Southern New Hampshire University
FIN-320 Principles of Finance
EXAM 8 questions and answers
1
A security that is plotted directly on the security market line is .
fairly priced for its expected return and level of risk
more attractive to an investor than one plotted above the
security market line
overvalued for its expected return and level of risk
more attractive to a company raising capital than one plotted
below the security market line
CONCEPT
Understanding the Security Market Line
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2
Chester purchased stock with an initial share price of $67 and sold it when the share price was $54. While
he owned the stock, he earned $4 in dividends.
What was his total percentage return on the investment?
-13.43%
-24.07%
-19.40%
-16.67%
CONCEPT
Understanding Returns
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3
Using the following variables, calculate an organization's cost of debt on a $200,000 bond.
•Rf: 1.5%
•credit-risk rate: 3%
•t: 30%
$9,000
$8,730
$2,700
$6,300
CONCEPT
Valuing Different Costs
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4
If a news announcement is seen as positive for a company and its fixed-income instruments
seem more creditworthy, what happens to bond prices and yield?
Bond prices will likely rise and yield will fall.
Bond prices will likely fall and yield will rise.
Bond prices and yield will both likely increase.
Bond prices and yield will both likely decrease.
CONCEPT
The Impact of News of Expected Returns
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5
Between the capital asset pricing model (CAPM), discounted cash flow analysis and bond yield plus
risk premium (BYPRP), which approach produces the least accurate estimates?
The bond yield plus risk premium (BYPRP) approach
The capital asset pricing model (CAPM)
The discount cash flow analysis
The three approaches are equally accurate
CONCEPT
Approaches to Calculating the Cost of Capital
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6
Which of the following is a tenet of weak-form efficiency?
No form of fundamental analysis can provide an investor with
excess returns.
Individual share prices follow a pattern, so studying their
movement over time can assist present-day investors.
Future price movements of securities are random and not
predictable based on past prices.
It is not possible for investors to earn excess returns through any
methods whatsoever.
CONCEPT
Market Efficiency
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7
Company A
Company B
Market Value of Equity
$100,000
$200,000
Market Value of Debt
$300,000
$200,000
Cost of Equity
10%
12%
Cost of Debt
2%
1.5%
Tax Rate
25%
35%
Based solely on their current weighted average cost of capital, which company should pursue an
investment opportunity with an expected return of 5%?
Only Company B
Both Company A and Company B
Neither Company A nor Company B
Only Company A
CONCEPT
The WACC
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8
One reason a company may choose to issue additional equity instead of debt when raising capital
is that
they want more leverage
debt does not have the same tax benefits that equity does
debt impacts a company's cost of capital, but equity does not
they don't want to over-leverage themselves for fear of defaulting
CONCEPT
Capital Structure Considerations
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9
The beta coefficient of a portfolio that does not correlate in any way with a benchmark index is .
10
-1
0
1
CONCEPT
Implications Across Portfolios
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10
The risk that the cost of your investment will rise over time is known as .
interest rate risk
model risk
market risk
credit risk
CONCEPT
Risk
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11
What is a company's ratio of its debt to its equity known as?
Weighted average cost of capital
Net present value
Leverage
Valuation
CONCEPT
The Basics of the Cost of Capital
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12
Theoretically, which of the following portfolios contains the least amount of risk?
A portfolio that contains 100% bonds
A portfolio that contains 25% stocks, 25% bonds, 25% cash
equivalents and 25% derivatives
A portfolio that contains 33.33% stocks, 33.33% bonds and
33.33% commodities
A portfolio that contains 50% stocks and 50% bonds
CONCEPT
Portfolio Considerations
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13
Select the true statement about the bankruptcy process.
The provisions of a Chapter 11 reorganization plan are
non- compulsory.
Filing for bankruptcy is the only option for a company that
can't meet its debts.
Creditors must approve a company's plan for reorganization in
a Chapter 11 bankruptcy.
A Chapter 11 bankruptcy is the most common form of bankruptcy
for businesses.
CONCEPT
Understanding the Bankruptcy Process
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14
You own a small manufacturing business that produces widgets. You have spent $300,000 acquiring the
fixed assets you need to produce widgets. Each widget costs you $3 to make and they sell for $18 each, so
your variable cost is 16.7% of the overall revenue.
At your current level of operating leverage, how many widgets must you sell to break even?
16,667
50,100
26,667
20,000
CONCEPT
Thinking About Operating Leverage
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15
How do systematic risk and unsystematic risk differ?
Passive fund management is better for systematic risk,
whereas active fund management is better for unsystematic
risk.
Diversification has little to no impact on systematic risk,
whereas it can have an impact on unsystematic risk.
Unsystematic risk commands a risk premium, whereas
systematic risk does not.
Systematic risk can be managed away, whereas unsystematic risk
cannot.
CONCEPT
Diversification
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16
Calculate a company's total leverage given the following information:
•Change in sales = 20%
•Change in earnings = 35%
Cannot calculate without ROE data
0.57
1.75
Cannot calculate without knowing degree of financial leverage
CONCEPT
Thinking About Financial Leverage
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17
A restaurant company purchases a number of its own shares of stock in order to increase the company's share
price.
What type of market transaction is taking place?
Private placement
IPO
Secondary market offering
Share buyback
CONCEPT
The Security Markets
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18
You invest $200 in a stock that has a 10% chance of a 1% return, a 40% chance of a 4% return and a 50% chance of
an 8% return.
What is your expected return after one year?
4.0%
5.7%
5.4%
4.2%
CONCEPT
Expected Return
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19
As the CEO of a publicly-traded company, Janson signs the company's federal income tax return.
By doing so, which federal regulation is he complying with?
Securities Act Amendments of 1975
Securities Act of 1933
Securities Exchange Act of 1934
Sarbanes-Oxley Act of 2002
