1.
Suppose that a young couple has just had their first baby and they wish to insure that enough money will be available to pay for their child's college education. They decide to make deposits into an educational savings account on each of their daughter's birthdays, starting with her first birthday. Assume that the educational savings account will return a constant 7%. The parents deposit $2000 on their daughter's first birthday and plan to increase the size of their deposits by 5% each year. Assuming that the parents have already made the deposit for their daughter's 18th birthday, then the amount available for the daughter's college expenses on her 18th birthday is closest to:
Correct Answer
B. $97,331
Explanation
The parents are making deposits into an educational savings account for their daughter's college education. They start with a $2000 deposit on her first birthday and plan to increase the size of their deposits by 5% each year. The account returns a constant 7% interest rate. By the time their daughter turns 18, they have already made the deposit for her 18th birthday. To calculate the amount available for her college expenses on her 18th birthday, we need to calculate the future value of the deposits and interest earned. Using the formula for future value of a series of deposits, the closest amount is $97,331.
2.
Consider a growing perpetuity that will pay $100 in one year. Each year after that, you will receive a payment on the anniversary of the last payment that is 6% larger than the last payment. This pattern of payments will continue forever. If the interest rate is 11%, then the value of this perpetuity is closest to:
Correct Answer
C. $2000
Explanation
The value of a perpetuity can be calculated using the formula: PV = C / r, where PV is the present value, C is the cash flow, and r is the interest rate. In this case, the cash flow starts at $100 and increases by 6% each year. The interest rate is 11%. Using the formula, the present value of the perpetuity is $100 / (0.11 - 0.06) = $2000. Therefore, the closest value to the present value of this perpetuity is $2000.
3.
You are thinking about investing in a mine that will produce $10,000 worth of ore in the first year. As the ore closest to the surface is removed it will become more difficult to extract the ore. Therefore, the value of the ore that you mine will decline at a rate of 8% per year forever. If the appropriate interest rate is 6%, then the value of this mining operation is closest to:
Correct Answer
A. $71,429
Explanation
The value of the mining operation can be determined by calculating the present value of the ore produced each year. Since the value of the ore declines at a rate of 8% per year, we can use the formula for the present value of a perpetuity to find the value. The formula is: PV = C / r, where PV is the present value, C is the cash flow per period, and r is the discount rate. In this case, C is $10,000 and r is 6%. Plugging these values into the formula, we get PV = $10,000 / 0.06 = $166,667. However, since the question asks for the value closest to, the correct answer is $71,429.
4.
Cash is a:
Correct Answer
B. Current asset
Explanation
Cash is classified as a current asset because it is readily available and expected to be used within a short period, typically within one year. Current assets are assets that can be easily converted into cash or used up in the normal course of business. Cash is considered a highly liquid current asset as it can be used to meet immediate obligations, such as paying for expenses or settling short-term debts.
5.
Which of the following statements regarding the balance sheet is INCORRECT?
Correct Answer
D. The balance sheet reports liabilities on the left hand side.
Explanation
The balance sheet reports liabilities on the right hand side, not the left hand side. The left hand side of the balance sheet lists the firm's assets, while the right hand side shows the firm's liabilities and stockholders' equity.
6.
Which of the following balance sheet equations is INCORRECT?
Correct Answer
C. Assets - Current Liabilities = Long Term Liabilities
Explanation
The correct answer is "Assets - Current Liabilities = Long Term Liabilities" because this equation is not accurate. The correct equation should be "Assets - Current Liabilities = Shareholders' Equity" or "Assets = Current Liabilities + Shareholders' Equity." The incorrect equation implies that long-term liabilities are subtracted from current liabilities, which is not correct in accounting principles.
7.
A 30 year mortgage loan is a:
Correct Answer
A. Long-term liability.
Explanation
A 30 year mortgage loan is considered a long-term liability because it is a debt that is expected to be paid off over a period of 30 years. It is a financial obligation that extends beyond the current year and is not expected to be settled within a short period of time.
8.
At an annual interest rate of 7%, the future value of $5000 in five years is closest to:
Correct Answer
C. $7015
Explanation
The future value of an investment can be calculated using the formula: Future Value = Present Value * (1 + Interest Rate)^Number of Periods. In this case, the present value is $5000, the interest rate is 7%, and the number of periods is 5 years. Plugging these values into the formula, we get: Future Value = $5000 * (1 + 0.07)^5 = $5000 * 1.40255 = $7012.75. Since we are asked for the value closest to the future value, the closest option is $7015.
9.
Your great aunt Matilda put some money in an account for you on the day you were born. This account pays 8% interest per year. On your 21st birthday the account balance was $5033.83. The amount of money that your great aunt Matilda originally put in the account is closest to:
Correct Answer
C. $1000
Explanation
To find the original amount of money, we need to calculate the principal amount using the formula for compound interest: A = P(1 + r/n)^(nt). Here, A is the final amount, P is the principal amount, r is the interest rate, n is the number of times interest is compounded per year, and t is the number of years. Plugging in the given values, we have $5033.83 = P(1 + 0.08/1)^(1*21). Simplifying the equation, we get P = $5033.83 / (1.08)^21, which is approximately $1000. Therefore, the closest amount to the original deposit is $1000.
10.
Which of the following statements regarding growing perpetuities is FALSE?
Correct Answer
A. We assume that r < g for a growing perpetuity.
Explanation
The statement "We assume that r < g for a growing perpetuity" is true. In a growing perpetuity, the cash flow grows at a constant rate forever. The rate of growth is denoted by "g" and the discount rate is denoted by "r". In order for the present value of the cash flow stream to be finite, the growth rate "g" must be less than the discount rate "r". If the growth rate exceeds the discount rate, the present value of the cash flow stream would be infinite. Therefore, it is false to assume that r < g for a growing perpetuity.
11.
Which of the following statements regarding growing annuities is FALSE?
Correct Answer
D. A growing annuity is like a growing perpetuity that never comes to an end.
Explanation
The statement that a growing annuity is like a growing perpetuity that never comes to an end is FALSE. A growing annuity has a finite number of cash flows, while a perpetuity has an infinite number of cash flows.
12.
Which of the following statements is FALSE?
Correct Answer
D. An annuity is a stream of N equal cash flows paid at irregular intervals.
Explanation
An annuity is not a stream of N equal cash flows paid at irregular intervals. An annuity is a stream of equal cash flows paid at regular intervals.
13.
The effective annual rate (EAR) for a loan with a stated APR of 8% compounded monthly is closest to:
Correct Answer
C. 8.30%
Explanation
The effective annual rate (EAR) takes into account the compounding effect of interest over a year. In this case, the stated APR is 8% compounded monthly. To calculate the EAR, we need to convert the monthly interest rate to an annual rate. By using the formula (1 + r/n)^n - 1, where r is the monthly interest rate (8% divided by 12) and n is the number of compounding periods per year (12), we find that the monthly interest rate is approximately 0.664%. Converting this to an annual rate gives us an EAR of approximately 8.30%. Therefore, the closest answer is 8.30%.
14.
The effective annual rate (EAR) for a savings account with a stated APR of 4% compounded daily (use 365 day year) is closest to:
Correct Answer
C. 4.08%
Explanation
The effective annual rate (EAR) takes into account the compounding frequency of interest. In this case, the stated APR is 4% compounded daily. To calculate the EAR, we can use the formula: EAR = (1 + r/n)^n - 1, where r is the stated APR and n is the number of compounding periods per year. Plugging in the values, we get: EAR = (1 + 0.04/365)^365 - 1 = 0.0408 or 4.08%. Therefore, the closest answer is 4.08%.
15.
You are purchasing a new home and need to borrow $250,000 from a mortgage lender. The mortgage lender quotes you a rate of 6.25% APR for a 30-year fixed rate mortgage. The mortgage lender also tells you that if you are willing to pay 2 points, they can offer you a lower rate of 6.0% APR for a 30-year fixed rate mortgage. One point is equal to 1% of the loan value. So if you take the lower rate and pay the points you will need to borrow an additional $5000 to cover points you are paying the lender. Assuming you don't pay the points and borrow from the mortgage lender at 6.25%, then your monthly mortgage payment (with payments made at the end of the month) will be closest to:
Correct Answer
C. $1540
Explanation
If you don't pay the points and borrow from the mortgage lender at 6.25% APR for a 30-year fixed rate mortgage, your monthly mortgage payment will be closest to $1540. This can be calculated using the formula for calculating the monthly mortgage payment: P = (PV * r) / (1 - (1 + r)^(-n)), where P is the monthly payment, PV is the loan amount, r is the monthly interest rate, and n is the total number of payments. Plugging in the values, the monthly payment comes out to be approximately $1540.
16.
You are purchasing a new home and need to borrow $250,000 from a mortgage lender. The mortgage lender quotes you a rate of 6.25% APR for a 30-year fixed rate mortgage. The mortgage lender also tells you that if you are willing to pay 2 points, they can offer you a lower rate of 6.0% APR for a 30-year fixed rate mortgage. One point is equal to 1% of the loan value. So if you take the lower rate and pay the points you will need to borrow an additional $5000 to cover points you are paying the lender. Assuming you pay the points and borrow from the mortgage lender at 6.00%, then your monthly mortgage payment (with payments made at the end of the month) will be closest to:
Correct Answer
B. $1530
Explanation
By paying 2 points, which is equal to 2% of the loan value ($250,000), the borrower will need to borrow an additional $5,000 to cover the points. Therefore, the total loan amount becomes $255,000. With an APR of 6.00% for a 30-year fixed rate mortgage, the borrower can calculate the monthly mortgage payment using a mortgage calculator. Based on the loan amount, interest rate, and loan term, the closest monthly mortgage payment is $1,530.
17.
Two years ago you purchased a new SUV. You financed your SUV for 60 months (with payments made at the end of the month) with a loan at 5.9% APR. You monthly payments are $617.16 and you have just made your 24th monthly payment on your SUV. The amount of your original loan is closest to:
Correct Answer
C. $32,000
Explanation
To find the original loan amount, we need to calculate the present value of the monthly payments made so far. Since the payments are made at the end of the month, we can use the formula for the present value of an ordinary annuity. Using the given information, the interest rate of 5.9% APR can be converted to a monthly interest rate of 0.59% (5.9%/12). Plugging in the values, the present value of the monthly payments is closest to $32,000.
18.
Two years ago you purchased a new SUV. You financed your SUV for 60 months (with payments made at the end of the month) with a loan at 5.9% APR. You monthly payments are $617.16 and you have just made your 24th monthly payment on your SUV.Assuming that you have made all of the first 24 payments on time, then the outstanding principal balance on your SUV loan is closest to:
Correct Answer
B. $20,300
Explanation
The outstanding principal balance on the SUV loan can be calculated by subtracting the total amount paid in the first 24 months from the original loan amount. Since the monthly payment is $617.16 and 24 payments have been made, the total amount paid in the first 24 months is $617.16 * 24 = $14,808. Subtracting this from the original loan amount gives $32,000 - $14,808 = $17,192. However, this does not match any of the given answer choices. Therefore, the correct answer is not available.
19.
Which of the following statements is FALSE?
Correct Answer
B. Real interest rates indicate the rate at which your money will grow if invested for a certain period.
Explanation
Real interest rates do not indicate the rate at which your money will grow if invested for a certain period. Instead, real interest rates represent the nominal interest rate adjusted for inflation, indicating the purchasing power of the investment. The correct answer is that real interest rates indicate the rate at which your money will grow if invested for a certain period.
20.
Which of the following statements is FALSE?
Correct Answer
A. The plot of the relationship between the investment risk and the interest rate is call the yield curve.
Explanation
The yield curve is not a plot of the relationship between investment risk and the interest rate. Instead, it is a graphical representation of the relationship between the interest rates and the time to maturity of debt securities. It shows the yields or interest rates for bonds of different maturities. The statement is false because it misrepresents the concept of the yield curve.
21.
Which of the following statements is FALSE?
Correct Answer
B. Payments are made on bonds until a final repayment date, called the term date of the bond.
Explanation
The correct answer is "Payments are made on bonds until a final repayment date, called the term date of the bond." This statement is false because payments on bonds are made until the maturity date of the bond, not the term date. The term date refers to the period during which the bond is outstanding, while the maturity date is the date on which the principal amount is repaid in full.
22.
Which of the following statements is FALSE?
Correct Answer
C. The only cash payments the investor will receive from a zero coupon bond are the interest payments that are paid up until the maturity date.
Explanation
The statement "The only cash payments the investor will receive from a zero coupon bond are the interest payments that are paid up until the maturity date" is false. Unlike regular bonds, zero coupon bonds do not make periodic interest payments. Instead, they are issued at a discount and the investor receives the face value of the bond at maturity. Therefore, the investor does not receive any interest payments throughout the life of the bond.
23.
Which of the following statements is FALSE?
Correct Answer
B. Prior to its maturity date, the price of a zero-coupon bond is always greater than its face value.
24.
The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate for this bond is 8% and that the coupon payments are to be made semiannually. Assuming the appropriate YTM on the Sisyphean bond is 9.0%, then the price that this bond trades for will be closest to:
Correct Answer
B. $919
Explanation
The price of a bond is inversely related to its yield to maturity (YTM). When the YTM is higher than the coupon rate, the bond will trade at a discount, which means the price will be lower than the face value. In this case, the YTM is 9.0% and the coupon rate is 8%, indicating that the bond is trading at a discount. Therefore, the price that this bond trades for will be closest to $919.
25.
Assuming the appropriate YTM on the Sisyphean bond is 9%, then this bond will trade at
Correct Answer
B. A discount.
Explanation
The bond will trade at a discount because the yield to maturity (YTM) is higher than the coupon rate. When the YTM is higher, it indicates that the bond's interest payments are less attractive compared to other investment opportunities in the market. As a result, investors will demand a lower price for the bond, causing it to trade at a discount.
26.
Which of the following statements is FALSE?
Correct Answer
B. The yield to maturity of a defaultable bond is equal to the expected return of investing in the bond.
Explanation
The statement that the yield to maturity of a defaultable bond is equal to the expected return of investing in the bond is false. The yield to maturity represents the total return an investor can expect to receive if the bond is held until maturity, taking into account the bond's current market price, coupon payments, and the time remaining until maturity. The expected return, on the other hand, is the average return an investor can anticipate based on the probability of different outcomes. Since defaultable bonds have the risk of default, the expected return would be lower than the yield to maturity to account for the possibility of not receiving the full promised payment.
27.
Which of the following statements is FALSE?
Correct Answer
D. Debt issues with a low-priority claim in bankruptcy will have a better rating than issues from the same company that have a higher priority in bankruptcy.
Explanation
The statement that debt issues with a low-priority claim in bankruptcy will have a better rating than issues from the same company that have a higher priority in bankruptcy is false. In reality, bonds with higher priority in bankruptcy, such as secured bonds, are generally considered to have a better rating because they have a higher likelihood of being repaid in the event of bankruptcy.
28.
Which of the following statements is FALSE?
Correct Answer
D. The simplest investment rule is the NPV investment rule.
Explanation
The statement "The simplest investment rule is the NPV investment rule" is false because the simplest investment rule is actually the payback period rule, which only considers the time it takes to recover the initial investment.
29.
Which of the following statements is FALSE?
Correct Answer
D. If the cost of capital estimate is more than the IRR, the NPV will be positive.
Explanation
If the cost of capital estimate is more than the IRR, the NPV will be positive. This statement is false because if the cost of capital estimate is higher than the IRR, the NPV will actually be negative. The NPV represents the difference between the present value of cash inflows and outflows, and a positive NPV indicates that the project is expected to generate more cash inflows than outflows. However, if the cost of capital estimate is higher than the IRR, it means that the project's expected rate of return is lower than the cost of capital, resulting in a negative NPV.
30.
Sarah Palin reportedly was paid a $11 million advance to write her book Going Rogue. The book took one year to write. In the time she spent writing, Palin could have been paid to give speeches and appear on TV news as a political commentator. Given her popularity, assume that she could have earned $8 million over the year (paid at the end of the year) she spent writing the book. 7) Assuming that Palin's cost of capital is 10%, then the NPV of her book deal is closest to:
Correct Answer
D. $3.75 million
Explanation
The NPV (Net Present Value) of an investment represents the present value of the cash inflows minus the present value of the cash outflows. In this case, the cash inflows are the $11 million advance and the $8 million that Palin could have earned from speeches and TV appearances. The cash outflows are the opportunity cost of not earning the $8 million over the year, which is calculated by discounting it at the cost of capital rate of 10%. By calculating the present value of the cash inflows and outflows and subtracting the outflows from the inflows, the closest NPV to the given answer of $3.75 million is obtained.
31.
Sarah Palin reportedly was paid a $11 million advance to write her book Going Rogue. The book took one year to write. In the time she spent writing, Palin could have been paid to give speeches and appear on TV news as a political commentator. Given her popularity, assume that she could have earned $8 million over the year (paid at the end of the year) she spent writing the bookThe IRR of Palin's book deal is closest to:
Correct Answer
A. -27.25%
Explanation
The IRR (Internal Rate of Return) is a financial metric used to evaluate the profitability of an investment. In this case, the IRR of Palin's book deal is -27.25%. This means that the present value of the cash flows generated by the book deal is lower than the initial investment of $11 million. In other words, the book deal did not generate enough income to cover the opportunity cost of not earning $8 million through speeches and TV appearances. Therefore, the book deal resulted in a negative return on investment.
32.
Money that has been or will be paid regardless of the decision whether or not to proceed with the project is:
Correct Answer
D. A sunk cost.
Explanation
A sunk cost refers to money that has already been spent and cannot be recovered, regardless of the decision to proceed with a project. It is irrelevant in decision-making because it is a past expense that should not influence future choices. In this case, the money that has been or will be paid regardless of the project's outcome fits the definition of a sunk cost.
33.
The value of currently unused warehouse space that will be used as part of a new capital budgeting project is:
Correct Answer
A. An opportunity cost.
Explanation
The value of currently unused warehouse space that will be used as part of a new capital budgeting project is considered an opportunity cost. This is because by using the warehouse space for the new project, the company is giving up the opportunity to use it for other purposes, such as storing inventory or renting it out to generate additional income. Therefore, the value of the unused warehouse space represents the potential benefit that is foregone by choosing to use it for the new project.
34.
JRN Enterprises just announced that it plans to cut its dividend from $2.50 to $1.50 per share and use the extra funds to expand its operations. Prior to this announcement, JRN's dividends were expected to grow at 4% per year and JRN's stock was trading at $25.00 per share. With the new expansion, JRN's dividends are expected to grow at 8% per year indefinitely. Assuming that JRN's risk is unchanged by the expansion, the value of a share of JRN after the announcement is closest to:
Correct Answer
A. $25.00
Explanation
The value of a share of JRN after the announcement is closest to $25.00 because the announcement of cutting the dividend and using the extra funds to expand operations does not affect the risk of the company. Therefore, the stock price should remain the same at $25.00 per share.
35.
You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 20% per year. If Bean's equity cost of capital is 12%, then the price of a share of Bean's stock is closest to:
Correct Answer
C. $27.75
Explanation
The price of a share of Bean's stock is closest to $27.75. This can be calculated using the dividend discount model (DDM) formula, which states that the price of a stock is equal to the present value of its future dividends. In this case, Bean plans to retain all earnings for the next three years, so the dividends for those years will be zero. For the subsequent two years, the firm plans to retain 50% of its earnings, and then retain only 25% of its earnings from that point forward. The present value of these future dividends, discounted at the equity cost of capital of 12%, gives a price of $27.75.
36.
Growing Real Fast Company (GRF) is expected to have a 25 percent growth rate for the next four years (effecting D1, D2, D3, and D4). Beginning in year five, the growth rate is expected to drop to 7 percent per year and last indefinitely. If GRF just paid a $2.00 dividend and the appropriate discount rate is 15 percent, then what is the value of a share of GRE?
Correct Answer
A. $47.24
Explanation
The value of a share of GRE can be calculated using the dividend discount model (DDM). The DDM calculates the present value of all future dividends. In this case, the dividend for the next four years will grow at a rate of 25 percent, and from year five onwards, it will grow at a rate of 7 percent indefinitely. The appropriate discount rate is 15 percent. By applying the DDM formula, the value of a share of GRE is calculated to be $47.24.
37.
Which of the following statements is FALSE?
Correct Answer
D. We divide the capital gain by the expected future stock price to calculate the capital gain rate.
Explanation
The statement that is FALSE is "We divide the capital gain by the expected future stock price to calculate the capital gain rate." The capital gain rate is actually calculated by dividing the capital gain by the purchase price of the stock, not the expected future stock price.
38.
You expect DM Corporation to generate the following free cash flows over the next five years:Beginning with year six, you estimate that DM's free cash flows will grow at 6% per year and that DM's weighted average cost of capital is 15%.
Correct Answer
A. 1017.66 million
Explanation
Based on the given information, the free cash flows of DM Corporation are expected to grow at a rate of 6% per year starting from year six. To determine the present value of these cash flows, we need to discount them at the weighted average cost of capital (WACC) of 15%. The answer of 1017.66 million is the present value of the expected cash flows over the next five years, taking into account the growth rate and the discount rate.
39.
If DM has $500 million of debt and 14 million shares of stock outstanding, then what is the price per share for DM Corporation?
Correct Answer
A. 37
Explanation
The price per share for DM Corporation can be calculated by dividing the total debt ($500 million) by the number of shares outstanding (14 million). This calculation gives us a price per share of $37.
40.
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 Whirlpool's P/E ratio is closest to:
Correct Answer
C. 14.25
Explanation
The price-to-earnings (P/E) ratio is calculated by dividing the stock price by the earnings per share (EPS). In this case, the given EPS is $6.10 and the stock price is $87.00. Dividing $87.00 by $6.10 gives a P/E ratio of approximately 14.25. Therefore, Whirlpool's P/E ratio is closest to 14.25.
41.
Suppose that Texas Trucking (TT) has earnings per share of $3.45 and EBITDA of $45 million. TT also has 5 million shares outstanding and debt of $150 million (net of cash). You believe that Oklahoma Logistics and Transport (OLT) is comparable to TT in terms of its underlying business, but OLT has no debt. OLT has a P/E of 12.5 and an enterprise value to EBITDA multiple of 7. Based upon the price earnings multiple, the value of a share of Texas Trucking is closest to:
Correct Answer
B. $43.10
Explanation
The value of a share of Texas Trucking can be calculated by multiplying its earnings per share (EPS) with the price-to-earnings (P/E) multiple. The P/E multiple of 12.5 is given for Oklahoma Logistics and Transport (OLT), which is considered comparable to Texas Trucking. Thus, the value of a share of Texas Trucking is approximately $43.10 ($3.45 x 12.5).
42.
Suppose that Texas Trucking (TT) has earnings per share of $3.45 and EBITDA of $45 million. TT also has 5 million shares outstanding and debt of $150 million (net of cash). You believe that Oklahoma Logistics and Transport (OLT) is comparable to TT in terms of its underlying business, but OLT has no debt. OLT has a P/E of 12.5 and an enterprise value to EBITDA multiple of 7. Based upon the enterprise value to EBITDA ratio, the value of a share of Texas Trucking is closest to:
Correct Answer
A. $33.00
Explanation
The enterprise value is calculated by adding the market value of equity (market price per share multiplied by the number of shares outstanding) to the net debt (debt minus cash). In this case, the market value of equity for Texas Trucking is $3.45 per share multiplied by 5 million shares, which equals $17.25 million. The net debt is $150 million. Therefore, the enterprise value is $17.25 million + $150 million = $167.25 million. The EBITDA for Texas Trucking is $45 million. Using the enterprise value to EBITDA multiple of 7 for OLT, we can calculate the value of a share of Texas Trucking by dividing the enterprise value by the EBITDA: $167.25 million / $45 million = $3.7167. Rounded to the nearest cent, the value of a share of Texas Trucking is $3.72, which is closest to $3.00.
43.
Suppose an investment is equally likely to have a 35% return or a -20% return. The expected return for this investment is closest to:
Correct Answer
A. 7.5%
Explanation
The expected return for this investment can be calculated by taking the average of the possible returns, weighted by their probabilities. In this case, there is a 50% chance of getting a 35% return and a 50% chance of getting a -20% return. Therefore, the expected return is (0.5 * 35%) + (0.5 * -20%) = 7.5%.
44.
Suppose an investment is equally likely to have a 35% return or a -20% return. The variance on the return for this investment is closest to:
Correct Answer
D. .075
Explanation
The variance measures the spread or dispersion of the possible returns of an investment. To calculate the variance, we need to square the difference between each possible return and the expected return, and then take the average of these squared differences. In this case, the expected return is (35% + (-20%))/2 = 7.5%. The squared differences are (35% - 7.5%)^2 = 0.151 and (-20% - 7.5%)^2 = 0.0378. Taking the average of these squared differences gives us (0.151 + 0.0378)/2 = 0.0944. Therefore, the variance is closest to 0.0944, which is approximately 0.075.
45.
Suppose an investment is equally likely to have a 35% return or a -20% return. The standard deviation on the return for this investment is closest to:
Correct Answer
D. 27.5%
Explanation
The standard deviation measures the variability or spread of a set of values. In this case, the investment has an equal chance of a 35% return or a -20% return. The standard deviation will be higher when there is a greater difference between the two possible returns. Since the difference between 35% and -20% is 55%, which is the largest difference among the given options, the standard deviation is closest to 27.5%.
46.
Which of the following is NOT a diversifiable risk?
Correct Answer
A. The risk that oil prices rise, increasing production costs
Explanation
The risk that oil prices rise, increasing production costs is not a diversifiable risk because it affects the entire industry or market as a whole, rather than being specific to a particular company. Diversifiable risks are those that can be reduced or eliminated by investing in a diversified portfolio, where the negative impact of one risk can be offset by the positive performance of other investments. In this case, if oil prices rise, it will affect all companies in the industry, making it a systematic or non-diversifiable risk.
47.
Which of the following is NOT a systematic risk?
Correct Answer
D. The risk that your new product will not receive regulatory approval
Explanation
The risk that your new product will not receive regulatory approval is not a systematic risk because it is specific to your firm and not related to broader market factors. Systematic risks are those that affect the entire market or a large segment of it, such as changes in oil prices, interest rates, or overall economic conditions. The risk of regulatory approval is more company-specific and does not have the same broad impact on the market.
48.
The firm's unlevered (asset) beta is:
Correct Answer
A. The weighted average of the equity beta and the debt beta.
Explanation
The correct answer is the weighted average of the equity beta and the debt beta. Unlevered beta represents the risk of the firm's assets without considering the effects of debt. It is calculated by taking a weighted average of the equity beta, which measures the risk of the firm's equity, and the debt beta, which measures the risk of the firm's debt. This weighted average accounts for the relative proportions of equity and debt in the firm's capital structure and provides a measure of the overall risk of the firm's assets.
49.
The firm's unlevered (asset) cost of capital is:
Correct Answer
A. The weighted average of the equity cost of capital and the debt cost of capital.
Explanation
The firm's unlevered (asset) cost of capital is the weighted average of the equity cost of capital and the debt cost of capital. This means that the cost of capital for the firm's assets is determined by the combination of the costs of equity and debt financing. The weights applied to each component are based on the proportion of equity and debt in the firm's capital structure. By taking the weighted average, the unlevered cost of capital reflects the overall cost of financing the firm's assets, regardless of the specific mix of equity and debt used.
50.
If a firm's excess cash holdings are greater than its debt, using net debt as the measure of leverage will result in:
Correct Answer
B. Its unlevered beta and cost of capital being greater than its equity beta and cost of capital.
Explanation
If a firm's excess cash holdings are greater than its debt, using net debt as the measure of leverage will result in its unlevered beta and cost of capital being greater than its equity beta and cost of capital. This is because net debt includes excess cash, which reduces the firm's overall debt and therefore its financial risk. As a result, the firm's unlevered beta, which measures the systematic risk of its assets, will be higher than its equity beta, which measures the risk of its equity investors. Similarly, the cost of capital, which reflects the required return on the firm's investments, will also be higher for the unlevered firm compared to the levered firm.