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Fin221Spring2006Exam3

Fin221Spring2006Exam3
ForFall2006Chapter8andExam3materialrefertoquestions1825

MultipleChoice
Identifytheletterofthechoicethatbestcompletesthestatementoranswersthequestion.

1.Whichofthefollowingstatementsismostcorrect?
A. Sincethemoneyisreadilyavailable,thecostofretainedearningsisusuallyalotcheaper
thanthecostofdebtfinancing.
B. Whencalculatingthecostofpreferredstock,acompanyneedstoadjustfortaxes,because
preferredstockdividendsaretaxdeductible.
C. Whencalculatingthecostofdebt,acompanyneedstoadjustfortaxes,becauseinterest
paymentsaretaxdeductible.
D. Statementsaandbarecorrect.
E. Statementsbandcarecorrect.

2.Whichofthefollowingfactorsinthediscountedcashflow(DCF)approachtoestimatingthecostofcommonequityistheleastdifficultto
estimate?
A. Expectedgrowthrate,g.
B. Dividendyield,D1/P0.
C. Requiredreturn,ks.
D. Expectedrateofreturn, .
E.

Alloftheaboveareequallydifficulttoestimate.

3.AcompanyestimatesthatanaverageriskprojecthasaWACCof10percent,abelowaverageriskprojecthasaWACCof8percent,andan
aboveaverageriskprojecthasaWACCof12percent.Whichofthefollowingindependentprojectsshouldthecompanyaccept?
A. ProjectAhasaverageriskandareturnof9percent.
B. ProjectBhasbelowaverageriskandareturnof8.5percent.
C. ProjectChasaboveaverageriskandareturnof11percent.
D. Alloftheprojectsaboveshouldbeaccepted.
E. Noneoftheprojectsaboveshouldbeaccepted.

4.AnanalysthascollectedthefollowinginformationregardingChristopherCo.:

Thecompany'scapitalstructureis70percentequityand30percentdebt.
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Theyieldtomaturityonthecompany'sbondsis9percent.
Thecompany'syearenddividendisforecastedtobe$0.80ashare.
Thecompanyexpectsthatitsdividendwillgrowataconstantrateof9percentayear.
Thecompany'sstockpriceis$25.
Thecompany'staxrateis40percent.
Thecompanyanticipatesthatitwillneedtoraisenewcommonstockthisyear,andtotal
flotationcostswillequal10percentoftheamountissued.

Assumethecompanyaccountsforflotationcostsbyadjustingthecostofcapital.Giventhisinformation,calculatethecompany'sWACC.
A. 10.41%
B. 12.56%
C. 10.78%
D. 13.55%
E. 9.29%

5.BillickBrothersisestimatingitsWACC.Thecompanyhascollectedthefollowinginformation:

Itscapitalstructureconsistsof40percentdebtand60percentcommonequity.
Thecompanyhas20yearbondsoutstandingwitha9percentannualcouponthataretradingat
par.
Thecompany'staxrateis40percent.
Theriskfreerateis5.5percent.
Themarketriskpremiumis5percent.
Thestock'sbetais1.4.

Whatisthecompany'sWACC?
A. 9.71%
B. 9.66%
C. 8.31%
D. 11.18%
E. 11.10%

6.HatchCorporation'stargetcapitalstructureis40percentdebt,50percentcommonstock,and10percentpreferredstock.Informationregarding
thecompany'scostofcapitalcanbesummarizedasfollows:

Thecompany'sbondshaveanominalyieldtomaturityof7percent.
Thecompany'spreferredstocksellsfor$42ashareandpaysanannualdividendof$4ashare.

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Thecompany'scommonstocksellsfor$28ashare,andisexpectedtopayadividendof$2a
shareattheendoftheyear(i.e.,D1=$2.00).Thedividendisexpectedtogrowataconstant
rateof7percentayear.
Thefirmwillbeabletouseretainedearningstofundtheequityportionofitscapitalbudget.
Thecompany'staxrateis40percent.

Whatisthecompany'sweightedaveragecostofcapital(WACC)?
A. 9.25%
B. 9.70%
C. 10.03%
D. 10.59%
E. 11.30%

CoetzerCompany
ThefollowinginformationappliestotheCoetzerCompany:

Coetzerhasatargetcapitalstructureof40percentdebtand60percentcommonequity.
Coetzerhas$1,000parvaluebondsoutstandingwitha15yearmaturity,a12percentannual
coupon,andacurrentpriceof$1,150.
Theriskfreerateis5percent.Themarketriskpremium(kMkRF)isalso5percent.
Coetzer'scommonstockhasabetaof1.4.
Coetzer'staxrateis40percent.

7.RefertoCoetzerCompany.Whatisthecompany'saftertaxcostofdebt?
A. 3.6%
B. 6.0%
C. 7.2%
D. 10.0%
E. 12.0%

8.IfatypicalU.S.companyusesthesamecostofcapitaltoevaluateallprojects,thefirmwillmostlikelybecome
A. Riskierovertime,anditsvaluewilldecline.
B. Riskierovertime,anditsvaluewillrise.
C. Lessriskyovertime,anditsvaluewillrise.
D. Lessriskyovertime,anditsvaluewilldecline.
E. Thereisnoreasontoexpectitsriskpositionorvaluetochangeovertimeasaresultofits
useofasinglediscountrate.

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9.Assumeaprojecthasnormalcashflows(thatis,theinitialcashflowisnegative,andallothercashflowsarepositive).Whichofthefollowing
statementsismostcorrect?
A. Allelseequal,aproject'sIRRincreasesasthecostofcapitaldeclines.
B. Allelseequal,aproject'sNPVincreasesasthecostofcapitaldeclines.
C. Allelseequal,aproject'sMIRRisunaffectedbychangesinthecostofcapital.
D. Statementsaandbarecorrect.
E. Statementsbandcarecorrect.

10.ProjectsAandBhavethesameexpectedlivesandinitialcashoutflows.However,oneproject'scashflowsarelargerintheearlyyears,while
theotherprojecthaslargercashflowsinthelateryears.ThetwoNPVprofilesaregivenbelow:

Whichofthefollowingstatementsismostcorrect?
A. ProjectAhasthesmallercashflowsinthelateryears.
B. ProjectAhasthelargercashflowsinthelateryears.
C. Werequireinformationonthecostofcapitalinordertodeterminewhichprojecthas
largerearlycashflows.
D. TheNPVprofilegraphisinconsistentwiththestatementmadeintheproblem.
E. Noneofthestatementsaboveiscorrect.

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11.CherryBooksisconsideringtwomutuallyexclusiveprojects.ProjectAhasaninternalrateofreturnof18percent,whileProjectBhasan
internalrateofreturnof30percent.Thetwoprojectshavethesamerisk,thesamecostofcapital,andthetimingofthecashflowsissimilar.Eachhasan
upfrontcostfollowedbyaseriesofpositivecashflows.Oneoftheprojects,however,ismuchlargerthantheother.Ifthecostofcapitalis16percent,
thetwoprojectshavethesamenetpresentvalue(NPV)otherwise,theirNPVsaredifferent.Whichofthefollowingstatementsismostcorrect?
A. Ifthecostofcapitalis12percent,ProjectBwillhaveahigherNPV.
B. Ifthecostofcapitalis17percent,ProjectBwillhaveahigherNPV.
C. ProjectBislargerthanProjectA.
D. Statementsaandcarecorrect.
E. Statementsbandcarecorrect.

12.Whichofthefollowingstatementsaboutnormalprojectsismostcorrect?
A. Ifaproject'sinternalrateofreturn(IRR)exceedsthecostofcapital,thentheproject'snet
presentvalue(NPV)mustbepositive.
B. IfProjectAhasahigherIRRthanProjectB,thenProjectAmustalsohaveahigherNPV.
C. TheIRRcalculationimplicitlyassumesthatallcashflowsarereinvestedatarateof
returnequaltothecostofcapital.
D. Statementsaandcarecorrect.
E. Noneofthestatementsaboveiscorrect.

13.TheSeattleCorporationhasbeenpresentedwithaninvestmentopportunitythatwillyieldcashflowsof$30,000peryearinYears1through4,
$35,000peryearinYears5through9,and$40,000inYear10.Thisinvestmentwillcostthefirm$150,000today,andthefirm'scostofcapitalis10
percent.Assumecashflowsoccurevenlyduringtheyear,1/365theachday.Whatisthepaybackperiodforthisinvestment?
A. 5.23years
B. 4.86years
C. 4.00years
D. 6.12years
E. 4.35years

14.OakFurnishingsisconsideringaprojectthathasanupfrontcostandaseriesofpositivecashflows.Theproject'sestimatedcashflowsare
summarizedbelow:

Year
ProjectCashFlow
0
?
1
$500million
2
300million
3
400million
4
600million
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Theprojecthasaregularpaybackof2.25years.Whatistheproject'sinternalrateofreturn(IRR)?
A. 23.1%
B. 143.9%
C. 17.7%
D. 33.5%
E. 41.0%

15.GreenGrocersisdecidingamongtwomutuallyexclusiveprojects.Thetwoprojectshavethefollowingcashflows:

Year
ProjectACashFlow
ProjectBCashFlow
0
1
2
3
4

$50,000
10,000
15,000
40,000
20,000

$30,000
6,000
12,000
18,000
12,000

Thecompany'sweightedaveragecostofcapitalis10percent(WACC=10%).Whatisthenetpresentvalue(NPV)oftheprojectwiththehighestinternalrate
ofreturn(IRR)?
A. $7,090
B. $8,360
C. $11,450
D. $12,510
E. $15,200

16.CowherCo.isconsideringtwomutuallyexclusiveprojects,ProjectXandProjectY.Theprojectsareequallyriskyandhavethefollowing
expectedcashflows:

Year
ProjectXCashFlow
ProjectYCashFlow
0
$3,700million
$3,200million
1
1,400million
900million
2
1,070million
1,000million
3
1,125million
1,135million
4
700million
720million

Atwhatcostofcapitalwouldthetwoprojectshavethesamenetpresentvalue(NPV)?
A. 8.07%
B. 45.80%
C. 70.39%
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D.
E.

Fin221Spring2006Exam3

6.90%
Cannotbedetermined.

17.Yourcompanyisconsideringtwomutuallyexclusiveprojects,XandY,whosecostsandcashflowsareshownbelow:

Year
ProjectXCashFlow
ProjectYCashFlow
0
1
2
3
4

$2,000
200
600
800
1,400

$2,000
2,000
200
100
75

Theprojectsareequallyrisky,andthefirm'scostofcapitalis12percent.Youmustmakearecommendation,andyoumustbaseitonthemodifiedIRR(MIRR).
WhatistheMIRRofthebetterproject?
A. 12.00%
B. 11.46%
C. 13.59%
D. 12.89%
E. 15.73%

18.Whatdoyoucalltheportionofyourtotalreturnonastockinvestmentthatiscausedbyanincreaseinthevalueofthestock.
A. Dividendyield.
B. Riskfreereturn.
C. Capitalgain.
D. Noneoftheabove.

19.AccordingtotheCAPM(capitalassetpricingmodel),thesecuritymarketlineisastraightline.Theslopeofthislineshouldbeequalto
A. zero
B. theexpectedriskpremiumonthemarketportfolio
C. theriskfreerate
D. theexpectedreturnonthemarketportfolio

20.Aparticularassethasabetaof1.2andanexpectedreturnof10%.Theexpectedreturnonthemarketportfoliois13%andtheriskfreeis5%.
Thestockis
A. overpriced
B. underpriced
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C.
D.

Fin221Spring2006Exam3

appropriatelypriced
Cannottellfromthegiveninformation

21.Aparticularstockhasanexpectedreturnof11%.Iftheexpectedriskpremiumonthemarketportfoliois8%,andtheriskfreerateis5%,whats
thestocksCAPMbeta?
A. 1.375
B. 0.750
C. 0.846
D. 0.462

22.Aninvestorput40%ofhermoneyinStockAand60%inStockB.StockAhasabetaof1.2andStockBhasabetaof1.6.Iftheriskfreerateis
5%andtheexpectedreturnonthemarketis12%,whatstheinvestorsexpectedreturn?
A. 22.28%
B. 14.80%
C. 15.08%
D. 21.80%

Exhibit71

Outcome
Probability
Return
Recession
25%
30%
Expansion
40%
15%
Boom
35%
55%

23.GivenExhibit71,whatistheexpectedstandarddeviation?
A. 957.38%
B. 1058.69%
C. 49.27%
D. 32.54%

24.Investorscaneliminatewhattypeofriskbydiversifying?
A. systematicrisk
B. unsystematicrisk
C. betarisk
D. totalrisk
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25.Ifyoubelievedastockwasgoingtofallinprice,astrategytoprofitfromthestockdeclineisknownas:
A. buyinglong.
B. buyingshort.
C. sellinglong.
D. sellingshort.

Fin221Spring2006Exam3
AnswerSection

MULTIPLECHOICE

1.C
2.B
3.B
4.A
5.B
6.B
7.B
8.A
9.B
10.B
11.B
12.A
13.B
14.D
15.E
16.A
17.C
18.C
19.B
20.A
21.B
22.C
23.D
24.B
25.D
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