FIN 302 Lecture Notes - Lecture 22: Preferred Stock, Capital Asset Pricing Model
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Which of the following risks cannot be diversified away?
A. | risk of a local natural disaster affecting company production | |
B. | risk created by world political happenings | |
C. | risk of losing a major contract | |
E. | risk of a failed marketing campaign |
Magee Company's stock has a beta of 1.20, the risk-free rate is 4.50%, and the market risk premium is 5.00%. What is Magee's required return?
A. | 10.25% | |
B. | 10.50% | |
D. | 11.00% | |
E. | 11.25% |
Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.)
A. | When held in isolation, Stock A has more risk than Stock B. | |
C. | Stock A would be a more desirable addition to a portfolio than Stock B. | |
D. | The required return on Stock A will be greater than that on Stock B. | |
E. | The required return on Stock B will be greater than that on Stock A. |
Which of the following statements is CORRECT?
B. | Portfolio diversification reduces the variability of returns on an individual stock. | |
C. | The smaller standard deviation is, the less likely that actual returns will be closer to expected returns, the lower the investment risk. | |
D. | A stock with a beta of 1 is more risky than an average stock on the market. | |
E. | A well-diversified investor will require to earn higher return on stocks with higher beta. |
Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT? (WACC is the weighted average cost of capital, the financing rate, or discount rate)
A. | The projectâs IRR increases as the WACC declines. | |
B. | The projectâs NPV increases as the WACC declines. | |
D. | The projectâs IRR decreases as the WACC declines. | |
E. | none of the above is correct. |
Burlees Inc.âs CFO has collected the following information to calculate its WACC:
⢠The companyâs capital structure consists of 60% debt and 40% common stock.
The company has 20-year, 12% annual coupon bonds that have a face value of $1,000 and sell for $1,200.
The company uses the CAPM to calculate the cost of common stock. Currently, the risk-free rate is 3% and the market risk premium is 5%. The companyâs common stock has a beta of 2.
The companyâs tax rate is 40%.
What is the companyâs cost of common equity?
A. | 9.65% | |
B. | 13.00% | |
D. | 17.60% | |
E. | 18.91% |
Burlees Inc.âs CFO has collected the following information to calculate its WACC:
⢠The companyâs capital structure consists of 60% debt and 40% common stock.
The company has 20-year, 12% annual coupon bonds that have a face value of $1,000 and sell for $1,200.
The company uses the CAPM to calculate the cost of common stock. Currently, the risk-free rate is 3% and the market risk premium is 5%. The companyâs common stock has a beta of 2.
The companyâs tax rate is 40%.
What is the companyâs weighted average cost of capital (WACC)?
A. | 8.69% | |
B. | 9.21% | |
D. | 11.04% | |
E. | 12.51% | |
Which of the following statement is correct?
A. | Higher flotation costs tend to reduce the cost of equity capital. | |
C. | The component cost of preferred stock is expressed as rp(1 - T), because preferred stock dividends are treated as fixed charges, similar to the treatment of debt interest. | |
D. | A higher risk projectâs WACC should be adjusted higher. | |
E. | Retained earnings bear no capital cost at all. |