MAS Review Material

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Indicate the answer choice that best completes the statement or answers the question.
1. Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the
largest percentage increase in price?
a. A 1-year bond with a 15% coupon.
b. A 3-year bond with a 10% coupon.
c. A 10-year zero coupon bond.
d. A 10-year bond with a 10% coupon.
e. An 8-year bond with a 9% coupon.
2. If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in
value?
a. A 1-year bond with an 8% coupon.
b. A 10-year bond with an 8% coupon.
c. A 10-year bond with a 12% coupon.
d. A 10-year zero coupon bond.
e. A 1-year zero coupon bond.
3. You are considering three different bonds for your portfolio. Each bond has a 10-year maturity and a yield to maturity
of 10%. Bond X has an 8% annual coupon, Bond Y has a 10% annual coupon, and Bond Z has a 12% annual coupon.
Which of the following statements is CORRECT?
a. Bond X has the greatest reinvestment rate risk.
b. If market interest rates decline, all of the bonds will have an increase in price, and Bond Z will have the largest
percentage increase in price.
c. If market interest rates remain at 10%, Bond Z's price will be 10% higher one year from today.
d. If market interest rates increase, Bond X's price will increase, Bond Z's price will decline, and Bond Y's price
will remain the same.
e. If the bonds' market interest rates remain at 10%, Bond Z's price will be lower one year from now than it is
today.
4. Bonds A, B, and C all have a maturity of 15 years and a yield to maturity of 9%. Bond A's price exceeds its par value,
Bond B's price equals its par value, and Bond C's price is less than its par value. Which of the following statements is
CORRECT?
a. Bond A has the most interest rate risk.
b. If the yield to maturity on the three bonds remains constant, the prices of the three bonds will remain the same
over the next year.
c. If the yield to maturity on each bond increases to 8%, the prices of all three bonds will decline.
d. Bond C sells at a premium over its par value.
e. If the yield to maturity on each bond decreases to 6%, Bond A will have the largest percentage increase in its
price.
5. Which of the following statements is CORRECT?

a. A 10-year, 10% coupon bond has less reinvestment rate risk than a 10-year, 5% coupon bond (assuming all
else equal).
b. The total return on a bond during a given year is the sum of the coupon interest payments received during the
year and the change in the value of the bond from the beginning to the end of the year.
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c. The price of a 20-year, 10% bond is less sensitive to changes in interest rates than the price of a 5-year, 10%
bond.
d. A $1,000 bond with $100 annual interest payments that has 5 years to maturity and is not expected to default
would sell at a discount if interest rates were below 9% and at a premium if interest rates were greater than
11%.
e. 10-year, zero coupon bonds have higher reinvestment rate risk than 10-year, 10% coupon bonds.

a. If the maturity risk premium (MRP) is greater than zero, then the yield curve must have an upward slope.
b. Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be
higher than yields on short-term T-bonds.
c. If the maturity risk premium (MRP) equals zero, the yield curve must be flat.
d. The yield curve can never be downward sloping.
e. If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero,
then the yield curve will have an upward slope.

a. The most likely explanation for an inverted yield curve is that investors expect inflation to increase.
b. The most likely explanation for an inverted yield curve is that investors expect inflation to decrease.
c. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.
d. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve
can never be inverted.
e. The higher the maturity risk premium, the higher the probability that the yield curve will be inverted.
8. Bonds for two companies were just issued: Short Corp.'s bonds will mature in 5 years, and Long Corp.'s bonds will
mature in 15 years. Both bonds promise to pay a semiannual coupon, they are not callable or convertible, and they are
equally liquid. Further, assume that the Treasury yield curve is based only on expectations about future inflation, i.e., that
the maturity risk premium is zero for T-bonds. Under these conditions, which of the following statements is correct?
a. If the Treasury yield curve is downward sloping, Long's bonds must under all conditions have the lower yield.
b. If the yield curve for Treasury securities is upward sloping, Long's bonds must under all conditions have a
higher yield than Short's bonds.
c. If the yield curve for Treasury securities is flat, Short's bond must under all conditions have the same yield as
Long's bonds.
d. If Long's and Short's bonds have the same default risk, their yields must under all conditions be equal.
e. If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short's bonds
must under all conditions have the lower yield.
9. Which of the following statements is NOT CORRECT?

a. The expected return on a corporate bond must be less than its promised return if the probability of default is
greater than zero.
b. All else equal, senior debt has less default risk than subordinated debt.
c. A company's bond rating is affected by its financial ratios and provisions in its indenture.
d. Under Chapter 11 of the Bankruptcy Act, the assets of a firm that declares bankruptcy must be liquidated, and
the sale proceeds must be used to pay off its debt according to the seniority of the debt as spelled out in the
Act.
e. All else equal, secured debt is less risky than unsecured debt.
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10. Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. She is highly
risk averse and has asked for your advice. The three stocks currently held all have b = 1.0, and they are perfectly
positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in
equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is
12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?
a. Stock A.
b. Stock B.
c. Neither A nor B, as neither has a return sufficient to compensate for risk.
d. Add A, since its beta must be lower.
e. Either A or B, i.e., the investor should be indifferent between the two.
11. Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true about these securities?
(Assume market equilibrium.)
a. Stock B must be a more desirable addition to a portfolio than A.
b. Stock A must be a more desirable addition to a portfolio than B.
c. The expected return on Stock A should be greater than that on B.
d. The expected return on Stock B should be greater than that on A.
e. When held in isolation, Stock A has more risk than Stock B.
12. Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true, according to
the CAPM?
a. Stock Y's realized return during the coming year will be higher than Stock X's return.
b. If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on
the two stocks should increase by the same amount.
c. Stock Y's return has a higher standard deviation than Stock X.
d. If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in
its required return than will Stock Y.
e. If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta
significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
13. Consider the following information for three stocks, A, B, and C. The stocks' returns are positively but not perfectly
positively correlated with one another, i.e., the correlations are all between 0 and 1.
Expected Standard
Stock Return Deviation Beta
A 10% 20% 1.0
B 10% 10% 1.0
C 12% 12% 1.4
Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its funds
invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal
expected returns. Which of the following statements is CORRECT?
a. Portfolio AB's coefficient of variation is greater than 2.0.
b. Portfolio AB's required return is greater than the required return on Stock A.
c. Portfolio ABC's expected return is 10.66667%.
d. Portfolio ABC has a standard deviation of 20%.

Name: Class: Date:
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e. Portfolio AB has a standard deviation of 20%.
14. The two stocks in your portfolio, X and Y, have independent returns, so the correlation between them, rXY is zero.
Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected
return of 15%, betas of 1.6, and standard deviations of 30%. Which of the following statements best describes the
characteristics of your 2-stock portfolio?
a. Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.
b. Your portfolio has a beta equal to 1.6, and its expected return is 15%.
c. Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.
d. Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.
e. Your portfolio has a standard deviation of 30%, and its expected return is 15%.
15. In a portfolio of three randomly selected stocks, which of the following could NOT be true; i.e., which statement is
false?
a. The standard deviation of the portfolio is greater than the standard deviation of one or two of the stocks.
b. The beta of the portfolio is lower than the lowest of the three betas.
c. The beta of the portfolio is equal to one of the three stock's betas.
d. The beta of the portfolio is equal to 1.
e. The standard deviation of the portfolio is less than the standard deviation of each of the stocks if they were
held in isolation.
16. Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)
a. The effect of a change in the market risk premium depends on the slope of the yield curve.
b. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.
c. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a
beta of 1.0.
d. The effect of a change in the market risk premium depends on the level of the risk-free rate.
e. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta
greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.
17. The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF,
is positive. Which of the following statements is CORRECT?
a. Stock B's required rate of return is twice that of Stock A.
b. If Stock A's required return is 11%, then the market risk premium is 5%.
c. If Stock B's required return is 11%, then the market risk premium is 5%.
d. If the risk-free rate remains constant but the market risk premium increases, Stock A's required return will
increase by more than Stock B's.
e. If the risk-free rate increases but the market risk premium stays unchanged, Stock B's required return will
increase by more than Stock A's.
18. Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of
the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?
a. The required return on both stocks would increase by 1%.
b. The required return on Portfolio P would remain unchanged.
c. The required return on Stock A would increase by more than 1%, while the return on Stock B would increase
Name: Class: Date:
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by less than 1%.

d. The required return for Stock A would fall, but the required return for Stock B would increase.
e. The required return on Portfolio P would increase by 1%.
19. Martin Ortner holds a $200,000 portfolio consisting of the following stocks:
Stock Investment Beta
A $50,000 0.95
B 50,000 0.80
C 50,000 1.00
D 50,000 1.20
Total $200,000
What is the portfolio's beta?
a. 0.938
b. 0.988
c. 1.037
d. 1.089
e. 1.143
20. Consider the following information and then calculate the required rate of return for the Universal Investment Fund,
which holds 4 stocks. The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are
as follows:
Stock Investment Beta
A $ 200,000 1.50
B $ 300,000 −0.50
C $ 500,000 1.25
D $1,000,000 0.75
a. 9.58%
b. 10.09%
c. 10.62%
d. 11.18%
e. 11.77%
21. Hazel Morrison, a mutual fund manager, has a $40 million portfolio with a beta of 1.00. The risk-free rate is 4.25%,
and the market risk premium is 6.00%. Hazel expects to receive an additional $60 million, which she plans to invest in
additional stocks. After investing the additional funds, she wants the fund's required and expected return to be 13.00%.
What must the average beta of the new stocks be to achieve the target required rate of return?
a. 1.68
b. 1.76
c. 1.85
d. 1.94
e. 2.04
22. The Lincoln Company sold a $1,000 par value, noncallable bond several years ago that now has 20 years to maturity
and a 7.00% annual coupon that is paid semiannually. The bond currently sells for $925 and the company's tax rate is
40%. What is the component cost of debt for use in the WACC calculation?
Name: Class: Date:
Review May1
a. 4.28%
b. 4.46%
c. 4.65%
d. 4.83%
e. 5.03%
Collins Group
The Collins Group, a leading producer of custom automobile accessories, has hired you to estimate the firm's weighted
average cost of capital. The balance sheet and some other information are provided below.
Assets
Current assets $ 38,000,000
Net plant, property, and equipment 101,000,000
Total assets $139,000,000
Liabilities and Equity

Accounts payable $ 10,000,000
Accruals 9,000,000
Current liabilities $ 19,000,000
Long-term debt (40,000 bonds, $1,000 par value) 40,000,000
Total liabilities $ 59,000,000
Common stock (10,000,000 shares) 30,000,000
Retained earnings 50,000,000
Total shareholders' equity 80,000,000
Total liabilities and shareholders' equity $139,000,000
The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with
semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the
yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an
average annual return of 14.50% during the past 5 years. The firm's tax rate is 40%.
23. Refer to the data for the Collins Group. What is the best estimate of the after-tax cost of debt?
a. 4.64%
b. 4.88%
c. 5.14%
d. 5.40%
e. 5.67%
24. A company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the
company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's
cost of preferred stock?
a. 7.81%
b. 8.22%
c. 8.65%
d. 9.10%
e. 9.56%
25. Adams Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05. What is the firm's cost of common from
reinvested earnings based on the CAPM?
Name: Class: Date:
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a. 11.30%
b. 11.64%
c. 11.99%
d. 12.35%
e. 12.72%
Collins Group
Assets

Accruals 9,000,000
26. Refer to the data for the Collins Group. Based on the CAPM, what is the firm's cost of common stock?
a. 11.15%
b. 11.73%
c. 12.35%
d. 13.00%
e. 13.65%

a. The after-tax cost of debt usually exceeds the after-tax cost of equity.
b. For a given firm, the after-tax cost of debt is always more expensive than the after-tax cost of non-convertible
preferred stock.
c. Retained earnings that were generated in the past and are reported on the firm's balance sheet are available to
finance the firm's capital budget during the coming year.
d. The WACC that should be used in capital budgeting is the firm's marginal, after-tax cost of capital.
e. The WACC is calculated using before-tax costs for all components.
28. The president and CFO of Spellman Transportation are having a disagreement about whether to use market value or
book value weights in calculating the WACC. Spellman's balance sheet shows a total of noncallable $45 million long-
Name: Class: Date:
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term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%. This debt currently has a market value of $50
million. The company has 10 million shares of common stock, and the book value of the common equity (common stock
plus retained earnings) is $65 million. The current stock price is $22.50 per share; stockholders' required return, rs, is
14.00%; and the firm's tax rate is 40%. The CFO thinks the WACC should be based on market value weights, but the
president thinks book weights are more appropriate. What is the difference between these two WACCs?
a. 1.55%
b. 1.72%
c. 1.91%
d. 2.13%
e. 2.36%
29. Granby Foods' (GF) balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%. The yield
to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million. The company has 10
million shares of stock, and the stock has a book value per share of $5.00. The current stock price is $20.00 per share, and
stockholders' required rate of return, rs, is 12.25%. The company recently decided that its target capital structure should
have 35% debt, with the balance being common equity. The tax rate is 40%. Calculate WACCs based on book, market,
and target capital structures. What is the sum of these three WACCs?
a. 28.36%
b. 29.54%
c. 30.77%
d. 32.00%
e. 33.28%
Collins Group
Assets

Accruals 9,000,000
30. Refer to the data for the Collins Group. Which of the following is the best estimate for the weight of debt for use in
calculating the firm's WACC?
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a. 18.67%
b. 19.60%
c. 20.58%
d. 21.61%
e. 22.69%
31. Trahern Baking Co. common stock sells for $32.50 per share. It expects to earn $3.50 per share during the current
year, its expected dividend payout ratio is 65%, and its expected constant dividend growth rate is 6.0%. New stock can be
sold to the public at the current price, but a flotation cost of 5% would be incurred. What would be the cost of equity from
new common stock?
a. 12.70%
b. 13.37%
c. 14.04%
d. 14.74%
e. 15.48%
Indicate whether the statement is true or false.
32. Suppose the debt ratio (D/TA) is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the
tax rate is 40%. An increase in the debt ratio to 60% would decrease the weighted average cost of capital (WACC).
a. True
b. False
Indicate the answer choice that best completes the statement or answers the question.
33. Burnham Brothers Inc. has no retained earnings since it has always paid out all of its earnings as dividends. This same
situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target
capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its
WACC?
a. The flotation costs associated with issuing new common stock increase.
b. The company's beta increases.
c. Expected inflation increases.
d. The flotation costs associated with issuing preferred stock increase.
e. The market risk premium declines.
34. A company’s free cash flow was just FCF0 = $1.50 million. The weighted average cost of capital is WACC = 10.1%,
and the constant growth rate is g = 4.0%. What is the current value of operations?
a. $23.11 million
b. $23.70 million
c. $24.31 million
d. $24.93 million
e. $25.57 million
35. Young & Liu Inc.'s free cash flow during the just-ended year (t = 0) was $100 million, and FCF is expected to grow at
a constant rate of 5% in the future. If the weighted average cost of capital is 15%, what is the firm's value of operations, in
millions?
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a. $948
b. $998
c. $1,050
d. $1,103
e. $1,158
36. If a firm's expected growth rate increased then its required rate of return would
a. decrease.
b. fluctuate less than before.
c. fluctuate more than before.
d. possibly increase, possibly decrease, or possibly remain constant.
e. increase.
37. You, in analyzing a stock, find that its expected return exceeds its required return. This suggests that you think
a. the stock should be sold.
b. the stock is a good buy.
c. management is probably not trying to maximize the price per share.
d. dividends are not likely to be declared.
e. the stock is experiencing supernormal growth.
38. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium,
which of the following statements is CORRECT?
A B
Required return 10% 12%
Market price $25 $40
Expected growth 7% 9%
a. These two stocks must have the same dividend yield.
b. These two stocks should have the same expected return.
c. These two stocks must have the same expected capital gains yield.
d. These two stocks must have the same expected year-end dividend.
e. These two stocks should have the same price.
39. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium,
which of the following statements is CORRECT?
A B
Price $25 $25
Expected growth (constant) 10% 5%
Required return 15% 15%
a. Stock A has a higher dividend yield than Stock B.
b. Currently the two stocks have the same price, but over time Stock B's price will pass that of A.
c. Since Stock A's growth rate is twice that of Stock B, Stock A's future dividends will always be twice as high
as Stock B's.
d. The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist.
e. Stock A's expected dividend at t = 1 is only half that of Stock B.
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40. Stock X has the following data. Assuming the stock market is efficient and the stock is in equilibrium, which of the
following statements is CORRECT?
Expected dividend, D1 $3.00

Current Price, P0 $50
Expected constant growth rate 6.0%
a. The stock's expected dividend yield and growth rate are equal.
b. The stock's expected dividend yield is 5%.
c. The stock's expected capital gains yield is 5%.
d. The stock's expected price 10 years from now is $100.00.
e. The stock's required return is 10%.
41. A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the
expected constant growth rate is g = 6.4%. What is the stock's current price?
a. $17.39
b. $17.84
c. $18.29
d. $18.75
e. $19.22
42. $35.50 per share is the current price for Foster Farms' stock. The dividend is projected to increase at a constant rate of
5.50% per year. The required rate of return on the stock, rs, is 9.00%. What is the stock's expected price 3 years from
today?
a. $37.86
b. $38.83
c. $39.83
d. $40.85
e. $41.69
43. If D1 = $1.25, g (which is constant) = 5.5%, and P0 = $44, what is the stock's expected total return for the coming
year?
a. 7.54%
b. 7.73%
c. 7.93%
d. 8.13%
e. 8.34%
44. Dyer Furniture is expected to pay a dividend of D1 = $1.25 per share at the end of the year, and that dividend is
expected to grow at a constant rate of 6.00% per year in the future. The company's beta is 1.15, the market risk premium is
5.50%, and the risk-free rate is 4.00%. What is Dyer's current stock price?
a. $28.90
b. $29.62
c. $30.36

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d. $31.12
e. $31.90
45. Connolly Co.'s expected year-end dividend is D1 = $1.60, its required return is rs = 11.00%, its dividend yield is
6.00%, and its growth rate is expected to be constant in the future. What is Connolly's expected stock price in 7 years, i.e.,
what is ?
a. $37.52
b. $39.40
c. $41.37
d. $43.44
e. $45.61
46. The last dividend paid by Wilden Corporation was $1.55. The dividend growth rate is expected to be constant at 1.5%
for 2 years, after which dividends are expected to grow at a rate of 8.0% forever. The firm's required return (rs) is 12.0%.
What is the best estimate of the current stock price?
a. $37.05
b. $38.16
c. $39.30
d. $40.48
e. $41.70
47. The required return for Williamson Heating's stock is 12%, and the stock sells for $40 per share. The firm just paid a
dividend of $1.00, and the dividend is expected to grow by 30% per year for the next 4 years, so D4 = $1.00(1.30)4 =
$2.8561. After t = 4, the dividend is expected to grow at a constant rate of X% per year forever. What is the stock's
expected constant growth rate after t = 4, i.e., what is X?
a. 5.17%
b. 5.44%
c. 5.72%
d. 6.02%
e. 6.34%

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Answer Key
1. c
2. d
3. e
4. c
5. b
6. e
7. b
8. e
9. d
10. b
11. c
12. b
13. c
14. b
15. b
16. c
17. b
18. e
19. b
20. e
21. b
22. c
23. c
24. d
25. a
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26. d
27. d
28. e
29. c
30. a
31. b
32. False
33. e
34. e
35. c
36. d
37. b
38. a
39. e
40. a
41. c
42. e
43. e
44. a
45. a
46. a
47. e

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5. Which of the following statements is CORRECT?

6. Which of the following statements is CORRECT?

7. Which of the following statements is CORRECT?

9. Which of the following statements is NOT CORRECT?

Copyright Cengage Learning. Powered by Cognero. Page 3

e. Portfolio AB has a standard deviation of 20%.

by less than 1%.

Liabilities and Equity

Liabilities and Equity

27. Which of the following statements is CORRECT?

Liabilities and Equity

Indicate whether the statement is true or false.

Expected dividend, D1 $3.00

Copyright Cengage Learning. Powered by Cognero. Page 11

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