Question 1

Given the sample of returns of the Top Black Asphalt Company and the S&P 500 index,calculate Top Black's covariance and beta.

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Question 2

Suppose that the Hu's Corporation common stock has a beta of 2.3. If the risk-free rate is 6% and the market risk premium is 5%,the expected return on Hu's common stock is:

Accepted Answer

The expected return on Hu's common stock can be calculated using the Capital Asset Pricing Model (CAPM):
Expected return = Risk-free rate + Beta x (Market risk premium)
= 6% + 2.3 x 5%
= 6% + 11.5%
= 17.5%
Therefore, the expected return on Hu's common stock is 17.5%. The best choice is E.

Question 3

Slippery Slope Roof's net cash flows are as follows:  After year 3,net cash flows grew at a constant rate of 3%. The weighted average cost of capital is 9%. What is the value of the firm?

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Question 4

Explain the factors that determine beta and how an asset beta can differ from equity betas.

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Question 5

The net cash flows of Advantage Leasing for the next 3 years are $42,000,$49,000 and $64,000 respectively,after which the growth rate will be a constant 2% with a WACC of 8%. What is the present value of the terminal value?

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Question 6

The Neptune Company offers network communications systems to computer users. The company is planning a major investment expansion but is unsure of the correct measure of equity capital as it has no traded equity. Your job is to determine the basis of the equity cost. List and explain the steps you will need to take.

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Question 7

Daniel's Sound Systems has 210,000 shares of common stock outstanding at a market price of $36 a share. Last month,Daniel's paid an annual dividend in the amount of $1.593 per share. The dividend growth rate is 4%. Daniel's also has 6,000 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 7% coupon,pay interest annually,and mature in 4.89 years. The bonds are selling at 99% of face value. The company's tax rate is 34%. What is Daniel's weighted average cost of capital?

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Question 8

Suppose the Barges Corporation's common stock has an expected return of 12%. Assume that the risk-free rate is 5%,and the market risk premium is 6%. If no unsystematic influence affected Barges' return,the beta for Barges is ______.

Accepted Answer

The correct answer is B.The beta for Barges can be calculated using the Capital Asset Pricing Model (CAPM):Expected return = Risk-free rate + Beta * Market risk premium12% = 5% + Beta * 6%Beta = (12% - 5%) / 6% = 1.17

Question 9

Eyes of the World Corporation has traditionally employed a firm wide discount rate for capital budgeting purposes. However,its two divisions - publishing and entertainment - have different degrees of risk given by ßP = 1.0,ßE = 2.0,and the beta for the overall firm is 1.3. The firm is considering the following capital expenditures:
  Which projects would the firm accept if it uses the opportunity cost of capital for the entire company?
 Which projects would it accept if it estimates cost of capital separately for each division?
 Use 6% as the risk-free rate and 12% as the expected return on the market.

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Question 10

The cost of equity for Ryan Corporation is 8.4%. If the expected return on the market is 10% and the risk-free rate is 5%,then the equity beta is ___.

Accepted Answer

The equation for the cost of equity using the Capital Asset Pricing Model (CAPM) is:

Cost of Equity = Risk-Free Rate + Beta * (Expected Return on Market - Risk-Free Rate)

Substituting the given information, we get:

8.4% = 5% + Beta * (10% - 5%)
3.4% = Beta * 5%
Beta = 3.4% / 5% = 0.68

Therefore, the equity beta is 0.68, which is option B.

Question 11

The cost of equity for Burgess Corporation is 9.4%. If the expected return on the market is 12% and the risk-free rate is 4%,then the equity beta is ___.

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Question 12

Assuming the CAPM or one-factor model holds,what is the cost of equity for a firm if the firm's equity has a beta of 1.2,the risk-free rate of return is 2%,the expected return on the market is 9%,and the return to the company's debt is 7%?

Accepted Answer

The cost of equity can be calculated using the CAPM formula: Cost of Equity = Risk-free rate + Beta * (Market return - Risk-free rate). Substituting the given values: 2% + 1.2 * (9% - 2%) = 10.4%.

Question 13

On-line Text Co. has four new text publishing products that it must decide on publishing to expand its services. The firm's WACC has been 17%. The projects are of equal risk,ßs of 1.6. The risk-free rate is 7% and the market rate is expected to be 12%. The projects are expected to earn as follows:
What projects should be selected and why?

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Question 14

The Consolidated Transfer Co. is an all-equity financed firm. The beta is .75,the market risk premium is 8% and the risk-free rate is 4%. What is the expected return of Consolidated?

Accepted Answer

The expected return can be calculated using the Capital Asset Pricing Model (CAPM): Expected Return = Risk-free rate + Beta * Market Risk Premium = 4% + 0.75 * 8% = 10%.

Question 15

Given the sample of returns of the Top Black Asphalt Company and the S&P 500 index,calculate Top Black's correlation. What can be said about the relationship of Top Black and the market return behavior?

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Question 16

Suppose that the Simmons Corporation's common stock has a beta of 1.6. If the risk-free rate is 5% and the market risk premium is 4%,the expected return on Simmons' common stock is:

Accepted Answer

The expected return on Simmons' common stock can be found using the Capital Asset Pricing Model (CAPM):
Expected return = Risk-free rate + Beta*(Market risk premium)
Expected return = 5% + 1.6*(4%) = 5% + 6.4% = 11.4%
Therefore, the expected return on Simmons' common stock is 11.4%. The best choice is E.

Question 17

The Hold-n-Trade Co. is an all-equity financed firm. The beta is .9,the market risk premium is 7% and the risk-free rate is 5%. What is the expected return of Hold-n-Trade?

Accepted Answer

The expected return of Hold-n-Trade can be calculated using the Capital Asset Pricing Model (CAPM):

Expected Return = Risk-Free Rate + Beta x (Market Risk Premium)

Expected Return = 5% + 0.9 x 7% = 11.3%

Therefore, the correct answer is D) 11.3%.

Question 18

The Norris Co. has an improved version of its hotel stand. The investment cost is expected to be $72 million and will return $13.5 million for 5 years in net cash flows. The ratio of debt to equity is 1 to 1. The cost of equity is 13%,the cost of debt is 9%,and the tax rate is 34%. The appropriate discount rate,assuming average risk,is:

Accepted Answer

First, we need to calculate the Weighted Average Cost of Capital (WACC) using the debt-to-equity ratio of 1:1.

WACC = (E/V x Re) + (D/V x Rd x (1-Tc))

where:
E = Equity
D = Debt
V = Total value of the company
Re = Cost of equity
Rd = Cost of debt
Tc = Tax rate

Since the debt-to-equity ratio is 1:1, then:

D/V = 1/2
E/V = 1/2

Plugging in the values:

WACC = (1/2 x 0.13) + (1/2 x 0.09 x (1-0.34))
WACC = 0.065 + 0.0378
WACC = 0.1028 or 10.28%

Therefore, the appropriate discount rate, assuming average risk, is 10.28%.

The closest answer choice to this is C) 9.47%, which is not an exact match but is the closest option available.

Question 19

Assuming the CAPM or one-factor model holds,what is the cost of equity for a firm if the firm's equity has a beta of 1.2,the risk-free rate of return is 4%,the expected return on the market is 10%,and the return to the company's debt is 7%?

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Quiz 13: Risk, Cost of Capital, and Valuation