Question

You have an opportunity to invest in a deal that will make yearly payments forever. These payments will grow at a rate of 5% per year. You will receive your first payment of 8,000 one year from today. Due to the risks associated with this investment, you will require a return of 15%. How much are you willing to pay for this deal today?

Select one:

a. 85,000

b. 87,500

c. 80,000

d. 100,000

The firm makes no use of debt and is entirely financed by common stock with a beta of 2. The expected return on the market portfolio is 10% and the risk-free rate is 3%. The required rate of return is

Select one:

a. 16%

b. 10%

c. 17%

d. 15%

Ideally, weights in the WACC formula should be determined using

Select one:

a. book value of equity and market value of debt

b. market value of equity and market value of debt

c. market value of equity and book value of debt

d. book value of equity and book value of debt

Generally, you would expect the beta of debt for a firm to be

Select one:

a. The same as the equity beta

b. Near zero

c. Negative

d. A percentage of the equity beta based on the firm’s capital structure

This type of risk is avoidable through proper diversification

Select one:

a. portfolio risk

b. total risk

c. unsystematic risk

d. systematic risk

An "aggressive" common stock would have a "beta"

Select one:

a. less than one

b. equal to zero

c. greater than one

d. equal to one

The risk-free security has a beta equal to                     , while the market portfolio's beta is equal to                     

Select one:

a. zero; one

b. less than zero; more than zero

c. one; more than one

d. one; less than one

In 10 years you are to receive $50,000. If the interest rate were to suddenly decrease, the present value of that future amount to you would

Select one:

a. cannot be determined without more information

b. fall

c. rise

d. remain unchanged

Market risk is also called

Select one:

a. non-diversifiable and systematic risk

b. systematic risk and diversifiable risk

c. systematic risk and unique risk

d. unique risk and non-diversifiable risk

Shareholder wealth in a firm is represented by

Select one:

a. the market price per share of the firm's common stock

b. the book value of the firm's assets less the book value of its liabilities

c. the amount of salary paid to its employees

d. the number of people employed in the firm

Answer 1

Q. 1). Answer :- Option c). $ 80,000.

Explanation :- Amount to be paid now for investing in deal = Amount to receive one year later / (Required return - Growth rate in payment receipt)

= 8000 / (0.15 - 0.05)

= 8000 / 0.10

= $ 80,000 (Option c).

Q. 2). Answer :- Option c). 17 %

Explanation :- Required rate of return = Risk free return + Beta of common stock * (Market return - Risk free return).

= 3 % + 2 * (10 % - 3 %)

= 3 % + 2 * 7 %

= 3 % + 14 %

= 17 %. (Option c).

Q. 3). Answer :- Option b). Market value of equity and market value of debt.

Explanation :- In the weighted average cost of capital (WACC) formula,

Weight of equity = Market value of equity / (Market value of equity + Market value of debt).

Weight of debt = Market value of debt / (Market value of equity + Market value of debt).

Q. 4). Answer :- Option b). Near zero.

Explanation :- Beta of debt (B_d) of firm is generally treated to be approx (or near to) 0 only.

Q. 5). Answer :- Option c). Unsystematic risk.

Explanation :- Unsystematic risk refers to risk unique to a particular company or industry. It is avoidable through diversification. This is the risk of price change due to the unique circumstances of a specified security as opposed to the overall market. This risk can be virtually eliminated from investor's portfolio through diversification.

Q. 6). Answer :- Option c). greater than one.

Explanation :- Beta of aggressive common stock is generally greater than one only.

Q. 7). Answer :- Option a). Zero ; One.

Explanation :- Risk free asset does not carry any risk, therefore, the beta of risk free asset is 0. The beta of market portfolio is always treated as one only.