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# CAPM, Valuation, Capital Budgeting

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1) Currently, the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT?

a) An index fund with beta =1.0 should have a required return of 11%
b) If a stock has a negative beta, its required return must also be negative
c) An index fund with beta =1.0 should have a required return less than 11%
d) If a stock's beta doubles, its required return must also double
e) An index fund with beta = 1.0 should have a required return greater than 11%

2) A stock has an expected return of 12.60%. Its beta is 1.49 and the risk-free rate is 5.00%. What is the market risk premium?

a) 5.10%
b) 5.23%
c) 5.36%
d) 5.49%
e) 5.63%

3) Millar Motors is a relatively small company and its beta is 1.30. The current 1-year T-Bill rate and 10-year T-bond rate are 2.00% and 4.00% respectively. In the past 10 years, the average rate on the 10-year T-bond rate has been 6.00%. For the same period the annual return on market indices for large stocks and small stocks have been 13.00% and 15.00% respectively. Investors expect Millar Motors' revenues to growth at 5% next year and the annual future stock market return to be 12.00%. For the purpose of Millar's cash flows, what is your estimate of the company cost of equity?

a) 13.0%
b) 18.9%
c) 13.1%
d) 15.7%
e) 15.1%

4) Suppose a company's projected free cash flow for next year is \$500 million and it is expected to grow at a constant rate of 6 percent. If the company's weighted average cost of capital is 11 percent, what is the current value of operations, to the nearest million.

a) \$530 million
b) \$4,545 million
c) \$8,333 million
d) \$10,000 million
e) \$10,600 million

5) The Target Copy Company is contemplating the replacement of its old printing machine with a new model costing \$60,000. The old machine, which originally cost \$40,000, has 6 years expected life remaining and a current book value of \$30,000 versus a current market value of \$24,000. Target's corporate tax rate is 40 percent. If Target sells the old machine at market value, what is the initial after-tax outlay for the new printing machine?

a) -\$22,180
b) -\$30,000
c) -\$33,600
d) -\$36,000
e) -\$40,000

#### Solution Preview

1) Currently, the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT?

a) An index fund with beta =1.0 should have a required return of 11%
b) If a stock has a negative beta, its required return must also be negative
c) An index fund with beta =1.0 should have a required return less than 11%
d) If a stock's beta doubles, its required return must also double
e) An index fund with beta = 1.0 should have a required return greater than 11%

Answer: a) An index fund with beta =1.0 should have a required return of 11%
expected return = risk-free rate + beta x market risk premium
required return for index fund with beta = 1 is 6% + 1 x 5% = 11%
Thus c) and e) are incorrect
It is not necessary for a stock with negative beta to have a negative required return.
Suppose, risk free rate is 10% and market risk ...

#### Solution Summary

Answers 5 Multiple Choice Questions on CAPM (Capital Asset Pricing Model), Valuation, Capital Budgeting

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