TCOs 1, 8, 9) Using the security market line formula rather than the dividend discount
formula, determine the expected return on a firm’s common stock when:
(a) beta = 1.0;
(b) the risk-free rate is 4%; and
(c) marketplace interest rates have hovered around 9%. (Points : 20)
2. (TCOs 1, 5, 6) Calculate the appropriate selling price of a 30-year 5% coupon, $1,000
corporate bond that was purchased five years ago. Marketplace interest rates are
averaging 8%. (Points : 20)
3. (TCO 6) Calculate the five ratios for the following company info.
Income Statement Balance Sheet
Revenue 10,000 Assets Liab. + OE
EBIT $2,000 cash $1,000 a/p $2,000
Interest $500 A/R $10,000 Bonds payable $50,000
Earnings B4 Tax $1,500 Equip $25,000 equity $84,000
EAT (at 40%) $900 Bldg $100,000
Total $136,000 $136,000
–
return on sales
ROA
ROE
fixed asset turnover
times interest earned
(Points : 20)
4. (TCO 2) Given the data below, calculate the expected return, variance, and standard
deviation of the following company.
In a recessionary economy, which is expected to occur with a 30% probability, the
expected returns would be -5%.
In an expanding economy with an expected probability of occurrence of 20%, the
expected return would be 20%.
In a normal economy expected to occur 50% of the time, the expected return would be
5%.
(Points : 20)
5. (TCO 9) As percentage of equity on the balance sheet increases, financial leverage
decreases, which makes EPS decrease. If this is the case, why don’t all firms try to end
up with 99.9% debt? (Points : 20)
6. (TCO 7) What would be the expected change to a 30-year bond’s market price or
value if its YTM increases to 9.4%? Its YTM is now 9%, it has an 8% annual coupon,
$1,000 face value, it is currently priced at $897.26, and its duration is eight years.
(Points : 20)
7. (TCO 9) What are M&M Propositions with and without taxes all about? Please explain,
and you must use your own words to earn credit. (Points : 20)
8. (TCO 6) A $1,000 face value bond was issued at par 20 years ago with a 6% coupon
paid semiannually. The bond now has nine years remaining to maturity and similar debt
obligations are yielding 12%.
Compute the current price of the bond.
Assuming that the bond is sold at its current price, what is the capital gain or loss from
the original purchase?
Now assume that the price of the bond returns to par. What is the percentage capital
gain or loss for the new owner?
Please explain why the percentage gain is different from the percentage loss.
(Points : 22)
9. (TCO 6) What is the interest rate needed on a $1,000 face value, 6% coupon
corporate bond to make it equivalent in terms of return to one whose interest rate is tax
free? Assume the corporate tax rate is 30%. (Points : 10)
1. (TCO 1) Which of the following is true about fixed-income securities? (Points : 6)
They are usually found on the income statement.
They are always found on the left side of the balance sheet.
They are usually shown on the right side of the balance sheet.
None of the above
2. (TCO 2) The concept of risk versus return _______. (Points : 6)
is all about investors’ expectation of higher risk deserving higher returns
means that most investors require 2 times the change in return for a given change in
risk
refers to most of us being risk-loving
None of the above
3. (TCO 5) Which of the following is true? (Points : 6)
Current yield = dividends / price paid.
Coupon rate = interest / price paid.
YTM = interest / 30.
None of the above
4. (TCO 9) Financial leverage _______. (Points : 6)
is affected by numerous factors including how much debt versus equity there is in the
firm
is primarily affected by sales levels
is never good if it’s too high
None of the above
5. (TCO 9) Which of the following is true about a firm’s WACC? (Points : 6)
WACC is only important when a firm needs to calculate its taxes.
WACC is important as it represents the percentage of debt versus equity.
WACC is important as it is the discount rate used in capital budgeting analysis.
None of the above
6. (TCO 7) The ideal capital structure of a firm is when ______. (Points : 6)
financial leverage = 1
WACC is minimized
the tax savings from added debt is exactly offset by increased bankruptcy costs
None of the above
7. (TCO 3) Which of the following are or could be part of the buying, selling, and trading
of corporate bonds? (Points : 6)
IPO process and shelf registration
Auction markets and dealer markets
Investment bankers
All of the above
8. (TCO 9) What is the premise behind M&M Principle 1 without taxes? (Points : 6)
Capital structure is primarily determined by a firm’s WACC.
In a world of no taxes, the value of the firm is unaffected by capital structure.
The higher the tax rate, the higher the firm’s value.
None of the above
9. (TCO 6) Which is true about the normal yield curve? (Points : 6)
It’s rarely a straight, horizontal line.
Its primary component is liquidity risk.
Its primary component is inflation premium.
None of the above
10. (TCO 4) Which of the following would give a good picture of the bond market?
(Points : 6)
Dow Jones Industrial Index
S&P 500
Nasdaq
None of the above
11. (TCO 8) Who would normally be required to create a portfolio investment policy?
(Points : 6)
Pension fund managers
401k plan administrators
Large insurance companies
All of the above
12. (TCOs 1, 8) Investors particularly interested in fixed-income securities could choose
from which of the following? (Points : 6)
Common stock, preferred stock, and municipal bonds
Preferred stock, Treasury bonds, and the money market
Preferred stock, municipal bonds, and corporate bonds
None of the above
13. (TCO 6) Portfolio diversification attempts to ______. (Points : 6)
maximize the investor’s return
minimize risk per unit of return
minimize the risk
None of the above
14. (TCO 5) What is the normal yield curve shape? (Points : 6)
Humped in the middle
Downward sloping to the right
Upward sloping to the right
None of the above
