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# WACC, CAPM, Holding period returns

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1. Calculating Returns. Suppose a stock had an initial price of \$84 per share, paid a dividend of \$1.40 per share during the year, and had an ending share price of \$96. Compute the percentage of total return.
2. Holding Period Returns. A stock has had returns of -17.62 percent, 15.38 percent, 10.95 percent, 26.83 percent, and 5.31% over the past five years, respectively. What was the holding period return for the stock?
3. Calculating Returns. You bought a share of 5.5 percent preferred stock for \$92.73 last year. The market price for the stock is now \$95.89. What is your total return for last year?
4. Calculating Returns. You bought a stock three months ago for \$32.81 per share. The stock paid no dividends. The current share price is \$37.53. What is the APR of your investment? The EAR?
5. Portfolio Expected Returns. You own a portfolio that has \$3,400 invested in Stock A and \$4,100 invested in Stock B. If the expected returns on these stocks are 9.5 percent and 15.2 percent, respectively, what is the expected return on the portfolio?
6. Using CAPM. A stock has a beta of 1.25, the expected return on the market is 11.5 percent, and the risk-free rate is 3.4 percent. What must the expected return on this stock be?
7. Calculating cost of equity. The XOXO Corporation's common stock has a beta of 1.15. If the risk-free rate is 4.5 percent and the expected return on the market is 11 percent, what is XOXO's cost of equity capital?
8. Calculating WACC. Libby Corporation has a target capital structure of 70 percent common stock and 30 percent debt. Its cost of equity is 15 percent, and the cost of debt is 8 percent. The relevant tax rate is 35%. What is Libby's WACC?

#### Solution Summary

The solutions shows how to calculate return on equity, cost of equity, etc..

\$2.19

## FINANCE calculations: NPV, ROE, MRP, CAPM, WACC, IRR, Beta and others

1. The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to _________. (Points: 10)
maximize its expected total corporate income
maximize its expected EPS
minimize the chances of losses
maximize the stock price per share over the long run, which is the stock's intrinsic value
maximize the stock price on a specific target date

2. What's the future value of \$2,000 after 3 years if the appropriate interest rate is 8%, compounded semiannually? (Points: 10)
\$2,854.13
\$2,781.45
\$2,324.89
\$2,011.87
\$2,530.64

3. You own an oil well that will pay you \$25,000 per year for 8 years, with the first payment being made today. If you think a fair return on the well is 7%, how much should you ask for if you decide to sell it? (Points: 10)
\$159,732
\$116,110
\$217,513
\$315,976
\$288,349

4. Suppose you borrowed \$25,000 at a rate of 8% and must repay it in 4 equal installments at the end of each of the next 4 years. How large would your payments be? (Points: 10)
\$7,691.45
\$7,548.02
\$7,324.89
\$7,011.87
\$7,854.13

5. If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT? (Points: 10)
The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.
The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.
Other things held constant, the lower the current asset ratio, the lower the interest rate the bank would charge the firm.
Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.
Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.

6. During the latest year Ruth Corp. had sales of \$300,000 and a net income of \$20,000, and its year-end assets were \$200,000. The firm's total debt to total assets ratio was 40%. Based on the Du Pont equation, what was the firm's ROE? (Points: 10)
15.33%
15.67%
16.00%
16.33%
16.67%

7. Rangoon Corp's sales last year were \$400,000, and its year-end total assets were \$300,000. The average firm in the industry has a total assets turnover ratio (TATO) of 2.5. The new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales. By how much must the assets be reduced to bring the TATO to the industry average? (Points: 10)
\$100,000
\$110,000
\$120,000
\$130,000
\$140,000

8. Which of the following statements is CORRECT? (Points: 10)
The NYSE does not exist as a physical location; rather it represents a loose collection of dealers who trade stock electronically.
An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift.
Capital market instruments include both long-term debt and common stocks.
If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction.
While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors.

9. Which of the following statements is CORRECT? (Points: 10)
If a market is strong-form efficient, this implies that the returns on bonds and stocks should be identical.
If a market is weak-form efficient, this implies that above-average returns can best be achieved by focusing on past movement of stock prices.
If your uncle earned a higher return on his portfolio over a 10-year period than the return on the overall stock market, this would demonstrate that the stock market is inefficient.
Because of increased globalization, all of the world's stock markets are equally efficient as that term is defined in the text.
If a market is semistrong-form efficient, this implies that above-average returns cannot be achieved by analyzing publicly available data because such information is already reflected in stock prices.

10. Keys Corporation's 5-year bonds yield 6.50%, and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the default risk premium for Keys' bonds is DRP = 0.40%, the liquidity premium on Keys' bonds is LP = 1.7% versus zero on T-bonds, and the inflation premium (IP) is 1.5%. What is the maturity risk premium (MRP) on a 5-year bond? (Points: 10)
0.20%
0.30%
0.40%
0.50%
0.60%

11. Leggio Corporation issued 20-year, 7% annual coupon bonds at their par value of \$1,000 one year ago. Today, the market interest rate on these bonds has dropped to 6%. What is the new price of the bonds, given that they now have 19 years to maturity? (Points: 10)
\$1,046.59
\$1,111.58
\$1,133.40
\$1,177.78
\$1,189.04

12. Moussawi Ltd's outstanding bonds have a \$1,000 par value, and they mature in 5 years. Their yield to maturity is 9%, based on semiannual compounding, and the current market price is \$853.61. The bonds have a par value of \$1,000. What is the bond's annual coupon interest rate? (Points: 10)
5.10%
5.20%
5.30%
5.40%
5.50%

13. Which of the following statements is NOT CORRECT? (Points: 10)
If a bond is selling at its par value, its current yield equals its yield to maturity.
If a bond is selling at a discount to par, its current yield will be less than its yield to maturity.
All else equal, bonds with longer maturities have more interest rate (price) risk than do bonds with shorter maturities.
All else equal, bonds with larger coupons have greater interest rate (price) risk than do bonds with smaller coupons.
If a bond is selling at a premium, its current yield will be greater than its yield to maturity.

14. Over the past 75 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of their annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following lists correctly ranks investments from highest to lowest returns and risk (thus, the highest risk security should be shown first, the lowest risk securities shown last)? (Points: 10)
small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills
small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills
large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds
U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks
large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills

15. Apex Roofing's stock has a beta of 1.50, its required return is 14.00%, and the risk-free rate is 5.00%. What is the required rate of return on the stock market? (Hint: First find the market risk premium.) (Points: 10)
10.50%
11.00%
11.50%
12.00%
12.50%

16. The Connors Company's last dividend was \$1.00. Its dividend growth rate is expected to be constant at 15% for 2 years, after which dividends are expected to grow at a rate of 10% forever. Connors' required return (rs) is 12%. What is Connors' current stock price? (Points: 10)
\$54.91
\$56.82
\$58.15
\$60.07
\$62.87

17. Assume that Mary Brown Inc. hired you as a consultant to help it estimate the cost of capital. You have been provided with the following data: D0 = \$1.20; P0 = \$40.00; and g = 7% (constant). Based on the DCF approach, what is Brown's cost of equity from retained earnings? (Points: 10)
10.06%
10.21%
10.37%
10.54%
10.68%

18. You were hired as a consultant to Locke Company, and you were provided with the following data: Target capital structure: 40% debt, 10% preferred, and 50% common equity. The interest rate on new debt is 7.5%, the yield on the preferred is 7.0%, the cost of retained earnings is 11.50%, and the tax rate is 40%. The firm will not be issuing any new stock. What is the firm's WACC? (Points: 10)
8.25%
8.38%
8.49%
8.61%
8.76%

19. Safeco Company and Risco Inc are identical in size and capital structure. However, the riskiness of their assets and cash flows are somewhat different, resulting in Safeco having a WACC of 10% and Risco a 12% WACC. Safeco is considering Project X, which has an IRR of 10.5% and is of the same risk as a typical Safeco project. Risco is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical Risco project.
Now assume that the two companies merge and form a new company, Safeco/Risco Inc. Moreover, the new company's market risk is an average of the pre-merger companies' market risks, and the merger has no impact on either the cash flows or the risks of projects X and Y. Which of the following statements is CORRECT?
(Points: 10)
Safeco/Risco's WACC, as a result of the merger, would be 10%.
If evaluated using the correct post-merger WACC, Project X would have a negative NPV.
After the merger, Safeco/Risco would have a corporate WACC of 11%. Therefore, it should reject Project X but accept Project Y.
If the firm evaluates these projects and all other projects at the new overall corporate WACC, it will become riskier over time.
After the merger, Safeco/Risco should select Project Y but reject Project X.

20. Blanchford Enterprises is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC (and even negative), in which case it will be rejected.
Year: 0 1 2 3
Cash flows: -\$1,000 \$450 \$450 \$450
(Points: 10)
16.20%
16.65%
17.10%
17.55%
18.00%

21. Swannee Resorts is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, would be depreciated by the straight line method over the project's 3 year life, and would have zero salvage value. No new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. What is the project's NPV? If you are working this problem by hand rather than by computer, ignore small rounding differences between your answer and the choices given. (Hint: Cash flows are constant in Years 1-3.)
WACC 10%
Net investment cost (depreciable basis) \$65,000
Straight line depr'n rate 33.33%
Sales revenues \$70,000
Operating costs excl. depr'n \$25,000
Tax rate 35%
(Points: 10)
\$22,156.24
\$23,791.14
\$24,354.87
\$25,189.71
\$26,599.05

22. Harmon Industries is considering adding a new store. As a final step in reviewing the proposed project, the CFO wants to take into account two real options that are attached to the proposed project.
First, there is a timing option. One year from now, the company will have a much better idea of whether the county will raise or lower its property taxes. The firm might want to wait a year to decide whether it makes sense to proceed with their proposed project because the county taxes could significantly affect the project's cash flows.
Second, there is an abandonment option. After two years, the company will have the option to shut down the store if it is determined that the store is losing money and will continue to lose money.
Which of the following statements is most correct?
(Points: 10)
In this case, the option to delay the project actually takes value away from the project.
The abandonment option is likely to increase the project's expected cash flows.
The abandonment option is likely to increase the project's risk.
An abandonment and investment timing option can not exist for the same project.
In this case, the option to delay the project is likely to increase the project's risk.

23. Business risk is concerned with the operations of the firm. Which of the following is NOT associated with (or not a part of) business risk? (Points: 10)
demand variability
sales price variability
the extent to which operating costs are fixed
changes in required returns due to financing decisions
the ability to change prices as costs change

24. Brandi Co. has an unlevered beta of 1.10. The firm currently has no debt, but is considering changing its capital structure to be 30% debt and 70% equity. If its corporate tax rate is 40%, what is Brandi's levered beta? (Points: 10)
1.2549
1.3829
1.5764
1.6235
1.7458

25. Ronaldo Inc. has a capital budget of \$1,000,000, but it wants to maintain a target capital structure of 60% debt and 40% equity. The company forecasts this year's net income to be \$600,000. If the company follows a residual dividend policy, what will be its dividend payout ratio? (Points: 10)
16.67%
20.00%
25.00%
33.33%
35.00%

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