# FI515 Financial Management: Week 6 Study Guide (version 6)

FI515 Financial Management

Week 6 Study Guide (version 6)

1. (TCO D) A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price?

A.$23.11

B.$23.70

c. $24.31

d. $24.93

e. $25.57

2. (TCO D) If D0 = $2.25, g (which is constant) = 3.5%, and P0 = $50, what is the stock’s expected dividend yield for the coming year?

A. 4.42%

B. 4.66%

C. 4.89%

D. 5.13%

E. 5.39%

3. (TCO D) Rebello's preferred stock pays a dividend of $1.00 per quarter, and it sells for $55.00 per share. What is its effective annual (not nominal) rate of return?

A. 6.62%

B.6.82%

C. 7.03%

D. 7.25%

E. 7.47%

4. (TCO E) Schalheim Sisters Inc. has always paid out all of its earnings as dividends; hence, the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC?

A. The market risk premium declines.

B. The flotation costs associated with issuing new common stock increase.

C. The company’s beta increases.

D. Expected inflation increases.

E. The flotation costs associated with issuing preferred stock increase.

5. (TCO E) If a typical U.S. company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely

A.become riskier over time, but its intrinsic value will be maximized.

B. become less risky over time, and this will maximize its intrinsic value.

C.accept too many low-risk projects and too few high-risk projects.

D.become more risky and also have an increasing WACC. Its intrinsic value will not be maximized.

E. continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital.

6. (TCO D) Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $27.50; and g = 8.00% (constant). What is the cost of common from retained earnings based on the DCF approach?

A. 9.42%

B. 9.91%

C.10.44%

D.10.96%

E.11.51%

7. (TCO F) Cornell Enterprises is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected.

WACC: 10.00%

Year 0 1 2 3

-----------------------------------------------

Cash flows -$1,050 $450 $460 $470

A. $ 92.37

B. $ 96.99

C. $101.84

D.$106.93

E. $112.28

8. (TCO F) Data Computer Systems is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC (and even negative), in which case it will be rejected.

Year 0 1 2 3

-----------------------------------------------

Cash flows -$1,100 $450 $470 $490

A. 9.70%

B. 10.78%

C.11.98%

D.13.31%

E.14.64%

9. (TCO F) Stern Associates is considering a project that has the following cash flow data. What is the project's payback?

Year 0 1 2 3 4 5

------------------------------------------------------------------------

Cash flows -$1,100 $300 $310 $320 $330 $340

A. 2.31 years

B. 2.56 years

C. 2.85 years

D. 3.16 years

E. 3.52 years

10. (TCO H) Sub-Prime Loan Company is thinking of opening a new office, and the key data are shown below. The company owns the building that would be used, and it could sell it for $100,000 after taxes, if it decides not to open the new office. The equipment for the project would be depreciated by the straight-line method over the project’s three-year life, after which it would be worth nothing, and thus it would have a zero salvage value. No new working capital would be required, and revenues and other operating costs would be constant over the project’s three-year life. What is the project’s NPV? (Hint: Cash flows are constant in years 1-3.)

Week 6 Study Guide (version 6)

1. (TCO D) A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price?

A.$23.11

B.$23.70

c. $24.31

d. $24.93

e. $25.57

2. (TCO D) If D0 = $2.25, g (which is constant) = 3.5%, and P0 = $50, what is the stock’s expected dividend yield for the coming year?

A. 4.42%

B. 4.66%

C. 4.89%

D. 5.13%

E. 5.39%

3. (TCO D) Rebello's preferred stock pays a dividend of $1.00 per quarter, and it sells for $55.00 per share. What is its effective annual (not nominal) rate of return?

A. 6.62%

B.6.82%

C. 7.03%

D. 7.25%

E. 7.47%

4. (TCO E) Schalheim Sisters Inc. has always paid out all of its earnings as dividends; hence, the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC?

A. The market risk premium declines.

B. The flotation costs associated with issuing new common stock increase.

C. The company’s beta increases.

D. Expected inflation increases.

E. The flotation costs associated with issuing preferred stock increase.

5. (TCO E) If a typical U.S. company correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely

A.become riskier over time, but its intrinsic value will be maximized.

B. become less risky over time, and this will maximize its intrinsic value.

C.accept too many low-risk projects and too few high-risk projects.

D.become more risky and also have an increasing WACC. Its intrinsic value will not be maximized.

E. continue as before, because there is no reason to expect its risk position or value to change over time as a result of its use of a single cost of capital.

6. (TCO D) Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $27.50; and g = 8.00% (constant). What is the cost of common from retained earnings based on the DCF approach?

A. 9.42%

B. 9.91%

C.10.44%

D.10.96%

E.11.51%

7. (TCO F) Cornell Enterprises is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected.

WACC: 10.00%

Year 0 1 2 3

-----------------------------------------------

Cash flows -$1,050 $450 $460 $470

A. $ 92.37

B. $ 96.99

C. $101.84

D.$106.93

E. $112.28

8. (TCO F) Data Computer Systems is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC (and even negative), in which case it will be rejected.

Year 0 1 2 3

-----------------------------------------------

Cash flows -$1,100 $450 $470 $490

A. 9.70%

B. 10.78%

C.11.98%

D.13.31%

E.14.64%

9. (TCO F) Stern Associates is considering a project that has the following cash flow data. What is the project's payback?

Year 0 1 2 3 4 5

------------------------------------------------------------------------

Cash flows -$1,100 $300 $310 $320 $330 $340

A. 2.31 years

B. 2.56 years

C. 2.85 years

D. 3.16 years

E. 3.52 years

10. (TCO H) Sub-Prime Loan Company is thinking of opening a new office, and the key data are shown below. The company owns the building that would be used, and it could sell it for $100,000 after taxes, if it decides not to open the new office. The equipment for the project would be depreciated by the straight-line method over the project’s three-year life, after which it would be worth nothing, and thus it would have a zero salvage value. No new working capital would be required, and revenues and other operating costs would be constant over the project’s three-year life. What is the project’s NPV? (Hint: Cash flows are constant in years 1-3.)

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