Examtype questions
For Final exam
Chapter 9
1.
If D1 = $2.00, g (which is constant) = 6%, and P0 = $40, what is the stocks expected
capital gains yield for the coming year?
a.
b.
c.
d.
5.2%
5.4%
5.6%
6.0% *
D1
g
P0
Capital gains yield
3.
$2.00
6%
$40.00
6.00%
The Lashgari Company is expected to pay a dividend of $1 per share at the end of the
year, and that dividend is expected to grow at a constant rate of 5% per year in the
future. The company's beta is 1.2, the market risk premium is 5%, and the riskfree
rate is 3%. What is the company's current stock price?
a.
b.
c.
d.
$15.00
$20.00
$25.00 *
$30.00
D1
b
rRF
RPM
g
$1.00
1.20
3.0%
5.0%
5.0%
rs
P0
4.
9.0%
$25.00
McKenna Motors is expected to pay a $1.00 pershare dividend at the end of the year
(D1 = $1.00). The stock sells for $20 per share and its required rate of return is 11
percent. The dividend is expected to grow at a constant rate, g, forever. What is the
growth rate, g, for this stock?
a.
b.
c.
d.
5%
6% *
7%
8%
ks = D1/P0 + g
g = ks  D1/P0
g = 0.11  $1/$20 = 0.06 = 6%.
5.
The last dividend paid by Klein Company was $1.00. Kleins growth rate is expected
to be a constant 5 percent for 2 years, after which dividends are expected to grow at a
rate of 10 percent forever. Kleins required rate of return on equity (ks) is 12 percent.
What is the current price of Kleins common stock?
a. $21.00
b. $33.33
c. $42.25
d. $50.16 *
0
1
k = 12%


gs = 5%
1.00
1.05
P0 = ?
CFt 0
1.05
Numerical solution:
$61.74
$1.05
2
P0 = 1.12 + (1.12) = $50.16.
gs =
2
3 Years


5%
gn = 10%
1.1025
1.21275
2 = 60.6375 = 1.21275
P
0.12 0.10
61.7400
6.
You must estimate the intrinsic value of Gallovits Technologies stock. Gallovitss endofyear free cash flow (FCF) is expected to be $25 million, and it is expected to grow
at a constant rate of 8.5% a year thereafter. The companys WACC is 11%. Gallovits
has $200 million of longterm debt plus preferred stock, and there are 30 million
shares of common stock outstanding. What is Gallovits' estimated intrinsic value per
share of common stock?
a.
b.
c.
d.
$22.67
$24.00
$25.33
$26.67 *
FCF1
Constant growth rate
WACC
Debt & preferred stock
Shares outstanding
Total firm value
Less: Value of debt & pf
Value of equity
Number of shares
Value per share
$25.00
8.5%
11.0%
$200
30
$1,000.00
$200.00
$800.00
30
$26.67
d. A required condition for one to use the constant growth model is that the
stocks expected growth rate exceeds its required rate of return.
9. The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the
following statements is CORRECT?
a. If the market is in equilibrium, and if Stock Y has the lower expected dividend
yield, then it must have the higher expected growth rate. *
b. If Stock Y and Stock X have the same dividend yield, then Stock Y must have
a lower expected capital gains yield than Stock X.
c. If Stock X and Stock Y have the same current dividend and the same expected
dividend growth rate, then Stock Y must sell for a higher price.
d. The stocks must sell for the same price.
Chapter 10
10. Campbell Co. is trying to estimate its weighted average cost of capital (WACC). Which
of the following statements is most correct?
a. The aftertax cost of debt is generally cheaper than the aftertax cost of equity. *
b. Since retained earnings are readily available, the cost of retained earnings is
generally lower than the cost of debt.
c. The aftertax cost of debt is generally more expensive than the beforetax cost of
debt.
d. Statements a and c are correct.
11.
Wyden Brothers has no retained earnings. The company uses the CAPM to calculate
the cost of equity capital. The companys capital structure consists of common stock,
preferred stock, and debt. Which of the following events will reduce the companys
WACC?
a.
b.
c.
d.
12.
Dick Boe Enterprises, an allequity firm, has a corporate beta coefficient of 1.5. The
financial manager is evaluating a project with an expected return of 21 percent,
before any risk adjustment. The riskfree rate is 10 percent, and the required rate of
return on the market is 16 percent. The project being evaluated is riskier than Boes
average project, in terms of both beta risk and total risk. Which of the following
statements is most correct?
a. The project should be accepted since its expected return (before risk adjustment)
is greater than its required return.
b. The project should be rejected since its expected return (before risk adjustment) is
less than its required return.
c. The accept/reject decision depends on the riskadjustment policy of the firm. If
the firms policy were to reduce a riskierthanaverage projects expected return
by 1 percentage point, then the project should be accepted. *
d. Riskierthanaverage projects should have their expected returns increased to
reflect their added riskiness. Clearly, this would make the project acceptable
regardless of the amount of the adjustment.
ks = 10% + (16%  10%)1.5 = 10% + 9% = 19%.
Expected return = 21%. 21%  Risk adjustment 1% = 20%.
Riskadjusted return = 20% > ks = 19%. Thus, the project should be
selected.
13.
14.
Schalheim Sisters Inc. has always paid out all of its earnings as dividends, hence
the firm has no retained earnings. This same situation is expected to persist in the
future. The company uses the CAPM to calculate its cost of equity, its target
capital structure consists of common stock, preferred stock, and debt. Which of
the following events would REDUCE its WACC?
a.
b.
c.
d.
16.
8.98%
9.26% *
9.54%
9.83%
Flaherty Electric has a capital structure that consists of 70 percent equity and 30 percent
debt. The companys longterm bonds have a beforetax yield to maturity of 8.4
percent. The company uses the DCF approach to determine the cost of equity.
Flahertys common stock currently trades at $40.5 per share. The yearend dividend
(D1) is expected to be $2.50 per share, and the dividend is expected to grow forever at a
constant rate of 7 percent a year. The company estimates that it will have to issue new
common stock to help fund this years projects. The companys tax rate is 40 percent.
What is the companys weighted average cost of capital, WACC?
a. 10.73% *
b. 10.30%
c. 11.31%
d. 7.48%
WACC = [0.3 0.084 (1  0.4)] + [0.7 ($2.5/($40.5) + 0.07)]
= 10.73%.
17.
Hamilton Companys 8 percent coupon rate, quarterly payment, $1,000 par value
bond, which matures in 20 years, currently sells at a price of $686.86. The
companys tax rate is 40 percent. What is the firms component cost of debt for
purposes of calculating the WACC?
a. 3.05%
b. 7.32% *
c. 7.36%
d. 12.20%
Time line:
0 kd = ?
1


PMT = 20
VB = 686.86
2

20
3

20
4

20
80

20
FV = 1,000
Quarters
18.
For a typical firm, which of the following is correct? All rates are after taxes, and
assume the firm operates at its target capital structure. Note. d is for debt; e is for
equity
a. rd > re > WACC.
b. re > rd > WACC.
c. WACC > re > rd.
Chapter 11
19.
20.
21.
22.
The Seattle Corporation has been presented with an investment opportunity that will
yield cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5
through 9, and $40,000 in Year 10. This investment will cost the firm $150,000
today, and the firms cost of capital is 10 percent. Assume cash flows occur evenly
during the year, 1/365th each day. What is the payback period for this investment?
a.
b.
c.
d.
5.23 years
4.86 years *
4.00 years
6.12 years
CFs 150
30
Cumulative
CFs 150
120
30
90
k = 10%
30
30
35
35
35
35
35
60
30
10 Yrs.
40
Using the even cash flow distribution assumption, the project will
completely recover the initial investment after $30/$35 = 0.86 of
Year 5:
$30
Payback = 4 + $35 = 4.86 years.
22.
Year
0
1
2
3
4
Project
Cash Flow
$700 million
200 million
370 million
225 million
700 million
a.
b.
c.
d.
3.15 years
4.09 years
1.62 years
3.09 years *
The PV of the outflows is $700 million. To find the discounted payback you need to
keep adding cash flows until the cumulative PVs of the cash inflows equal the PV of
the outflow:
Year
0
1
2
3
4
Cash Flow
$700 million
200 million
370 million
225 million
700 million
Discounted
Cash Flow @ 10%
$700.0000
181.8182
305.7851
169.0458
478.1094
Cumulative PV
$700.0000
518.1818
212.3967
43.3509
434.7585
The payback occurs somewhere in Year 4. To find out exactly where, we calculate
$43.3509/$478.1094 = 0.0907 through the year. Therefore, the discounted payback is
3.091 years.
23.
As the director of capital budgeting for Denver Corporation, you are evaluating two
mutually exclusive projects with the following net cash flows:
Project X
Project Z
a.
b.
c.
d.
Neither project. *
Project X, since it has the higher IRR.
Project Z, since it has the higher NPV.
Project X, since it has the higher NPV.
Time line:
Project X (in thousands):
0
1
50
40
30
10
30
40
60
k = 15%
CFX
100
Years
NPVX = ?
k = 15%
CFZ
100
10
Years
NPVZ = ?
Numerical solution:
$50,000
$40,000
$30,000
$10,000
1.15
(1.15)2
(1.15)3
(1.15)4
832.97 $833.
NPVX $100,000
$10,000
$30,000
$40,000
$60,000
1.15
(1.15)2
(1.15)3
(1.15)4
$8,014.19 $8,014.
NPVZ $100,000
24.
0 k = 10%

1,000
1

500
Project L:
0
k = 10%

2,000
668.76
1

668.76
a.
b.
c.
d.
2

500
3

500
2

3

668.76
668.76
4

5

668.76
$243.43
$291.70 *
$332.50
$481.15
Project S:
Project L:
Value sacrificed:
25. Assume a project has normal cash flows. All else equal, which of the following
statements is CORRECT?
a.
b.
c.
d.
26.
10
b. One defect of the IRR method is that it does not take account of the time value of
money.
c. One defect of the IRR method is that it does consider the time value of money.
d. One defect of the IRR method is that it assumes that the cash flows to be received
from a project can be reinvested at the IRR itself, and that assumption is often not
valid. *
Questions similar with 26 above can be asked about the other three capital budgeting
methods, NPV, payback period.
11