Question 1

A firm might categorize its projects into
I.cost improvements;
II.expansion projects (existing business);
III.new products;
IV.speculative ventures

Accepted Answer

A) III only 
B) I, II, and III only. 
C) II and IV only 
D) I, II, III, and IV 
A) III only 
B) I, II, and III only. 
C) II and IV only 
D) I, II, III, and IV

Question 2

In general, one should use higher discount rates for longer-term projects.

Accepted Answer

A) True 
 B)False

Question 3

Companies with high ratios of fixed costs to project values tend to have high betas.

Accepted Answer

A) True 
 B)False

Question 4

The cost of capital for a project depends on

Accepted Answer

A) the company's cost of capital. 
B) the use of the capital (the project). 
C) the industry cost of capital. 
D) the company's level of debt financing. 
A) the company's cost of capital. 
B) the use of the capital (the project). 
C) the industry cost of capital. 
D) the company's level of debt financing.

Question 5

Portfolio betas for an industry are usually higher than the average betas of individual stocks in that same industry.

Accepted Answer

A) True 
 B)False

Question 6

If a firm uses a project-specific cost of capital for evaluating all projects, which situation(s)will likely occur?
I.The firm will accept poor low-risk projects.
II.The firm will reject good high-risk projects.
III.The firm will correctly accept projects with average risk.

Accepted Answer

A) I only 
B) II only 
C) III only 
D) I, II, and III 
A) I only 
B) II only 
C) III only 
D) I, II, and III

Question 7

Briefly discuss the risk-adjusted discount rate approach to estimating the NPV of a project.

Accepted Answer

The risk-adjusted discount rate approach

Question 8

For firms with relatively high levels of debt, the company cost of capital is the cost of equity of the firm.

Accepted Answer

A) True 
 B)False

Question 9

Which of the following types of projects has the lowest unique risk?

Accepted Answer

A) Speculative ventures 
B) New products 
C) Expansions of existing business 
D) Cost improvements 
A) Speculative ventures 
B) New products 
C) Expansions of existing business 
D) Cost improvements

Question 10

The market portfolio's historical returns for the past three years were 10 percent, 10 percent, and 16 percent. Suppose the risk-free rate of return is 4 percent. Estimate the market risk premium.

Accepted Answer

A) 4 percent 
B) 8 percent 
C) 12 percent 
D) 16 percent 
A) 4 percent 
B) 8 percent 
C) 12 percent 
D) 16 percent

Question 11

The historical returns for the past three years for Stock B and the stock market portfolio were Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent. Calculate the observed covariance of returns between Stock B and the market portfolio. (Ignore the correction for the loss of a degree of freedom set out in the text.)

Accepted Answer

A) 16 
B) 28 
C) 36 
D) 292 
A) 16 
B) 28 
C) 36 
D) 292

Question 12

One calculates the weighted average cost of capital (WACC), on an after-tax basis, as WACC = (rD)(1 − TC )(D/V)+ (rE)(E/V), where V = D + E.

Accepted Answer

A) True 
 B)False

Question 13

The market value of Charter Cruise Company's equity is $15 million and the market value of its debt is $5 million. If the required rate of return on the equity is 20 percent and that on its debt is 8 percent, calculate the company's cost of capital. (Assume no taxes.)

Accepted Answer

A) 20 percent 
B) 17 percent 
C) 14 percent 
D) 11 percent 
A) 20 percent 
B) 17 percent 
C) 14 percent 
D) 11 percent

Question 14

The market value of Charcoal Corporation's common stock is $20 million, and the market value of its risk-free debt is $5 million. The beta of the company's common stock is 1.25, and the market risk premium is 8 percent. If the Treasury bill rate is 5 percent, what is the company's cost of capital? (Assume no taxes.)

Accepted Answer

A) 15.0 percent 
B) 14.6 percent 
C) 13.0 percent 
D) 7.0 percent 
A) 15.0 percent 
B) 14.6 percent 
C) 13.0 percent 
D) 7.0 percent

Question 15

A sensible way for a manager to account for overoptimistic cash-flow forecasts is to adjust the discount rate.

Accepted Answer

A) True 
 B)False

Question 16

The company cost of capital is the correct discount rate only for investments that have the same risk as the company's overall business.

Accepted Answer

A) True 
 B)False

Question 17

An analyst computes a beta coefficient with a low standard error. This implies that

Accepted Answer

A) this particular beta is more reliable than most. 
B) this particular beta has little meaning. 
C) too few observations were used to compute this particular beta. 
D) this stock responds less to market changes than most stocks. 
A) this particular beta is more reliable than most. 
B) this particular beta has little meaning. 
C) too few observations were used to compute this particular beta. 
D) this stock responds less to market changes than most stocks.

Question 18

The market value of Cable Company's equity is $60 million and the market value of its debt is $40 million. If the required rate of return on the equity is 15 percent and that on its debt is 5 percent, calculate the company's cost of capital. (Assume no taxes.)

Accepted Answer

A) 15 percent 
B) 10 percent 
C) 11 percent 
D) 9 percent 
A) 15 percent 
B) 10 percent 
C) 11 percent 
D) 9 percent

Question 19

The historical returns for the past three years for Stock B and the stock market portfolio are Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent. If the risk-free rate is 4 percent, calculate the market risk premium.

Accepted Answer

A) 18.1 percent 
B) 14.0 percent 
C) 10.0 percent 
D) 6.0 percent 
A) 18.1 percent 
B) 14.0 percent 
C) 10.0 percent 
D) 6.0 percent

Question 20

If one uses a long-term risk-free rate for the CAPM instead of a short-term risk-free rate, then one will generate a flatter security market line.

Accepted Answer

A) True 
 B)False

Exam 9: Risk and the Cost of Capital

A firm might categorize its projects into I.cost improvements; II.expansion projects (existing business); III.new products; IV.speculative ventures

In general, one should use higher discount rates for longer-term projects.

Companies with high ratios of fixed costs to project values tend to have high betas.

The cost of capital for a project depends on

Portfolio betas for an industry are usually higher than the average betas of individual stocks in that same industry.

If a firm uses a project-specific cost of capital for evaluating all projects, which situation(s)will likely occur? I.The firm will accept poor low-risk projects. II.The firm will reject good high-risk projects. III.The firm will correctly accept projects with average risk.

Briefly discuss the risk-adjusted discount rate approach to estimating the NPV of a project.

For firms with relatively high levels of debt, the company cost of capital is the cost of equity of the firm.

Which of the following types of projects has the lowest unique risk?

The market portfolio's historical returns for the past three years were 10 percent, 10 percent, and 16 percent. Suppose the risk-free rate of return is 4 percent. Estimate the market risk premium.

One calculates the weighted average cost of capital (WACC), on an after-tax basis, as WACC = (rD)(1 − TC )(D/V)+ (rE)(E/V), where V = D + E.

The market value of Charter Cruise Company's equity is $15 million and the market value of its debt is $5 million. If the required rate of return on the equity is 20 percent and that on its debt is 8 percent, calculate the company's cost of capital. (Assume no taxes.)

A sensible way for a manager to account for overoptimistic cash-flow forecasts is to adjust the discount rate.

The company cost of capital is the correct discount rate only for investments that have the same risk as the company's overall business.

An analyst computes a beta coefficient with a low standard error. This implies that

The market value of Cable Company's equity is $60 million and the market value of its debt is $40 million. If the required rate of return on the equity is 15 percent and that on its debt is 5 percent, calculate the company's cost of capital. (Assume no taxes.)

The historical returns for the past three years for Stock B and the stock market portfolio are Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent, 12 percent, 20 percent. If the risk-free rate is 4 percent, calculate the market risk premium.

If one uses a long-term risk-free rate for the CAPM instead of a short-term risk-free rate, then one will generate a flatter security market line.

Introduction to Corporate Finance

How to Calculate Present Values

Valuing Bonds

The Value of Common Stocks

Net Present Value and Other Investment Criteria

Making Investment Decisions With the Net Present Value Rule

Introduction to Risk and Return

Portfolio Theory and the Capital Asset Pricing Model

Project Analysis

How to Ensure That Projects Truly Have Positive Npvs

Agency Problems and Investment

Efficient Markets and Behavioral Finance

An Overview of Corporate Financing

How Corporations Issue Securities

Payout Policy

Does Debt Policy Matter

How Much Should a Corporation Borrow

Financing and Valuation

Understanding Options

Valuing Options

Real Options

Credit Risk and the Value of Corporate Debt

The Many Different Kinds of Debt

Leasing

Managing Risk

Managing International Risks

Financial Analysis

Financial Planning

Working Capital Management

Mergers

Corporate Restructuring

Governance and Corporate Control Around the World

Filters

One calculates the weighted average cost of capital (WACC), on an after-tax basis, as WACC = (r_D)(1 − T_C )(D/V)+ (r_E)(E/V), where V = D + E.