1.

An "aggressive" common stock would have a "beta"

equal to zero.

greater than one.

equal to one.

less than one.

2. According to the capital-asset pricing model (CAPM), a security's expected (required)

return is equal to the risk-free rate plus a market premium

equal to the security's beta.

based on the unsystematic risk of the security.

based on the total risk of the security.

based on the systematic risk of the security.

3. Plaid Pants, Inc. common stock has a beta of 0.90, while Acme Dynamite Company
common stock has a beta of 1.80. The expected return on the market is 10 percent,
and the risk-free rate is 6 percent. According to the capital-asset pricing model (CAPM)
and making use of the information above, the required return on Plaid Pants' common
stock should be , and the required return on Acme's common stock should
be .
3.6 percent; 7.2 percent

9.6 percent; 13.2 percent

9.0 percent; 18.0 percent

14.0 percent; 23.0 percent

4. For an all-equity financed firm, a project whose expected rate of return plots should be rejected.
above the characteristic line

above the security market line

below the security market line

below the characteristic line

5. Lei-Feng, Inc.'s $100 par value preferred stock just paid its $10 per share annual
dividend. The preferred stock has a current market price of $96 a share. The firm's
marginal tax rate (combined federal and state) is 40 percent, and the firm plans to
maintain its current capital structure relationship into the future. The component cost
of preferred stock to Lei-Feng, Inc. would be closest to .

6 percent

6.25 percent

10 percent

10.4 percent

6. The common stock of a company must provide a higher expected return than the debt
of the same company because
there is less demand for stock than for bonds.

there is greater demand for stock than for bonds.

there is more systematic risk involved for the common stock.

there is a market premium required for bonds.

7. In calculating the costs of the individual components of a firm's financing, the

corporate tax rate is important to which of the following component cost formulas?
common stock.

debt.

preferred stock.

none of the above.

8. A firm's degree of operating leverage (DOL) depends primarily upon its
sales variability.

level of fixed operating costs.

closeness to its operating break-even point.

debt-to-equity ratio.

9. An EBIT-EPS indifference analysis chart is used for

evaluating the effects of business risk on EPS.

examining EPS results for alternative financing plans at varying EBIT levels.

determining the impact of a change in sales on EBIT.

showing the changes in EPS quality over time.

10. In the context of operating leverage break-even analysis, if selling price per unit rises
and all other variables remain constant, the operating break-even point in units will:
fall.

rise.

stay the same.

still be indeterminate until interest and preferred dividends paid are known.

11. If a firm has a DOL of 5 at Q units, this tell us that:

if sales rise by 5%, EBIT will rise by 5%.

if sales rise by 1%, EBIT will rise by 1%.

if sales rise by 5%, EBIT will fall by 25%.

if sales rise by 1%, EBIT will rise by 5%.

12. A firm's degree of total leverage (DTL) is equal to its degree of operating leverage
its degree of financial leverage (DFL).
plus

minus

divided by

multiplied by

13. The further a firm operates above its operating break-even point, the closer its degree
of operating leverage (DOL) measure approaches
minus one.

zero.

one.

infinity.

14. In an efficient market, the price of a security will:

o react immediately to new information with no further price adjustments related
to that information.
o react to new information over a two-day period after which time no further
price adjustments related to that information will occur.
o rise sharply when new information is first released and then decline to a new
stable level by the following day.
o always rise immediately upon the release of new information with no further
price adjustments related to that information.

15. According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate
of return is a function of
o market risk.
o unsystematic risk.
o unique risk.
o reinvestment risk.
16. The risk-free rate and the expected market rate of return are 5% and 10% respectively.
According to the Capital Asset Pricing Model (CAPM), the expected rate of return on
security X with a beta 1.2 is equal to
o 11%
o 8%
o 15%
o 12.5%
17. The Security Market Line (SML) is
o the line that describes the expected return-beta relationship for well-diversified
portfolios only.
o the line that represents the expected return-beta relationship.
o also called the Capital Allocation Line.
o the line that is tangent to the efficient frontier of all risky assets.

18. Your opinion is that Boeing has an expected rate of return of 0.0952. It has a beta of
0.92. The risk-free rate is 0.04 and the market expected rate of return is 0.10.
According to the Capital Asset Pricing Model, this security is

o underpriced.

o overpriced.

o fairly priced.

o Cannot be determined from data provided.

19. What is the expected return of a zero-beta security?

o The market rate of return.
o Zero rate of return.
o A negative rate of return.
o The risk-free rate.

20. Scholastic Toys is considering developing and distributing a new board game for
children. The project is similar in risk to the firm's current operations. The firm
maintains a debt-equity ratio of 0.90 and retains all profits to fund the firm's rapid
growth. How should the firm determine its cost of equity?
o by using the capital asset pricing model
o by adding the market risk premium to the after-tax cost of debt
o by multiplying the market risk premium by (1 - 0.90)
o by using the dividend growth model

21. AirVent Inc, has 8,700 bonds outstanding that were originally issued at $1000 per bond
but which are currently trading at $875 per bond. The coupon rate is 3.5% and the
most recent yield-to-maturity is 6.2%. The company has 130,500 shares of stock
outstanding. The stock price is $114.75 and the book value per share is $75.50. The
expected return on the stock is 14.10%. The corporate tax rate is 21 percent. What is
the weighted average cost of capital (WACC)?
o The WACC is 15.60%.
o The WACC is 11.44%
o The WACC is 11.00%.
o The WACC is 5.95%.
22. Sanders and Marks, Inc. currently has 1,000,000 common shares
outstanding that are currently trading at $55 per share. When the
shares were originally issued one year ago, their price was $20. The
Beta of the company is 1.1 and the market risk premium is 4.5%. The
company also has 250,000 shares of preferred stock outstanding for
which it pays an annual dividend of $2.50 per share. These preferred
shares currently trade at $60 per share. Sanders and Marks have also
just issued 3,000 bonds that are currently valued at 94% of par and
have a yield-to-maturity of 6.42%. The company is in the 21% tax
bracket. Treasury bills currently yield 6%. What is the WACC of the
company at market value?
o 9.33%
o 8.67%
o 11.33%
o 10.87%
23. Acme Inc. currently has 500,000 common shares outstanding that are
currently trading at $35 per share. When the shares were originally
issued one year ago, their price was $20. The Beta of the company is
1.1 and the market risk premium is 4.5%. The company also has
250,000 shares of preferred stock outstanding for which it pays an
annual dividend of $2.50 per share. These preferred shares currently
trade at $60 per share. Acme has also just issued 1,500 bonds that are
currently valued at 96% of par and have a yield-to-maturity of 6.42%.
The company is in the 34% tax bracket. Treasury bills currently yield
6%. What is the WACC of the company at market value?
o 8.90%
o 7.67%
o 15.97%
o 9.20%

24. Which one of the following statements is correct?

o Firms should accept low risk projects prior to funding high risk projects.
o Making subjective adjustments to a firm's WACC when determining project
discount rates unfairly punishes low-risk divisions within a firm.
o A project that is unacceptable today might be acceptable tomorrow given a
change in market returns.
o Firms that elect to use the pure play method for determining a discount rate for
a project cannot subjectively adjust the pure play rate.

25. The APT differs from the CAPM because the APT _________.
o minimizes the importance of diversification
o recognizes multiple unsystematic risk factors
o recognizes multiple systematic risk factors
o places more emphasis on systematic risk
 26. Portfolio A has expected return of 10% and standard deviation of 19%. Portfolio B has
expected return of 12% and standard deviation of 17%. Rational investors will:
o Sell B short and buy A.
o Sell A short and buy B.
o Borrow at the risk-free rate and buy B.
o Lend at the risk-free rate and buy B.

27. An important difference between CAPM and APT is

o CAPM depends on risk-return dominance; APT depends on a no arbitrage
condition and assumes many small changes are required to bring the market
back to equilibrium.
o CAPM depends on risk-return dominance; APT depends on a no arbitrage
condition.
o CAPM assumes many small changes are required to bring the market back to
equilibrium; APT assumes a few large changes are required to bring the market
back to equilibrium
o CAPM depends on risk-return dominance; APT depends on a no arbitrage
condition, CAPM assumes many small changes are required to bring the market
back to equilibrium; APT assumes a few large changes are required to bring the
market back to equilibrium, implications for prices derived from CAPM
arguments are stronger than prices derived from APT arguments.

28. In the context of the Arbitrage Pricing Theory, as a well-diversified portfolio becomes
larger as its non-systematic risk approaches
o one.
o infinity.
o zero.
o negative one
29. Assume that a security is fairly priced and has an expected rate of return of 0.13. The
market expected rate of return is 0.13 and the risk-free rate is 0.04. The beta of the stock is
___.
o 1.65.
o B. 1.
o C. 1.5
o E. -1.3.

30. Firms in Japan often employ both high operating and financial
leverage because of the use of modern technology and close
borrower-lender relationships. Assume the Mitaka Company has a
sales volume of 149,000 units at a price of $29 per unit: variable costs
are $5 per unit, and fixed costs are $2,040,000. Interest expense is
$424,000. What is the degree of combined leverage for this Japanese
firm? (Round your answer to 2 decimal places.)
o 4.50
 o 3.22
o 5.67
o 2.45

31. The capital structure for Cain Supplies is presented below.

Compute the stock price for Cain if it sells at 19 times earnings
per share and EBIT is $50,000. The tax rate is 20%. Find the
stock price of the company.

Debt @ 10% $100,000

Common stock, $10 par 200,000
total $300,000
Common Shares 20,000

o $147.69
o $89.76
o $79.88
o $30.40
32. What is cost of equity?
o The cost of equity is the return required by equity investors given the risk of the
cash flows from the firm
o The cost of equity is the return that the firm’s creditors demand on new
borrowing.
o The cost of equity increases as the unsystematic risk of the firm increases.
o The cost of equity equals the firm's pretax weighted average cost of capital.

33. 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.
o This model considers a firm's rate of growth.
o The model is dependent upon a reliable estimate of the market risk premium.
o The model applies only to non-dividend paying firms.
o The model generally produces the same cost of equity as the dividend growth model.

34. What are the disadvantages of using the security market line?
I. Applicable to all companies, as long as we can compute beta
II. Have to estimate the expected market risk premium, which does vary over time
III. Have to estimate beta, which also varies over time
 IV. We are relying on the past to predict the future, which is not always reliable
o I and III only
o II and III only
o I, II, and III only
o II, III, and IV only

35. Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to
as the:
o compound rate.
o current yield.
o cost of debt.
o capital gains yield.

36. North-western Savings and Loan has a current capital

structure consisting of $220,000 of 18% (annual interest) debt
and 3,000 shares of common stock. The firm pays taxes at the
rate of 40%. Using $80,000 of EBIT as a base, calculate the
degree of financial leverage (DFL).

o 1.98

o 2.34

o -1.20

o 1.12

37. Which of the following is true of the degree of financial

leverage of a firm?

o The degree of financial leverage affects the earnings before

interest and taxes of the firm.
o The degree of financial leverage is defined as the
percentage change in net operating income with a given
percentage change in sales.
o The degree of financial leverage affects the operating
section of the income statement.
o A higher degree of financial leverage suggests that higher
risk is associated with the firm's mix of debt and equity
financing.
38. How do changes in capital structure affect the value of the
firm, all else equal?

I. Increase leverage by issuing debt and repurchasing

outstanding shares

II. A firm might accept a project that is not profitable for the firm.

III. The intrinsic stock price estimation might be incorrect.

IV. Decrease leverage by issuing new shares and retiring

outstanding debt

o I and III only

o II and III only
o I, II, and III only
o I and IV only

39. 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.
o subjective risk
o divisional cost of capital
o pure play
o security market line

40. Boulder Furniture has bonds outstanding that mature in 15 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 $1,075. What is
the company's after-tax cost of debt if its tax rate is 32 percent?
o 12.46 percent
o 3.58 percent
o 3.40 percent
o 14.08 percent