1) If a corporation were to choose between issuing a debenture, a mortgage bond, or a subordinated debenture, which would have the highest yield to maturity, everything else equal?
A) the debenture
B) the mortgage bond
C) the subordinated debenture
D) all of the above
2) Put the following in order of their claim on assets of a firm, starting with the LAST to have a claim:
A. Subordinated debentures
B. Debentures (unsubordinated)
C. Common Stock
D. Preferred stock
A) C, B, A, D
B) C, D, A, B
C) B, A, C, D
D) D, C, B, A3)
3. Which of the following statements concerning bonds and risk is true?
A) Because the interest payments and maturing value are known, the only risk associated with investing in bonds is default risk.
B) Zero coupon bonds are always more risky than bonds with high coupon rates because of the time value of money.
C) Bonds are generally less risky than common stock because of the preference for debt over equity in the event of bankruptcy and liquidation.
D) B-rated bonds are above average for risk, i.e., less risky than the average bond.
4) Finance theory suggests that the current market value of a bond is based upon which of the following?
A) the future value of interest paid on a bond
B) the sum total of principal and interest paid on a bond
C) the sum of the present value of the bond’s interest payments and the present value of the principal
D) the present value of a bond’s par value plus the future value of the bond’s present value
5) Which type of value is shown on the firm’s balance sheet?
A) book value
B) liquidation value
C) market value
D) intrinsic value
6) What is the value of a bond that matures in 5 years, has an annual coupon payment of $110, and a par value of $2,000? Assume a required rate of return of 8.69%.
Chapter 8 The Valuation and Characteristics of Stock
7) Preferred stock is similar to a bond in the following way
A) preferred stock always contains a maturity date.
B) both investments provide a stated income stream.
C) both contain a growth factor similar to common stock.
D) both provide interest payments.
8) Stimpson Inc. preferred stock pays a $.50 annual dividend. What is the value of the stock if your required rate of return is 10%?
9) Whistle Corp. has a preferred stock that pays a dividend of $2.40. If you are willing to purchase the stock at $11, what is your required rate of return (round your answer to the nearest .1% and assume that there are no transaction costs)?
10) How is preferred stock similar to common stock?
A) Preferred dividend payments usually have unlimited growth potential.
B) Investors cannot sue a corporation for the non-payment of dividends.
C) Both preferred and common stockholders have voting control of a firm.
D) Preferred stock dividends and common stock dividends are fixed.
11) ACME, Inc. expects its current annual $2.50 per share common stock dividend to remain the same for the foreseeable future. Therefore, the value of the stock to an investor with a required return of 12% is
12) Perrine Industrial Inc. just paid a dividend of $5 per share. Future dividends are expected to grow at a constant rate of 7% per year. What is the value of the stock if the required return is 16%?
13) Beaver Corp preferred stock has a market price of $14.50. If it has a yearly dividend of $3.50, what is your expected rate of return if you purchase the stock at its market price?
Chapter 9 The Cost of Capital
14) In general, which of the following rankings, from highest to lowest cost, is most accurate?
A) cost of new common stock, cost of preferred stock, cost of debt, cost of retained earnings
B) cost of debt, cost of preferred stock, cost of new common stock, cost of retained earnings
C) cost of new common stock, cost of retained earnings, cost of preferred stock, cost of debt
D) cost of preferred stock, cost of new common stock, cost of retained earnings, cost of debt
15) The risk free rate of return is 3% and the expected return on the market portfolio is 14%. Oklahoma Oilco has a beta of 2.0 and a standard deviation of returns of 26%. Oilco’s marginal tax rate is 35%. Analysts expect Oilco’s net income to grow by 12% per year for the next 5 years. Using the capital asset pricing model, what is Oklahoma Oilco’s cost of retained earnings?
16) The average cost associated with each additional dollar of financing for investment projects is
A) the incremental return.
B) the marginal cost of capital.
C) CAPM required return.
D) the component cost of capital.
17) GPS Inc. wishes to estimate its cost of retained earnings. The firm’s beta is 1.3. The rate on 6-month T-bills is 2%, and the return on the S&P 500 index is 15%. What is the appropriate cost for retained earnings in determining the firm’s cost of capital?
18) Baxter Inc. has a target capital structure of 30% debt, 15% preferred stock, and 55% common equity. The company’s after-tax cost of debt is 7%, its cost of preferred stock is 11%, its cost of retained earnings is 15%, and its cost of new common stock is 16%. The company stock has a beta of 1.5 and the company’s marginal tax rate is 35%. What is the company’s weighted average cost of capital if retained earnings are used to fund the common equity portion?
WACC = (30% * 7%) + (15% * 11%) + (55% * 15%)= 12%
19) Texas Transport has five possible investment projects for the coming year. Each project is indivisible. They are:ProjectInvestment (million) IRR A $ 6 18% B $10 15% C $ 9 20% D $ 4 12% E $ 3 24%
The firm’s weighted marginal cost of capital schedule is 12 percent for up to $6 million of investment; 16 percent for between $6 million and $18 million of investment; and above $18 million the weighted cost of capital is 18 percent. The optimal capital budget is
A) $12 million.
B) $18 million.
C) $23 million.
D) $28 million.
20) The DEF Company is planning a $64 million expansion. The expansion is to be financed by selling $25.6 million in new debt and $38.4 million in new common stock. The before-tax required rate of return on debt is 9 percent and the required rate of return on equity is 14 percent. If the company is in the 35 percent tax bracket, what is the firm’s cost of capital?
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