Complete all questions on the document. 32 multiple choice 4 short response.

Question 1

When the market is in equilibrium, which of the following statements is correct?

1. Each stock's expected return should equal its realized return as seen by the marginal investor.

2. All stocks should have the same expected return as seen by the marginal investor

3. Each stock's expected return should equal its required return as seen by the marginal investor.

4. All stocks should have the same realized return during the coming year.

Question 2

Kimberly was unable to attend the stockholder's annual meeting and gave the manager the right to vote on her behalf, this is an example of:

1. A proxy fight

2. The preemptive right

3. A proxy

4. She has class B stocks

Question 3

Luke is an investor, he estimates that the stock’s expected return exceeds its required return, this suggests that he thinks:

1. the stock is a good buy.

2. management is probably not trying to maximize the price per share

3. dividends are not likely to be declared.

4. the stock is experiencing supernormal growth.

Question 4

A purpose of the preemptive right is to:

1. Allow higher dividends per share.

2. protects the current shareholders against a dilution of their ownership interests.

3. allows managers to buy additional shares below the current market price.

4. protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.

Question 5

A small new company seeking funds from outside sources frequently use different types of common stock, this is referred to as:

1. Founders Shares

2. Class A stock

3. Common Stock

4. Classified stock

Question 6

The data for three stocks X, Y and Z are below.  It is assumed that the stock market is efficient. Besides, the stocks are in equilibrium, which of the following statements is CORRECT?

1. These three stocks must have the same dividend yield.

2. These three stocks should have the same price.

3. These three stocks should have the same expected return.

4. These three stocks must have the same expected year-end dividend.

Question 7

Aaron purchased a share of stock and the firm's dividend is expected to grow at a constant rate of 6% a year, which of the following statements is CORRECT?  assuming the stock is in equilibrium.

1. The stock’s price one year from now is expected to be 6% above the current price.

2. The stock’s required return must be equal to or less than 6%.

3. The price of the stock is expected to decline in the future

4. The stock’s dividend yield is 6%.

Question 8

Juan purchased two stocks M and N. The stocks are in equilibrium and the market is said to be efficient, which of the following statements is CORRECT?
 

1. Stock M and N are both in equilibrium.

2. No difference one year from now since they have the same price.

3. One year from now would be a good time to sell both stocks.

4. One year from now, Stock M’s price is expected to be higher than Stock N's price.

Question 9

Daniel Insurance and Investment Inc.,  is expected to have growth rates for the next 3 years as follows:  22%, for year 1, 20% for year 2,  and 18% for year 3. After year 3, the growth rate declines to 10%. The firm is experiencing:

1. Constant Growth

2. Normal Growth

3. Nonconstant Growth

4. Capital Gains

Question 10

An action whereby a person or group succeeds in ousting a firm's management and taking control of the company.

1. Proxy

2. Takeover

3. Proxy fight

4. Preemptive right

Question 11

The mix of debt, preferred stock, and common equity the firm plans to raise to fund its future projects.

1. Target Capital Structure

2. The WACC

3. CAPM Approach

4. Capital Components

Question 12

Which items in the liability section of the balance sheet are not included in the WACC calculation?

1. Notes payable and accruals

2. Accounts payable and accruals

3. Current liabilities and long term debt

4. Retained earnings and accounts payable

Question 13

Michael's IT Consulting Inc. has no retained earnings since it pays everything out in dividends and this trend is likely to continue in the expected future.  CAPM is used to calculate the cost of equity, and the targeted capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC?

1. The flotation costs associated with issuing new common stock increase.

2. The company’s beta increases.

3. The market risk premium declines.

4. The flotation costs associated with issuing preferred stock increase.

Question 14

Landon Corporation projections on the purchase of new assets is running over budget so the firm would need to issue new common stock. Since new stock has a higher cost than retained earnings, the firm would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock?

1. Increase the dividend payout ratio for the upcoming year.

2. Increase the proposed capital budget

3. Increase the percentage of debt in the target capital structure.

4. Reduce the percentage of debt in the target capital structure.

Question 15

If corporate taxes are lowered how would it affect the firm's cost of debt, rd(1-T), the cost of equity (rs) and WACC?

1. The cost of debt would increase, no effect on cost of equity and increase the WACC

2. The cost of debt would decrease, no effect on cost of equity and decrease the WACC

3. The cost of debt would increase, cost of equity increase, and increase the WACC

4. No effect on the cost of debt, no effect on cost of equity and increase the WACC

Question 16

Which of the following statements is CORRECT?

1. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.

2. When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation.

3. Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of debt than on the cost of common stock as measured by the CAPM.

4. If a company’s beta increases, this will increase the cost of equity used to calculate the WACC, but only if the company does not have enough retained earnings to take care of its equity financing and hence must issue new stock

Question 17

Trevor's Investment Inc. targeted capital structure is 50% debt and 50% common equity, which of the following statements is CORRECT?

1. The cost of equity is always equal to or greater than the cost of debt.

2. The interest rate used to calculate the WACC is the average after-tax cost of all the company's outstanding debt as shown on its balance sheet.

3. The WACC is calculated on a before-tax basis.

4. The cost of retained earnings typically exceeds the cost of new common stock.

Question 18

The rate of return required by stockholders on a firm's common stock.

1. Cost of Preferred Equity

2. Cost of Retained Earnings rs

3. Cost of Debt

4. Cost of Goods Sold

Question 19

The percentage cost of issuing new stock:

1. Flotation Cost Adjustment

2. Flotation Project

3. Flotation cost

4. External Equity

Question 20

The three most important factors in reference to the WACC that the firm cannot directly control are:

1. Interest rates in the economy, changing its capital structure, and tax rates

2. Interest rates in the economy, the general level of stock prices, and changing dividend payout

3. Interest rates in the economy, the general level of stock prices, and altering its capital budgeting decision rules

4. Interest rates in the economy, the general level of stock prices, and tax rates

Question 21

Which of the following statements is CORRECT?

1. Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt.

2. If a company assigns the same cost of capital to all of its projects regardless of each project’s risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.

3. Higher flotation costs tend to reduce the cost of equity capital.

4. The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes.

Question 22

How are stocks valued?

1. Value of a stock is the future value of the Present dividends expected to be generated by the stock

2. The nonconstant growth rate of the stock vs the constant growth

3. The value of a stock is the present value of the future dividends expected to be generated by the stock

4. The value given by the firm's managers

Question 23

Which of the following statements is CORRECT?

1. Beta measures market risk, which is, theoretically, the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value. This is true even if not all of the firm’s stockholders are well diversified

2. The discounted cash flow method of estimating the cost of equity cannot be used unless the growth rate, g, is expected to be constant forever.

3. If the calculated beta underestimates the firm’s true investment risk—i.e., if the forward-looking beta that investors think exists exceeds the historical beta—then the CAPM method based on the historical beta will produce an estimate of rs and thus WACC that is too high.

4. The specific risk premium used in the CAPM is the same as the risk premium used in the bond-yield-plus-risk-premium approach.

Question 24

The cash flow of the firm’s after-tax operating income less the net capital investment is called:

1. The EBITDA

2. Gross Income

3. The EBIT

4. Free cash flow

Question 25

A hybrid security in that it has similar features of a bond and common stock.

1. Preferred Stock

2. Class B Stock

3. Class A Stock

4. Founders Shares

Question 26

Connor Marketing plans to retain $55 million of earnings for the year. The firm wants to finance its capital budget using a target capital structure of 40% debt, 2% preferred, and 58% common equity. How large could its capital budget be before it must issue new common stock?

1. 94.83 Million

2. 93.84 million

3. 92.84 million

4. 83.94 Million

Question 27

Kailyn's Advertising firm common stock has D1 = $1.10; P0 = $45; g = 4%; and F = 3%.

If the firm must issue new stock, what is its cost of new external equity?

1. 6.25%

2. 6.85%

3. 6.75%

4. 6.52%

Question 28

Joshua and Company Inc. plans to retain $60 million of earnings for the year. It wants to finance its capital budget using a target capital structure of 41% debt, 2% preferred, 57% common equity. How large could its capital budget be before it must issue new common stock?

1. 104.50 million

2. 105.26 million

3. 102.65 million

4. 107.26 million

Question 29

A company has outstanding 10-year, noncallable bonds with a face value of $1,000, an 11% annual coupon, and a market price of $1,101.52. If the company was to issue new debt:

1. what would be a reasonable estimate of the interest rate on that debt?

2. If the company’s tax rate is 40%, what is its after-tax cost of debt?

Answers might be a little off based on the method of calculation, chose the closest answer.

1. 9.4%, 5.64%

2. 4.9%, 6.5%

3. 9.0%, 5.0%

4. 5%, 9%

Question 30

Sean's Car Rental has preferred stock that currently trades at $50.11 per share and pays a $5 annual dividend per share. Ignoring flotation costs, what is the firm's cost of preferred stock?

1. 9.98% or 10%

2. 9%

3. 8.9%

4. 8.7%

Question 31

If a firm has YTM of 9% and a tax rate of 40%, what is the after tax cost of debt

1. 4.5%

2. 5.4%

3. 4.55%

4. 5.1%

Question 32

A firm's growth rate is 20%, 15%, 7%, 4%, rs=8% and D0 of $1.50. What is the dividend at year 4?

1. $2.3036

2. $2.215

3. $1.80

4. $2.070

Question 33

John's Financial Inc. required rate of return is 7%, pays $1.12 for dividend and it is expecting a growth of 25% the first year, 20% the second year, 15% the third year, and return to 4 % indefinitely

1. What is the stock’s value under these conditions?

2. What are its expected dividend and capital gains yields in Year 1? Year 4?

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Question 34

Financial Analyst Zachary was presented with the following data: rRF = 2.5%; rM – rRF = 7%; b = 0.9; D1 = $.76; P0 = $36.00; g = 3%; rd = firm’s bond yield = 5.5%, RP=2.00%

A. What is this firm’s cost of equity using the CAPM approach?

B. What is this firm’s cost of equity using the DCF approach?

C. What is this firm’s cost of equity using the Bond Yield approach?

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Question 35

Heather's Consulting Inc. just landed a contract with two fortune 500 firms. To fullfill these contracts, the firm would need to cut cost in the form of dividend payments and finance funds of $10 million. The firm's WACC is 10%, and the projected free cash flow for the next 5 years are: -$1 million, $5 million, $10 million, $15 million, $20 million. After year 5 the free cash flow is expected to grow at 4%. What is the firm's total value? If it has 5 million in shares outstanding and $10 million in debt with no preferred stock.  What is the price per share?

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Question 36

Victor Investment Firm has the following data: Target capital structure of 42% debt, 4% preferred, and 54% common equity, Tax rate = 40%; rd = 6%; rp = 7.%; rs = 10.8%; and re = 12.1%.

1.What is the firm’s WACC if it does not issue any new stock?  

2. What is the WACC if it issues new common stock?

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