Quiz questions Flashcards
MM Proposition II, without taxes, implies that the required return on equity is
a result of homemade leverage.
inversely related to the firm’s debt-to-equity ratio.
directly affected by the firm’s debt-to-equity ratio.
independent of the firm’s capital structure.
a linear function of the market’s rate of interest.
directly affected by the firm’s debt-to-equity ratio.
Which one of these applies to the dividend growth model of stock valuation?
The dividend must be for the same time period as the stock price.
The growth rate must be less than the discount rate.
The rate of growth must be positive.
The model cannot be applied if the growth rate is zero.
The dividend amount must be constant over time.
The growth rate must be less than the discount rate
Assume an all-equity company is considering expanding its current operations by increasing the size of its warehouse. The discount rate used for this project should be the
market rate of return.
company’s cost of equity capital.
discount rate used when the company expanded into a new high-risk product line.
lowest discount rate the company assigned to any project over the past 2 years.
company’s cost of debt.
company’s cost of equity capital.
A firm with high operating leverage is best defined as a firm that has
a high debt-to-equity ratio.
high fixed costs relative to variable costs.
a low, relatively stable beta.
high variable costs relative to fixed costs.
a high sales/assets ratio
high fixed costs relative to variable costs.
As we add more diverse securities to a portfolio, the unsystematic risk of the portfolio will decrease.
True
The standard deviation is a measure of total return.
False
The underlying assumption of the dividend growth model is that a stock is worth:
the same amount to every investor regardless of their desired rate of return.
the present value of the future income that the stock is expected to generate.
an amount computed as the next annual dividend divided by the market rate of return.
the same amount as any other stock that pays the same current dividend and has the same required rate of return.
the present value of the future income that the stock is expected to generate.
A stock with a beta of zero would be expected to have a rate of return equal to the risk-free rate.
True
An increase in the rate of inflation will:
increase both the real and the nominal rate of interest.
decrease both the real and the nominal rate of interest.
increase the nominal interest rate while lowering the real interest rate.
increase the real interest rate but not affect the nominal interest rate.
increase the nominal interest rate but will not affect the real interest rate.
increase the nominal interest rate but will not affect the real interest rate.
Companies A and B are identical except for their capital structures. Company A is an all-equity company while Company B is levered. Given this, you can assume that Company B’s equity beta is ______ Company A’s beta and its debt beta is assumed to be ______.
greater than; equal to zero
greater than; equal to one
equal to; equal to the market beta
less than: equal to zero
less than; equal to one
greater than; equal to zero
Over the period from 1926 through 2020, the annual rate of return on _____ was more volatile than the annual rate of return on _____.
small-company stocks; large-company stocks
U.S. Treasury bills; small-company stocks
U.S. Treasury bills; long-term government bonds
long-term corporate bonds; small-company stocks
small-company stocks; large-company stocks
Standard deviation measures _____ risk while beta measures ____ risk.
unsystematic; total
unsystematic; systematic
total; systematic
total; systematic
No answer text provided.
total; systematic
The constant dividend growth model:
is more complex than the differential growth model.
equires the growth period be limited to a set number of years.
is never used because firms never attempt to maintain steady dividend growth.
can be used to compute a stock price at any point in time.
can be used to compute a stock price at any point in time.
Which one of the following is the best example of systematic risk?
The price of lumber declines sharply
The machinery operators at a firm go on strike
Inflation increases consumer prices
A storm causes a power outage in a city
People become health aware and avoid fast food restaurants
Inflation increases consumer prices
Corporations in the U.S. tend to
have extremely high debt-equity ratios.
rely less on equity financing than they should.
minimize taxes.
underutilize debt.
rely more heavily on bonds than stocks as the major source of financing.
underutilize debt.
The interest tax shield is a key reason why
the value of an unlevered firm is equal to the value of a levered firm.
the net cost of debt to a firm is generally less than the cost of equity.
firms tend to minimize their borrowing.
the cost of debt is equal to the cost of equity for a firm with a debt-to-equity ratio of 1.
firms prefer equity financing over debt financing.
the net cost of debt to a firm is generally less than the cost of equity.
You are writing a comparison of an all-equity structure to a levered capital structure for a firm. It is accurate to state in this comparison that
earnings per share will always be higher in the all-equity structure.
firms will only select the levered structure when individual rates on borrowed funds are lower than corporate rates.
leverage lowers shareholders’ returns in bad financial times.
the all-equity firm has a greater advantage the higher the firm’s earnings before interest.
leverage improves shareholders’ returns regardless of the firm’s level of earnings.
leverage lowers shareholders’ returns in bad financial times.
Which one of these statements is correct?
Firms across all industries in the U.S. tend to have similar debt-to-equity ratios.
The banking industry tends to have the lowest debt-to-equity ratio of any United States industry.
Financial leverage lowers risk to equity holders.
MM Propositions ignore bankruptcy costs.
MM Propositions, without taxes, illustrate that a firm’s overall cost of capital is affected by leverage.
MM Propositions ignore bankruptcy costs.
The optimal capital structure has been achieved when the
weight of equity is equal to the weight of debt.
debt-equity ratio selected results in the lowest possible weighted average cost of capital.
firm is totally financed with debt.
debt-equity ratio is such that the cost of debt exceeds the cost of equity.
cost of equity is maximized.
debt-equity ratio selected results in the lowest possible weighted average cost of capital.
Suppose you are utilizing the dividend growth model to assess ALL stocks. In the event that you anticipate a universal decrease in the market rate of return for all equity securities, the expected outcome on prices is:
Market values remain unaffected by changes in market rates, resulting in unchanged prices
Prices of non-dividend-paying stocks to decrease, while dividend-paying stocks maintain a constant price.
Prices of all stocks to decrease, all else constant.
Prices of all stocks to increase, all else constant.
Prices of all stocks to increase, all else constant.
Conflicts of interest between stockholders and bondholders are known as
trustee costs.
financial distress costs.
dealer problems.
agency problems.
underwriting costs.
agency problems
The return earned in an average year over a multi-year period is called the _____ average return.
arithmetic
standard
variant
geometric
arithmetic
If a bond’s yield to maturity is less than its coupon rate, the bond will sell at a _____, and increases in market interest rates will:
discount; decrease this discount.
discount; increase this discount.
premium; decrease this premium.
premium; increase this premium.
premium; not affect this premium.
premium; decrease this premium.
Aspens is preparing a bond offering with a coupon rate of 5.5 percent. The bonds will be repaid in 10 years. The company plans to issue the bonds at par value and pay interest annually. Which one of the following statements is correct? Assume a face value of $1,000.
The bonds will pay 19 interest payments and one principal payment.
The bonds will initially sell at a discount.
At maturity, the bonds will pay a final payment of $1,027.50.
The bonds will pay twenty equal coupon payments.
At issuance, the bond’s yield to maturity is 5.5 percent.
At issuance, the bond’s yield to maturity is 5.5 percent.
In general, the capital structures of U.S. firms:
tend to overweight debt in relation to equity.
employ less debt when the firm requires large amounts of tangible assets.
are constant over time on a firm-by-firm basis.
tend to be those that maximize the use of each firm’s available tax shelters.
vary significantly across industries.
vary significantly across industries.
The terminal value of a firm is also commonly referred to as the:
final value.
cash value.
non-constant value.
estimated value.
horizon value
horizon value
When calculating the WACC, you should use book values of debt and equity rather than market values.
False
The expected return on a portfolio is calculated as a(n) ____ average of the expected returns on the individual securities held in the portfolio.
weighted
arithmetic
geometric
compounded
weighted
The optimal capital structure will tend to include more debt for firms with
less taxable income.
lower probability of financial distress.
substantial tax shields from other sources.
the lowest marginal tax rate.
the highest depreciation deductions.
lower probability of financial distress.
Which one of the following is a correct ranking of securities based on their volatility during the period from 1926 to 2020? Rank from highest to lowest volatility.
Large-company stocks, intermediate-term government bonds, long-term government bonds
Small-company stocks, long-term corporate bonds, large-company stocks
Long-term government bonds, long-term corporate bonds, small-company stocks
Small-company stocks, large-company stocks, long-term corporate
Long-term corporate bonds, large-company stocks, U.S. Treasury bills
Small-company stocks, large-company stocks, long-term corporate
Interest rate risk _____ as the time to maturity decreases and ____ as the coupon rate decreases.
decreases; increases
decreases; decreases
increases; increases
increases; decreases
decreases; increases
Among the given options, which bond is exposed to the LOWEST interest rate risk?
1 year; 10% coupon
1 year; 2% coupon
3 year; 5% coupon
10 year; 3% coupon
1 year; 10% coupon
When comparing levered versus unlevered capital structures, leverage works to increase EPS for high levels of EBIT because interest payments on the debt
increase as EBIT increases.
stay fixed, leaving more income to be distributed over fewer shares.
stay fixed, leaving less income to be distributed over fewer shares.
stay fixed, leaving less income to be distributed over more shares.
decrease as EBIT increases.
stay fixed, leaving more income to be distributed over fewer shares
Based on the historical returns (from 1926-2020), what conclusion should you draw from the performance of stocks and bonds?
Bonds have greater volatility than stocks.
Stocks are riskier than bonds.
Stock returns have a smaller risk premium than bond returns.
In any year, stocks will outperform bonds.
Stock returns have a lower standard deviation than bond returns.
Stocks are riskier than bonds.
The differential growth model of stock valuation:
makes allowance for one change in the discount rate.
uses dividend at T + 1 as the dividend amount throughout the formula.
requires g2 to be less than the discount rate.
assumes the second growth rate will be zero.
requires g2 to be less than the discount rate.
