Question 1
1. Which of the following statements is incorrect?

a. The slope of the security market line is measured by beta.

b. Two securities with the same stand-alone risk can have different betas.

c. Company-specific risk can be diversified away.

d. The market risk premium is affected by attitudes about risk.

e. Higher beta stocks have a higher required return.

1 points
Question 2
1. Which of the following statements is CORRECT?

The WACC as used in capital budgeting is an estimate of a company’s before-tax cost of capital.

The percentage flotation cost associated with issuing new common equity is typically smaller than the flotation cost for new debt.

The WACC as used in capital budgeting is an estimate of the cost of all the capital a company has raised to acquire its assets.

There is an “opportunity cost” associated with using retained earnings, hence they are not “free.”

The WACC as used in capital budgeting would be simply the after-tax cost of debt if the firm plans to use only debt to finance its capital budget during the coming year.
1 points
Question 3
1. You were recently hired by Scheuer Media Inc. to estimate its cost of capital. You obtained the following data: D1 = $1.75; P0 = $95.00; g = 7.00% (constant); and F = 5.00%. What is the cost of equity raised by selling new common stock?

11.08%

8.49%

9.21%

8.94%

6.97%
1 points
Question 4
1. Your company’s stock sells for $50 per share, its last dividend (D0) was $2.00, its growth rate is a constant 5 percent, and the company will incur a flotation cost of 15 percent if it sells new common stock. What is the firm’s cost of new equity?

a. 9.20%

b. 9.94%

c. 10.50%

d. 11.75%

e. 12.30%

1 points
Question 5
1. Which of the following statements is most correct?

a. The WACC measures the after-tax cost of capital.

b. The WACC measures the marginal cost of capital.

c. There is no cost associated with using retained earnings.

d. Statements a and b are correct.

e. All of the statements above are correct.

1 points
Question 6
1. A stock has an expected return of 12.25 percent. The beta of the stock is 1.15 and the risk-free rate is 5 percent. What is the market risk premium?

a. 1.30%

b. 6.50%

c. 15.00%

d. 6.30%

e. 7.25%

1 points
Question 7
1. You were hired as a consultant to Giambono Company, whose target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 13.00%. The firm will not be issuing any new stock. What is its WACC?

9.38%

11.44%

9.19%

7.22%

10.22%
1 points
Question 8
1. Which of the following statements is CORRECT?

When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are deductible by the paying corporation.

All else equal, an increase in a company’s stock price will increase its marginal cost of retained earnings, rs.

All else equal, an increase in a company’s stock price will increase its marginal cost of new common equity, re.

Since the money is readily available, the after-tax cost of retained earnings is usually much lower than the after-tax cost of debt.

If a company’s tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall.
1 points
Question 9
1. You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio’s beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.75. What will the portfolio’s new beta be?

1.197

1.325

1.023

1.163

0.895
1 points
Question 10
1. A company’s perpetual preferred stock currently sells for $115.00 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm’s cost of preferred stock?

7.32%

5.93%

6.08%

6.00%

7.18%
1 points
Question 11
1. Which of the following statements is most correct?

a. Higher flotation costs reduce investor returns, and therefore reduce a company’s WACC.

b. The WACC represents the historical cost of capital and is usually calculated on a before-tax basis.

c. The cost of retained earnings is zero because retained earnings are readily available and do not require the payment of flotation costs.

d. All of the statements above are correct.

e. None of the statements above is correct.

1 points
Question 12
1. Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?

If a stock has a negative beta, its required return under the CAPM would be less than 5%.

If a stock’s beta doubled, its required return under the CAPM would also double.

If a stock’s beta doubled, its required return under the CAPM would more than double.

If a stock’s beta were 1.0, its required return under the CAPM would be 5%.

If a stock’s beta were less than 1.0, its required return under the CAPM would be less than 5%.
1 points
Question 13
1. Mulherin’s stock has a beta of 1.23, its required return is 9.50%, and the risk-free rate is 2.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

9.87%

8.40%

8.15%

8.72%

8.32%
1 points
Question 14
1. Which of the following statements is CORRECT?

When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.

Portfolio diversification reduces the variability of returns on an individual stock.

Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events.

The SML relates a stock’s required return to its market risk. The slope and intercept of this line cannot be controlled by the firms’ managers, but managers can influence their firms’ positions on the line by such actions as changing the firm’s capital structure or the type of assets it employs.

A stock with a beta of -1.0 has zero market risk if held in a 1-stock portfolio.
1 points
Question 15
1. For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.

rs > re > rd > WACC.

re > rs > WACC > rd.

WACC > re > rs > rd.

rd > re > rs > WACC.

WACC > rd > rs > re.
1 points
Question 16
1. Inflation, recession, and high interest rates are economic events that are best characterized as being

systematic risk factors that can be diversified away.

company-specific risk factors that can be diversified away.

among the factors that are responsible for market risk.

risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers.

irrelevant except to governmental authorities like the Federal Reserve.
1 points
Question 17
1. Which of the following statements is most correct about a stock that has a beta = 1.2?

a. If the stock’s beta doubles its expected return will double.

b. If expected inflation increases 3 percent, the stock’s expected return will increase by 3 percent.

c. If the market risk premium increases by 3 percent the stock’s expected return will increase by less than 3 percent.

d. All of the statements above are correct.

e. Statements b and c are correct.

1 points
Question 18
1. Which of the following statements is CORRECT?

A stock’s beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.

If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless.

The required return on a firm’s common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm’s required return.

Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio.

A security’s beta measures its non-diversifiable, or market, risk relative to that of an average stock.
1 points
Question 19
1. Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.

The effect of a change in the market risk premium depends on the slope of the yield curve.

If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.

If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.

The effect of a change in the market risk premium depends on the level of the risk-free rate.
1 points
Question 20
1. Which of the following statements is CORRECT?

In the WACC calculation, we must adjust the cost of preferred stock (the market yield) to reflect the fact that 70% of the dividends received by corporate investors are excluded from their taxable income.

We should use historical measures of the component costs from prior financings that are still outstanding when estimating a company’s WACC for capital budgeting purposes.

The cost of new equity (re) could possibly be lower than the cost of retained earnings (rs) if the market risk premium, risk-free rate, and the company’s beta all decline by a sufficiently large amount.

Its cost of retained earnings is the rate of return stockholders require on a firm’s common stock.

The component cost of preferred stock is expressed as rp(1 – T), because preferred stock dividends are treated as fixed charges, similar to the treatment of interest on debt.