Question

PRINCIPLE OF CORPORATE FINANCE

9.      The risk-free rate is 5%, the market risk premium is 8%, and the market return is 13%. Stock Y's beta is 1.85 and the standard deviation of its returns is 62.5%. What should be the stock's expected rate of return to make the investor indifferent toward buying or selling the stock?

a)      11.66%

b)      12.50%

c)      15.54%

d)      19.80%

10. The expected rate of return of an investment _____.

a)      is the median value of the probability distribution of possible returns

b)      equals the required rate of return for the investment

c)      is the mean value of the probability distribution of possible returns

d)      equals the required rate of return for the investment

11. When the market value of debt is the same as its face value, it is said to be selling at the:

a)      discounted value.

b)      maturity value.

c)      par value.

d)      yield value.

12. Tony's Pizzeria plans to issue bonds with a par value of $1,000 and 10 years to maturity. These bonds will pay $45 interest every 6 months. Current market conditions are such that the bonds will be sold at net $937.79. What is the yield to maturity (YTM) of the issue as a broker would quote it to an investor? (Round the answer to the nearest whole number.)

a)      9%

b)      11%8%

c)      10%

13. Everything else equal, an asset's value is directly related to

a)      the cash flow the asset is expected to generate.

b)      the risk associated with the investment in that asset.

c)      the rate of return that the firm must earn to satisfy investors' demands.

d)      the cost of raising additional capital.

14. Which of the following is the only risk that is relevant to a rational, diversified investor?

a)      Unsystematic risk

b)      Market risk

c)      Diversifiable risk

15. Risk is indicated by variability, whether the variability is considered positive or negative. Both the positive and negative outcomes must be evaluated when considering risk.

a)      true

b)      false

16. The Beta coefficient is a measure of_______

a)      Systematic risk

b)      Unsystematic risk

c)      Diversifiable risk

17. The value that represents the firm’s average cost of funds, which is the average return required by firm’s investors is known as:

a)      The cost of capital

b)      The required rate of return of the firm

c)      The weighted average cost of capital (WACC)

d)      All of the above

18. A $1,000 par value bond pays interest of $35 each quarter and will mature in 10 years. If an investor's simple annual required rate of return is 12 percent with quarterly compounding, how much should the investor be willing to pay for this bond? (Round the answer to two decimal places.)

19. Assume that a 15-year, $1,000 face value bond pays interest of $37.50 every 3 months. If an investor requires a simple annual rate of return of 12 percent with quarterly compounding, how much should the investor be willing to pay for this bond? (Round the answer to two decimal places.)

20. Devine Divots issued a bond a few years ago. The bond has a face value equal to $1,000 and pays investors $30 interest every six months. The bond has eight years remaining until maturity. If an investor requires a 7 percent rate of return to invest in this bond, what is the maximum price the investor should be willing to pay to purchase the bond? (Round the answer to two decimal places.)

21. You recently purchased a stock for $25 that produces a 10% rate of return. You expect dividends of $3 every year for the next 5 years. What is the present value of the stock?

22. Your broker offers to sell you some shares of Winglet & Company common stock, which paid a dividend of $2 yesterday. You expect the dividend to grow at a rate of 5 percent per year into perpetuity. Given that the appropriate discount rate is 12 percent, what is the market value of Winglet’s stock?

23. Snyder Computer Chips, Inc. is experiencing a period of rapid growth. Earnings and dividends are expected to grow at a rate of 15 percent during the next two years, at 13 percent in the third year, and at a constant rate of 6 percent thereafter. Snyder’s last dividend was $1.15, and the required rate of return on the stock is 12 percent. Calculate the current stock price.

24. Super Solutions Inc. is a constant growth firm, which just paid a dividend of $3.00, sells for $33.00 per share, and has a growth rate of 6 percent. Which of the following is the cost of retained earnings using the discounted cash flow (DCF) approach? (Round off the answer to two decimal places.)

25. Brother’s and Sister’s Inc. has a capitalization structure of $5 million in long-term debt at a 5% interest rate, and $45 million in common equity at a 10% ROE. Calculate the weighted cost of capital (WACC) for this company.

Answer 1

9) risk-free rate = rf = 5%

market risk premium , m = 8%

market return , rm = 13%

beta of stock Y , b = 1.85

standard deviation of Y , s1 = 62.5%

expected rate of return = rf + (b*m) = 5 + (1.85*8) = 19.80%

hence the correct option is d) 19.80%

10) The correct option is

c) is the mean value of the probability distribution of possible returns

11) When the market value of debt is the same as its face value, it is said to be selling at the:

c) par value

12)

maturity of the bond, m = 10

no. of semi-annual periods = 2*m = 2*10 = 20

par value of the bond,M = $1000

Coupon value ,C = $45 ( semi-annual)

current price of the bond, P = $937.79

Semi-annual YTM = (C + (M - P )/n)/(0.4*M+0.6*P) = (45 + (1000 - 937.79 )/20)/(0.4*1000+0.6*937.79)

= 48.1105 / 962.674 = 0.0499759 = 4.99759% ( per half year /semi annual )

This is an approximate value of YTM,

annual YTM = semi-annual YTM *2 = 2*4.99759 = 0.0999518 or 9.99518% or 10% ( rounding off to 2 decimal places)

hence correct option is c) 10.00%

13. Everything else equal, an asset's value is directly related to

a) the cash flow the asset is expected to generate.