FNCE30001 Study Guide - Final Guide: Capital Asset Pricing Model, Expected Return, Standard Deviation

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lavendermoose527

21 Nov 2018

School

University of Melbourne

Department

Finance

Course

FNCE30001

Professor

Brown

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Document Summary

Problem 1. 1 [question 1 on page 173 of bodie, et al principles of investments] Suppose investors believe that the standard deviation of the market-index portfolio has increased by 50%. Problem 1. 2 [question 7 on page 174 of bodie, et al principles of investments] Problem 1. 3 [question 8 on page 174 of bodie, et al principles of investments] Consider the following table, which gives a security analyst"s predicted return on two shares for two particular market returns: For the next three questions, assume the risk-free rate is 8% and the expected rate of return on the market is 18%. Problem 1. 4 [question 16 on page 175 of bodie, et al principles of investments] It will pay a dividend of per share at the end of the year. Problem 1. 5 [question 17 on page 175 of bodie, et al principles of investments] Taren is buying a firm with an expected perpetual cash flow of but is unsure of its risk.

Related Questions

1. Which of the following is true?

The corporation model can be used to value divisions and firms that do not pay dividends.
The discounted dividend model can be used to value divisions and firms that do not pay dividends.
For the discounted dividend model, a firm's weighted average cost of capital is used as the discount rate.
For the corporate valuation model, a firm's cost of equity is used as the discount rate.

Question 2.2. Which of the following is false?

For the constant growth model to hold, a firm's cost of equity needs to be smaller than its constant dividend growth rate (i.e., rs < g).
For the constant growth model to hold, a firm's cost of equity needs to be greater than its constant dividend growth rate (i.e., rs > g).
From the constant growth model, if the constant dividend growth rate is equal to zero, a firm's share price is equal to the constant dividend divided by the cost of equity (i.e., g=0).
If a company's constant dividend growth rate is negative, the formula for the constant growth model cannot be applied.

Question 3.3. From the discussion of a firm's capital budgeting problem in chapter 11, which of the following is false? (Points : 3.5)

The net present value method (NPV) assumes that cash flows are reinvested at the weighted average cost of capital (WACC).
The internal rate of return method (IRR) assumes that cash flows are reinvested at the internal rate of return.
The modified internal rate of return method (MIRR) assumes that cash flows are reinvested at the weighted average cost of cpaital.
For mutually exclusive projects, if there is a conflict between NPV and IRR, the project with the highest IRR is chosen.
The IRR is independent of a firm's weighted average cost of capital.

Question 4.4. Which of the following is true? (

As a firm's dividend payout ratio increases, the firm's WACC decreases.
The WACC only represents the "hurdle rate" for a typical project with average risk. Therefore, the project's WACC should be adjusted to reflect the project's risk.
Firms with riskier projects generally have a lower WACC.
Holding all else constant, an increase in the target debt ratio tends to lower the WACC.

Question 5.5. Which of the following is false?

If interest rates rise, the price of the bond will rise and its YTM (yield to maturity) will fall.
Short-term bond prices are less sensitive than long-term bond prices to interest rate changes.
Companies are not likely to call bonds unless interest rates have declined significantly. Thus, the call provision is valuable to firms but detrimental to long term investors.
On balance, bonds that have a sinking fund are regarded as being safer than those without such a provision.

Question 6.6. Which of the following is not true? (Points : 3.5)

According to SML (security market line), the risk premium on a high-beta stock would increase more than that on a low-beta stock.
If beta < 1.0, the security is less risky than average.
According to the Security Market Line (SML), in general, a companyâs expected return will double when its beta doubles.
According to the Security Market Line (SML), if a portfolio of real world stocks has a beta of zero, the required rate of return for the portfolio is equal to the risk-free rate.

Question 7.7. P&G Industries bonds have a maturity of 15 years with a $1,000 face value, have an 8% semiannual coupon, are callable in 10 years at $1,125, and currently sell at a price of $1,105. What is their nominal annual yield to call?

6.87%.
7.37%.
11.05%.
8.32%.

Question 8.8. Which of the following is not the flaw (weakness) of the discounted payback method? (Points : 3.5)

It does not tells us by how much the project should increase shareholder wealth, or by how much a project yields over the cost of capital; it merely tells us when we recover our investment.
It ignores cash flows occurring after the payback period.
It ignores the time value of money, that is, dollars received in different years are all given the same weight.

Question 9.9. Jermey Lin has $52,500 invested a stock with a beta of 0.80 and another $47,500 invested in a stock with a beta of 3.2. If these are the only two investments in his portfolio, what is his portfolio's beta?

1.56.
1.82.
2.00.
1.94

Question 10.10. According to CAPM, if the required rate of the return of Stock A obtained from the security market line (SML) is less than the expected rate of the return of stock A from the capital market transaction, then stock A is

fairly priced.
undervalued.
overvalued.

Question 11.11. Determine the yield-to-call (to nearest 0.1 of a percent) of an LTV bond with a 12 percent coupon, that pays interest annually. The bond can be called in 5 years, has a call premium of $114, and is currently selling for $912.50. The bond has a face value of $1,000.

14.58%.
13.92%.
16.34%.
12.17%.

Question 12.12. Project M costs $1,000, its expected cash inflows are $500 per year for 3 years, and its WACC is 11%. What is the project's NPV? (Points : 3.5)

$259.57.
$221.86.
$195.23.
$257.35.

Question 13.13. Project J costs $1,025, its expected cash inflows are $425 per year for 3 years, and its WACC is 10%. What is the project's IRR?

12.58%.
10.82%.
11.76%.
9.64%.

Question 14.14. Project X costs $6,750, its expected cash inflows are $1250 per year for 10 years, and its WACC is 10%. What is the project's payback?(Note, the regular payback is asked in this question, not the discounted payback.) (Points : 3.5)

5.40 years.
10 years.
4.58 years.
6.12 years.

Question 15.15. Project S costs $800, its expected cash inflows are $350 per year for 3 years, and its WACC is 7%. What is the project's MIRR?

13.97%.
12.04%.
14.93%.
9.15%.

Question 16.16. Project Y costs $650, its expected cash inflows are $500 per year for 5 years, and its WACC is 10%. What is the project's discounted payback?

1.47 years.
1.24 years.
1.62 years.
1.15 years.

1. Which of the following is true?

Question 2.2. Which of the following is false?

Question 3.3. From the discussion of a firm's capital budgeting problem in chapter 11, which of the following is false?

Question 4.4. Which of the following is true? (Points : 3.5)

Question 5.5. Which of the following is false? (Points : 3.5)

Question 6.6. Which of the following is not true? (Points : 3.5)

6.87%.
7.37%.
11.05%.
8.32%.

Question 8.8. Which of the following is not the flaw (weakness) of the discounted payback method? (Points : 3.5)

1.56.
1.82.
2.00.
1.94

fairly priced.
undervalued.
overvalued.

14.58%.
13.92%.
16.34%.
12.17%.

Question 12.12. Project M costs $1,000, its expected cash inflows are $500 per year for 3 years, and its WACC is 11%. What is the project's NPV?

$259.57.
$221.86.
$195.23.
$257.35.

Question 13.13. Project J costs $1,025, its expected cash inflows are $425 per year for 3 years, and its WACC is 10%. What is the project's IRR? (

12.58%.
10.82%.
11.76%.
9.64%.

5.40 years.
10 years.
4.58 years.
6.12 years.

Question 15.15. Project S costs $800, its expected cash inflows are $350 per year for 3 years, and its WACC is 7%. What is the project's MIRR? (

13.97%.
12.04%.
14.93%.
9.15%.

Question 16.16. Project Y costs $650, its expected cash inflows are $500 per year for 5 years, and its WACC is 10%. What is the project's discounted payback?

1.47 years.
1.24 years.
1.62 years.
1.15 years.

QUESTION 1

In the lease versus buy decision, leasing is often preferable

	A.	because the lessee owns the property at the end of the least term.
	B.	because lease obligations do not affect the firm's risk as seen by investors.
	C.	because, generally, no down payment is required, and there are no indirect interest costs.
	D.	because it has no effect on the firm's ability to borrow to make other investments.
	E.	because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.

2 points

QUESTION 2

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

True

False

2 points

QUESTION 3

Ratio analysis involves analyzing financial statements in order to appraise a firm's financial position and strength.

True

False

2 points

QUESTION 4

Which of the following statements is CORRECT?

	A.	If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1.0) and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks.
	B.	If a stock has a negative beta, its expected return must be negative.
	C.	A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.
	D.	According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.
	E.	A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.

2 points

QUESTION 5

Many leases written today combine the features of operating and financial leases. Such leases are often called "combination leases."

True

False

2 points

QUESTION 6

The owner of a convertible bond owns, in effect, both a bond and a call option.

True

False

2 points

QUESTION 7

If a firm raises capital by selling new bonds, it is called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk.

True

False

2 points

QUESTION 8

Which of the following statements is most CORRECT?

	A.	Warrants can sometimes be detached and traded separately from the debt with which they were issued, but this is unusual.
	B.	One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds.
	C.	The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt.
	D.	Warrants have an option feature but convertibles do not.
	E.	The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant.

2 points

QUESTION 9

Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

True

False

2 points

QUESTION 10

The form of organization for a business is not an important issue, as this decision has very little effect on the income and wealth of the firm's owners.

True

False

2 points

QUESTION 11

Two important issues in corporate governance are (1) the rules that cover the board's ability to fire the CEO and (2) the rules that cover the CEO's ability to remove members of the board.

True

False

2 points

QUESTION 12

The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will common stock.

True

False

2 points

QUESTION 13

If an investment project would make use of land which the firm currently owns, the project should be charged with the opportunity cost of the land.

True

False

2 points

QUESTION 14

Operating leases help to shift the risk of obsolescence from the user to the lessor.

True

False

2 points

QUESTION 15

Starting to invest early for retirement increases the benefits of compound interest.

True

False

2 points

QUESTION 16

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

True

False

2 points

QUESTION 17

Other things held constant, an increase in the cost of capital will result in a decrease in a project's IRR.

True

False

2 points

QUESTION 18

An option is a contract that gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time.

True

False

2 points

QUESTION 19

The optimal distribution policy strikes that balance between current dividends and capital gains that maximizes the firm's stock price.

True

False

2 points

QUESTION 20

If the current price of a stock is below the strike price, then an option to buy the stock is worthless and will have a zero value.

True

False

2 points

QUESTION 21

The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.

True

False

2 points

QUESTION 22

Taylor Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?

	A.	Project C, which is of above-average risk and has a return of 11%.
	B.	Project A, which is of average risk and has a return of 9%.
	C.	None of the projects should be accepted.
	D.	All of the projects should be accepted.
	E.	Project B, which is of below-average risk and has a return of 8.5%.

2 points

QUESTION 23

To finance the construction of a new plant, Pietersen Corporation must raise an additional $10,000,000 of equity capital through the sale of common stock. The firm currently has an EPS of $5.40 and a P/E ratio of 10, with 1,200,000 shares outstanding. If the firm wants its ex-rights price to be $50, what subscription price must it set on the new shares?

	A.	$39.28
	B.	$50.00
	C.	$29.55
	D.	$41.80
	E.	$33.78

2 points

QUESTION 24

Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?

	A.	A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.
	B.	A bank loan's nominal interest rate will always be equal to or less than its effective annual rate.
	C.	The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.
	D.	If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%.
	E.	Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.

2 points

QUESTION 25

Which of the following statements is CORRECT?

	A.	In the statement of cash flows, a decrease in inventories is reported as a use of cash.
	B.	In the statement of cash flows, a decrease in accounts receivable is reported as a use of cash.
	C.	In the statement of cash flows, depreciation charges are reported as a use of cash.
	D.	In the statement of cash flows, a decrease in accounts payable is reported as a use of cash.
	E.	Dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity.

2 points

QUESTION 26

The term "additional funds needed (AFN)" is generally defined as follows:

	A.	A forecasting approach in which the forecasted percentage of sales for each balance sheet account is held constant.
	B.	Funds that are obtained automatically from routine business transactions.
	C.	Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock to support operations.
	D.	The amount of internally generated cash in a given year minus the amount of cash needed to acquire the new assets needed to support growth.
	E.	The amount of assets required per dollar of sales.

2 points

QUESTION 27

The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.

True

False

2 points

QUESTION 28

Which of the following statements is CORRECT?

	A.	The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV.
	B.	Identifying an externality can never lead to an increase in the calculated NPV.
	C.	Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.
	D.	An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to increase.
	E.	An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. If the project would have a favorable effect on other operations, then this is not an externality.

2 points

QUESTION 29

Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly.

True

False

2 points

QUESTION 30

A warrant is an option, and as such it cannot be used as a "sweetener."

True

False

2 points

QUESTION 31

BLW Corporation is considering the terms to be set on the options it plans to issue to its executives. Which of the following actions would decrease the value of the options, other things held constant?

	A.	The life of the option is increased, i.e., the time until it expires is lengthened.
	B.	The exercise price of the option is increased.
	C.	The Federal Reserve takes actions that increase the risk-free rate.
	D.	BLW's stock price becomes more risky (higher variance).
	E.	BLW's stock price suddenly increases.

2 points

QUESTION 32

Convertible debentures for Kulik Corporation were issued at their $1,000 par value in 2012. At any time prior to maturity on February 1, 2032, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc?

	A.	$48.62
	B.	$40.00
	C.	$42.00
	D.	$46.31
	E.	$44.10

2 points

QUESTION 33

A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock's current price?

	A.	$18.29
	B.	$17.39
	C.	$19.22
	D.	$18.75
	E.	$17.84

2 points

QUESTION 34

If a firm's goal is to maximize its earnings per share, this is the best way to maximize the price of the common stock and thus shareholders' wealth.

True

False

2 points

QUESTION 35

The common stock of Southern Airlines currently sells for $33, and its 8% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 25 shares of common stock at any time before 2025. What is the conversion value of the bond?

	A.	$783.75
	B.	$744.56
	C.	$825.00
	D.	$866.25
	E.	$707.33

2 points

QUESTION 36

Which of the following statements is CORRECT?

	A.	If interest rates increase, the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond.
	B.	If a bond's yield to maturity exceeds its annual coupon, then the bond will trade at a premium.
	C.	If a coupon bond is selling at par, its current yield equals its yield to maturity.
	D.	If a coupon bond is selling at a premium, its current yield equals its yield to maturity.
	E.	If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity.

2 points

QUESTION 37

A proxy is a document giving one party the authority to act for another party, including the power to vote shares of common stock. Proxies can be important tools relating to control of firms.

True

False

2 points

QUESTION 38

Projects S and L are equally risky, mutually exclusive, and have normal cash flows. Project S has an IRR of 15%, while Project L's IRR is 12%. The two projects have the same NPV when the WACC is 7%. Which of the following statements is CORRECT?

	A.	Project S's NPV is more sensitive to changes in WACC than Project L's.
	B.	If the WACC is 13%, Project S will have the lower NPV.
	C.	If the WACC is 6%, Project S will have the higher NPV.
	D.	If the WACC is 10%, both projects will have positive NPVs.
	E.	If the WACC is 10%, both projects will have a negative NPV.

2 points

QUESTION 39

A firm's AFN must come from external sources. Typical sources include short-term bank loans, long-term bonds, preferred stock, and common stock.

True

False

2 points

QUESTION 40

Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership?

	A.	Less of a corporation's income is generally subjected to taxes than would be true if the firm were a partnership.
	B.	Corporate shareholders escape liability for the firm's debts, but this factor may be offset by the tax disadvantages of the corporate form of organization.
	C.	Corporations generally find it relatively difficult to raise large amounts of capital.
	D.	Corporations generally face relatively few regulations.
	E.	Corporate investors are exposed to unlimited liability.

2 points

QUESTION 41

The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.

True

False

2 points

QUESTION 42

Amram Company's current ratio is 1.9. Considered alone, which of the following actions would reduce the company's current ratio?

	A.	Use cash to reduce accruals.
	B.	Borrow using short-term notes payable and use the proceeds to reduce long-term debt.
	C.	Use cash to reduce accounts payable.
	D.	Borrow using short-term notes payable and use the proceeds to reduce accruals.
	E.	Use cash to reduce short-term notes payable.

2 points

QUESTION 43

ESOPs were originally designed to help improve worker productivity, but today they are also used to help prevent hostile takeovers.

True

False

2 points

QUESTION 44

High current and quick ratios always indicate that a firm is managing its liquidity position well.

True

False

2 points

QUESTION 45

A firm should never accept a project if its acceptance would lead to an increase in the firm's cost of capital (its WACC).

True

False

2 points

QUESTION 46

"Capital" is sometimes defined as funds supplied to a firm by investors.

True

False

2 points

QUESTION 47

Heavy use of off-balance sheet lease financing will tend to

	A.	affect a company's cash flows but not its degree of risk.
	B.	make a company appear less risky than it actually is because its stated debt ratio will appear lower.
	C.	make a company appear more risky than it actually is because its stated debt ratio will be increased.
	D.	affect the lessee's cash flows but only due to tax effects.
	E.	have no effect on either cash flows or risk because the cash flows are already reflected in the income statement.

2 points

QUESTION 48

As a firm's sales grow, its current assets also tend to increase. For instance, as sales increase, the firm's inventories generally increase, and purchases of inventories result in more accounts payable. Thus, spontaneous liabilities that reduce AFN arise from transactions brought on by sales increases.

True

False

2 points

QUESTION 49

On the balance sheet, total assets must always equal total liabilities and equity.

True

False

2 points

QUESTION 50

The annual report contains four basic financial statements: the income statement, balance sheet, statement of cash flows, and statement of stockholders' equity.

True

False

FNCE30001 Study Guide - Final Guide: Capital Asset Pricing Model, Expected Return, Standard Deviation

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