Name:_______________________ BUS 320 Spring 2011 Section 5 FINANCIAL MANAGEMENT EXAM 2

1. (8-3) Portfolio risk
i.

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Answer: a

When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

a. True b. False

2.(8-3) Market risk
ii.

FN

Answer: a

An individual stock's idiosyncratic risk can be lowered by adding more stocks to the portfolio in which the stock is held.

a. True b. False

3. (8-2) CV vs. SD
iii.

FN

Answer: b

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

a. True

recession. e. d. (8-2) Coefficient of variation vi. 5. d. irrelevant except to governmental authorities like the Federal Reserve. systematic risk factors that can be diversified away. Stock A must be a more desirable addition to a portfolio than B. and high interest rates are economic events that are best characterized as being a. CN Answer: b Inflation. CN Answer: e Stock A's beta is 2. is considering an investment that has an expected return of 15% and a standard deviation of 10%.b. Which of the following statements must be true about these securities? (Assume market equilibrium. What is the investment's coefficient of variation? . b. CN Answer: a Bae Inc. When held in isolation. among the factors that are responsible for market risk. False 4. c.3 and Stock B's beta is 1. 6. risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers.(8-3) Market risk v. e. The expected return on Stock A should be greater than that on B. b. company-specific risk factors that can be diversified away. Stock A has more risk than Stock B. The expected return on Stock B should be greater than that on A.(8-3) Beta coefficients iv. c.) a.2. Stock B must be a more desirable addition to a portfolio than A.

36% b. What is the portfolio's beta? a. 0.50 and Y’s beta is 0.(8-4) CAPM: required rate of return CN Answer: c viii.25%.89 e. 11. 11.98 8. and the market risk premium is 5. X's beta is 1.50%.40.73 c.72 c. 12. 0.89 e. Cooley Company's stock has a beta of 1.67 b.98 7. CN Answer: e Bill Dukes has $100. the risk-free rate is 4.95% d.(8-3) Portfolio beta vii.65% c. $35. 0. 0. 0.81 d. 0.80 d.000 invested in a 2-stock portfolio. 0. What is the firm's required rate of return? a. 0.000 is invested in Stock X and the remainder is invested in Stock Y.25% . 11.65 b. 0. 0.a.70.

this means that stockholders have the right to call for a meeting to vote to replace the management. 10.64% d. the real risk-free rate is 4.00% future inflation rate. CN Answer: a Porter Inc's stock has an expected return of 12. 10. and is in equilibrium.55% 9. CN Answer: c Google has a beta of 1.40% 10. 6. 5.67% c.80% b. . FG Answer: b If a firm's stockholders are given the preemptive right. a beta of 1.50%. what is the market risk premium? a. rate of return x. investors expect a 3. Without the preemptive right.00%. and the market risk premium is 3. 10.83% 11.95% c.43% b.00%.25.(8-4) CAPM: req. If the risk-free rate is 5. 9. 6. (9-1) Preemptive right xi.77% e.e. 6. 12. 9.09% d.04.25% e. 5.25%.(8-4) Market risk premium ix. dissident stockholders would have to seek a change in management through a proxy fight. What is Google's required rate of return? a.

8(9-5) Required return CG Answer: c . a. True b. (9-4) Total stock returns xiv. (9-7) Corporate valuation model FG Answer: a xiii. True b.a. False 15. and they generally have more votes per share than the other classes of common stock. FG Answer: b Preferred stock is a type of stock where the shares are owned by the firm's founders. False 13. a. True b. False 14. False 12. True b. a. FG Answer: b The total return on a share of stock refers to the dividend yield less any commissions paid when the stock is purchased and sold.(9-2) Founders' shares xii. The corporate valuation model can be used if a company doesn't pay dividends.

(9-5) Required return xvi. possibly increase. possibly decrease.95 and B's expected dividend is $1. d. increase.75. The two stocks could not be in equilibrium with the numbers given in the question. d. (9-5) Dividend yield and g CG Answer: b . CG Answer: c Stocks A and B have the following data. c. A's expected dividend is $2. A's expected dividend is $2. 16. 17. fluctuate less than before. B's expected dividend is $1.50. b. e. or possibly remain constant. decrease.xv. The two stocks should have the same expected dividend. which of the following statements is CORRECT? A Price Expected growth Expected return $50 4% 9% B $30 6% 11% a.50. A decrease in a firm’s expected growth rate would cause its required rate of return to a. fluctuate more than before. Assuming the stock market is efficient and the stocks are in equilibrium. c. e. b.

Stock B must have a higher dividend yield than Stock A. d. e.31 d. $24.11 b. $24. what is the stock’s expected dividend yield for the coming year? a. The required rate of return is rs = 10. $23. If Stock A has a lower dividend yield than Stock B. A stock just paid a dividend of D0 = $1. $25. g (which is constant) = 3.70 c. and P0 = $50.93 e. and the constant growth rate is g = 4.0%.5%.25. but Stock A has the higher required rate of return. What is the current stock price? a. its expected capital gains yield must be higher than Stock B’s. (9-5) Constant growth valuation CG Answer: e xviii. 18.42% . b. Which of the following statements is CORRECT? (Hint: rs  D1 g) P0 a. Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B. CG Answer: b If D0 = $2. its expected capital gains yield must be lower than Stock B’s. (9-5) Expected dividend yield xix. Stock A must have a higher dividend yield than Stock B.xvii. c.57 19.50. If Stock A has a higher dividend yield than Stock B.1%. 4. Stocks A and B have the same price and are in equilibrium. $23.

True b.13% e.125 b. what is the value of its operations? a.150.572.5%.) Capital components CI Answer: b . $2. (9-7) Corporate valuation model xx. $3. (10-1) Cost of capital xxi.000 e. (Comp. $2. 5.000. FI Answer: a The cost of capital used in capital budgeting should reflect the average cost of the various sources of long-term funds a firm uses to acquire assets.707.39% 20. CG Answer: d Suppose Boyson Corporation’s projected free cash flow for next year is FCF1 = $150.66% c.000. $3. False 22.500 c.850. 4. 4. a.5%.89% d. If the company’s weighted average cost of capital is 11. and FCF is expected to grow at a constant rate of 6. $2. 5.b.000 d.000 21.

25%. and assume that the firm operates at its target capital structure. 23. RPM = 5. e. WACC > re > rs > rd. what is the cost of equity from retained earnings? a. 10. a. Based on the CAPM approach. 10.10%. 10. d. rs > re > rd > WACC. 9. Scanlon Inc. rd > re > rs > WACC. a. which of the following sequences is CORRECT? All rates are after taxes. The after-tax cost of debt. False 24. b. (10-5) Cost of RE: CAPM CI Answer: e xxiv. For a typical firm. You have been provided with the following data: rRF = 4.67% b.xxii. True b.30. 9. is used as the component cost of debt for purposes of developing the firm's WACC.97% c. WACC > rd > rs > re.93% . which is lower than the before-tax cost. c. (10-3) Cost of debt FI Answer: a xxiii.'s CFO hired you as a consultant to help her estimate the cost of capital.60% e. and b = 1. re > rs > WACC > rd.28% d.

8. 8.iii.00%.54% 4. (8-2) CV vs. The firm will not be issuing any new stock. . 9. (10-7) WACC and target cap. SD iv. 8. and the tax rate is 40%. and 55% common equity. 9.25%. The interest rate on new debt is 6.82% d. ii. xxv. the cost of retained earnings is 11. whose target capital structure is 35% debt. (8-3) Beta coefficients (8-3) Market risk (8-2) Coefficient of variation v. 10% preferred. CI Answer: a You were hired as a consultant to Quigley Company.25.i. (8-3) Portfolio risk (8-3) Market risk FN FN FN CN CN CN Answer: a Answer: b Answer: b Answer: d Answer: c Answer: a 2.17% e.15% b.48% c. vi. the yield on the preferred is 6.50%. What is Quigley's WACC? a. struc.

98 = Portfolio beta Answer: c viii.50 0.0% 10.35 0.25 × RPM 7.40 4.50% 11.000 $65.000 $100.65 1.53 0.25 5.95% Beta 1. (8-3) Portfolio beta CN Weight Answer: e Company X Y Investment $35.Expected return Standard deviation 15. (8-4) Market risk premium CN Answer: a Use the SML to determine the market risk premium with the given data.25% 5. (8-4) CAPM: req. rs = rRF + bStock × RPM 12.000 Weight 0.80% = RPM 20.00% + 1.x.25% = 5.0% Coefficient of variation = std dev/expected return = 0. rate of return CN Answer: d .67 vii.70 × beta 0. rate of return Beta Risk-free rate Market risk premium Required return ix.25% = RPM × 1. (8-4) CAPM: req.00 CN 1.46 0.

20 xvii. (9-5) Dividend yield and g CG Answer: a . b Risk-free rate = r* + IP = 2. (9-4) Total stock returns (9-5) Required return (9-5) Required return xv. The following calculations show that answer e is correct.17% xi.Real risk-free rate. r* Expected inflation. xvi. (9-7) Corporate valuation model xiv.00% 3.10 5. A Price Expected growth Expected return $25 7% 10% B $40 9% 12% A = P0 = D1/(r – g) = D1=P0(r) – P0(g) = $0. (9-1) Preemptive right (9-2) Founders' shares FG FG FG FG CG CG Answer: b Answer: a Answer: b Answer: b Answer: e Answer: e xii.75 B = P0 = D1/(r – g) = D1=P0(r) – P0(g) = $1. RPM Beta. The others are all wrong. IP Market risk premium. xiii.00% Kollo's required return = rRF + b(RPM) = 10.70% 1.00% 4.

50% 11. xviii.50% $3.66% xx.1% 4. the growth rate for Stock A must be higher to offset this.000 Answer: d xxi. because if the required return for Stock A is higher than that of Stock B.329 Dividend yield = D1/P0 = 4.5% $50. and if the dividend yield for Stock A is lower than Stock B’s. (10-1) Cost of capital FI Answer: a . $1.25 3. (9-5) Constant growth valuation CG Answer: e D0 rs g D1 = D0(1 + g) = P0 = D1/(rs − g) xix.000 6.000.56 $25.50 10.00 $2.0% $1.57 CG Answer: b (9-5) Expected dividend yield D0 g P0 D1 = D0(1 + g) = $2.Statement a is true. (9-7) Corporate valuation model FCF1 g WACC Value ops = FCF1/(WACC – g) = CG $150.

30 10.00% 11. (Comp. struc.50% Answer: a AT Costs 3.10% 5.15% .25% 1.25% 8. (10-3) Cost of debt xxiv. Tax rate = 40% Weights Debt Preferred Common WACC 35% 10% 55% 100% rd 6.xxii.) Capital components CI FI CI 4.925% CI Answer: b Answer: b Answer: e xxiii. (10-5) Cost of RE: CAPM rRF RPM b rs = rRF + (RPM × b) xxv. (10-7) WACC and target cap.90% 6.

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