I need help on questions 12-15 in section 5. Could you also explain how you solved them

1 Sample Questions from Previous FIN 3310 Departmental Final Exams (Revised 2015) Printed below is a sampling of questions from previous FIN 3310 Departmental Final Exams. The questions are grouped by major topic and include both theory and problem questions. Note that some TVM problems have been worked using interest factor tables while others have been worked using formulas or a business calculator. Thus, your calculated answer, even though correct, may differ slightly from the correct answer listed. However, the answer choices should be sufficiently different to preclude any confusion as to which answer to choose. The following questions relate to the given chapters in the RWJ Text: Chapters Chapter 1 Chapter Chapter Chapter Chapter Chapter Chapter Chapter Chapter 2&3 4 5 6 8 9 10 11 Chapter 13 Chapter 14 Chapter 15 I. Secti on I Questio ns 1, 2 III 1-9 1-3, 5-12 31-42 43-48 13-19 4, 21-30 IV IV IV IV IV II V 1 12-22 Section III Questio ns 1, 2 V 1-11 OBJECTIVE OF THE FINANCIAL MANAGER 1. The primary goal of a publicly-owned firm interested in serving its stockholders is to: a. maximize total corporate profit b. maximize earnings per share of common stock c. minimize the weighted average cost of capital d. maximize the price per share of common stock e. minimize the chance of any loss 2. The agency problem faced by stockholders a. derives from the conflict that a firm's managers face in serving their own interests as well as the interests of the firm's owners. b. is to convince bond holders to subordinate their own interests to those of the stockholders. c. is increased if the managers own a substantial share of the firm's stock. d. is increased if the managers' compensation is tied to the performance of the firm. e. All of the above 2 II. 3 FINANCIAL MARKETS AND INSTITUTIONS 1. When securities markets are efficient, a. securities will trade at prices above their intrinsic (economic) value. b. securities will trade at prices below their intrinsic (economic) value. c. investors will tend to be more risk averse. d. security prices will quickly adjust to maintain equality with their intrinsic (economic) values. III. FINANCIAL STATEMENTS ANALYSIS AND FORECASTING 1. Corporations are allowed to deduct all of the following expenses for tax purposes except a. sales commission. b. advertising expense. c. interest expense. d. dividends paid. e. All of the above are tax deductible expenses. 2. Assuming a tax rate of 34 percent, then a depreciation expense of $150,000 will a. reduce net income by $150,000 but increase cash flow by $150,000. b. reduce net income by $99,000 but increase cash flow by $51,000. c. reduce taxes by $51,000 but increase cash flow by $150,000. d. reduce cash flow by $51,000 but reduce net income by only $99,000. e. reduce both net income and cash flow by $99,000. 3. In common-size financial statements the income statement is normally expressed as a percentage of _______________ and the balance sheet is expressed as a percentage of ____________. a. total assets; sales b. sales; equity c. net income; total assets d. sales; total assets 4. Which of the following is a source of funds? a. a decrease in accounts receivable b. an increase in inventories c. a decrease in accounts payable d. a decrease in stockholders' equity e. a decrease in depreciation 5. Retry Corp. recently recorded a decline in its return on equity (ROE). What is the most likely source of this decline? a. increase in profit margin b. increase in equity multiplier c. increase in debt turnover d. decrease in asset turnover e. None of the above 4 6. Which of the following actions (each considered independently) would reduce the firm's need for external financing? a. An increase in the dividend payout ratio. b. A decrease in the profit margin. c. An increase in expected sales growth. d. An increase in the accrual accounts (accrued wages and taxes). e. None of the above 7. Alwright Co. anticipates that sales will grow by 8% next year over current sales of $300,000. If assets are expected to increase by $60,000, and spontaneous liabilities are expected to rise by $15,000, how much additional external funds would Alwright Co. need if its profit margin is 0.6 and it retains no earnings? a. $60,000 b. $45,000 c. $24,000 d. $ 9,000 e. Alwright Co. would need no additional external funds 8. Assume a firm has a dividend payout ratio of 50%. Normally, the larger the firm's growth rate in sales, a. the larger the required increase in assets. b. the larger the increase in spontaneous liabilities c. the larger the increase in retained earnings d. the greater the firm's need for external financing e. All of the above are correct 9. You own of a small business that has the following balance sheet: Current assets Net fixed assets $ 5,000 10,000 Total assets $15,000 Accounts payable Accruals Long-term debt Common equity Total $ 1,000 1,000 5,000 8,000 $15,000 Fixed and current assets are fully utilized, and the sales/assets and sales/spontaneous liabilities ratios will remain constant. Next year you expect sales to increase by 50 percent to $120,000. You also expect to retain $2,000 of next year's earnings within the firm. What is next year's additional external funding requirement? a. No additional funds are required. b. $3,500 c. $4,500 d. $5,500 e. $6,500 5 IV. VALUATION 1. On the day you were born, your grandfather established an educational trust fund in your name by depositing $1,000 in an account that pays 7.0% interest per year. Now, eighteen years later, you are about to enter college. How much money is in the account, assuming no withdrawals? a. $ 296 b. $ 1,070 c. $ 1,700 d. $ 3,380 e. $10,059 2. You are planning to withdraw $300 from your savings account 10 years from today. The rate earned on your account is 16% per year compounded quarterly. How much must you have in your account today to allow you to make this withdrawal? a. $1,971.16 b. $ 166.67 c. $ 62.49 d. $ 50.54 e. $ 25.00 3. You have just deposited $250 in a saving account paying 12% annual interest. How long will it be before you have $493.46 in your account? a. 16.4 years b. 6.0 years c. 4.0 years d. 2.0 years e. Cannot be determined from information given 4. You sold 100 shares of stock today for $30 per share, for which you paid $20 for 6 years ago. Determine the average annual rate of return on your investment; assume the stock paid no dividends. a. 15 percent b. 10 percent c. 8 percent d. 7 percent e. 6 percent 5. Billy Bob has decided to put $2,400 a year (at the end of each year) into an IRA over his 40 year working life and then retire. What will Billy have at retirement if the account will earn 10 percent compounded annually? a. $ 108,622 b. $ 923,470 c. $1,062,222 d. $1,810,917 e. $2,157,210 6 6. To break the cycle of indebtedness, you have decided to start saving now for your next car. Five years from now, you plan to purchase a new minivan for $35,000. If you plan to make 60 monthly deposits into an account paying 1% per month, how much will you need to save at the end of each month to reach your goal? a. $19,265.74 b. $ 778.56 c. $ 627.42 d. $ 583.33 e. $ 428.56 7. What would you pay for a cash flow stream that promises you $150 at the beginning of each of the next 16 years? Assume your opportunity cost is 9 percent. a. $1,480 b. $1,359 c. $1,256 d. $1,210 e. $1,155 8. You have just borrowed $150,000 to buy a new house. The rate of interest on this loan is 9% per year. If you plan to make 30 annual payments, what will your payments be? a. $ 5,000 b. $11,306 c. $13,500 d. $14,600 e. $17,500 9. Your retirement goal is to save $400,000 by the time you are 65 years old. You have been saving $926.65 per year for the last 30 years, and you will retire in 5 years (at age 65). The interest rate has just changed from 12% (which has been the level for the last 30 years) to 9%. How much must you set aside at the end of each of the next 5 years to reach your goal? a. $ 926 b. $ 9,343 c. $11,183 d. $29,469 e. $35,273 10. If all other things are equal, which of the following factors would cause the present value of an annuity to decrease? a. The annuity payment is to be received for a larger number of years. b. The discount rate is increased. c. The discount rate is decreased. d. The size of the annuity payment is increased. e. None of the above. 7 11. After the assassination of President John F. Kennedy, an "eternal flame" was placed on his grave. It is a torch that should remain lit forever. Assume that the annual fuel and maintenance costs of the flame are $185, and that the cost of capital for the Foundation that maintains the flame is estimated to be 8%. What was the estimated present value of the cost of the eternal flame at the time that it was placed on President Kennedy's grave if the initial $185 outlay was made at the end of the first year? a. $ 171 b. $ 200 c. $1,250 d. $2,313 e. An infinite amount of money. 12. Dr. Seward desperately wants to retire with $400,000 in his retirement fund. If he saves $754.28 per year in a mutual fund that earns 16% per year, how long must he work before he meets his retirement objective? (The mutual fund is not subject to federal income tax.) a. 22 years b. 30 years c. 40 years d. 50 years e. An infinite number of years 13. A $1,000 par value bond with a 10 percent coupon rate recently sold for $900. The yield to maturity is: a. 10 percent b. greater than 10 percent c. less then 10 percent d. Cannot be determined 14. Footfall Corporation has two bonds outstanding, both of which have a 9 percent coupon rate (interest is paid annually). Bond One has five years to maturity. Bond Two has ten years to maturity. If market rates rise by 1 percentage point for all maturities of bonds, how would the prices of the bonds change, and which bond (if any) would have the GREATER price change? a. The prices of both bonds would fall, but Bond One would have the greater price decline. b. The prices of both bonds would fall, but Bond Two would have the greater price decline. c. The prices of both bonds would rise, but Bond One would have the greater price increase. d. The prices of both bonds would rise, but Bond Two would have the greater price increase. e. The prices of both bonds would change by the same amount. 15. What is the yield to maturity of a 9-year bond that pays a coupon rate of 20% per year, has a $1,000 par value, and is currently priced at $1,426? Assume annual interest payments. a. 14 percent b. 12 percent c. 11 percent d. 8 percent e. 5 percent 8 16. A bond that pays no interest payments is called a: a. junk bond. b. income bond. c. subordinated bond. d. put bond. e. zero coupon bond. 17. A call feature a. requires the firm to systematically set aside funds for debt retirement. b. allows the firm to retire debt early. c. allows the bondholder to convert his bonds into common stock. d. allows the bondholder to redeem her bonds at par. e. allows your computer to access a local bulletin board free of charge. 18. A 20-year bond has 5 years left to maturity, and it pays a 10% coupon rate on a semiannual basis on a face value of $1,000. If similar bonds are currently yielding 8%, what is the current market value of this bond? a. $ 950 b. $1,000 c. $1,081 d. $1,196 e. $1,198 19. All of the following may serve to reduce the coupon rate that would otherwise be required to issue a bond at par except a. A sinking fund. b. A restrictive covenant. c. A call provision. d. A change in rating from Aa to Aaa. e. None of the above (all may reduce the rate). 20. The pre-emptive right a. protects bondholders against dilution of value. b. allows current stockholders to purchase as many shares as they want of a new issue of stock. c. gives bondholders the opportunity to buy a pro rata share of a new bond issue. d. protects the existing stockholders' control. e. None of the above 21. The type of voting that allows minority stockholders to gain representation on the board of directors is a. majority voting. b. rights on voting. c. cumulative voting. d. preemptive voting. e. none of the above. 9 22. Hondo Motors recently paid a dividend of $6 per share common stock and expects to increase its dividend by 4% next year and every year thereafter. If the required return on Hondo stock is 14%, what is the value of Hondo stock today? a. $15.00 b. $60.00 c. $61.00 d. $62.40 e. $64.38 23. The expected rate of return on the common stock of Northwest Corporation is 14 percent. The stock's dividend is expected to grow at a constant rate of 8 percent a year. The stock currently sells for $50 a share. Which of the following statements is correct? a. The stock's dividend yield is 6 percent. b. The stock's dividend yield is 7 percent. c. The current dividend per share is $4.00. d. The stock price is expected to be $56 a share in one year. e. The stock price is expected to be $57 a share in one year. 24. Which of the following factors would cause a decrease in the price of a share of stock? Assume that the changes mentioned are the only things that change, and consider each part of the problem separately. a. A decrease in the rate of return required by investors. b. An increase in the expected growth rate. c. An increase in the expected dividend. d. A decrease in the expected rate of return on the market portfolio. e. A decrease in the expected growth rate. 25. The total return to common stockholders is composed of a (an) a. opportunity cost plus a risk premium. b. dividend yield plus a capital gains yield. c. opportunity cost plus an inflation premium. d. current yield plus a capital gains yield. 26. The Texas Corp. common stock is selling for $50 per share. The next expected dividend is $2.00 per share. If investors require a 14% rate of return on this stock what is the expected growth rate. a. 10 percent b. 8 percent c. 6 percent d. 4 percent e. 3 percent 27. A share of common stock is expected to pay a dividend of $2.30 next year. If the expected longrun 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? a. $57.50 b. $62.25 c. $71.86 d. $64.00 e. $44.92 10 28. The market value of a firm's stock is determined by a. the amount of the cash flows expected to be generated for the benefit of stockholders. b. the timing of the cash flows expected to be generated for the benefit of stockholders. c. the risk of the cash flows expected to be generated for the benefit of stockholders. d. Both a and c are correct e. a, b, and c are correct 29. What is the expected rate of return for a stock with a price of $44, assuming the last dividend paid was $2 and the earnings, dividends and stock price are growing at 10 percent year. a. 12.0% b. 12.5% c. 13.4% d. 14.45% e. 15.0% 30. The Morrow Corp. just paid a dividend of $1.00 on its common stock. Twelve years ago the dividend was $0.50 per share. If the past growth rate of dividends (rounded to the nearest whole number) is expected to continue in the future, what is the value of the stock, assuming a required rate of return of 13%? a. $8 b. $12 c. $15 d. $23 e. $30 The following data applies to Questions 31 and 32: Project Saturn has an initial outlay (cost) of $12,640. The cost of capital is 14 percent. The aftertax cash flows are estimated to be: Year 1 $1,000 Year 2 $3,000 Year 3 $6,000 Year 4 $8,000 31. The net present value of Project Saturn is a. -$ 668 b. -$ 421 c. $ 0 d. $ 789 e. $1,013 32. The internal rate of return of Project Saturn is a. 8 percent b. 9 percent c. 10 percent d. 12 percent e. 14 percent 11 33. Which of the following capital budgeting methods might not consider the salvage value of a proposed new machine? a. Internal rate of return b. Net present value c. Payback d. Profitability index e. Both c and d are correct 34. The Seattle Corp. has been presented with an investment opportunity that will yield net cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10 percent. What is the payback period for this investment? Assume cash flows occur evenly during the year, 1/365th each day. a. 4.00 years b. 4.35 years c. 4.86 years d. 5.23 years e. 6.12 years 35. Which of the following is not a problem with using the payback period decision rule? a. ignores timing of cash flows b. ignores some cash flows c. arbitrary criteria d. difficult to calculate e. All of the above are problems with the payback period decision rule. 36. Two mutually exclusive projects each have a cost of $10,000. The total, undiscounted cash flows from Project L are $15,000, while the undiscounted cash flows from Project S total $13,000. Their NPV profiles cross at a discount rate of 10 percent. Which of the following statements best describes this situation? a. The NPV and IRR methods will select the same projects if the cost of capital is greater than 10 percent, for example, 18 percent. b. The NPV and IRR methods will select the same projects if the cost of capital is less than 10 percent, for example, 6 percent. c. More information is needed to determine if a ranking conflict will occur between the two projects. d. Project L should be selected at any cost of capital because it has a higher IRR. e. Project S should be selected at any cost of capital because it has a higher IRR. 12 37. The Criterion Corp., an all equity firm, has a new project that appears to be very risky. The expected net cash flows over the three-year life of the project are given below. The initial cost (net investment outlay) is $30,000 with a project beta of 1.6. The risk-free rate is 8%, and the market risk premium is 5%. What is the net present value of this project? Year 1 2 3 a. b. c. d. e. Expected Cash Flow $12,000 15,000 20,000 -$695 $3,231 $4,305 $6,362 $17,000 38. Hamilton, Inc. will invest $10,000,000 in a new rocket assembly plant this year. The company expects net cash flows of $4,000,000 per year for three years and $1,202,700 at the end of the fourth year. The firm's cost of capital is 10%. The internal rate of return for the assembly plant is a. 8% b. 10% c. 12% d. 14% e. 16% 39. The relationship between NPV and IRR is such that: a. both would always agree on which project to select for mutually exclusive projects b. if the NPV of a project is negative, the IRR must be greater than the cost of capital c. if the cost of capital changes, IRR will also change d. the IRR of a project is equal to the firm's cost of capital if the NPV of the project is $0 e. None of the above is correct. 40. While analyzing a proposed capital budgeting project, you observe that undertaking the proposed project will result in lost sales of $3,000 per year on an existing product. What is the effect of this factor on the proposed project's NPV? a. NPV is unchanged since the lost sales are unrelated to the proposed project. b. NPV is reduced by the present value of the after-tax lost sales. c. NPV is increased because of the higher net cash flows generated by the lost sales. d. NPV is reduced because of the reduction in sunk costs. e. None of the above is correct. 41. For a profitable firm, a. MACRS allowances produce lower depreciation charges than straight line depreciation in the early years of an asset's life. b. MACRS allowances produce smaller cash flows than straight line depreciation in the early years of an asset's life. c. MACRS allowances produce larger total accounting profits than straight line depreciation over the economic life of an asset. d. MACRS allowances produce a higher NPV for a capital budgeting project than straight line depreciation. e. Two of the above statements are correct. 13 42. Which of the following is a sunk cost and thus would not be included as an incremental cash flow in NPV analysis done today? a. A bill received from a survey company for surveying the land. The survey was completed two weeks ago. The bill is due 30 days from now. b. If the plant is not built, land that would have been used for building the plant and can be sold for $100,000 c. If the plant is built, sales will increase by $15,000 per year for 10 years. d. If the plant is built, sales at existing stores will fall by $1,500 per year for as long as the store is open. e. None of the above is correct. 43. Brigham Buggy Whips Inc. has refused to accept the fact that technological developments have made horse drawn buggies obsolete and is considering building a new buggy whip outlet (most buggy whips are now sold as novelty items). Sales at the new outlet will equal $5,000 per year. However, $4,000 of these sales will be coming from a reduction of sales at Brigham's existing stores. How do these sales affect Brigham's incremental annual cash flows if Brigham's marginal tax rate is 34%? a. $ 660 annual inflow b. $1,000 annual inflow c. $2,640 annual outflow d. $3,300 annual inflow e. $5,000 annual inflow 44. Initial outlay for a new machine includes a. changes in net working capital b. installation fees c. shipping fees d. All of the above are correct. e. Both b & c are correct. Use the following information to answer Questions 45 and 46: Parker Corp. is considering the purchase of a new machine that costs $2,000,000, requires installation expenses of $100,000, and necessitates a $200,000 increase in net working capital. The new machine will generate net cash flows of $500,000 per year for five years. It will be depreciated to a zero book value over the five years and will have an estimated salvage value of $167,500. The firm's tax rate is 40 percent. 45. What is the net investment outlay (initial cost) for this machine? a. $2,300,000 b. $2,200,000 c. $2,100,000 d. $2,000,000 e. $1,900,000 46. What is the nonoperating (terminal) cash flow received at the end of Year 5? a. $100,500 b. $167,500 c. $200,500 d. $267,500 e. $300,500 14 47. Firm X is considering the replacement of an old machine with one that has a purchase price of $60,000. The current market value of the old machine is $15,000 but the book value is $22,000. The firm's tax rate for ordinary income is 30%. What is the initial outlay (net investment) for the new machine after considering the sale of the old machine? a. $47,100 b. $45,000 c. $42,900 d. $40,000 e. $38,000 48. Raymont, Inc. is considering the acquisition of a new machine costing $72,000. The machine is expected to generate income before depreciation and tax of $62,000 annually for three years and then become worthless. Straight-line depreciation is used. The firm's tax rate is 40 percent. The cost of capital is 12%. What is the annual cash flow for Raymont, Inc.? a. $22,800 b. $25,486 c. $38,000 d. $46,800 e. $82,187 V. ASSET SELECTION AND THE RISK-RETURN TRADEOFF Use the following information to answer Questions 1 and 2: You have recently constructed a portfolio containing the following stocks: Firm General Mediocrity (GM) Lemon Computers Dizzy Entertainment Investment $150 300 350 Expected Return 12.5% 11.2% 9.5% 1. The expected return on this portfolio is a. 3.4% b. 10.1% c. 10.7% d. 13.3% e. 33.2% 2. The market-related (systematic) risk of this portfolio is a. 1.08 b. 1.17 c. 3.00 d. 9.20 e. 10.10 Standard Deviation 14.5% 6.2% 9.5% Beta 1.5 1.2 0.8 15 3. Which of the following statements is (are) correct? a. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all the market risk from the portfolio. b. If you form a large portfolio of stocks each with a beta greater than 1.0, this portfolio will have more market risk than a single stock with a beta = 0.8. c. Company-specific (or unsystematic) risk can be reduced by forming a large portfolio, but normally even highly diversified portfolios are subject to market (or systematic) risk. d. Answers a, b, and c are correct. e. Answers b and c are correct. 4. What is the required return on asset A if it has a beta of 0.3, the expected return on an average stock (the market) is 14%, and the risk-free rate is 5%? a. 6.0% b. 7.2% c. 7.7% d. 8.3% e. 9.2% 5. Ace Supply Co. has $50 million of assets, is financed totally with equity capital, and has a beta coefficient of 1.2. The market currently requires a 16% rate of return on Ace's common stock. If Ace sells off its riskiest assets, the result generally will be to a. raise Ace's beta b. lower Ace's beta c. lower Ace's required rate of return d. lower Ace's beta but have no effect on Ace's required rate of return e. Both b and c are correct 6. 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 efficient) a. When held in isolation, Stock A has greater risk than Stock B. b. Stock B would be a more desirable addition to a portfolio than Stock A. c. Stock A would be a more desirable addition to a portfolio than Stock B. d. The expected return on Stock A will be greater than that on Stock B. e. The expected return on Stock B will be greater than that on Stock A. 7. Unsystematic risk a. can be diversified away b. is risk that is unique to the firm, that is, company-specific risk c. is the variability in a security's returns that is caused by such factors as management capabilities and decisions, strikes, and the efforts of foreign competition. d. generally decreases for the portfolio as an investor adds additional stocks. e. All of the above are correct. 8. Which of the following statements is (are) correct? a. The slope of the security market line is beta. b. The slope of the security market line is the market risk premium. c. If you double a company's beta, its required return more than doubles. d. Both a and c are correct. e. Both b and c are correct. 16 9. Compute the risk premium for the stock of Omega Tools Corp., assuming the risk-free rate is 6%, the expected market return is 14%, and Omega's stock has a beta of 0.8. a. 6.4% b. 8.0% c. 11.2% d. 12.4% e. 17.2% 10. If the rate of inflation is expected to rise and investors become more risk averse, then the security market line will a. shift up and become more steep b. shift up and become less steep c. shift down and become more steep d. shift down and become less steep e. shift up (The slope will not change) 11. Chalk Dust Recyclers Inc. expects to pay a dividend of $4 per share one year from today. Chalk expects to maintain this dividend forever. Chalk's beta is 0.8. What is the price of Chalk Stock if the risk free rate is 5% and the market risk premium is 6%? a. $33 b. $41 c. $44 d. $59 e. $89 The following data applies to Questions 12-14: J. Ross and Sons Inc., has a target capital structure that calls for 40 percent debt, l0 percent preferred stock, and 50 percent common equity. The firm can sell new bonds with a 10 percent coupon rate for $1,000 per bond. The firm's preferred stock currently sells for $90 per share, and it pays a dividend of $l0 per share. Common stock currently sells for $40 per share. The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow at a constant rate of l0 percent a year indefinitely. The firm's average tax rate is 32 percent, and its marginal tax rate is 40 percent. 12 What is the firm's cost of debt? a. 4.0 % b. 6.0 % c. 6.8 % d. 10.0 % e. l2.5 % 13. What is the firm's cost of common equity? a. l2.5 % b. l5.0 % c. l5.5 % d. l5.9 % e. l6.5 % 17 14. What is the firm's cost of preferred stock? a. l1.1 % b. l2.5 % c. l5.0 % d. l5.5 % e. l6.5 % 15. The cost of common equity is a. the cost of the guaranteed stated dividend. b. the opportunity cost to investors of owning common stock in the firm. c. the after-tax cost of the firm's interest obligations. d. the historical cost of issuing stock. e. None of the above 16. Robinson Electric Co. plans to finance all capital expenditures with 30 percent debt and 70 percent common equity. Robinson has the following after-tax component costs of capital: debt, 7.5%; common equity, 13.1%. If Robinson's tax rate is 40 percent, what is the firm's weighted average cost of capital (WACC)? a. 6.85% b. 10.30% c. 10.52% d. 10.93% e. 11.42% 17. Which of the following may be true concerning debt and common equity? a. The cost of debt for Firm A is greater than the cost of common equity for Firm A. b. The cost of debt for Firm A is greater than the cost of common equity for Firm B. c. The cost of debt for Firm A is less than the cost of common equity for Firm B. d. Both b and c could be true e. None of the above could be true. 18. A firm has common stock with a market price of $55 per share and expects to pay a dividend of $2.84 per share one year from today. The dividends paid on the outstanding stock over the past five years have increased from $2.00 to $2.68 per share and are expected to continue to grow at the same rate in the future. The cost of the firm's common equity is a. 4.1 percent. b. 5.1 percent. c. 11.2 percent. d. 15.4 percent. e. 17.2 percent. 19. For a given firm with a given capital structure, which of the following is generally true? (Assume ka = weighted average cost of capital; kd = after-tax cost of debt; ke = cost of common equity.) a. ke > ka > kd. b. kd > ke > ka. c. ke > kd > ka. d. ka > ke > kd. e. None of the above. 18 20. The Highlite Lamp Co. has a beta of 0.8. If the risk-free rate is 4.5% and the market risk premium is 5.0%, calculate the cost of common equity using the CAPM. a. 4.9% b. 7.6% c. 8.5% d. 8.9% e. 11.6% 21. Suppose you forgot how to calculate the weighted average cost of capital. Your boss tells you to determine which of six projects being considered for adoption by your firm should be accepted. If you use the cost of debt (after tax) as the discount rate, the effect on the appropriate project(s) to accept would be a. none, because the value of the firm will not be affected. b. possible selection of projects that have negative net present values. c. possible selection of projects that have IRR's lower than the correct weighted cost of capital. d. Both b and c are correct e. a, b and c are correct 22. Given the following information on SWHC Corporation capital structure, compute the company's weighted average cost of capital (marginal tax rate is 40%). Type of Capital Bonds Pref. Stock Common Equity a. b. c. d. e. 23. Capital Structure $40 million $10 million $50 million Before Tax Component Cost 8.0% l2.0% l7.0% 7.l percent 10.0 percent 10.6 percent 11.6 percent 11.9 percent Which of the following statements is accurate regarding capital market efficiency? a. In an efficient market, prices adjust quickly and correctly to new information. b. Asset prices in an efficient market are usually too high or too low. c. When stock prices move in an overreaction and correction pattern as a result of the release of new information, the market for this market for this stock is said to be efficient. d. A market is efficient if the price is quoted in the Wall Street Journal. 19 Solutions 20 Section I 1. d 2. a Section II 1. d Section III 1. d 2. b 3. d 4. a 5. d 6. d 7. b 8. e 9. c Section IV 1. d 2. c 3. b 4. d 5. c 6. e 7. b 8. d 9. b 10. b 11. d 12. b 13. b 14. b 15. b 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. e b c c d c d a e b a a e e c a d c c d a c d d b e a a d a e c d Section V 1. c 2. a 3. e 4. c 5. e 6. d 7. e 8. b 9. a 10. a 11. b 12. b 13. c 14. a 15. b 16. e 17. d 18. c 19. a 20. c 21. d 22. d 23. a Section VI 1. e 2. a 3. a 4. b 5. c 6. c 21