the betas of the individual stocks in the portfolio.
Correct
Answer: a. false
 Question 6
1 out of 1 points
According to the CAPM, for each unit of Beta an asset’s required rate of return increases by
the market’s return.
Correct
Answer: a. false
 Question 7
0 out of 1 points
Investment A and Investment B both have the same expected return, but Investment A is
more risky than Investment B. In the technical jargon of modern portfolio theory, Investment
A is said to “dominate” Investment B.
Correct
Answer: a. false
 Question 8
0 out of 1 points
Company unique risk can be virtually eliminated with a portfolio consisting of approximately
20 securities.
Correct
Answer: b. true
 Question 9
0 out of 1 points
The required rate of return for an asset is equal to the risk-free rate plus a risk premium.
Correct
Answer: b. true
 Question 10
0 out of 1 points
Of the following, which differs in meaning from the other three?
Correct Answer:
 Question 11
0 out of 1 points
Which of the following statements is most correct regarding beta?
Correct Answer:
 Question 12
1 out of 1 points
Assume that you have $165,000 invested in a stock whose beta is 1.25, $85,000 invested in
a stock whose beta is 2.35, and $235,000 invested in a stock whose beta is 1.11. What is
the beta of your portfolio?
Correct
Answer: a. 1.37
 Question 13
0 out of 1 points
Because risk is measured by variability of returns, how long we hold our investments does
not matter very much when it comes to reducing risk.
Correct
Answer: a. false
 Question 14
0 out of 1 points
Stock A has the following returns for various states of the economy:
Stock A’s expected return is:
Correct
c. 8.2%.
Answer:
 Question 15
1 out of 1 points
You are considering buying some stock in Continental Grain. Which of the following are
examples of non-diversifiable risks?
Correct
Answer: a. I and II
Saturday, December 27, 2014 4:23:32 PM CST
 Question 1
0 out of 1 points
Company unique risk can be virtually eliminated with a portfolio consisting of approximately
20 securities.
Correct
Answer: b. true
 Question 2
0 out of 1 points
Emery Inc. has a beta equal to 1.8 and a required return of 15% based on the CAPM. If the
risk free rate of return is 4.2%, the expected return on the market portfolio is:
Correct
Answer: d.
 Question 3
0 out of 1 points
Assume that you have $165,000 invested in a stock whose beta is 1.25, $85,000 invested in
a stock whose beta is 2.35, and $235,000 invested in a stock whose beta is 1.11. What is
the beta of your portfolio?
Correct
Answer: a. 1.37
 Question 4
1 out of 1 points
Another name for an asset’s expected rate of return is holding-period return.
Correct
Answer: a. false
 Question 5
1 out of 1 points
The relevant risk to an investor is that portion of the variability of returns that cannot be
diversified away.
Correct
Answer: b. true
 Question 6
Needs Grading
Bay Land, Inc. has the following distribution of returns:
Assuming that these returns are normally distributed, what is the probability that Bay Land,
Inc. will return less than 7.25%? Show all work, and clearly explain and state your answer.
Correct Answer:
 Question 7
1 out of 1 points
Diversifying among different kinds of assets is called asset allocation.
Correct
Answer: b. true
 Question 8
0 out of 1 points
Stock A has an expected return of 12% with a standard deviation of 8%. If returns are
normally distributed, then approximately two-thirds of the time the return on stock A will be
Correct Answer:
 Question 9
0 out of 1 points
The slope of the characteristic line of a security is that security’s Beta.
Correct
Answer: b. true
 Question 10
0 out of 1 points
What is the name given to the equation that financial managers use to measure an investor’s
required rate of return?
Correct Answer:
 Question 11
0 out of 1 points
The portfolio beta is simply the sum of the betas of the individual stocks in the portfolio.
Correct
Answer: a. false
 Question 12
Needs Grading
Bankers Corp has a very conservative Beta of .7, while Biotech Corp has a Beta of 2.1.
Given that the T-bill rate is 5%, and the market is expected to return 15%, what is the
expected return of Bankers Corp, Biotech Corp, and a portfolio composed of 60% of Bankers
Corp and 40% Biotech Corp?
a. Solve this problem first by weighting the Betas to calculate a portfolio Beta, and then using
CAPM to calculate the portfolio expected return.
b. Then solve the problem again by calculating the expected return of each asset and
weighting those returns to calculate the portfolio expected return.
c. Why is Biotech Corp’s expected return not three times that of Bankers Corp?
Correct Answer:
 Question 13
1 out of 1 points
The realized rate of return, or holding period return, is equal to the holding period dollar gain
divided by the price at the beginning of the period.
Correct
Answer: b. true
 Question 14
1 out of 1 points
Assume that you have $165,000 invested in a stock that is returning 11.50%, $85,000
invested in a stock that is returning 22.75%, and $235,000 invested in a stock that is
returning 10.25%. What is the expected return of your portfolio?
Correct
Answer: b. 12.9%
 Question 15
0 out of 1 points
Stanley Corp. common stock has a required return of 17.5% and a beta of 1.75. If the
expected risk free return is 3%, what is the expected return for the market based on the
CAPM?
Correct
Answer: a.
Saturday, December 27, 2014 4:27:08 PM CST
 Question 1
Needs Grading
Security A has an expected rate of return of 29.8 percent and a beta of 3.1. Security B has a
beta of 1.70. If the Treasury bill rate is 5 percent, what is the expected rate of return for
Security B?
Correct Answer:
 Question 2
0 out of 1 points
Assume that you have $165,000 invested in a stock whose beta is 1.25, $85,000 invested in
a stock whose beta is 2.35, and $235,000 invested in a stock whose beta is 1.11. What is
the beta of your portfolio?
Correct
Answer: a. 1.37
 Question 3
1 out of 1 points
Another name for an asset’s expected rate of return is holding-period return.
Correct
Answer: a. false
 Question 4
0 out of 1 points
The risk-free rate of interest is 4% and the market risk premium is 9%. Howard Corporation
has a beta of 2.0, and last year generated a return of 16% with a standard deviation of
returns of 27%. The required return on Howard Corporation stock is:
Correct
Answer: d. 22%.
 Question 5
0 out of 1 points
Diversifying among different kinds of assets is called asset allocation.
Correct
Answer: b. true
 Question 6
0 out of 1 points
Portfolio risk is typically measured by ________ while the risk of a single investment is
measured by ________.
Correct Answer:
 Question 7
0 out of 1 points
Stock A has an expected return of 12% with a standard deviation of 8%. If returns are
normally distributed, then approximately two-thirds of the time the return on stock A will be
Correct Answer:
 Question 8
0 out of 1 points
Of the following, which differs in meaning from the other three?
Correct Answer:
 Question 9
0 out of 1 points
Which of the following is/are true:
Correct Answer:
 Question 10
0 out of 1 points
A stock with a beta of 1.4 has 40% more variability in returns than the average stock.
Correct
Answer: b. true
 Question 11
0 out of 1 points
The required rate of return for an asset is equal to the risk-free rate plus a risk premium.
Correct
Answer: b. true
 Question 12
0 out of 1 points
If we are able to fully diversify, what is the appropriate measure of risk to use?
Correct
Answer: c. Beta
 Question 13
0 out of 1 points
You are considering investing in Ford Motor Company. Which of the following are examples
of diversifiable risk?
Correct
Answer: d. II, III
 Question 14
0 out of 1 points
If you were to use the standard deviation as a measure of investment risk, which of the
following has historically been the highest risk investment?
Correct Answer:
 Question 15
1 out of 1 points
Investment A and Investment B both have the same expected return, but Investment A is
more risky than Investment B. In the technical jargon of modern portfolio theory, Investment
A is said to “dominate” Investment B.
Correct
Answer: a. false
Saturday, December 27, 2014 4:30:26 PM CST
 Question 1
0 out of 1 points
An investor with a required return of 8% for stock A will purchase stock A if the expected
return for stock A is less than or equal to 8%.
Selected
Answer: b.
true
Correct
Answer:
fals
e
 Question 2
0 out of 1 points
Investment A has an expected return of 14% with a standard deviation of 4%, while
investment B has an expected return of 20% with a standard deviation of 9%. Therefore,
Correct Answer:
 Question 3
0 out of 1 points
Because risk is measured by variability of returns, how long we hold our investments does
not matter very much when it comes to reducing risk.
Correct
Answer: a. false
 Question 4
0 out of 1 points
The slope of the characteristic line of a security is that security’s Beta.
Correct
Answer: b. true
 Question 5
1 out of 1 points
Which of the following measures the average relationship between a stock’s returns and the
market’s returns?
Correct Answer:
coefficient
 Question 6
1 out of 1 points
Beta is a measurement of the relationship between a security’s returns and the general
market’s returns.
Correct
b. true
Answer:
 Question 7
1 out of 1 points
Investment A and Investment B both have the same expected return, but Investment A is
more risky than Investment B. In the technical jargon of modern portfolio theory, Investment
A is said to “dominate” Investment B.
Correct
Answer: a. false
 Question 8
Needs Grading
Bay Land, Inc. has the following distribution of returns:
Assuming that these returns are normally distributed, what is the probability that Bay Land,
Inc. will return less than 7.25%? Show all work, and clearly explain and state your answer.
Correct Answer:
 Question 9
0 out of 1 points
If you hold a portfolio made up of the following stocks:
What is the beta of the portfolio?
Correct
Answer: c. 1.15
 Question 10
1 out of 1 points
In an efficient market, a stock with a standard deviation of returns of 12% could have a
higher expected return than a stock with a standard deviation of 10% because the beta for
the higher standard deviation stock could be lower than the beta for the lower standard
deviation stock.
Correct
Answer: b. true
 Question 11
0 out of 1 points
Billings, Inc. common stock has a beta of 1.2. If the expected risk free return is 4% and the
expected market risk premium is 9%, what is the expected return on Billing’s stock?
Correct
Answer: d. 14.8%
 Question