The weighted average of the firm's costs of equity, preferred

stock, and after tax debt is the:

reward to risk ratio for the firm.
expected capital gains yield for the stock.
expected capital gains yield for the firm.
portfolio beta for the firm.
weighted average cost of capital (WACC).
E

If the CAPM is used to estimate the cost of equity capital, the

expected excess market return is equal to the:
return on the stock minus the risk-free rate.
difference between the return on the market and the risk-free
rate.
beta times the market risk premium.
beta times the risk-free rate.
market rate of return.
B

The best fit line of a pairwise plot of the returns of the security
against the market index returns is called the:
Security Market Line.
Capital Market Line.

characteristic line.
risk line.
None of these.
C

The present value of cash flows is important in

multiples analysis
discounted cash flow analysis
time series analysis
growth projections
None of these
B

The weighted average cost of capital for a firm is the:

discount rate which the firm should apply to all of the projects it
undertakes.
overall rate which the firm must earn on its existing assets to
maintain the value of its stock.
rate the firm should expect to pay on its next bond issue.
maximum rate which the firm should require on any projects it
undertakes.
rate of return that the firm's preferred stockholders should
expect to earn over the long term.
B

The WACC is used to _______ the expected cash flows when

the firm has _______.
discount; debt and equity in the capital structure
discount; short term financing on the balance sheet
increase; debt and equity in the capital structure
decrease; short term financing on the balance sheet
None of these.
A

Using the CAPM to calculate the cost of capital for a risky

project assumes that:
using the firm's beta is the same measure of risk as the project.
the firm is all-equity financed.
the financial risk is equal to business risk.
Both using the firm's beta is the same measure of risk as the
project; and the firm is all-equity financed.
Both using the firm's beta is the same measure of risk as the
project; and the financial risk is equal to business risk.
D

The use of WACC to select investments is acceptable when the:

correlations of all new projects are equal.
NPV is positive when discounted by the WACC.

risks of the projects are equal to the risk of the firm.

firm is well diversified and the unsystematic risk is negligible.
None of these.
C

If the risk of an investment project is different than the firm's

risk then:
you must adjust the discount rate for the project based on the
firm's risk.
you must adjust the discount rate for the project based on the
project risk.
you must exercise risk aversion and use the market rate.
an average rate across prior projects is acceptable because
estimates contain errors.
one must have the actual data to determine any differences in
the calculations.
B

If the project beta and IRR coordinates plot above the SML the
project should be:
accepted.
rejected.
It is impossible to tell.
It will depend on the NPV.

None of these.
A

The beta of a security provides an:

estimate of the market risk premium.
estimate of the slope of the Capital Market Line.
estimate of the slope of the Security Market Line.
estimate of the systematic risk of the security.
None of these
D

Regression analysis can be used to estimate:

beta.
the risk-free rate.
standard deviation.
variance.
expected return.
A

Beta measures depend highly on the:

direction of the market variance.
overall cycle of the market.

variance of the market and asset, but not their co-movement.

covariance of the security with the market and how they are
correlated.
All of these.
D

The formula for calculating beta is given by the dividing the

___________ of the stock with the market portfolio by the
___________ of the market portfolio.
variance; covariance
covariance; variance
standard deviation; variance
expected return; variance
expected return; covariance
B

When valuing an entire firm with both debt and equity, the
basic starting point in choosing a discount rate is:
WACC.
CAPM.
pre-tax cost of debt.
after-tax cost of debt.
None of these.

Companies that have highly cyclical sales will have a:

low beta if sales are highly dependent on the market cycle.
high beta if sales are highly dependent on the market cycle.
high beta if sales are independent of the market cycle.
All of these.
None of these.
B

MC Qu. 17
Betas may vary substantially across an industry. The decision to
use the industry or firm beta to estimate the cost of capital
depends on:
how small the estimation errors are of all betas across
industries.
how similar the firm's operations are to the operations of all
other firms in the industry.
whether the company is a leader or follower.
the size of the company's public float.
None of these.
B

Beta is useful in the calculation of the:

company's variance.

company's discount rate.

company's standard deviation.
unsystematic risk.
company's market rate.
B

For a multi-product firm, if a project's beta is different from

that of the overall firm, then the:
CAPM can no longer be used.
project should be discounted using the overall firm's beta.
project should be discounted at a rate commensurate with its
own beta.
project should be discounted at the market rate.
project should be discounted at the T-bill rate.
C

The problem of using the overall firm's beta in discounting

projects of different risk is the:
firm would accept too many high-risk projects.
firm would reject too many low risk projects.
firm would reject too many high-risk projects.
firm would accept too many low risk projects.

Both firm would accept too many high-risk projects; and firm
would reject too many low risk projects.
E

When valuing a firm with debt and equity, the cash flows during
the non-constant growth period should be:
multiplied by the WACC
multiplied by the cost of equity.
divided by (1 + WACC)^n.
divided by (1 + CAPM)^n.
divided by (r - g).
C

Comparing two otherwise equal firms, the beta of the common

stock of a levered firm is ____________ than the beta of the
common stock of an unlevered firm.
equal to
significantly less
slightly less
greater
None of these.
D

The beta of a firm is determined by which of the following firm

characteristics?

Cycles in revenues
Operating leverage
Financial leverage
All of these.
None of these.
D

The beta of a firm is more likely to be high under what two

conditions?
High cyclical business activity and low operating leverage
High cyclical business activity and high operating leverage
Low cyclical business activity and low financial leverage
Low cyclical business activity and low operating leverage
None of these.
B

A firm with cyclical earnings is characterized by:

revenue patterns that vary with the business cycle.
high levels of debt in its capital structure.
high fixed costs.
high price per unit.

low contribution margins.

A

A firm with high operating leverage has:

low fixed costs in its production process.
high variable costs in its production process.
high fixed costs in its production process.
high price per unit.
low price per unit.
C

If a firm has low fixed costs relative to all other firms in the
same industry, a large change in sales volume (either up or
down) would have:
a smaller change in EBIT for the firm versus the other firms.
no effect in any way on the firms, as volume does not affect
fixed costs.
a decreasing effect on the cyclical nature of the business.
a larger change in EBIT for the firm versus the other firms.
None of these.
A

Terminal value of a firm is also known as

final value

cash value
non-constant value
estimated value
horizon value
E

Firms whose revenues are strongly cyclical and whose operating

leverage is high are likely to have:
low betas.
high betas.
zero betas.
negative betas.
None of these.
B

An industry is likely to have a low beta if the:

stream of revenues is stable and less volatile than the market.
economy is in a recession.
market for its goods is unaffected by the market cycle.
Both stream of revenues is stable and less volatile than the
market; and economy is in a recession.
Both stream of revenues is stable and less volatile than the

market; and market for its goods is unaffected by the market

cycle.
E

For the levered firm the equity beta is __________ the asset
beta.
greater than
less than
equal to
sometimes greater than and sometimes less than
None of these.
A

All else equal, a more liquid stock will have a lower ________.
beta
market premium
cost of capital
Both beta and market premium.
Both beta and cost of capital.
E

Two stock market based costs of liquidity that affects the cost of
capital are the:
bid-ask spread and the specialist spread.

market impact cost and the brokerage costs.

investor opportunity cost and the brokerage costs.
bid-ask spread and the market impact costs.
None of these.
D

The following are methods to estimate the market risk

premium:
use historical data to estimate future risk premium.
use the dividend discount model to estimate risk premium.
use the bond valuation model to estimate growth in bond prices
with different costs of capital.
use historical data to estimate future risk premium and use the
dividend discount model to estimate risk premium.
use historical data to estimate future risk premium and use the
bond valuation model to estimate growth in bond prices with
different costs of capital.
D

The CAPM:
explicitly adjusts for risk.
applies to companies that do not pay dividends.
applies to companies that have dividend growth that is hard to
estimate.

explicitly adjusts for risk; and applies to companies that do not

pay dividends only.
explicitly adjusts for risk; applies to companies that do not pay
dividends; and applies to companies that have dividend growth
that is hard to estimate.
E

Net cash flow is calculated as:

EBIT - tax + depreciation - capital spending - increases in net
working capital.
EBIT + tax + depreciation - capital spending - increases in net
working capital.
EBIT - tax - depreciation - capital spending + increases in net
working capital.
EBIT - tax - depreciation + capital spending - increases in net
working capital.
EBIT + tax + depreciation - capital spending + increases in net
working capital.
A

When using the cost of debt, the relevant number is the:

pre-tax cost of debt, since most corporations pay taxes at the
same tax rate.
pre-tax cost of debt, since it is the actual rate the firm is paying
bondholders.
post-tax cost of debt, since dividends are tax deductible.
post-tax cost of debt, since interest is tax deductible.

None of these.
D

Jack's Construction Co. has 80,000 bonds outstanding that are

selling at par value. Bonds with similar characteristics are
yielding 8.5%. The company also has 4 million shares of
common stock outstanding. The stock has a beta of 1.1 and sells
for $40 a share. The U.S. Treasury bill is yielding 4% and the
market risk premium is 8%. Jack's tax rate is 35%. What is
Jack's weighted average cost of capital?
7.10%
7.39%
10.38%
10.65%
11.37%
C

Peter's Audio Shop has a cost of debt of 7%, a cost of equity of

11%, and a cost of preferred stock of 8%. The firm has 104,000
shares of common stock outstanding at a market price of $20 a
share. There are 40,000 shares of preferred stock outstanding
at a market price of $34 a share. The bond issue has a total face
value of $500,000 and sells at 102% of face value. The tax rate
is 34%. What is the weighted average cost of capital for Peter's
Audio Shop?
6.14%
6.54%
8.60%

9.14%
9.45%
D

Phil's Carvings, Inc. wants to have a weighted average cost of

capital of 9%. The firm has an after-tax cost of debt of 5% and a
cost of equity of 11%. What debt-equity ratio is needed for the
firm to achieve its targeted weighted average cost of capital?
.33
.40
.50
.60
.67
C

Daniel's Sound Systems has 210,000 shares of common stock

outstanding at a market price of $36 a share. Last month,
Daniel's paid an annual dividend in the amount of $1.593 per
share. The dividend growth rate is 4%. Daniel's also has 6,000
bonds outstanding with a face value of $1,000 per bond. The
bonds carry a 7% coupon, pay interest annually, and mature in
4.89 years. The bonds are selling at 99% of face value. The
company's tax rate is 34%. What is Daniel's weighted average
cost of capital?
5.3%
5.8%
6.3%

6.9%
7.2%
D

The Consolidated Transfer Co. is an all-equity financed firm.

The beta is .75, the market risk premium is 8% and the risk-free
rate is 4%. What is the expected return of Consolidated?
7%
8%
9%
10%
13%
D

Assuming the CAPM or one-factor model holds, what is the cost

of equity for a firm if the firm's equity has a beta of 1.2, the riskfree rate of return is 2%, the expected return on the market is
9%, and the return to the company's debt is 7%?
10.4%
10.8%
12.8%
14.4%
None of these.
A

The cost of equity for Ryan Corporation is 8.4%. If the expected

return on the market is 10% and the risk-free rate is 5%, then
the equity beta is ___.
0.48
0.68
1.25
1.68
Impossible to calculate with information given.
B

Suppose that the Simmons Corporation's common stock has a

beta of 1.6. If the risk-free rate is 5% and the market risk
premium is 4%, the expected return on Simmons' common
stock is:
4.0%.
5.0%.
5.6%.
10.6%.
11.4%.
E

Suppose the Barges Corporation's common stock has an

expected return of 12%. Assume that the risk-free rate is 5%,
and the market risk premium is 6%. If no unsystematic
influence affected Barges' return, the beta for Barges is
______.

1.00
1.17
1.20
2.50
It is impossible to calculate with the information given.
B

Slippery Slope Roof's net cash flows are as follows:

Y1 70,000
Y2 60,000
Y3 96,000
After year 3, net cash flows grew at a constant rate of 3%. The
weighted average cost of capital is 9%. What is the value of the
firm?

1,215,650
1,328,141
1,461,409
1,575,941
None of these
C

The net cash flows of Advantage Leasing for the next 3 years are
$42,000, $49,000 and $64,000 respectively, after which the
growth rate will be a constant 2% with a WACC of 8%. What is
the present value of the terminal value?

51,822
55,967
59,259
60,444
None of these
B

The Norris Co. has an improved version of its hotel stand. The
investment cost is expected to be $72 million and will return
$13.5 million for 5 years in net cash flows. The ratio of debt to
equity is 1 to 1. The cost of equity is 13%, the cost of debt is 9%,
and the tax rate is 34%. The appropriate discount rate,
assuming average risk, is:
8.65%
9%
9.47%
10.5%
13%
C

The Hold-n-Trade Co. is an all-equity financed firm. The beta

is .9, the market risk premium is 7% and the risk-free rate is 5%.
What is the expected return of Hold-n-Trade?
8%

8.5%
9%
11.3%
12%
D

Assuming the CAPM or one-factor model holds, what is the cost

of equity for a firm if the firm's equity has a beta of 1.2, the riskfree rate of return is 4%, the expected return on the market is
10%, and the return to the company's debt is 7%?
11.2%
11.4%
12.8%
12.9%
None of these.
A

The cost of equity for Burgess Corporation is 9.4%. If the

expected return on the market is 12% and the risk-free rate is
4%, then the equity beta is ___.
0.52
0.68
0.82
1.23

1.67.
B

Suppose that the Hu's Corporation common stock has a beta of

2.3. If the risk-free rate is 6% and the market risk premium is
5%, the expected return on Hu's common stock is:
5.0%.
6.8%.
10.5%.
15.2%.
17.5%.
E