1.Walter Industries’ current ratio is 0.5. Considered alone, which of the following actions would increase the company’s current ratio?
a. Borrow using short-term notes payable and use the cash to increase inventories.
b. Use cash to reduce accruals.
c. Use cash to reduce accounts payable.
d. Use cash to reduce short-term notes payable.
e. Use cash to reduce long-term bonds outstanding
2. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?
a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.
b. The discount rate increases.
c. The riskiness of the investment’s cash flows decreases.
d. The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.
e. The discount rate decreases.
3. Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)
a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years.
b. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant.
c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.
d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year.
e. The outstanding balance declines at a slower rate in the later years of the loan’s life.
4. Which of the following statements is CORRECT?
a. If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.
b. Liquidity premiums are generally higher on Treasury than corporate bonds.
c. The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.
d. Default risk premiums are generally lower on corporate than on Treasury bonds.
e. Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.
5. Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25%. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is 0.6. Portfolio P has 50% invested in Stock A and 50% invested in B. Which of the following statements is CORRECT?
a. Portfolio P has a standard deviation of 25% and a beta of 1.0.
b. Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium.
c. Portfolio P has more market risk than Stock A but less market risk than B.
d. Stock A should have a higher expected return than Stock B as viewed by the marginal investor.
e. Portfolio P has a coefficient of variation equal to 2.5.
6. Stock A has a beta of 1.2 and a standard deviation of 25%. Stock B has a beta of 1.4 and a standard deviation of 20%. Portfolio AB was created by investing in a combination of Stocks A and B. Portfolio AB has a beta of 1.25 and a standard deviation of 18%. Which of the following statements is CORRECT?
a. Stock A has more market risk than Portfolio AB.
b. Stock A has more market risk than Stock B but less stand-alone risk.
c. Portfolio AB has more money invested in Stock A than in Stock B.
d. Portfolio AB has the same amount of money invested in each of the two stocks.
e. Portfolio AB has more money invested in Stock B than in Stock A.
7. Which of the following statements is CORRECT?
a. If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor’s standpoint, assuming the investor’s only asset is one or the other of the mutual funds.
b. If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change.
c. An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk.
d. There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML.
e. Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.
8. Savickas Petroleum’s stock has a required return of 12%, and the stock sells for $40 per share. The firm just paid a dividend of $1.00, and the dividend is expected to grow by 30% per year for the next 4 years, so D4 = $1.00(1.30)4 = $2.8561. After t = 4, the dividend is expected to grow at a constant rate of X% per year forever. What is the stock’s expected constant growth rate after t = 4, i.e., what is X?
9. Stock X has the following data. Assuming the stock market is efficient and the stock is in equilibrium, which of the following statements is CORRECT?
Expected dividend, D0 $3.00
Current price $50
Expected constant growth rate 6%
a. The stock’s required return is 10%
b. The stock’s expected dividend yield and growth rate are equal.
c. The stock’s expected dividend yield is 5%.
d. The stock’s expected capital gains yield is 5%.
e. The stock’s expected price 10 years from now is $100.00.
10. Which of the following statements is CORRECT?
a. Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity.
b. The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes.
c. If a company assigns the same cost of capital to all of its projects regardless of each project’s risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.
d. Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt.
e. Higher flotation costs tend to reduce the cost of equity capital.
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