FIN3403 EXAM 4 VERSION A1. When calculating the weighted average cost of capital, weights are based on A. book values. B. book weights. C. market values. D. market betas. 2. Which of these completes this statement to make it true? The constant growth model is A. always going to have assumptions that will hold true. B. able to be adjusted for stocks that don't expect constant growth without sizeable errors. C. only going to be appropriate for the limited number of stocks that just happen to expect constant growth. D. only going to be appropriate for the limited number of stocks that just happen to expect nonconstant growth. 3. Which of the following is a true statement? A. To estimate the before-tax cost of debt, we need to solve for the Yield to Maturity (YTM) on the firm's existing debt. B. To estimate the before-tax cost of debt, we need to solve for the Yield to Call (YTC) on the firm's existing debt. C. To estimate the before-tax cost of debt, we use the coupon rate on the firm's existing debt. D. To estimate the before-tax cost of debt, we use the average rate on the firm's existing debt. 4. Which of the following is a true statement regarding the appropriate tax rate to be used in the WACC? A. One would use the marginal tax rate that the firm paid the prior year. B. One would use the average tax rate that the firm paid the prior year. C. One would use the weighted average of the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. D. One would use the marginal tax rates that would have been paid on the taxable income shielded by the interest deduction. 5. TJ Co stock has a beta of 1.45, the current risk-free rate is 5.75, and the expected return on the market is 14 percent. What is TJ Co's cost of equity? A. 17.71% B. 21.20% C. 26.05% D. 28.64% 6. WC Inc. has a $10 million (face value), 10-year bond issue selling for 99 percent of par that pays an annual coupon of 9 percent. What would be WC's before-tax component cost of debt? A. 9.00% B. 9.10% C. 9.16% D. 18.32% FIN3403 EXAM 4 VERSION A 7. Suppose that Model Nails, Inc.'s capital structure features 60 percent equity, 40 percent debt, and that its before-tax cost of debt is 6 percent, while its cost of equity is 10 percent. If the appropriate weighted average tax rate is 28 percent, what will be Model Nails' WACC? A. 7.73% B. 8.00% C. 8.40% D. 16.00% 8. Bill's Boards has 20 million shares of common stock outstanding, 4 million shares of preferred stock outstanding, and 20 thousand bonds. If the common shares are selling for $30 per share, the preferred shares are selling for $17 per share, and the bonds are selling for 96 percent of par, what would be the weight used for debt in the computation of Bill's WACC? A. 0.83% B. 2.79% C. 2.87% D. 3.33% 9. Paper Exchange has 80 million shares of common stock outstanding, 60 million shares of preferred stock outstanding, and 50 thousand bonds. If the common shares are selling for $20 per share, the preferred shares are selling for $10 per share, and the bonds are selling for 105 percent of par, what would be the weight used for preferred stock in the computation of Paper's WACC? A. 26.64% B. 27.27% C. 33.33% D. 42.84% 10. Carrie D's has 6 million shares of common stock outstanding, 2 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $15 per share, the preferred shares are selling for $28 per share, and the bonds are selling for 109 percent of par, what would be the weight used for equity in the computation of Carrie D's WACC? A. 33.33% B. 57.36% C. 61.64% D. 75.00% 11. Pumpkin Pie Industries has 5 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10 thousand bonds. If the common shares are selling for $50 per share, the preferred shares are selling for $31 per share, and the bonds are selling for 98 percent of par ($1000), what would be the weights used in the calculation of Pumpkin Pie's WACC for common stock, preferred stock, and bonds, respectively? A. 33.33%, 33.33%, 33.33% B. 83.19%, 16.64%, 0.17% C. 85.97%, 10.67%, 3.38% D. 27.93%, 17.32%, 54.75% FIN3403 EXAM 4 VERSION A 12. Suppose that Tan Lotion's common shares sell for $18 per share, are expected to set their next annual dividend at $1.00 per share, and that all future dividends are expected to grow by 7 percent per year, indefinitely. If Tan Lotion faces a flotation cost of 12% on new equity issues, what will be the flotation-adjusted cost of equity? A. 6.37% B. 7.06% C. 12.56% D. 13.31% 13. An all-equity firm is considering the projects shown below. The T-bill rate is 4 percent and the market risk premium is 9 percent. If the firm uses its current WACC of 14 percent to evaluate these projects, which project(s) will be incorrectly rejected? A. Project A B. Project B C. Project C D. Project D 14. These markets trade currencies for immediate or for some future stated delivery. A. money markets B. primary markets C. foreign exchange markets D. over-the-counter stocks 15. This is a security formalizing an agreement between two parties to exchange a standard quantity of an asset at a predetermined price on a specified date in the future. A. derivative security B. initial public offering C. liquidity asset D. trading volume 16. Which of these does NOT perform vital functions to securities markets of all sorts by channeling funds from those with surplus funds to those with shortages of funds? A. commercial banks B. secondary markets C. insurance companies D. mutual funds FIN3403 EXAM 4 VERSION A 17. This is the ease with which an asset can be converted into cash. A. direct transfer B. liquidity C. primary market D. secondary market 18. Unbiased Expectations Theory One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities? A. 5.50% B. 5.625% C. 5.75% D. 11.25% 19. Liquidity Premium Hypothesis One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. The liquidity premium on two-year securities is 0.075 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities? A. 3.775% B. 5.625% C. 5.662% D. 11.325% 20. Interest rates You are considering an investment in 30-year bonds issued by a corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 3.50 percent. Your broker has determined the following information about economic activity and the corporation bonds: Real interest rate = 2.50% Default risk premium = 1.75% Liquidity risk premium = 0.70% Maturity risk premium = 1.50% What is the inflation premium? What is the fair interest rate on the corporation's 30-year bonds? A. 1% and 1.49%, respectively B. 1% and 6.45%, respectively C. 1% and 7.45%, respectively D. 3.50% and 9.95%, respectively FIN3403 EXAM 4 VERSION A 21. Unbiased Expectations Theory Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: Using the unbiased expectations theory, what is the current (long-term) rate for four-year- maturity Treasury securities? A. 6.00% B. 6.33% C. 6.75% D. 7.00% 22. Liquidity Premium Hypothesis The Wall Street Journal reports that the rate on 3-year Treasury securities is 4.75 percent and the rate on 4-year Treasury securities is 5.00 percent. The one-year interest rate expected in three years is E( 4 r 1 ), 5.25 percent. According to the liquidity premium hypotheses, what is the liquidity premium on the 4-year Treasury security, L 4 ? A. 0.0375% B. 0.504% C. 5.01% D. 5.04% 23. Forecasting Interest Rates You note the following yield curve in The Wall Street Journal. According to the unbiased expectations hypothesis, what is the one-year forward rate for the period beginning one year from today, 2 f 1 ? A. 1.01% B. 1.19% C. 5.625% D. 7.51% 24. Of the capital budgeting techniques discussed, which works equally well with normal and non-normal cash flows and with independent and mutually exclusive projects? A. payback period B. discounted payback period C. modified internal rate of return D. net present value FIN3403 EXAM 4 VERSION A 25. The Net Present Value decision technique uses a statistic denominated in A. years. B. currency. C. a percentage. D. time lines. 26. The Net Present Value decision technique may not be the only pertinent unit of measure if the firm is facing A. time or resource constraints. B. a labor union. C. the election of a new board of directors. D. a major investment. 27. All capital budgeting techniques A. render the same investment decision. B. use the same measurement units. C. include all crucial information. D. exclude some crucial information. 28. Compute the NPV for Project X and accept or reject the project with the cash flows shown below if the appropriate cost of capital is 9 percent. A. $-639.96 B. $360.04 C. $392.44 D. $486.29 29. Compute the Payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 10 percent and the maximum allowable payback is 5 years. A. 3.67 years, accept B. 4.67 years, accept C. 3.67 years, reject D. 4.67 years, reject FIN3403 EXAM 4 VERSION A 30. Compute the IRR for Project X and note whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 9 percent. A. 9%, accept B. 9%, reject C. 16.61%, accept D. 16.61%, reject 31. Compute the MIRR statistic for Project X and note whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 10 percent. A. 13.26%, accept B. 13.89%, accept C. 13.26%, reject D. 15.73%, accept 32. Compute the PI statistic for Project X and note whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 10 percent. A. -.0977%, reject B. -9.77%, reject C. -24.41%, reject D. 24.41%, accept FIN3403 EXAM 4 VERSION A 33. How many possible IRRs could you find for the following set of cash flows? A. 1 B. 2 C. 3 D. Unable to determine unless we have the cost of capital. 34. How many possible IRRs could you find for the following set of cash flows? A. 1 B. 2 C. 3 D. 4 35. Projects A and B are mutually exclusive. Project A costs $20,000 and is expected to generate cash inflows of $7,500 for 4 years. Project B costs $10,000 and is expected to generate a single cash flow in year 4 of $20,000. The cost of capital is 12%. Which project would you accept and why? A. Project B because it has the higher NPV. B. Project B because it has the higher IRR. C. Project A because it has the higher NPV. D. Project A because it has the higher IRR. 36. We accept projects with a positive NPV because it means that ____________. A. We have recovered all our costs B. We are creating wealth for shareholders C. The project's expected return exceeds the cost of capital D. All of these