FINC5331 CHAPTER 12 QUIZ WITH
COMPLETE SOLUTIONS
Which one of these formulas will provide an estimate of the growth rate of a security's
dividends? - ANSWER Retention ratio × Return on equity
What value should you assign as the flotation cost of internally generated equity
financing? - ANSWER A cost of zero
The use of WACC as the discount rate when evaluating a project is acceptable when
the - ANSWER risk of the project is equal to the company's overall level of risk.
The discount rate for a project should equal the - ANSWER expected return on a
financial asset of comparable risk.
Which one of the following statements is correct? - ANSWER The DDM seems to have
more estimation error than the CAPM
Which one of these statements is correct? - ANSWER Financial leverage refers to a
firm's use of debt and its related fixed costs of finance.
The asset beta is defined as the beta of - ANSWER the common stock of an unlevered
firm
Although a definitive value cannot be determined, which one of the following values is
considered to be the best estimate of the market's historical risk premium according to
your textbook authors? - ANSWER 7%
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 - ANSWER company's cost of equity capital.
Diversified Industries is a multiproduct company operating in a number of industries.
Assume the company is analyzing a new project that has risks unrelated to those of the
current company's products. When computing the net present value of the new project
, the cash flows should be discounted using - ANSWER a rate commensurate with the
risk level of the project.
The beta of a firm is more likely to be high under which two conditions? - ANSWER
High cyclical business activity and high operating leverage
Assume a company's cost of equity exceeds its pretax cost of debt. Given this
assumption and assuming all else is held constant, the company's WACC must
increase if the - ANSWER tax rate decreases.
Tires and More is a levered company providing automobile supplies through its retail
outlets. The company is considering expanding into electric scooter sales. Since this is
an entirely new venture, the company should - ANSWER use the pure play approach to
assign a discount rate to the project.
If a company is all-equity financed, its WACC will equal - ANSWER RS.
Which of the following outcomes may occur if a company uses its overall cost of capital
as the discount rate for all projects?
I. Profitable low-risk projects may be incorrectly rejected.
II. Only projects with risks similar to the current company will be accepted.
III. Too many high-risk projects may be accepted.
IV. Only low-risk projects will be accepted. - ANSWER I and III only
An all-equity firm has a beta of 1.2. The firm is evaluating a project that will increase the
output of the firm's existing products. The market risk premium is 6.5 percent and the
risk-free rate is 3.5 percent. What discount rate should be assigned to this expansion
project? - ANSWER 11.3%
The cost of equity for Rosenthal Corporation is 13.61 percent. The expected return on
the market is 12.5 percent, the risk-free rate is 1.4 percent, and the expected inflation
rate is 3.3 percent. What is the company's equity beta? - ANSWER 1.10
A stock portfolio consists of 9.36 percent Stock A, 61.05 percent Stock B, and the
remainder is invested in Stock C. The security betas are .40, .97, and 1.80 for Stocks A,
B, and C, respectively. What is the portfolio beta? - ANSWER 1.16
Tangential is an all-equity financed firm. The beta is .90, the market risk premium is 5.7
percent, and the tax rate is 21 percent. The firm just issued its annual dividend of $5.50
per share and announced that future dividends will increase by 4.5 percent annually.
The stock sells for $53.25 per share. What is the cost of equity? - ANSWER 15.29%
Afandy stock has a beta that is 13 percent higher than the overall market beta. The risk-
free rate is 3.1 percent, and the market rate of return is 10.6 percent. What is the
company's cost of equity? - ANSWER 11.58%
COMPLETE SOLUTIONS
Which one of these formulas will provide an estimate of the growth rate of a security's
dividends? - ANSWER Retention ratio × Return on equity
What value should you assign as the flotation cost of internally generated equity
financing? - ANSWER A cost of zero
The use of WACC as the discount rate when evaluating a project is acceptable when
the - ANSWER risk of the project is equal to the company's overall level of risk.
The discount rate for a project should equal the - ANSWER expected return on a
financial asset of comparable risk.
Which one of the following statements is correct? - ANSWER The DDM seems to have
more estimation error than the CAPM
Which one of these statements is correct? - ANSWER Financial leverage refers to a
firm's use of debt and its related fixed costs of finance.
The asset beta is defined as the beta of - ANSWER the common stock of an unlevered
firm
Although a definitive value cannot be determined, which one of the following values is
considered to be the best estimate of the market's historical risk premium according to
your textbook authors? - ANSWER 7%
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 - ANSWER company's cost of equity capital.
Diversified Industries is a multiproduct company operating in a number of industries.
Assume the company is analyzing a new project that has risks unrelated to those of the
current company's products. When computing the net present value of the new project
, the cash flows should be discounted using - ANSWER a rate commensurate with the
risk level of the project.
The beta of a firm is more likely to be high under which two conditions? - ANSWER
High cyclical business activity and high operating leverage
Assume a company's cost of equity exceeds its pretax cost of debt. Given this
assumption and assuming all else is held constant, the company's WACC must
increase if the - ANSWER tax rate decreases.
Tires and More is a levered company providing automobile supplies through its retail
outlets. The company is considering expanding into electric scooter sales. Since this is
an entirely new venture, the company should - ANSWER use the pure play approach to
assign a discount rate to the project.
If a company is all-equity financed, its WACC will equal - ANSWER RS.
Which of the following outcomes may occur if a company uses its overall cost of capital
as the discount rate for all projects?
I. Profitable low-risk projects may be incorrectly rejected.
II. Only projects with risks similar to the current company will be accepted.
III. Too many high-risk projects may be accepted.
IV. Only low-risk projects will be accepted. - ANSWER I and III only
An all-equity firm has a beta of 1.2. The firm is evaluating a project that will increase the
output of the firm's existing products. The market risk premium is 6.5 percent and the
risk-free rate is 3.5 percent. What discount rate should be assigned to this expansion
project? - ANSWER 11.3%
The cost of equity for Rosenthal Corporation is 13.61 percent. The expected return on
the market is 12.5 percent, the risk-free rate is 1.4 percent, and the expected inflation
rate is 3.3 percent. What is the company's equity beta? - ANSWER 1.10
A stock portfolio consists of 9.36 percent Stock A, 61.05 percent Stock B, and the
remainder is invested in Stock C. The security betas are .40, .97, and 1.80 for Stocks A,
B, and C, respectively. What is the portfolio beta? - ANSWER 1.16
Tangential is an all-equity financed firm. The beta is .90, the market risk premium is 5.7
percent, and the tax rate is 21 percent. The firm just issued its annual dividend of $5.50
per share and announced that future dividends will increase by 4.5 percent annually.
The stock sells for $53.25 per share. What is the cost of equity? - ANSWER 15.29%
Afandy stock has a beta that is 13 percent higher than the overall market beta. The risk-
free rate is 3.1 percent, and the market rate of return is 10.6 percent. What is the
company's cost of equity? - ANSWER 11.58%
