CF Chap 13

The cost of capital used to compute the present value of a project should be the rate that can be earned on:

• A) the overall market portfolio.
• B) the sponsoring firm's return on assets.
• C) a financial asset of comparable risk.
• D) a riskless asset with a similar life span.
• E) the sponsoring firm's return on equity.

If the CAPM is used to estimate the cost of equity capital, the expected excess market return is equal to the:

• A) return on the stock minus the risk-free rate.
• B) return on the market minus the risk-free rate.
• C) beta times the market risk premium.
• D) beta times the risk-free rate.
• E) market rate of return

The issuance of stock to fund a project tends to:

• A) have no effect on the previous shareholders.
• B) create costless benefits for the firm.
• C) cause any potential gains to the firm from the project to be lost.
• D) affect future dividends but not the appreciation realized by previous shareholders.
• E) dilute the capital gains that would have been earned by the previous shareholders

A project with the same level of risk as an all-equity firm should be accepted if the project's:

• A) internal rate of return exceeds the firm's cost of equity capital.
• B) expected rate of return exceeds the market rate of return.
• C) anticipated rate of return exceeds the firm's return on assets.
• D) internal rate of return is positive given this level of risk.
• E) expected rate of return exceeds the risk-free rate

Which one of these statements is correct concerning the CAPM?

• A) The CAPM is the only available method for determining an appropriate discount rate for a proposed project.
• B) The market rate of return is most commonly based on the forecasted return on the market for the next 5-year period.
• C) CAPM is used quite frequently by firms in their capital budgeting process.
• D) The expected return on the 30-year U.S. Treasury bond is the most commonly used as the risk-free rate of return.
• E) An increase in the risk-free rate combined with a beta greater than 1.0 increases the discount rate computed using the CAPM

When estimating the cost of equity using the DDM, the factor that is the most apt to add error to this estimate is the:

• A) value of the last dividend.
• B) firm's tax rate.
• C) historical beta.
• D) dividend growth rate.
• E) current stock price.

Which one of these statements related to beta is correct?

• A) Firm betas have less error than industry betas.
• B) Firms should always rely on their own beta rather than their industry's beta.
• C) Beta is unaffected by a firm's capital structure.
• D) The sample size used to compute beta may be too small to yield a reliable result.
• E) Firm betas rarely vary over time

The beta of a security is calculated as: (________ of a security's return with the return on the market portfolio/________).

• A) Variance; Covariance of the market return
• B) Covariance; Variance of the market return
• C) Covariance; Standard deviation of the market return
• D) Variance; Covariance of the security return
• E) Covariance; Variance of the security return

Assume you plot the monthly returns for a stock and also for the S&P 500. Using regression analysis, the straight line through these points that is developed by the analysis is referred to as the ________ which has a slope of ________ and an intercept of ________.

• A) security market line; alpha; gamma
• B) characteristic line; beta; alpha
• C) characteristic line; alpha; beta
• D) security market line; beta; gamma
• E) characteristic line; gamma; alpha

Companies will generally have a ________ beta if their:

• A) low; stock price is relatively low.
• B) high; sales are highly dependent on the market cycle.
• C) high; sales are growing at a steady rate of increase.
• D) high; sales are high compared to other firms in their industry.
• E) low; production costs are primarily fixed in nature.