QUESTION 26

....................... Standard Deviation ......... Beta

Security X .............. 0.35 ........................ 1.45

Security Y .............. 0.28 ........................ 1.06

Security Z .............. 0.44 ......................... 1.22

.

Which security has the greatest expected return?

.

	A.	Y because it has the lowest standard deviation.
	B.	X because it has the largest beta coefficient.
	C.	Z because it has the highest ratio of standard deviation to beta.
	D.	Y because it has the lowest beta coefficient, and therefore the lowest systematic risk.
	E.	It is not possible to tell given the information above.

3 points

QUESTION 27

Beta measure indicates:

.

		The ability to diversify risk
		The change in the rate of return on an investment for a given change in the market return
		The actual return on an asset
		A and C

3 points

QUESTION 28

If a firm uses the same company cost of capital for evaluating all projects, which of the following is likely?

.

	A.	Accepting poor low risk projects.
	B.	Accepting poor high risk projects.
	C.	Accepting good high risk projects.
	D.	Both A and C

3 points

QUESTION 29

What is the best measure of risk for an asset hold in isolation? What is the best measure of risk for an asset in a well diversified portfolio? Assume investors have homogeneous expectations and so all investors hold the market portfolio.

.

	A.	Beta; variance
	B.	Correlation coefficient; variance
	C.	Beta; correlation coefficient
	D.	Beta; beta
	E.	Standard deviation; beta

3 points

QUESTION 30

According to the Capital Asset Pricing Model, the introduction of a risk-free asset renders the efficient frontier of efficient portfolios linear. How many portfolios of risky assets (portfolios of only risky assets) lie on the resulting Capital Market Line?

.

	A.	Two portfolios of risky assets lie on the Capital Market Line.
	B.	One portfolio of risky assets lies on the Capital Market Line.
	C.	ALL portfolios of risky assets must lie on the Capital Market Line.
	D.	The number cannot be determined.

3 points

QUESTION 31

If the beta of Exxon Mobil is 0.4, the risk-free rate is 5.5%, and the market rate of return is 13.5%, calculate the expected rate of return for Exxon Mobll.

.

	A.	12.6%
	B.	15.6%
	C.	13.9%
	D.	8.7%

3 points

QUESTION 32

The beta of a firm is likely to be high under what two conditions?

.

	A.	High cyclical business activity and low operating leverage.
	B.	High cyclical business activity and high operating leverage.
	C.	Low cyclical business activity and low financial leverage.
	D.	Low cyclical business activity and low operating leverage.
	E.	None of the above.

3 points

QUESTION 33

Comparing two otherwise equal firms, the beta of the common stock of a levered firm is ___________ than the beta of the common stock of an unlevered firm.

.

	A.	equal to
	B.	significantly less than
	C.	slightly less than
	D.	greater than
	E.	none of the above

3 points

QUESTION 34

Currently the risk-free rate is 6% and the expected return on the market portfolio is 11%, the expected return for 3 stocks as priced in the market are listed below with their estimate of beta.

.

Stock ... Expected Return ..... Beta

X .................... 14% .............. 1.5

Y .................... 12% .............. 2.0

Z .................... 10% .............. 0.8

.

Which of these stocks is underpriced?

.

	A.	X
	B.	Y
	C.	Z
	D.	None, they are all fairly priced.
	E.	None, they are all over priced.

3 points

QUESTION 35

The following applies to questions 35 and 36

.

A privately hold corporation wishes to estimate its cost of equity. The firm has a target debt-to-equity ratio of 0.5 and the marginal tax rate is 35%. The yield on 10 year U.S. Treasury securities is 4% and the expected market risk premium is 6%. It has identified 3 pure play firms with the following equity betas and debt-to-equity rations:

.

Firm .......... Beta ........ D/E Ratio

A ............... 1.8 ............ 0.6

B ............... 1.2 ............ 0.4

C .............. 2.1 ............ 0.8

.

What is the firm's estimated equity beta (levered beta)?

.

	A.	1.60
	B.	1.40
	C.	1.21
	D.	1.70
	E.	1.51

3 points

QUESTION 36

The following applies to questions 35 and 36

.

A privately hold corporation wishes to estimate its cost of equity. The firm has a target debt-to-equity ratio of 0.5 and the marginal tax rate is 35%. The yield on 10 year U.S. Treasury securities is 4% and the expected market risk premium is 6%. It has identified 3 pure play firms with the following equity betas and debt-to-equity rations:

.

Firm ......... Beta ........... D/E Ratio

A ............... 1.8 ............ 0.6

B ............... 1.2 ............ 0.4

C .............. 2.1 ............ 0.8

.

What is the cost of equity for the privately held firm?

.

	A.	18.06%
	B.	14.2%
	C.	11.26%
	D.	12.4%
	E.	13.6%

3 points

QUESTION 37

Jacks Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding 8.5%. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. Treasury bill is yielding 4% and the market risk premium is 8%. Jacks tax rate is 35%. What is Jacks weighted average cost of capital?

.

	A.	7.10 %
	B.	7.39 %
	C.	10.38 %
	D.	11.37 %
	E.	11.87 %

3 points

QUESTION 38

Which of the following describes a portfolio that plots above the security market line?

.

	A.	The security is overvalued.
	B.	The security is undervalued.
	C.	The security is providing a return that is less than expected.
	D.	The securitys beta is too high.
	E.	The security provides a return that is less than the average return on the market.

3 points

QUESTION 39

Conducting scenario analysis helps managers see the:

.

	A.	impact of an individual variable on the outcome of a project.
	B.	potential range of outcomes from a proposed project.
	C.	changes in long-term debt over the course of a proposed project.
	D.	possible range of market prices for their firms stock over the life of a project.

3 points

QUESTION 40

As the degree of sensitivity of a project to a single variable rises, the:

.

	A.	lower the forecasting risk of the project.
	B.	smaller the range of possible outcomes given a pre-defined range of values for the input.
	C.	more attention management should place on accurately forecasting the future value of that variable.
	D.	lower the maximum potential value of the project.

3 points

QUESTION 41

The present value (financial) break-even point is superior to the accounting break-even point because:

.

	A.	present value break-even is more complicated to calculate.
	B.	present value break-even covers the economic opportunity costs of the investment; the accounting break-even does not cover the economic opportunity costs of the investment.
	C.	present value break-even is the same as sensitivity analysis.
	D.	present value break-even covers the variable costs of production, which the accounting break-even does not.

3 points

QUESTION 42

Calculate the present value break-even point (also called the financial break-even point).

.

Initial Investment: $700

Fixed Cost: $200 per year

Variable Cost: $3 per unit

Depreciation: $140 per year

Price: $8 per unit

Discount Rate: 12%

Project Life: 3 years

Tax Rate: 34%

.

	A.	68 units per year
	B.	75 units per year
	C.	84 units per year
	D.	114 units per year
	E.	None of the Above

3 points

QUESTION 43

Legion, Inc. is a small high tech firm whose stock trades on the NASDAQ. You want to estimate the stock's beta using a regression based on the empirical market line. That requires regressing the stock's returns against the contemporaneous returns on a market index. You will use the beta to estimate the stock's expected return using the CAPM. Which of the following would be your best choice for a market index in the regression?

.

	A.	an industry index of high tech firms
	B.	Nasdaq market index because Legion, Inc is a small firm.
	C.	SP 500 Index, five hundred largest firms traded on the NYSE
	D.	Wiltshire 5000 Index, a total market index.

3 points

QUESTION 44

A firm is financing its growth with retained earnings. It is retaining 80 percent of its annual earnings. The firm's historic return on equity is 16 percent, a figure that is expected to continue into the future. How much will earnings grow over the year?

.

	A.	16%
	B.	3.2%
	C.	21.4%
	D.	12.8%

3 points

QUESTION 45

A firm is investing retained earnings in investments earning positive returns. As a result of these investments, earnings-per-share is growing. Can we assume that common stock prices are also increasing as a result of these investments?

.

	A.	Yes, because higher earnings translates into higher dividends and, therefore, higher stock prices.
	B.	No, earnings will always grow if investment earns a positive return. But, investments will create shareholder value only if their returns are greater than their opportunity costs of capital.