EXAM 3 VERSION A PUT YOUR NAME AND TEST VERSION ON …

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MBA 765 Financial Decision Making

Prof. Thistle Spring 2019

EXAM 3 VERSION A

PUT YOUR NAME AND TEST VERSION ON THE SCANTRON FORM

PART A - MULTIPLE CHOICE. (3 pts. each) Choose the one alternative that best completes the statement or answers the question.

1) The excess return if the difference between the average return on a security and the average return for: 1) _________

A) Treasury Bills. B) a portfolio of securities with similar risk. C) Treasury Bonds. D) a broad based market portfolio like the S&P 500 index.

Use the following information to answer the question(s) below.

Eenie Meenie Miney

Moe

Beta 0.45 0.75 1.05 1.20

Volatility 20% 18% 35% 25%

Assume that the risk-free rate of interest is 3% and you estimate the markets expected return to be 9%.

2) Which firm has the least market risk? 2) _________

A) Eenie

B) Meenie

C) Miney

D) Moe

3) Which of the following investments offered the highest overall return over the past eighty years?

A) Treasury Bills

B) Small stocks

C) S&P 500 D) Corporate bonds

3) _________

4) In practice which market index is most widely used as a proxy for the market portfolio in the CAPM? 4) _________

A) S&P 500 B) Dow Jones Industrial Average

C) Wilshire 5000

D) U.S. Treasury Bill

Use the following information to answer the question(s) below.

Rearden Metals has a current stock price of $30 share, is expected to pay a dividend of $1.20 in one year, and its expected price right after paying that dividend is $33.

5) Reardens expected dividend yield is closest to:

5) _________

A) 4.00%

B) 3.40%

C) 4.20%

D) 3.65%

6) Which of the following is NOT a systematic risk? 6) _________ A) The risk that the Federal Reserve raises interest rates B) The risk that your new product will not receive regulatory approval C) The risk that oil prices rise, increasing production costs D) The risk that the economy slows, reducing demand for your firms products

Exam 3 Version A

Use the information for the question(s) below. Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share.

7) The weight on Abbott Labs in your portfolio is: A) 30% B) 50% C) 40% D) 20%

7) _________

8) Suppose over the next year Ball has a return of 12.5%, Lowes has a return of 20%, and Abbott Labs has a return of -10%. The return on your portfolio over the year is: 8) _________

A) 0% B) 3.5% C) 5.0% D) 7.5%

9) When discounting dividends you should use: 9) _________ A) the before tax cost of debt. B) the after tax weighted average cost of capital. C) the equity cost of capital. D) the weighted average cost of capital.

10) The firms unlevered (asset) beta is: 10) ________ A) the weighted average of the equity beta and the debt beta. B) the weighted average of the levered beta and the equity beta. C) the unlevered beta minus the cost of capital. D) the debt beta minus the equity beta.

11) Which of the following is NOT a diversifiable risk? 11) ________ A) The risk that the CEO is killed in a plane crash B) The risk that oil prices rise, increasing production costs C) The risk of a product liability lawsuit D) The risk of a key employee being hired away by a competitor

Use the following information to answer the question(s) below.

Consider the following information regarding corporate bonds:

Rating

AAA

Average Default Rate 0.0%

Recession Default Rate 0.0%

Average Beta 0.05

AA 0.1% 1.0% 0.05

A 0.2% 3.0% 0.05

BBB 0.45% 3.0% 0.10

BB 2.2% 8.0% 0.17

B 5.5% 16.0% 0.26

CCC 12.2% 48.0% 0.31

Market

Company

Capitalization ($mm)

Taggart Transcontinental $4,500

Rearden Metal $3,800

Wyatt Oil $2,400

Nielson Motors $1,500

Total Enterprise Value ($mm)

8,000 7,200 3,800 4,400

Equity Beta 1.1 1.3 0.9 1.75

2

Debt Rating

BBB AAA

A BB

Exam 3 Version A

12) Your estimate of the asset beta for Taggart Transcontinental is closest to: A) 0.71 B) 0.66 C) 0.42 D) 0.59

12) ________

13) Your estimate of the debt beta for Taggart Transcontinental would be: A) 1.00 B) 0.17 C) 0.05 D) 0.10

13) ________

14) Von Bora Corporation (VBC) is expected to pay a $2.00 dividend at the end of this year. If you expect VBCs dividend to grow by 5% per year forever and VBCs equity cost of capital is 13%, then the value of a share of VBS stock is closest to:

14) ________

A) $11.10

B) $15.40

C) $25.00

D) $40.00

Use the table for the question(s) below. Consider the following expected returns, volatilities, and correlations:

Stock Duke Energy Microsoft Wal-Mart

Expected Return

14% 44% 23%

Standard Correlation with Correlation with Correlation with

Deviation Duke Energy

Microsoft

Wal-Mart

6%

1.0

-1.0

0.0

24%

-1.0

1.0

0.7

14%

0.0

0.7

1.0

15) The expected return of a portfolio that is equally invested in Duke Energy and Microsoft is closest to: 15) ________ A) 24% B) 28% C) 23% D) 29%

16) The volatility of a portfolio that is equally invested in Duke Energy and Microsoft is closest to:16) ________ A) 9% B) 11% C) 6% D) 8%

Use the following information to answer the question(s) below. Taggart Transcontinental pays no dividends, but spent $4 billion on share repurchases last year. Taggarts equity cost of capital is 13% and if the amount spent on repurchases is expected to grow by 5% per year. Taggart currently has 2 billion shares outstanding.

17) Taggarts market capitalization is closest to: 17) ________ A) $50 billion B) $40 billion C) $31 billion D) $25 billion

18) Suppose that Google Stock has a beta of 1.06 and Boeing stock has a beta of 1.31. If the risk-free interest rate is 4% and the expected return from the market portfolio is 12%, then the expected return on a portfolio that consists of 30% Google stock and 70% Boeing stock is closest to: 18) ________

A) 12.5%

B) 13.9%

C) 13.1%

D) 13.5%

19) You expect Whirlpool Corporation (WHR)to have earnings per share of $6.10 over the coming year. If Whirlpool

stock is currently trading at $87.00 per share, then Whirlpools P/E ratio is closest to:

19) ________

A) 7.00 B) 17.00 C) 13.50D) 14.25

3

Exam 3 Version A

Use the following information to answer the question(s) below.

Company

Ticker Beta

Ford Motor Company

F 2.77

International Business Machines IBM 0.73

Merck

MRK 0.90

20) If the market risk premium is 6% and the risk-free rate is 4%, then the expected return of investing in Ford Motor Company is closest to: 20) ________

A) 10.0%

B) 20.6%

C) 16.2%

D) 17.1%

4

Exam 3 Version A

PART B ? PROBLEMS (10 pts. each) Show your work. Draw the timeline where appropriate, write any formulas used ans show intermediate steps. Be sure all work is clear and easy to follow. Answers should be accurate to the nearest cent (e.g., $109.82) for dollar amounts and to the nearest basis point for interest rates (8.16% or 0.0816).

21) Grow Real Fast Inc. (GRF) is expected to have a 25% growth rate for the next three years (affecting d1, d2, and d3). Beginning in year 4 the growth rate is expected to drop to 7% and remain at that rate indefinitely. GRF just paid a dividend of $2.00 and the appropriate discount rate is 15%. What is the value of a share of GRF?

P0

N dt PN t1 (1 rE )t (1 rE )N

N

dt

1

d N 1

t1 (1 rE )t (1 rE ) N rE g

d0 = 2.00

d1 = (1.25)2.00 = 2.50 d2 = (1.25)2.50 = 3.13 d3 = (1.25)3.125 = 3.91 d4 = (1.07)3.91 = 4.18

P3 = 4.18/(0.15 ? 0.07) = 52.25

0___________1__________2_________3_________ 2.50 3.13 3.91 + 52.25

P0 = $41.47

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