A stock pays annual dividends. It just paid a dividend of $2.50. The growth rate in the dividend is 3% pa. You estimate that the stock's required return is 7% pa. Both the discount rate and growth rate are given as effective annual rates.

Which of the following statements is NOT correct?

a.

Dividend growth rate is equal to the long term expected dividend yield.

b.

The dividend at time t=3 will be $2.7318

c.

Total return of the stock is equal to the company's long term cost of equity.

d.

The long-term capital return of the stock is 3%

e.

The share price at time t=0 is $64.375

You discover an investment costing $2,000 which has an expected total return of 13% pa, but a required return of only 9% pa. Of the 13% pa total expected return, the capital return is expected to be 7% pa. Assume that the required return of 9% remains constant, the dividends can only be re-invested at 9% pa and all returns are given as effective annual rates.

Which of the following statements is NOT correct?

a.

The investment is currently under-priced

b.

When plotted on the Security Market Line, the investment would have a positive alpha.

c.

The expected dividend return is 6%

d.

You would use a discount rate of 13% to find the NPV of this investment

e.

The investments price at time t=20 would be $7,739.37

Use the following information to value a firms assets.

Assume the following:

• the market value of the firm's assets is expected to remain constant over time so the firm doesn't grow and can be valued as a level perpetuity,
• the firm has a constant debt-to-assets ratio,
• the bonds are priced at par, and
• the stock's expected capital returns are zero.

Relevant data:

• The number of shares on issue is 1 million and the number of bonds is 500,000
• The constant annual dividend per share is $4
• The bonds have an annual fixed coupon payment of $5
• 10-year government bonds have a yield of 2.5% and the market risk premium is 6%
• The beta of levered equity is 0.7
• The beta of the bonds is 1.2

Which of the following is the market value of the levered firms assets?

a.

$54.8 million

b.

$85.5 million

c.

$92.1 million

d.

$100.6 million

e.

$69.2 million

Which statement about capital structure is the most correct?

a.

The more the company borrows, the higher will be its tax shields, therefore a company will always prefer to issue debt than equity.

b.

The more the company borrows, the lower will be the after-tax WACC. This increases the present value of the firm free cash flows which represents the value of the levered firm.

c.

A company should always try to reduce its debt because of the high bankruptcy risk associated with debt. A company should aim to have 100% equity financing if it is possible.

d.

Lenders rank ahead of shareholders when the company goes bankrupt. To protect shareholders interests, it is always preferred to issue equity rather than debt.

e.

Because the cost of debt is cheaper than the cost of equity, a company should use as much debt as possible to finance their projects

Which of the following would increase a firms WACC before tax?

a.

A pharmaceutical research company develops a 100% effective COVID vaccine, which reduces its systematic risk in the market.

b.

A firm invests in an average-risk project using equity, rather than debt financing.

c.

A firm issues shares and uses the proceeds to pay off a bank loan.

d.

A firm issues bonds and uses the proceeds to repurchase stock.

e.

A supermarket chain decides to establish hardware stores which increases its sensitivity to market fluctuations.