Question 1

Consolidated Transfer is an all-equity financed firm.The beta is .75,the market risk premium is 7.78 percent,and the risk-free rate is 3.84 percent.What is the expected rate of return on this stock?

Accepted Answer

A) 6.80 percent 
B) 8.22 percent 
C) 9.54 percent 
D) 9.68 percent 
E) 8.46 percent

Question 2

HNT is an all-equity firm with a beta of .88.What will the firm's equity beta be if the firm switches to a debt-equity ratio of .35?

Accepted Answer

A) .88 
B) 1.23 
C) .97 
D) 1.19 
E) 1.06

Question 3

The cost of preferred stock:

Accepted Answer

A) should be adjusted for taxes when computing WACC. 
B) is ignored by all firms when computing WACC. 
C) is generally calculated using the overall firm's beta. 
D) is equal to the stock's dividend yield. 
E) is set equal to the pretax cost of debt since it is a fixed income security.

Question 4

Which one of these statements related to beta is correct?

Accepted Answer

A) Firm betas have less error than industry betas. 
B) Firms should always rely on their own beta rather than their industry's beta. 
C) Beta is unaffected by a firm's capital structure. 
D) The sample size used to compute beta may be too small to yield a reliable result. 
E) Firm betas rarely vary over time.

Question 5

BG's cost of equity is 9.4 percent,the expected return on the market is 13.6 percent,and the risk-free rate is 3.8 percent.What is the firm's debt-equity ratio if its asset beta is .36? Assume there is no preferred stock.

Accepted Answer

A) .52 
B) .59 
C) .82 
D) .77 
E) .63

Question 6

A firm's net cash flow is calculated as:

Accepted Answer

A) EBIT − Taxes + Depreciation − Capital spending − Increases in net working capital. 
B) EBIT + Taxes + Depreciation − Capital spending − Increases in net working capital. 
C) EBIT − Taxes − Depreciation − Capital spending + Increases in net working capital. 
D) EBIT − Taxes + Depreciation + Capital spending − Increases in net working capital. 
E) EBIT + Taxes + Depreciation − Capital spending + Increases in net working capital.

Question 7

What is the cost of equity for a firm that has a beta of 1.2 if the risk-free rate of return is 2.9 percent and the expected market return is 11.4 percent?

Accepted Answer

A) 13.1 percent 
B) 10.8 percent 
C) 12.8 percent 
D) 14.4 percent 
E) 13.6 percent

Question 8

A firm with high operating leverage has:

Accepted Answer

A) low fixed costs in its production process. 
B) high variable costs in its production process. 
C) high fixed costs in its production process. 
D) high total costs per unit. 
E) low total costs per unit.

Question 9

As of 2018,U.S.tax law limits the tax deduction for interest payments to 30 percent of:

Accepted Answer

A) EBIT. 
B) EBT. 
C) net income. 
D) net revenue. 
E) the total interest paid.

Question 10

The CAPM has an advantage over DDM because the CAPM:

Accepted Answer

A) explicitly adjusts for risk. 
B) applies to firms that pay dividends. 
C) has no measurement risk. 
D) specifically considers a firm's rate of growth. 
E) ignores changes in the overall market over time.

Question 11

When calculating the weighted average flotation cost,the weights should be based on the:

Accepted Answer

A) mix of debt and equity that will be used to finance the specific project. 
B) firm's target capital structure. 
C) percentages of internal and external financing that will be used for the project. 
D) firm's current mix of debt and equity. 
E) average amounts of external capital raised during the past twelve months.

Question 12

Barges has an asset beta of .57,the risk-free rate is 4.3 percent,and the market risk premium is 7.7 percent.What is the equity beta if the firm has a debt-equity ratio of .56?

Accepted Answer

A) .46 
B) .89 
C) .74 
D) .37 
E) .32

Question 13

Assume a levered firm plans to raise new capital to finance a project.To properly account for the flotation costs,the firm should:

Accepted Answer

A) subtract the pretax flotation cost from the project's NPV. 
B) deduct the amount of the flotation cost from the cash flows for Year 1 of the project. 
C) add the percentage of the flotation cost to the WACC when discounting the cash flows. 
D) divide the amount of project capital needed by (1 − Weighted average flotation cost). 
E) increase the target weights of both debt and equity to account for the flotation percentage.

Question 14

Which one of these statements is correct concerning the CAPM?

Accepted Answer

A) The CAPM is the only available method for determining an appropriate discount rate for a proposed project. 
B) The market rate of return is most commonly based on the forecasted return on the market for the next 5-year period. 
C) CAPM is used quite frequently by firms in their capital budgeting process. 
D) The expected return on the 30-year U.S.Treasury bond is the most commonly used as the risk-free rate of return. 
E) An increase in the risk-free rate combined with a beta greater than 1.0 increases the discount rate computed using the CAPM.

Question 15

If a firm increases its use of both operating and financial leverage,then you should expect the firm's:

Accepted Answer

A) asset beta to exceed its equity beta. 
B) beta of debt to exceed 1.0. 
C) beta to remain constant as the increased operating leverage will offset the increased financial leverage. 
D) equity beta to increase. 
E) debt beta to exceed its equity beta.

Question 16

Norris Co.has developed an improved version of its most popular product.To get this improvement to the market will cost $48 million but the project will return an additional $13.5 million for 5 years in net cash flows.The firm's debt-equity ratio is .25,the cost of equity is 13 percent,the pretax cost of debt is 9 percent,and the tax rate is 21 percent.All interest is tax deductible.What is the net present value of this proposed project?

Accepted Answer

A) $906,411 
B) $902,459 
C) $879,838 
D) $884,318 
E) $889,760

Question 17

LR Engines stock is selling for $42.39 a share,has an ROE of 14.3 percent,and a dividend payout ratio of 35 percent.The next expected dividend is $1.62 a share.What is the cost of equity for this firm?

Accepted Answer

A) 12.86 percent 
B) 13.12 percent 
C) 13.47 percent 
D) 12.52 percent 
E) 13.70 percent

Question 18

Peter's Audio has a yield to maturity on its debt of 7.8 percent,a cost of equity of 12.4 percent,and a cost of preferred stock of 8 percent.The firm has 105 shares of common stock outstanding at a market price of $22 a share.There are 25 shares of preferred stock outstanding at a market price of $45 a share.The bond issue has a total face value of $1,500 and sells at 98 percent of face value.If the tax rate is 21 percent,what is the weighted average cost of capital assuming all interest is tax deductible?

Accepted Answer

A) 9.68 percent 
B) 8.54 percent 
C) 8.69 percent 
D) 9.52 percent 
E) 9.45 percent

Question 19

The use of leverage:

Accepted Answer

A) increases both the asset and the equity betas. 
B) decreases both the asset and the equity betas. 
C) decreases the equity beta and increases the asset beta. 
D) increases the equity beta but does not affect the asset beta. 
E) decreases the equity beta but does not affect the asset beta.

Question 20

When valuing a firm financed with debt and equity,the individual cash flows should be discounted using:

Accepted Answer

A) the market rate of return. 
B) the average of the DDM and CAPM costs of equity. 
C) (1 + WAC
C) T. 
D) (1 + CAPM)T. 
E) (r − g).

Exam 13: Risk, cost of Capital, and Valuation