Midterm 1
MGT 3470B
Conceptual
This part of the exam is worth 40 points.
1- The long-range time period, usually the next two to five years, over which the
financial planning process focuses is known as the:
A) Planning horizon.
B) Planning strategy.
C) Planning agenda.
D) Short run.
E) Current financing period.
2- Pro forma financial statements are:
A) Illegal.
B) Accounting statements filed with the Securities and Exchange Commission
(SEC).
C) Accounting statements filed with CCRA.
D) Projections in the form of accounting statements, based on a sales forecast
assumption.
E) The most-recently compiled accounting statements of the firm released to
the public.
3- The internal growth rate of a firm is best described as:
A) The minimum growth rate achievable if the firm does not pay out any cash
dividends.
B) The minimum growth rate achievable if the firm maintains a constant equity
multiplier.
C) The maximum growth rate achievable without external financing of any
kind.
D) The maximum growth rate achievable without using any external equity
financing, while maintaining a constant debt-equity ratio.
E) The maximum growth rate achievable without any limits on the amount of
debt financing used.
4- Which of the following is NOT a basic policy element of financial planning?
A) The firm's needed investment in new fixed assets.
B) The degree of financial leverage a firm chooses to employ.
C) The amount of cash the firm thinks is necessary and appropriate to pay
shareholders.
D) The level of sales growth the market will provide in future years.
E) The amount of liquidity and working capital the firm needs on an ongoing
5- If total assets increase by the same percentage as sales increase,
I. it is likely assets and sales will increase by identical dollar amounts.
II. the larger the increase in sales, the more likely there will be a need for external
financing.
III. the firm is assumed to be operating at full capacity.
A) I only
B) III only
C) I and III only
D) II and III only
E) I, II, and III
6- Assume that markets are semi-strong form efficient. Suppose, then, that during a
trading day, important new information is released for the first time concerning a
certain company. This information indicates that one of the firm's oil fields,
previously thought to be very promising, just came up dry. How would you
expect the price of a share of stock to react to this information?
A) The value of a share will fall over an extended period of time as investors
begin to sell shares in the company.
B) The value of a share will drop immediately to a price that reflects the value
of the new information.
C) The value of a share will fall below what is considered appropriate because
of the decreased demand for the shares, but eventually the price will rise to
the correct level.
D) The value of a share will rise over a long period of time as investors sell the
stock.
E) The stock price will not change since this type of information has no impact
in markets that are semi-strong form efficient.
7- Which of the following is NOT correct about market efficiency?
A) The EMH says that actual capital markets, such as the TSX, are efficient.
B) Strong form efficiency says all information of any kind is reflected in stock
prices.
C) Semi-strong form efficiency says all public and private information is
reflected in stock prices.
D) Weak form efficiency says studying past prices in an attempt to identify
mispriced stocks is futile.
E) The price a firm obtains when it sells its stock in an efficient market is a fair
price, in the sense that the price reflects available information about the
stock.
8- Which of the following statements is (are) true concerning risk and return?
I. To accept higher levels of risk, investors must be paid a higher risk premium.
II. Small-company stocks offer a higher return and less risk than large-company
stocks.
III. The risk-free rate of return is based on the long-term government bond rate.
IV. The higher the standard deviation, the less predictable the rate of return in
any one year.
A) I only
B) II only
C) III and IV only
D) I and II only
E) I and IV only
9- A symmetric, bell-shaped statistical distribution that is completely defined by its mean
and standard deviation is the _______________ distribution.
A) gamma
B) Poisson
C) bi-modal
D) normal
E) uniform
10- The 95% probability range is defined as the:
A) Risk premium plus or minus two times the standard deviation.
B) Risk premium plus or minus two times the variance.
C) Mean plus or minus two times the standard deviation.
D) Mean plus or minus three times the standard deviation.
E) Mean plus or minus three times the variance.
11- If portfolio weights are positive: 1) Can the return on a portfolio ever be less than the
smallest return on an individual security in the portfolio? 2) Can the variance of a
portfolio ever be less than the smallest variance of an individual security in the
portfolio?
A) 1) yes;
2) yes
B) 1) yes; 2) no
C) 1) no; 2) yes
D) 1) no; 2) no
E) 1) maybe; 2) no
12- Which of the following are examples of systematic risk?
I. An increase in the rate of GDP growth
II. An increase in the productivity of ABC Co. workers
III. A decrease in the rate of inflation
IV. A decrease in a firm's cost of borrowing
A) I and II only
B) I and III only
C) II and IV only
D) II and III only
E) I, III, and IV only
13- Which one of the following statements concerning beta is correct?
A) The beta of a portfolio must be greater than or equal to zero but less than or
equal to one.
B) The beta of a portfolio can be greater than the highest beta of an individual
security within the portfolio.
C) If the weights of the individual securities within a portfolio are changed, the
beta of the portfolio will remain constant.
D) The beta of a portfolio measures the systematic risk of the portfolio and has
a value that can not exceed the value of the highest beta of any individual
security in the portfolio.
E) The beta of a portfolio measures the unsystematic risk of the portfolio and
has a value that must be greater than or equal to zero.
14- The process of eliminating unsystematic risk through the purchase of a number of
assets is called:
A) Portfolio reduction.
B) The systematic risk principle.
C) The beta principle.
D) The risk-reward slope.
E) Portfolio diversification.
15- The percentage of a portfolio's total value invested in a particular asset is called that
asset's:
A) Portfolio return.
B) Portfolio weight.
C) Portfolio risk.
D) Rate of return.
E) Investment value.
16- Which of the following formulas correctly describes the cost of equity capital?
A) RE = D0/P0 + g
B) RE = D1+ g/P0
C) RE = D1/P0 + g
D) RE = Rf – b ´ (Rf – Rm)
E) RE = Rf + b ´ (Rm + Rf)
17- Calculation of the weighted average cost of capital requires all of the following
EXCEPT:
A) The total market value of a firm's debt via the number of bonds outstanding
and the current par value per bond.
B) The market value of bonds outstanding relative to the total market value of
the firm.
C) The corporate tax rate.
D) The current market value of a firm's equity via the total number of shares
and the stock price.
E) The market value of equity outstanding relative to the total market value of
the firm.
18- In using the ___________ approach, we place projects into risk classes in order to
assign discount rates.
A) subjective
B) capital analysis
C) pure play
D) SML
E) yield play
19- If a firm recalculates its WACC based solely on lower growth expectations for the
firm, the new WACC will be:
A) The same as the previous WACC because growth expectations do not affect
WACC.
B) Lower than the previous WACC because the cost of debt will decline.
C) Lower than the previous WACC because the cost of equity will decline.
D) Higher than the previous WACC because the cost of debt will increase.
E) Higher than the previous WACC because the cost of equity will increase.
20- The security market line approach depends on which three factors to estimate the
expected return on a risky asset?
I. Risk-free rate of return
II. Marginal tax rate
III. Market risk premium
IV. Systematic risk of the asset
A) I, II, and III only
B) I, II, and IV only
C) I, III, and IV only
D) II, III, and IV only
E) I, II, III, and IV only
Problems
This part of the exam is worth 60 points.
1- The current price of XYZ stock is $80.00. Dividends are expected to grow at 5%
indefinitely and the most recent dividend was $2.75. What is the required rate of return
on XYZ stock?
2- What is the expected return on asset A if it has a beta of 0.6, the expected market
return is 15%, and the risk-free rate is 6%?
3- Suppose a firm has net income of $50, dividends of $15, assets of $1,200 and a debtequity ratio of 3.0. What is the sustainable growth rate?
Use the following information to solve problem 4:
Stone Roses Co.
Cash
Inventory
Fixed assets
$ 50
$150
$600
Total assets
$800
Balance Sheet
Accounts payable
Notes payable
Long-term debt
Equity
Total liabilities & equity
$100
100
350
250
$800
Stone Roses Co.
Income statement
Sales
Costs
EBT
Taxes (34%)
Net income
$800
600
$200
68
$132
4- Suppose that current assets, costs, and accounts payable maintain a constant ratio to
sales. The firm retains 40% of earnings. If the firm is producing at only 90%
capacity, what is the total external financing needed if sales increase 25%?
5- You purchased 500 shares of a stock at a price of $22.50 per share. One year later, the
shares sold for $21 each. At that end of the year, a $1.50 per share dividend was paid.
What is the total dollar return, capital gains yield, dividend yield, and total percentage
return for the investment?
6- A stock produced total returns of 9.78%, 13.61%, 1.19%, and -4.90% over the past
four years, respectively. Based on this information what range of returns would you
expect to see 99% of the time?
7- An investor has a portfolio comprised of stock A, which has a beta of 1.4 and an
expected return of 10%, and Treasury bills, which have an expected return of 4%. The
portfolio has an expected return of 7.30%. What is the portfolio weight of stock A?
8- Given the following information, what is JEM Inc.'s weighted average cost of capital?
Market value of equity = $50 million; market value of debt = $30 million; cost of equity
= 16%; cost of debt = 8%; equity beta = 1.25; tax rate = 34%.