TAMUC

| November 13, 2015

Question

Question 1. Question : Rank in ascending order (lowest to highest) the relative risk associated with holding the preferred stock, common stock and bonds of a firm:

 

Student Answer: preferred stock, bonds, common stock

 

bonds, common stock, preferred stock

 

common stock, preferred stock, bonds

 

bonds, preferred stock, common stock

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 2. Question : The quality of a debenture depends on the

 

Student Answer: general credit-worthiness of the issuing company

 

value of the assets used as collateral

 

the coupon rate of the debenture

 

length of time to maturity

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 3. Question : An AT&T 5½05 bond with a current yield of 6.2% must be selling ____ its face value.

 

Student Answer: above

 

at

 

below

 

any of the above could be correct

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 4. Question : Up in Smoke Tobacco Shops’ bond carries a 9 percent coupon, pays interest semiannually, and has 10 years to maturity. What is the bond’s yield to maturity if the bond is selling for $937.75 (rounded to the nearest whole percent)?

 

Student Answer: 8.0%

 

10.0%

 

9.0%

 

7.0%

 

 

 

 

 

 

 

Question 5. Question : Determine the yield to maturity to the nearest tenth of 1 percent of a zero coupon bond with 8 years to maturity that is currently selling for $404.

 

Student Answer: 11.3%

 

12.3%

 

11.7%

 

12.0%

 

 

 

 

Question 6. Question : What is the value of a Northern Pacific bond with an 11 percent coupon, maturing in 15 years? Assume the market rate for this bond is 14 percent and that the interest is paid semiannually.

 

Student Answer: $1,000

 

$790.74

 

$813.50

 

$853.30

 

 

3 of 3

Comments:

 

 

 

Question 7. Question : What is the required rate of return to the investor who is willing to purchase a Duke Power preferred stock with a $8.70 dividend, a par value of $100, and a current market price of $87?

 

Student Answer: 10.7%

 

8.7%

 

9.4%

 

10.0%

 

 

 

 

 

Question 8. Question : ICX Company has an issue of perpetual bonds (par value to $1,000) that pays 5% annual interest. Determine the yield (to the nearest tenth of 1 percent) if the bonds are currently selling for $625.

 

Student Answer: 5.0%

 

8.0%

 

3.1%

 

6.25%

 

 

 

 

Question 9. Question : Equipment trust certificates are used mainly by

 

Student Answer: equipment manufacturers

 

oil drilling companies

 

state governments

 

trucking companies

 

 

 

 

 

 

 

Question 10. Question : All of the following types of bonds are secured except

 

Student Answer: collateral trust

 

mortgage

 

debentures

 

equipment trust certificates

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 11. Question : The call feature is an advantage to the issuing firm

 

Student Answer: if the bond has a floating rate

 

if interest rates decline

 

if the bond has a low par value

 

if interest rates increase

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 12. Question : Which of the following is not a characteristic of common stock:

 

Student Answer: has no maturity date

 

considered a permanent form of long-term financing

 

has claims on assets prior to those of preferred stock

 

is a residual form of ownership

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 13. Question : Common stockholders have a number of general rights, including all of the following except:

 

Student Answer: voting rights

 

management rights

 

asset rights

 

dividend rights

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 14. Question : In a reverse stock split

 

Student Answer: the number of shares are decreased

 

the market value is decreased

 

retained earnings decrease

 

par value decreases

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 15. Question : When a stock is split 2 for 1, then the ____ figure on the firm’s balance sheet is cut in half.

 

Student Answer: value of the common stock

 

par value

 

capital surplus

 

retained earnings

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 16. Question : Keeping Pace Enterprises, makers of track and field equipment, has common stock that sells for $29, and its dividends are expected to grow at a rate of 9 percent annually. If investors in Pace require a return of 14%, what is the expected dividend next year?

 

Student Answer: $1.33

 

$2.40

 

$1.45

 

$1.60

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 17. Question : Chill Pill Pharmaceuticals is expecting a growth rate of 14% for the next two years due to its new drug. Thereafter it should level to an 8% growth rate. The last dividend paid was $.65 per share. What price should the stock sell for if investors require 12% return.

 

Student Answer: $18.14

 

$22.75

 

$19.47

 

$20.16

 

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 18. Question : Haulin’ It Towing Company is selling a stock for $16. The stock just paid a dividend of $.60 and this dividend is expected to grow by 15% per year for three years. After that it will grow at a constant rate of 4%. The stock’s beta is 1.7, the risk-free rate of interest is 1.75% and the market risk premium is 5.25%. Should you buy the stock? (Round to dollars and cents or two decimal points)

Hint: You need to use the CAPM to get cost of equity before you can solve for the price based on abnormal growth.

 

Student Answer: No, the stock is not a good value since it is only worth about $8.

No, the stock is not a good value since it is only worth about $12.

Yes, the stock is a good value since it should sell for about $25.

Yes, the stock is a good value since it should sell for about $18.

 

 

 

 

 

 

 

 

 

 

Question 19. Question : Beta is defined as:

 

Student Answer: a measure of volatility of a security’s returns relative to the returns of a broad-based market portfolio of securities.

the ratio of the variance of market returns to the covariance of returns on a security with the market

the inverse of the slope of the security regression line

 

all of the above

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 20. Question : Kermit Industries current common stock dividend is $1.35 per share and the dividend is expected to grow at 6% per year into the foreseeable future. Currently the risk-free rate is 4.5% and the estimated market risk premium is 8.5%. Merrill Lynch has estimated KI’s beta to be 1.10. Compute the expected price for KI’s common stock.

 

Student Answer: $17.20

 

$10.33

 

$18.23

 

$49.35

 

 

 

 

Question 21. Question : Phoenix Company common stock is currently selling for $20 per share. Security analysts at Smith Blarney have assigned the following probability distribution to the rate of return on Phoenix stock one year from now:

 

 

 

 

 

 

Rate of Return Probability

-20% 0.25

0% 0.30

+20% 0.25

+40% 0.20

 

 

 

 

 

Assuming that Phoenix is not expected to pay any dividends during the coming year, determine the expected rate of return on Phoenix Stock.

 

Student Answer: 8%

 

0%

 

10%

 

40%

 

 

:

 

 

 

Question 22. Question : Phoenix Company common stock is currently selling for $20 per share. Security analysts at Smith Blarney have assigned the following probability distribution to the rate of return on Phoenix stock one year from now:

 

 

Rate of Return Probability

-20% 0.25

0% 0.30

+20% 0.25

+40% 0.20

 

 

 

Assuming that Phoenix is not expected to pay any dividends during the coming year, determine the coefficient of variation for the rate of return on Phoenix stock.

 

Student Answer: 0.0

 

2.68

 

2.61

 

0.275

 

 

:

 

 

 

Question 23. Question : Quick Start, Inc. is expected to pay a dividend of $1.05 next year and dividends are expected to continue their 7 percent annual growth rate. The SML has been estimated as follows:

 

 

 

kj = 0.08 + 0.064?j

 

 

 

If Quick Start has a beta of 1.1, what would happen to its stock price if inflation expectations went from the current 5 percent to 8 percent?

Hint: You need to compute two different values for Ke and that leads to two different values in the stock. Remember changes in inflationary expectations in chapter 8 and combine that with the equity valuation from chapter 7.

 

Student Answer: decrease $8.14

 

decrease $3.55

 

decrease $3.18

 

stock price will not change

 

 

 

 

Points Received: 3 of 3

Comments:

 

 

 

Question 24. Question : An investor, who believes the economy is slowing down, wishes to reduce the risk of her portfolio. She currently owns 12 securities, each with a market value of $3,000. The current beta of the portfolio is 1.21 and the beta of the riskiest security is 1.62. What will the portfolio beta be if the riskiest security is replaced with a security of equal market value but a beta of 0.80?

 

Student Answer: 1.14

 

1.18

 

1.05

 

1.10

 

 

 

 

 

Question 25. Question : Determine the (after-tax) percentage cost of a $50 million debt issue that the Mattingly Corporation is planning to place privately with a large insurance company. Assume that the company has a 40% marginal tax rate. This long-term debt issue will yield 12% to the insurance company.

 

Student Answer: 4.8%

 

7.2%

 

12.0%

 

10.6%

 

 

 

Question 26. Question : Calculate the after-tax cost of preferred stock for Ohio Valley Power Company, which is planning to sell $100 million of $3.25 cumulative preferred stock to the public at a price of $25 per share. Flotation costs are $1.00 per share. Ohio Valley has a marginal income tax rate of 40%.

 

Student Answer: 13.0%

 

7.8%

 

8.12%

 

13.54%

 

 

 

Question 27. Question : The Allegheny Valley Power Company common stock has a beta of 0.80. If the current risk-free rate is 6.5% and the expected return on the stock market as a whole is 16%, determine the cost of equity capital for the firm (using the CAPM).

 

Student Answer: 14.1%

 

7.6%

 

6.5%

 

13.0%

 

 

 

 

Question 28. Question : The following financial information is available on Rawls Manufacturing Company:

 

 

Current per share market price $48.00

Current (t = 0) per share dividend $3.50

Expected long-term growth rate 5.0%

 

 

 

Rawls can issue new common stock to net the company $44 per share. Determine the cost of internal equity capital using the dividend capitalization model approach. (Compute answer to the nearest 0.1%).

 

Student Answer: 12.3%

 

13.4%

 

13.0%

 

12.7%

 

 

 

 

 

Question 29. Question : Rank in ascending order (lowest to highest) investors’ required rates of return on the various types of corporate securities.

 

Student Answer: preferred stock, corporate debt, common stock

 

common stock, preferred stock, corporate debt

 

preferred stock, common stock, corporate debt

 

corporate debt, preferred stock, common stock

 

 

 

 

 

 

 

Question 30. Question : A firm with a 40 percent marginal tax rate has a capital structure of $60,000,000 in debt and $140,000,000 in equity. What is the firm’s weighted cost of capital if the marginal pretax cost of debt is 12 percent, the firm’s average pretax cost of debt outstanding is 8%, and the cost of equity is 14.5 percent?

 

Student Answer: 13.75%

 

11.59%

 

12.31%

 

10.45%

 

 

 

Question 31. Question : Easy Slider Inc. sold a 15 year $1,000 face value bond with a 10 percent coupon rate. Interest is paid annually. After flotation costs, Easy Slider received $928 per bond. Compute the after-tax cost of debt for these bonds if the firm’s marginal tax rate is 40 percent.

 

Student Answer: 6.0%

 

7.2%

 

7.8%

 

6.6%

 

 

 

 

 

 

Question 32. Question : Wright Express(WE) has a capital structure of 30% debt and 70% equity. WE is considering a project that requires an investment of $2.6 million. To finance this project, WE plans to issue 10-year bonds with a coupon interest rate of 12%. Each of these bonds has a $1,000 face value and will be sold to net WE $980. If the current risk-free rate is 7% and the expected market return is 14.5%, what is the weighted cost of capital for WE? Assume WE has a beta of 1.20 and a marginal tax rate of 40%.

 

Student Answer: 14.9%

 

12.4%

 

13.4%

 

16.0%

 

 

 

 

Question 33. Question : Due to Flotation costs,

 

Student Answer: debt is the costliest source for a firm among all the components of cost of capital.

Cost of external common equity exceeds cost of retained earnings.

companies do not normally float any issues

 

dividends are paid on a monthly basis

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