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FRL 301 Part 1 and 2 Exam With Correct
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A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment?
A. Dividend Yield B. Cost of Equity C. Capital Gains Yield D. Cost of Capital E. Income Return - ANSWER B. Cost of Equity
Textile Mills borrows money at a rate of 13.5%. This interest rate is referred to as..
A. compound rate B. current yield C. cost of debt D. capital gains yield E. cost of capital - ANSWER C. Cost of Debt
The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the:
A. reward to risk ratio B. weighted capital gains rate
C. structured cost of capital D. subjective cost of capital E. weighted average cost of capital - ANSWER E. weighted average cost of capital
When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project, the manager is utilizing the _______ approach.
A. subjective risk B. pure play C. divisional cost of capital D. capital adjustment E. security market line - ANSWER B. Pure play
A firm's cost of capital:
A. will decrease as the risk level of the firm increases. B. for a specific project is primarily dependent upon the source of the funds used for the project. C. is independent of the firm's capital structure. D. should be applied as the discount rate for any project considered by the firm. E. depends upon how the funds raised are going to be spent. - ANSWER E. depends upon how the funds raised are going to be spent.
The weighted average cost of capital for a wholesaler:
A. is equivalent to the after-tax cost of the firm's liabilities. B. should be used as the required return when analyzing a potential acquisition of a retail outlet.
B. an increase in the dividend amount. C. a reduction in the market rate of return. D. a reduction in the firm's beta. E. a reduction in the risk-free rate. - ANSWER E. a reduction in the risk-free rate.
A firm's overall cost of equity is:
A. is generally less than the firm's WACC given a leveraged firm. B. unaffected by changes in the market risk premium. C. highly dependent upon the growth rate and risk level of the firm. D. generally less than the firm's after-tax cost of debt. E. inversely related to changes in the firm's tax rate. - ANSWER C. highly dependent upon the growth rate and risk level of the firm.
The cost of equity for a firm:
A. tends to remain static for firms with increasing levels of risk. B. increases as the unsystematic risk of the firm increases. C. ignores the firm's risks when the cost is based on the dividend growth model. D. equals the risk-free rate plus the market risk premium. E. equals the firm's pretax weighted average cost of capital. - ANSWER C. ignores the firm's risks when that cost is based on the dividend growth model.
The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations?
I. firms that have a 100% retention ratio. II. firms that pay a constant dividend.
III. firms that pay an increasing dividend. IV. firms that pay a decreasing dividend.
A. I and II only B. I and III only C. II and III only D. I, II, and III only E. II, III, and IV only - ANSWER E. II, III, and IV only.
The dividend growth model:
A. is only as reliable as the estimated rate of growth B. can only be used if historical dividend information is available. C. considers the risk that future dividends may vary from their estimated values. D. applies only when a firm is currently paying dividends. E. uses beta to measure the systematic risk of a firm. - ANSWER A. is only as reliable as the estimated rate of growth.
Which one of the following statements related to the SML approach to equity valuation is correct. Assume the firm uses debt in its capital structure.
A. the model considers a firm's rate of growth. B. The model applies only to non-dividend paying firms. C. the model is dependent upon a reliable estimate of the market risk premium. D. the model generally produces the same cost of equity as the dividend growth model. E. this approach generally produces a cost of equity that equals the firm's overall cost of capital. - ANSWER C. the model is dependent upon a reliable estimate of the market risk premium.
IV. bond prices rise.
A. I and III only B. II and III only C. I, II, and III only D. II, III, and IV only E. I, II, III, and IV - ANSWER B. II and III only
The cost of preferred stock is computed the same as the:
A. pre-tax cost of debt B. return on annuity C. aftertax cost of a debt D. return on a perpetuity E. cost of an irregular growth common stock - ANSWER D. return on a perpetuity
The cost of preferred stock: A. is equal to the dividend yield. B. is equal to the yield to maturity. C. is highly dependent on the dividend growth rate D. is independent of the stock's price. E. decreases when tax rates increase. - ANSWER A. is equal to the dividend yield.
The capital structure weights used in computing the weighted average cost of capital:
A. are based on the book values of total debt and total equity. B. are based on the market value of the firm's debt and equity securities.
C. are computed using the book value of the long-term debt and the book value of equity. D. remain constant over time unless the firm issues new securities. E. are restricted to the firm's debt and common stock. - ANSWER B. are based on the market value of the firm's debt and equity securities.
Morris Industries has a capital structure of 55% common stock, 10 percent preferred stock, and 45% debt. The firm has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38%. Given this, which one of the following statements is correct?
A. The after-tax cost of debt will be greater than the current yield-to-maturity on the firm's bonds. B. The firm's cost of equity is unaffected by a change in the firm's tax rate. C. The firm's cost of equity is unaffected by a change in the firm's tax rate. D. The cost of equity can only be estimated using the SML approach. E. The firm's weighted average cost of capital will remain constant as long as the capital structure remains constant. - ANSWER C. The firm's cost of equity in unaffected by a change in the firm's tax rate.
The after-tax cost of debt: A. varies inversely to changes in market interest rates. B. will generally exceed the cost of equity if the relevant tax rate is zero. C. will generally equal the cost of preferred if the tax rate is zero. D. is unaffected by changes in the market rate of interest. E. has a greater effect on a firm's cost of capital when the debt-equity ratio increases. - ANSWER E. has a greater effect on a firm's cost of capital when the debt-equity ratio increases.
The weighted average cost of capital for a firm may be dependent upon the firm's:
I. rate of growth
the number of shares outstanding multiplied by the book value per share. E. The WACC will remain constant unless a firm retires some of its debt. - ANSWER A. The WACC should decrease as the firm's debt-equity ratio increases.
If a firm uses its WACC as the discount rate for all the projects it undertakes then the firm will tend to:
I. reject some positive net present value projects. II. accept some negative net present value projects. III. favor high risk projects over low risk projects. IV. increase its overall level of risk over time.
A. I and III only. B. III and IV only. C. I, II, and III only. D. I, II, and IV only. E. I, II, III, and IV. - ANSWER E. I, II, III, and IV.
Peterson industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 70% of the firm's overall sales. Division A is also riskier of the two divisions. Division B is the smaller and least risky of the two. When management is deciding which of the various divisional projects should be accepted, the managers should:
A. allocate more funds to Division A since it is the largest of the two divisions. B. fund all of Division B's projects first since they tend to be less risky and then allocate the remaining funds to Division A projects that have the highest net present values. C. allocate the company's funds to the projects with the highest net present values based on the firm's weighted average cost of capital. D. assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.
E - ANSWER D. assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.
Markley and Stearns is a multi-divisional firm that used its WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to:
A. receive less funding if its line of business is riskier than that of the other divisions. B. avoid risky projects so it can receive more project funding. C. become less risky over time based on the projects that are accepted. D. have equal probability of receiving funding as compared to the other divisions. E. prefer higher risk projects over lower risk projects. - ANSWER E. prefer higher risk projects over lower risk projects.
The discount rate assigned to an individual project should be based on:
A. the firm's weighted average cost of capital. B. the actual sources of funding used for the project. C. an average of the firm's overall cost of capital for the past five years. D. the current risk level of the overall firm. E. the risks associated with the use of the funds required by the project. - ANSWER E. the risks associated with the use of the funds required by the project.
Assigning discount rates to individual projects based on the risk level of each project:
A. may cause the firm's overall weighted average cost of capital to either increase or decreased over time. B. will prevent the firm's overall cost of capital from changing over time. C. will cause the firm's overall cost of capital to decrease over time.
Wilderness Adventures specialized in back-country tours and resort management. Travel Excitement specializes in making travel reservations and promoting vacation travel. Wilderness Adventures has an aftertax cost of capital of 13 percent and Travel Excitement has an aftertax cost of capital of 11 percent. Both firms are considering building wilderness campgrounds complete with man-made lakes and hiking trails. The estimated net present value of such a project is estimates at $87,000 at a discount rate of 11 percent and -$12,500 at a 13 percent discount rate. Which firm or firms, if either, should accept this project?
A. Wilderness Adventures only. B. Travel Excitement only. C. Both Wilderness Adventures and Travel Excitement. D. Neither Wilderness nor Travel. E. Cannot be determined without further information. - ANSWER D. Neither Wilderness nor Travel.
The subjective approach to project analysis:
A. is used only when a firm has an all-equity capital structure. B. uses the WACC of firm X as the basis for the discount rate for a project under consideration by firm Y. C. assigns discount rates to projects based on the discretion of their senior managers of a firm. D. allows managers to randomly adjust the discount rate assigned to a project once the project's beta has been determined. E. applies a lower discount rate to projects that are financed totally with equity as compared to those that are partially financed with debt. - ANSWER C. assigns discount rates to projects based on the discretion of the senior managers of a firm.
Which one of the following statements is correct?
A. The subjective approach assesses the risks of each project and assigns an adjustment factor that is unique just for that project.
B. Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects. C. Firms will correctly accept or reject every project if they adopt the subjective approach. D. Mandatory projects should only be accepted if they produce a positive NPV when the firm's WACC is used as the discount rate. E. The pure play approach should only be used with low-risk projects. - ANSWER B. Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.
When a firm has flotation costs equal to 7 percent of the funding need, project and analysts should:
A. increase the project's discount rate to offset these expenses by multiplying the firm's WACC by 1.07. B. increase the project's discount rate to offset these expenses by dividing the firm's WACC by (1-0.07). C. add 7 perept to the firm's WACC to get the discount rate for the project. D. increase the initial project cost by multiplying that cost by 1. E. increase the initial project cost by dividing that cost by (1-0.07). - ANSWER E. increase the initial project cost by dividing that cost by (1-0.07).
The flotation cost for a firm is computed as:
A. The arithmetic average of the flotation costs of both debt and equity. B. The weighted average of the flotation costs associated with each form of financing. C. The geometric average of the flotation costs associated with each form of financing. D. one-half of the flotation costs of debt plus one half of the flotation cost of equity. E. a weighted average based on the book values of the firm's debt and equity. - ANSWER B. The weighted average of the flotation costs associated with each form of financing.
Re = ($0.80/$22.40) + .05 = 8.57%
The Shoe Outlet has paid annual dividends of $0.65, $0.70, $0.72, and $0.75 per share over the last four years, respectively. The stock is currently selling for $26 a share. What is the firm's cost of equity?
A. 7.56 percent B. 7.93 percent C. 10.38 percent D. 10.53 percent E. 11.79 - ANSWER B. 7.93 percent
g= (0.076923 + 0.028571 + 0.041667)/3 =.
Re= [($0.75 x 1.049054)/$26] + .049054 = 7.93 percent
Sweet Treats common stock is currently priced at $19.06 a share. The company just paid $1.15 per share as its annual dividend. The dividends have been increasing by 2. percent annually and are expected to continue doing the same. What is the firm's cost of equity?
A. 6.03 percent B. 6.18 percent C. 8.47 percent
D. 8.68 percent E. 8.82 percent - ANSWER D. 8.68 percent
e = [($1.15 x 1.025)/$19.06] + 0.025 = 8.
The common stock of Metal Molds has a negative growth rate of 1.5 percent and a required return of 18 percent. The current stock price is $11.40. What was the amount of the last dividend paid?
A. $2. B. $2. C. $2. D. $2. E. $2.26 - ANSWER E. $2.
D1= [(0.18 - (-0.015)) x $11.40] = $2.
D0= $2.223/(1 - 0.015) = $2.
Highway Express has just paid annual dividends of $1.16, $1.20, $1.25, $1.10, and $0. over the past 5 years respectively. What is the average dividend growth rate?
A. -4.51 percent B. -3.60 percent C. 2.28 percent D. 2.47 percent E. 4.39 percent - ANSWER A. -4.51 percent
Re = (0.106 - 0.075) + (1.38 x 0.075) = 0.
Re = [($0.94 x 1.045)/$19] + 0.045 = 0.
Re Average = (0.1345 + 0.0967)/2 = 11.56 percent
Henessy Markets has a growth rate of 4.8 percent and is equally as risky as the market. The stock is currently selling for $17 a share. The overall stock market has a 10. percent rate of return and risk premium of 8.7 percent. What is the expected rate of return on this stock?
A. 8.7 percent B. 9.2 percent C. 10.6 percent D. 11.3 percent E. 11.7 percent - ANSWER Re= (0.106 - 0.087) + (1.00 x 0.087) = 10.6 percent
Tidewater Fishing has a current beta of 1.48. The market risk premium is 8.9 percent and the risk-free rate of return is 3.2 percent. By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.60?
A. 0.88 percent B. 1.07 percent C. 1.50 percent D. 2.10 percent E. 2.26 percent - ANSWER Increase in cost of equity = (1.60 - 1.48) x 0.089 = 1. percent
Wind Power Systems has 20 year, semi annual bonds outstanding with a 5 percent coupon. The face amount of each bond is $1000. These bonds are currently selling for 114 percent of the face value. What is the company's pre-tax cost of debt?
A. 3.98 percent B. 4.42 percent C. 4.71 percent D. 5.36 percent E. 5.55 percent - ANSWER A. 3.98 percent
N= 20 x 2 = 40 PV = 1.14 x 1000 = - PMT = 50/2 = 25 FV = 1000 I/Y = /2 = 3.
Boulder Furniture has bonds outstanding that mature in 13 years, have a 6 percent coupon, and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,040. What is the company's aftertax cost of debt if its tax rate is 32 percent?
A. 2.97 percent B. 3.24 percent C. 3.78 percent D. 5.21 percent E. 5.53 percent - ANSWER C. 3.78 percent
N= 13 PV= -1,
