7. Within-firm risk and beta risk Aa Aa Understanding risks that affect projects and the impact of risk consideration wSp Inc. is involved in a wide range of unrelated projects. The company will pursue any project that it thinks will create value for its stockholders. Consequently, the risk level of the company's projects tends to vary a great deal from project to project. Ir WSP Inc. does not risk-adjust its discount rate for specific projects properly, which of the following is likely to occur over time? Check all that apply The firm will become less risky. The firm will make poor capital budgeting decisions that could jeopardize the long-run viability of the company The firm will reject too many relatively safe projects. Generally, a positive correlation exists between a project's returns and the returns on the firm's other assets. If this correlation is, stand-alone risk will be a good proxy for within-firm risk. high low Consider the case of another company. Davis Printing is evaluating two mutually exclusive projects. They both require a $5 million investment today and have expected NPVs of $1,000,000. Management conducted a full risk analysis of these two projects, and the results are shown below. Risk Measure Standard deviation of project's expected Npvs Project beta Project A Project B $400,000 $600,000 1.2 Correlation coefficient of project cash flows (relative to the firm's existing projects) 0.7 1.0 0.9 Which of the following statements about these projects risk is correct? Check all that apply
7. Within-firm risk and beta risk Aa Aa Understanding risks that affect projects and the impact of risk consideration wSp Inc. is involved in a wide range of unrelated projects. The company will pursue any project that it thinks will create value for its stockholders. Consequently, the risk level of the company's projects tends to vary a great deal from project to project. Ir WSP Inc. does not risk-adjust its discount rate for specific projects properly, which of the following is likely to occur over time? Check all that apply The firm will become less risky. The firm will make poor capital budgeting decisions that could jeopardize the long-run viability of the company The firm will reject too many relatively safe projects. Generally, a positive correlation exists between a project's returns and the returns on the firm's other assets. If this correlation is, stand-alone risk will be a good proxy for within-firm risk. high low Consider the case of another company. Davis Printing is evaluating two mutually exclusive projects. They both require a $5 million investment today and have expected NPVs of $1,000,000. Management conducted a full risk analysis of these two projects, and the results are shown below. Risk Measure Standard deviation of project's expected Npvs Project beta Project A Project B $400,000 $600,000 1.2 Correlation coefficient of project cash flows (relative to the firm's existing projects) 0.7 1.0 0.9 Which of the following statements about these projects risk is correct? Check all that apply
Related questions
Question 5
The coefficient of variation is a better measure of risk than the standard deviation if the expected returns of the securities being compared differ significantly.
| True |
| False |
Question 6.
In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are interested in ex ante (future) data.
| True |
| False |
Question 7
Typically, debentures have higher interest rates than mortgage bonds primarily because the mortgage bonds are backed by assets while debentures are unsecured.
| True |
| False |
Question 8
If two firms have the same current dividend and the same expected growth rate, their stocks must sell at the same current price or else the market will not be in equilibrium.
| True |
| False |
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Question 9
Which of the following is the best measure of the wealth of a firm's stockholders?
| The firm's Net Income during the past year |
| Expected Earnings per Share during the coming year |
| Book Value (or Net Worth) as recorded on the balance sheet |
| The price of the firm's stock on the open market |
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Question 10
Consider the following firms:
| Net Income | Stock Price at | Stock Price at | |
| this year | Beg of Year | End of Year | |
| Firm A: | $10,000,000 | $20 | $10 |
| Firm B: | $(10,000,000) | $10 | $20 |
| The manager of Firm A is doing a better job than B |
| The manager of Firm B is doing a better job than A |
| Neither manager is doing a good job |
| Both managers are doing a good job |
Question 11
A company has the following income statement. What is its net operating profit after taxes (NOPAT)?
Sales $1,000
Costs 700
Depreciation 100
EBIT $ 200
Interest expense 50
EBT $ 150
Taxes (40%) 60
Net income $ 90
| $ 90 |
| $120 |
| $150 |
| $180 |
| $200 |
Question 12
Carter Corporation has some money to invest, and its treasurer is choosing between City of Chicago municipal bonds and U.S. Treasury bonds. Both have the same maturity, and they are equally risky and liquid. If Treasury bonds yield 6 percent, and Carter's marginal income tax rate is 40 percent, what yield on the Chicago municipal bonds would make Carter's treasurer indifferent between the two?
| 2.40% |
| 3.60% |
| 4.50% |
| 5.25% |
| 6.00% |
Question 13
If a firm's current ratio is less than 1.0, it indicates that:
| The firm had negative net income for the year |
| The firm will be unable to pay its shortterm loans which come due this year |
| Current Assets are less than Current Liabilities |
| The firm is insolvent |
Question 14
A firm which has a relatively large amount of cash and receivables in its current assets accounts and a relatively small amount of current liabilities would be considered:
| liquid |
| profitable |
| risky |
| nuts |
Question 15
In November 2011 you bought 100 shares of Microsoft stock for $35.375 a share. In November 2013 you sold your stock for $92.5625 a share. What was your average annual rate of return on your Microsoft investment? (disregard dividends and commissions)
| 262% |
| 62% |
| 585% |
| 1.6% |
Question 16
You deposit $2,000 in a savings account that pays 10 percent interest, compounded annually. How much will your account be worth in 15 years?
| $2,030.21 |
| $5,000.00 |
| $8,091.12 |
| $8,354.50 |
| $9,020.10 |
Question 17
You can earn 8 percent interest, compounded annually. How much must you deposit today to withdraw $10,000 in 6 years?
| $5,402.69 |
| $6,301.70 |
| $6,756.76 |
| $8,432.10 |
| $9,259.26 |
Question 18
Calculate the required rate of return for Mercury, Inc., assuming that the real rate of interest is 3 percent, investors expect a 5 percent rate of inflation in the future, and they expect the rate of return on the overall stock market to be 13 percent. Mercury has a beta of 2.0.
| 15% |
| 16% |
| 17% |
| 18% |
| None of the above |
Question 19
Which is the best measure of risk for an asset held in isolation? Which is the best measure for an asset held in a diversified portfolio?
| Variance; correlation coefficient |
| Standard deviation; correlation coefficient |
| Beta; variance |
| Coefficient of variation; beta |
| Beta; beta |
Question 20
You have three stocks in your portfolio. $10,000 is invested in a stock with a beta of 1.50 and $15,000 is invested in a stock with a beta of 1.00, and $25,000 is invested in a stock with a beta of 0.50. What is the beta of your portfolio?
| 0.28 |
| 0.85 |
| 1.00 |
| 3.00 |
Question 21
A corporate bond with a $1,000 face value pays a $50 coupon every six months. The bond will mature in ten years, and has a nominal yield to maturity of 9 percent. What is the price of the bond?
| $ 634.86 |
| $1,064.18 |
| $1,065.04 |
| $1,078.23 |
| $1,094.56 |
Question 22
The Jones Company has decided to undertake a large project. Consequently, there is a need for additional funds. The financial manager plans to issue preferred stock with a perpetual annual dividend of $5 per share and a par value of $30. If the required return on this stock is currently 20 percent, what should be the stock's market value?
| $150 |
| $100 |
| $ 50 |
| $ 25 |
| $ 10 |
Question 23
A share of common stock has just paid a dividend of $2.00. If the expected long-run growth rate for this stock is 15 percent, and if investors require a 19 percent rate of return, what is the price of the stock?
| $57.50 |
| $62.25 |
| $71.86 |
| $64.00 |
| $44.92 |
Question 24
A stock is not expected to pay a dividend over the next four years. Five years from now, the company anticipates that it will establish a dividend of $1.00 per share (i.e., D5 = $1.00). Once the dividend is established, the market expects that the dividend will grow at a constant rate of 5 percent per year forever. The risk-free rate is 5 percent, the company's beta is 1.2, and the market risk premium is 5 percent. The required rate of return on the companyâs stock is expected to remain constant. What is the current stock price?
| $ 7.36 |
| $ 8.62 |
| $ 9.89 |
| $10.98 |
| $11.53 |