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11 May 2019

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 project’s IRR increases as the WACC declines.

B.

The project’s NPV increases as the WACC declines.

D.

The project’s IRR decreases as the WACC declines.

E.

none of the above is correct.

Burlees Inc.’s CFO has collected the following information to calculate its WACC:

• The company’s 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 company’s common stock has a beta of 2.

The company’s tax rate is 40%.

What is the company’s cost of common equity?

A.

9.65%

B.

13.00%

D.

17.60%

E.

18.91%

Burlees Inc.’s CFO has collected the following information to calculate its WACC:

• The company’s 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 company’s common stock has a beta of 2.

The company’s tax rate is 40%.

What is the company’s 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 project’s WACC should be adjusted higher.

E.

Retained earnings bear no capital cost at all.

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Trinidad Tremblay
Trinidad TremblayLv2
11 May 2019

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Related questions

Evaluating risk and return

Stock X has a 9.5% expected return, a beta coefficient of 0.8, and a 40% standard deviation of expected returns. Stock Y has a 12.5% expected return, a beta coefficient of 1.2, and a 25.0% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%.

Calculate each stock's coefficient of variation. Round your answers to two decimal places. Do not round intermediate calculations.
CVx =
CVy =

Which stock is riskier for a diversified investor?

For diversified investors the relevant risk is measured by beta. Therefore, the stock with the higher beta is more risky. Stock Y has the higher beta so it is more risky than Stock X.

For diversified investors the relevant risk is measured by standard deviation of expected returns. Therefore, the stock with the higher standard deviation of expected returns is more risky. Stock X has the higher standard deviation so it is more risky than Stock Y.

For diversified investors the relevant risk is measured by beta. Therefore, the stock with the lower beta is more risky. Stock X has the lower beta so it is more risky than Stock Y.

For diversified investors the relevant risk is measured by standard deviation of expected returns. Therefore, the stock with the lower standard deviation of expected returns is more risky. Stock Y has the lower standard deviation so it is more risky than Stock X.

For diversified investors the relevant risk is measured by beta. Therefore, the stock with the higher beta is less risky. Stock Y has the higher beta so it is less risky than Stock X.


-Select-IIIIIIIVVItem 3

Calculate each stock's required rate of return. Round your answers to two decimal places.
rx = %
ry = %

On the basis of the two stocks' expected and required returns, which stock would be more attractive to a diversified investor?
-Select-Stock XStock YItem 6

Calculate the required return of a portfolio that has $4,500 invested in Stock X and $9,000 invested in Stock Y. Do not round intermediate calculations. Round your answer to two decimal places.
rp = %

If the market risk premium increased to 6%, which of the two stocks would have the larger increase in its required return?
-Select-Stock XStock Y

Stock Q has a beta (β) equal to 1.6 and Stock P has a beta equal to 0.8. Based on this information, according to the capital asset pricing model (CAPM), which of the following statements is correct? Select one: a. The required rate of return for Stock Q, rQ, should be 1.6 times greater than the required rate of return for Stock P, rP. b. The risk premium associated with Stock Q, RPQ, should be 1.6 times greater than the risk premium associated with Stock P, RPP. c. The required rate of return for Stock Q, rQ, should be two times greater than the required rate of return for Stock P, rP. d. The risk premium associated with Stock Q, RPQ, should be two times greater than the risk premium associated with Stock P, RPP. e. None of the above is a correct answer.

Evaluating risk and return Stock X has a 10.5% expected return, a beta coefficient of 1.0, and a 35% standard deviation of expected returns. Stock Y has a 13.0% expected return, a beta coefficient of 1.3, and a 20.0% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%.

a. Calculate each stock's coefficient of variation. Round your answers to two decimal places. Do not round intermediate calculations.

CVx =

CVy =

b. Which stock is riskier for a diversified investor?

I.For diversified investors the relevant risk is measured by beta. Therefore, the stock with the higher beta is less risky. Stock Y has the higher beta so it is less risky than Stock X.

II.For diversified investors the relevant risk is measured by beta. Therefore, the stock with the higher beta is more risky. Stock Y has the higher beta so it is more risky than Stock X.

III.For diversified investors the relevant risk is measured by standard deviation of expected returns. Therefore, the stock with the higher standard deviation of expected returns is more risky. Stock X has the higher standard deviation so it is more risky than Stock Y.

IV.For diversified investors the relevant risk is measured by beta. Therefore, the stock with the lower beta is more risky. Stock X has the lower beta so it is more risky than Stock Y.

V.For diversified investors the relevant risk is measured by standard deviation of expected returns. Therefore, the stock with the lower standard deviation of expected returns is more risky. Stock Y has the lower standard deviation so it is more risky than Stock X.

Select correct answer

c. Calculate each stock's required rate of return. Round your answers to two decimal places. rx = % ry = %

d.On the basis of the two stocks' expected and required returns, which stock would be more attractive to a diversified investor? -Select-Stock XStock Y

e.Calculate the required return of a portfolio that has $6,500 invested in Stock X and $7,500 invested in Stock Y. Do not round intermediate calculations. Round your answer to two decimal places. rp = %

f. If the market risk premium increased to 6%, which of the two stocks would have the larger increase in its required return?

-Select-Stock X or Stock Y

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