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Question
In a world with taxes, which of the following is the rate we should use to evaluate a project with the same risk and the same financing as the firm itself?A) The weighted-average cost of capital
B) The pre-tax WACC
C) The cost of equity
D) The cost of debt
Answer
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Related questions
Q:
Which firm has the highest cost of equity capital?
A) Eenie
B) Meenie
C) Miney
D) Moe
Q:
Assume that the Wilshire 5000 currently has a dividend yield of 2% and that on average, the dividends of Wilshire 5000 firms have increased by about 7% per year. If the risk-free interest rate is 4%, then your estimate for the future market risk premium is:
A) 4%
B) 7%
C) 8%
D) 5%
Q:
Which of the following statements is FALSE?
A) The CAPM remains the predominant model use in practice to determine the equity cost of capital.
B) Low beta stocks have tended to perform somewhat better than the CAPM predicts.
C) The empirically estimated security market line is somewhat steeper than that predicted by the CAPM.
D) Some evidence suggests that the market risk premium has declined over time.
Q:
Use the following information to answer the question(s) below.
Luther Industries has 25 million shares outstanding trading at $18 per share. In addition, Luther has $150 million in outstanding debt. Suppose Luther's equity cost of capital is 13%, its debt cost of capital is 7%, and the corporate tax rate is 40%.
Luther's weighted average cost of capital is closest to:
A) 9.8%
B) 10.8%
C) 11.5%
D) 13.0%
Q:
If a project has a higher proportion of fixed to variable costs, holding the risk of its revenues constant:
A) its beta will be lower, hence its cost of capital will be lower.
B) its beta will be higher, hence its cost of capital will be higher.
C) its beta will be unaffected, since beta does not measure the sensitivity of the project's cash flows to market risk.
D) its financial leverage will be higher.
Q:
Firms should adjust for execution risk by:
A) assigning a higher cost of capital to new projects.
B) ignoring execution risk since it is diversifiable.
C) capturing this risk in the expected cash flows generated by the project.
D) noticing missteps in the firm's execution of new projects.
Q:
Use the following information to answer the question(s) below.
Consider the following information regarding corporate bonds: Rating
AAA
AA
A
BBB
BB
B
CCC Average Default Rate
0.0%
0.1%
0.2%
0.45%
2.2%
5.5%
12.2% Recession Default Rate
0.0%
1.0%
3.0%
3.0%
8.0%
16.0%
48.0% Average Beta
0.05
0.05
0.05
0.10
0.17
0.26
0.31 Company
Market Capitalization ($mm)
Total Enterprise Value ($mm)
Equity Beta
Debt Rating Taggart Transcontinental
$4,500
8,000
1.1
BBB Rearden Metal
$3,800
7,200
1.3
AAA Wyatt Oil
$2,400
3,800
0.9
A Nielson Motors
$1,500
4,400
1.75
BB Your estimate of the asset beta for Nielson Motors is closest to:
A) 0.59
B) 0.66
C) 0.71
D) 1.75
Q:
Use the following information to answer the question(s) below.
Consider the following information regarding corporate bonds: Rating
AAA
AA
A
BBB
BB
B
CCC Average Default Rate
0.0%
0.1%
0.2%
0.5%
2.2%
5.5%
12.2% Recession Default Rate
0.0%
1.0%
3.0%
3.0%
8.0%
16.0%
48.0% Average Beta
0.05
0.05
0.05
0.10
0.17
0.26
0.31 Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to maturity of 8.6%, and a B rating. The corresponding risk-free rate is 3% and the market risk premium is 6%. Assuming a normal economy, the expected return on Rearden Metal's debt is closest to:
A) 0.6%
B) 1.6%
C) 4.6%
D) 6.0%
Q:
Use the following information to answer the question(s) below.
Consider the following information regarding corporate bonds: Rating
AAA
AA
A
BBB
BB
B
CCC Average Default Rate
0.0%
0.1%
0.2%
0.5%
2.2%
5.5%
12.2% Recession Default Rate
0.0%
1.0%
3.0%
3.0%
8.0%
16.0%
48.0% Average Beta
0.05
0.05
0.05
0.10
0.17
0.26
0.31 Wyatt Oil has a bond issue outstanding with seven years to maturity, a yield to maturity of 7.0%, and a BBB rating. The bondholders' expected loss rate in the event of default is 70%. Assuming the economy is in recession, then the expected return on Wyatt Oil's debt is closest to:
A) 3.5%
B) 4.9%
C) 5.5%
D) 7.0%
Q:
Which of the following statements is FALSE?
A) One difficulty when trying to estimate beta for a security is that beta depends on the correlation and volatilities of the security's and market's returns in the future.
B) It is common practice to estimate beta based on the expectations of future correlations and volatilities.
C) One difficulty when trying to estimate beta for a security is that beta depends on investors expectations of the correlation and volatilities of the security's and market's returns.
D) Securities that tend to move less than the market have betas below 1.
Q:
Use the following information to answer the question(s) below. Year
Risk-free Return
Market Return
Wyatt Oil Return
Market Excess Return
Wyatt Oil Excess Return
Beta 2007
3.0%
6.0%
5.5%
3.0%
2.5%
0.833 2008
1.5%
-38.5%
-32.6%
.40%
-34.1%
0.853 2009
1.0%
22.5%
19.6%
21.5%
18.6%
0.865 Using the average historical excess returns for both Wyatt Oil and the Market portfolio, your estimate of Wyatt Oil's Beta is closest to:
A) 0.75
B) 0.84
C) 1.00
D) 1.19
Q:
Which pharmaceutical company faces less risk?
Q:
Use the information for the question(s) below.
Big Cure and Little Cure are both pharmaceutical companies. Big Cure presently has a potential "blockbuster" drug before the Food and Drug Administration (FDA) waiting for approval. If approved, Big Cure's blockbuster drug will produce $1 billion in net income for Big Cure. Little Cure has 10 separate less important drugs before the FDA waiting for approval. If approved, each of Little Cure's drugs would produce $100 million in net income for Little Cure. The probability of the FDA approving a drug is 50%.
What is the expected payoff for Little Cure's ten drugs?
A) $500 million
B) $100 million
C) $1 billion
D) $0
Q:
Use the information for the question(s) below.
Big Cure and Little Cure are both pharmaceutical companies. Big Cure presently has a potential "blockbuster" drug before the Food and Drug Administration (FDA) waiting for approval. If approved, Big Cure's blockbuster drug will produce $1 billion in net income for Big Cure. Little Cure has 10 separate less important drugs before the FDA waiting for approval. If approved, each of Little Cure's drugs would produce $100 million in net income for Little Cure. The probability of the FDA approving a drug is 50%.
What is the expected payoff for Big Cure's Blockbuster drug?
A) $100 million
B) $0
C) $1 billion
D) $500 million
Q:
Use the table for the question(s) below.
Consider the following realized annual returns: Year End
Market Realized Return
Stock B Realized Return 2000
21.2%
88.3% 2001
30.3%
56.4% 2002
22.3%
114.6% 2003
25.3%
68.4% 2004
-11.0%
-62.8% 2005
-11.3%
52.7% 2006
-20.8%
-22.0% 2007
33.1%
6.9% 2008
13.0%
9.2% 2009
7.3%
-0.9% Suppose that you want to use the 10 year historical average return on Stock B to forecast the expected future return on Stock B. Calculate the 95% confidence interval for your estimate of the expect return.
Q:
Use the table for the question(s) below.
Consider the following realized annual returns: Year End
Market Realized Return
Stock B Realized Return 2000
21.2%
88.3% 2001
30.3%
56.4% 2002
22.3%
114.6% 2003
25.3%
68.4% 2004
-11.0%
-62.8% 2005
-11.3%
52.7% 2006
-20.8%
-22.0% 2007
33.1%
6.9% 2008
13.0%
9.2% 2009
7.3%
-0.9% Suppose that you want to use the 10 year historical average return on the Market to forecast the expected future return on the Market. Calculate the 95% confidence interval for your estimate of the expect return.
Q:
Use the information for the question(s) below.
Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share.
The weight on Abbott Labs in your portfolio is:
A) 50%
B) 40%
C) 30%
D) 20%
Q:
Which of the following statements is FALSE?
A) Without trading, the portfolio weights will decrease for the stocks in the portfolio whose returns are above the overall portfolio return.
B) The expected return of a portfolio is simply the weighted average of the expected returns of the investments within the portfolio.
C) Portfolio weights add up to 1 so that they represent the way we have divided our money between the different individual investments in the portfolio.
D) A portfolio weight is the fraction of the total investment in the portfolio held in an individual investment in the portfolio.
Q:
What is the market portfolio?
Q:
Which of the following is consistent with the CAPM and efficient capital markets?
A) A security with a beta of 1 has a return last year of 8% when the market has a return of 12%.
B) Small stocks with a beta of 1.5 tend to have higher returns on average than large stocks with a beta of 1.5.
C) A security with only diversifiable risk has an expected return that exceeds the risk-free interest rate.
D) A security with only systematic risk has an expected return that exceeds the risk-free interest rate.
Q:
Use the following information to answer the question(s) below. Company
Ticker
Beta Ford Motor Company
F
2.77 International Business Machines
IBM
0.73 Merck
MRK
0.90 If the risk-free rate is 5% and the expected return of investing in Merck is 11.3%, then the expected return on the market must be:
A) 8.0%
B) 10.0%
C) 10.4%
D) 12.0%
Q:
Use the following information to answer the question(s) below. Company
Ticker
Beta Ford Motor Company
F
2.77 International Business Machines
IBM
0.73 Merck
MRK
0.90 If the expected return on the market is 11% and the expected return of investing in Merck is 10.35%, then the risk-free rate must be:
A) 3.0%
B) 4.0%
C) 4.5%
D) 5.0%
Q:
Use the information for the question(s) below.
Suppose the market portfolio's excess return tends to increase by 30% when the economy is strong and decline by 20% when the economy is weak. A type S firm has excess returns that increase by 45% when the economy is strong and decrease by 30% when the economy is weak. A type I firm will also have excess returns of either 45% or -30%, but the type I firm's excess returns will depend only upon firm-specific events and will be completely independent of the state of the economy.
What is the Beta for a type I firm?
A) 1.0
B) 0.75
C) 0.0
D) 1.5
Q:
Which of the following statements is FALSE?
A) Because diversification improves with the number of stocks held in a portfolio an efficient portfolio should be a large portfolio containing many different stocks.
B) The beta of a security is the sensitivity of the security's return to the return of the overall market.
C) An efficient portfolio cannot be diversified further, that is there is no way to reduce the risk of the portfolio without lowering its expected return.
D) We call a portfolio that contains only unsystematic risk an efficient portfolio.
Q:
Which of the following statements is FALSE?
A) Because investors are risk averse, they will demand a risk premium to hold unsystematic risk.
B) Over any given period, the risk of holding a stock is that the dividends plus the final stock price will be higher or lower than expected, which makes the realized return risky.
C) The risk premium for diversifiable risk is zero, so investors are not compensated for holding firm-specific risk.
D) Because investors can eliminate firm-specific risk "for free" by diversifying their portfolios, they will not require a reward or risk premium for holding it.
Q:
Use the table for the question(s) below.
Consider the following realized annual returns: Year End
Index Realized Return
Stock A Realized Return 2000
23.6%
46.3% 2001
24.7%
26.7% 2002
30.5%
86.9% 2003
9.0%
23.1% 2004
-2.0%
0.2% 2005
-17.3%
-3.2% 2006
-24.3%
-27.0% 2007
32.2%
27.9% 2008
4.4%
-5.1% 2009
7.4%
-11.3% The standard deviation of the returns on Stock A from 2000 to 2009 is closest to:
A) 33.2%
B) 16.4%
C) 31.5%
D) 11.0%
Q:
Use the table for the question(s) below.
Consider the following realized annual returns: Year End
Index Realized Return
Stock A Realized Return 2000
23.6%
46.3% 2001
24.7%
26.7% 2002
30.5%
86.9% 2003
9.0%
23.1% 2004
-2.0%
0.2% 2005
-17.3%
-3.2% 2006
-24.3%
-27.0% 2007
32.2%
27.9% 2008
4.4%
-5.1% 2009
7.4%
-11.3% The variance of the returns on Stock A from 2000 to 2009 is closest to:
A) .3145
B) .0990
C) .1100
D) .9890
Q:
Use the table for the question(s) below.
Consider the following probability distribution of returns for Alpha Corporation: Current Stock Price ($)
Stock Price in One Year ($)
Return R
Probability PR $35
40%
25% $25
$25
0%
50% $20
-20%
25% Suppose an investment is equally likely to have a 35% return or a -20% return. The standard deviation on the return for this investment is closest to:
A) 38.9%
B) 0%
C) 19.4%
D) 27.5%
Q:
Use the table for the question(s) below.
Consider the following probability distribution of returns for Alpha Corporation: Current Stock Price ($)
Stock Price in One Year ($)
Return R
Probability PR $35
40%
25% $25
$25
0%
50% $20
-20%
25% Suppose an investment is equally likely to have a 35% return or a - 20% return. The variance on the return for this investment is closest to:
A) .151
B) .0378
C) 0
D) .075
Q:
Use the table for the question(s) below.
Consider the following probability distribution of returns for Alpha Corporation: Current Stock Price ($)
Stock Price in One Year ($)
Return R
Probability PR $35
40%
25% $25
$25
0%
50% $20
-20%
25% The variance of the return on Alpha Corporation is closest to:
A) 5.00%
B) 4.75%
C) 3.625%
D) 3.75%