CHS 4&5 quiz
$100 million of free cash flow to be received at the end of the first year of a
company's projection period given a WACC of 10% would be worth what amount
today?
A) $91 million
B) $95 million
C) $100 million
D) $110 million - ANS - A) $91 million
The present value of $100 million assumed to be received at the end of year 1 of a
company's projection period would be determined as $100 million / (1+10%) = $91
million. Alternatively, a discount factor can be multiplied by $100 million to
determine the appropriate value. This calculation would be performed as follows:
$1.00 / (1 + 10%) = 0.91 and 0.91 multiplied by $100 million = $91 million. The
discount factor is the fractional value representing the present value of one dollar
received at a future date given an assumed discount rate.
Reference: Textbook Section: 5.3.4
\A company's outstanding debentures are currently trading at 91, and have a
nominal yield of 5.9%. The risk free rate is 3.7%, the expected return on the S&P
500 is 8.5% and the tax rate is 35%. What post-tax cost of debt would you use in a
WACC calculation?
A) 2.30%
B) 3.80%
C) 4.20%
D) 6.50% - ANS - C) 4.20%
Current yield on the debentures is 5.9%/91 = 6.5%. The post-tax cost of debt is
then 6.5% × (1 - 35%) = 4.2%. The risk free rate and expected return on the S&P
500 were not required.
Reference: Textbook Section: 5.2.1
\A company's outstanding debentures are currently trading at 91, and have a
nominal yield of 5.9%. The risk free rate is 3.7%, the expected return on the S&P
500 is 8.5% and the tax rate is 35%. What post-tax cost of debt would you use in a
WACC calculation?
, A) 2.30%
B) 3.80%
C) 4.20%
D) 6.50% - ANS - C) 4.20%
Current yield on the debentures is 5.9%/91 = 6.5%. The post-tax cost of debt is
then 6.5% × (1 - 35%) = 4.2%. The risk free rate and expected return on the S&P
500 were not required.
Reference: Textbook Section: 5.2.1
\A stock has an expected return of 5.5% and a Beta of .80. By how much will the
excess return of the stock change if the excess return of the S&P 500 falls by 1%?
A) It will fall by 1.2%
B) It will rise by 1.2%
C) It will fall by .8%
D) It will rise by .8% - ANS - C) It will fall by .8%
Excess return = expected return above risk-free rate. The expected return of any
stock will change by an amount equal to the expected return change of the
market portfolio (S&P 500) multiplied by the stock's Beta. A 1% decline in
expected return in the S&P 500 will cause the stock to decline by 1% x .8 = .8%.
Reference: Textbook Section: 5.2.2
\Jackson, an investment banker, is valuing a company based on a Gordon growth
model. The company has projected that it will increase its total dividend payout
by 3% per year. What event could cause the model's value per share estimate to
change?
A) A significant change in the company's shares outstanding
B) A significant change in the company's total debt
C) A reduction in the firm's share buyback plan.
D) An increase in net profit margins - ANS - A) A significant change in the
company's shares outstanding
A Gordon growth model - also known as a discounted dividend growth model -
estimates company value based on expected future returns to investors, mainly
from dividends. It is useful in evaluating companies with strong, steady and
rising dividends. However, it's important to note whether projected dividend
growth is on a total payout basis or a per share basis. If it is total payout, any
significant change in shares outstanding (such as those resulting from share
$100 million of free cash flow to be received at the end of the first year of a
company's projection period given a WACC of 10% would be worth what amount
today?
A) $91 million
B) $95 million
C) $100 million
D) $110 million - ANS - A) $91 million
The present value of $100 million assumed to be received at the end of year 1 of a
company's projection period would be determined as $100 million / (1+10%) = $91
million. Alternatively, a discount factor can be multiplied by $100 million to
determine the appropriate value. This calculation would be performed as follows:
$1.00 / (1 + 10%) = 0.91 and 0.91 multiplied by $100 million = $91 million. The
discount factor is the fractional value representing the present value of one dollar
received at a future date given an assumed discount rate.
Reference: Textbook Section: 5.3.4
\A company's outstanding debentures are currently trading at 91, and have a
nominal yield of 5.9%. The risk free rate is 3.7%, the expected return on the S&P
500 is 8.5% and the tax rate is 35%. What post-tax cost of debt would you use in a
WACC calculation?
A) 2.30%
B) 3.80%
C) 4.20%
D) 6.50% - ANS - C) 4.20%
Current yield on the debentures is 5.9%/91 = 6.5%. The post-tax cost of debt is
then 6.5% × (1 - 35%) = 4.2%. The risk free rate and expected return on the S&P
500 were not required.
Reference: Textbook Section: 5.2.1
\A company's outstanding debentures are currently trading at 91, and have a
nominal yield of 5.9%. The risk free rate is 3.7%, the expected return on the S&P
500 is 8.5% and the tax rate is 35%. What post-tax cost of debt would you use in a
WACC calculation?
, A) 2.30%
B) 3.80%
C) 4.20%
D) 6.50% - ANS - C) 4.20%
Current yield on the debentures is 5.9%/91 = 6.5%. The post-tax cost of debt is
then 6.5% × (1 - 35%) = 4.2%. The risk free rate and expected return on the S&P
500 were not required.
Reference: Textbook Section: 5.2.1
\A stock has an expected return of 5.5% and a Beta of .80. By how much will the
excess return of the stock change if the excess return of the S&P 500 falls by 1%?
A) It will fall by 1.2%
B) It will rise by 1.2%
C) It will fall by .8%
D) It will rise by .8% - ANS - C) It will fall by .8%
Excess return = expected return above risk-free rate. The expected return of any
stock will change by an amount equal to the expected return change of the
market portfolio (S&P 500) multiplied by the stock's Beta. A 1% decline in
expected return in the S&P 500 will cause the stock to decline by 1% x .8 = .8%.
Reference: Textbook Section: 5.2.2
\Jackson, an investment banker, is valuing a company based on a Gordon growth
model. The company has projected that it will increase its total dividend payout
by 3% per year. What event could cause the model's value per share estimate to
change?
A) A significant change in the company's shares outstanding
B) A significant change in the company's total debt
C) A reduction in the firm's share buyback plan.
D) An increase in net profit margins - ANS - A) A significant change in the
company's shares outstanding
A Gordon growth model - also known as a discounted dividend growth model -
estimates company value based on expected future returns to investors, mainly
from dividends. It is useful in evaluating companies with strong, steady and
rising dividends. However, it's important to note whether projected dividend
growth is on a total payout basis or a per share basis. If it is total payout, any
significant change in shares outstanding (such as those resulting from share
