FIN 571 Wk 2 – Practice: Wk 2 Practice Questions

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FIN 571 Wk 2 - Practice: Wk 2 Practice Questions
FIN 571 Wk 2 – Practice: Wk 2 Practice Questions
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FIN 571 Wk 2 – Practice: Wk 2 Practice Questions

A firm has a debt-to-equity ratio of 1/4. The WACC is 18.6%, and the pretax cost of debt is 9.4%. What is the cost of common equity if the tax rate is 21%?

Multiple Choice

  • 19.90%

  • 20.90%

  • 21.48%

  • 22.73%

 

 

Changing the capital structure by adding debt will:

Multiple Choice

  • reduce the return that shareholders require.

  • reduce default risk.

  • increase debtholder risk.

  • reduce the cost of debt.

 

 

What return on equity do investors expect for a firm with a $55 share price, an expected dividend of $4.60, a beta of 0.9, and a constant growth rate of 3.5%?

Multiple Choice

  • 9.87%

  • 12.48%

  • 13.95%

  • 11.86%

 

What would you estimate as the cost of equity if a stock sells for $40, pays a $4.25 dividend, and is expected to grow at a constant rate of 5%?

Multiple Choice

  • 17.46%

  • 14.52%

  • 12.69%

  • 15.63%

 

 

Company X has 2 million shares of common stock outstanding with a book value of $2 per share. The stock trades for $3 per share. It also has $2 million in face value of debt that trades at 90% of face value. What is the debt ratio that should be used to calculate WACC?

Multiple Choice

  • 13.91%

  • 23.08%

  • 31.03%

  • 27.67%

 

 

Which one of the following statements is in?

Multiple Choice

  • The equity component of WACC reflects the return expected by the company’s shareholders.

  • Market values should be used in calculating WACC.

  • Preferred equity is a separate component of WACC.

  • There is a tax shield on the equity dividends paid.

 

 

The company cost of capital:

Multiple Choice

  • measures the return that investors require from the company.

  • depends on current profits and cash flows.

  • is measured using security book values.

  • depends on historical profits and cash flows.

 

 

According to CAPM estimates, what is the cost of equity for a firm with a beta of 1.5 when the risk-free interest rate is 6% and the expected return on the market portfolio is 15%?

Multiple Choice

  • 19.5%

  • 21.0%

  • 22.5%

  • 24.0%

 

 

Which one of the following changes offers the greatest chance of changing a project’s NPV from negative to positive?

Multiple Choice

  • Substituting preferred stock for debt

  • Selling the debt at less than par value

  • Reducing the risk of the project

  • Reducing the maturity of the debt

 

 

Capital structure decisions refer to the:

Multiple Choice

  • dividend yield of the firm’s stock.

  • blend of equity and debt used by the firm.

  • capital gains available on the firm’s stock.

  • maturity date for the firm’s securities.

 

 

An investor exercises the right to buy one additional share at $20 for every five shares held. How much should each share be worth after the rights issue if they previously sold for $50 each?

Multiple Choice

  • $35.00

  • $41.67

  • $45.00

  • $46.00

 

Roadshows:

Multiple Choice

  • give companies an opportunity to thank investors who have bought the new issue.

  • describe the meetings that managers have with investment bankers to select the underwriter to an issue.

  • provide underwriters and the company’s management an opportunity to meet potential investors.

  • describe the meetings that management has with the SEC to finalize the issue prospectus.

 

 

In return for providing funds, venture capitalists generally require:

Multiple Choice

  • collateral equal in value to the funds provided.

  • first right to all of the firm’s assets.

  • an equity position in the firm.

  • ownership of the entire fir

 

 

Who bears the bulk of the cost of underpricing an IPO?

Multiple Choice

  • The underwriters

  • The investors who purchase IPO shares

  • All of the after-IPO shareholders

  • The pre-IPO shareholders

 

 

An IPO was offered to the public at $18 a share with the issuing firm receiving $16.50 of that amount. The issuer incurred $750,000 in legal and administrative costs. At the end of the first trading day, the stock was priced at $22.40 a share. What was the total dollar cost, including both direct and indirect costs, of issuing the securities if 225,000 shares were offered?

Multiple Choice

  • $1,687,500

  • $1,540,000

  • $2,077,500

  • $1,087,500

 

 

If an underwriter charges the public $40 per share for a new issue after having promised the issuer $38 per share, the spread per share is:

Multiple Choice

  • $1.

  • $2.

  • $38.

  • $40.

 

Which one of the following is least likely to explain why entrepreneurs contribute their personal funds to start-up projects? Their contribution:

Multiple Choice

  • acts as a signal to venture capitalists.

  • repays debt held by the venture capitalist.

  • retains a portion of the firm’s equity.

  • provides incentive to expend effort.

 

 

In a firm commitment, the underwriter:

Multiple Choice

  • encounters virtually no risk because the spread is fixed.

  • is allowed to sell the shares at any price they choose.

  • is protected against being stuck with unsold shares.

  • is allowed to sell the shares at a price slightly higher than the price it paid to the company.

 

 

Assume the issuer incurs $2 million in other expenses to sell 4 million shares at $55 each to an underwriter and the underwriter sells the shares at $59 each. By the end of the first day’s trading, the issuing company’s stock price had risen to $68. What is the cost of underpricing?

Multiple Choice

$20 million

$32 million

$36 million

$40 million

 

 

Shelf registration was enacted to allow:

Multiple Choice

  • the Department of Justice to prosecute those guilty of insider trading.

  • the prospectus to be distributed after the sale of securities begins.

  • underwriters to join together in syndication.

  • a joint filing for multiple issues of a single security.

 

 

How much cash flow before tax and interest is necessary to support a project if $2 million is used to pay interest, the tax rate is 21%, and equity investors require annual income of $4 million?

Multiple Choice

$7.06 million

$7.86 million

$8.15 million

$8.85 million

 

Capital structure decisions refer to the:

Multiple Choice

dividend yield of the firm’s stock.

blend of equity and debt used by the firm.

capital gains available on the firm’s stock.

maturity date for the firm’s securities.

 

Al’s Market plans to close after 3 more years. The firm expects to have free cash flows of $148,000 next year, $128,000 in Year 2, and $65,000 in Year 3 after incurring the costs of closing. The firm’s cost of equity is 15.5% and its after-tax cost of debt is 6.2%. What is the present value of the firm if its debt to value ratio is 30%?

Multiple Choice

$312,020

$248,915

$277,467

$301,004

 

What proportion of a firm is equity financed if the WACC is 14%, the before-tax cost of debt is 10.77%, the tax rate is 21%, and the required return on equity is 18%?

Multiple Choice

54.00%

57.86%

70.26%

77.78%

 

Which one of the following statements is in?

Multiple Choice

The equity component of WACC reflects the return expected by the company’s shareholders.

Market values should be used in calculating WACC.

Preferred equity is a separate component of WACC.

There is a tax shield on the equity dividends paid.

 

A firm is considering expanding its current operations and has estimated the internal rate of return on that expansion to be 12.2%. The firm’s WACC is 11.8%. Given this, you know that the:

Multiple Choice

project will have a lower debt-equity ratio than the firm’s current operations.

appropriate discount rate for the project is between 11.8% and 12.2%.

project has slightly more risk than the firm’s current operations.

expansion should be undertaken as it has a positive net present value.

 

A firm is considering a project that will generate perpetual cash flows of $50,000 per year beginning next year. The project has the same risk as the firm’s overall operations. If the firm’s WACC is 12%, and its debt-to-equity ratio is 1.33, what is the most it could pay for the project and still earn its required rate of return?

Multiple Choice

$313,283

$375,094

$416,667

$554,167

 

For purposes of computing the WACC, if the book value of equity exceeds the market value of equity, then:

Multiple Choice

the book value of equity should be used.

the book value of equity less retained earnings should be used.

the market value of equity should be used.

the market value of equity less retained earnings should be used.

 

A project will generate a $1 million net cash flow annually in perpetuity. If the project costs $7 million, what is the break-even WACC?

Multiple Choice

13.33%

12.08%

14.29%

16.67%

 

What is the WACC for a firm with 50% debt and 50% equity that pays 12% on its debt, 20% on its equity, and has a 21% tax rate?

Multiple Choice

9.6%

12.0%

14.7%

16.0%

 

Assume the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each. By the end of the first day’s trading, the issuing company’s stock price had risen to $70. What is the total cost of issuing the securities?

Multiple Choice

$81 million

$91 million

$101 million

$111 million

 

A firm’s first offering of stock to the general public is known as:

Multiple Choice

first-stage financing.

an IPO.

a general cash offer.

a seasoned offering.

 

In a firm commitment, the underwriter:

Multiple Choice

encounters virtually no risk because the spread is fixed.

is allowed to sell the shares at any price they choose.

is protected against being stuck with unsold shares.

is allowed to sell the shares at a price slightly higher than the price it paid to the company.

 

Which one of the following is least likely to explain why entrepreneurs contribute their personal funds to start-up projects? Their contribution:

Multiple Choice

acts as a signal to venture capitalists.

repays debt held by the venture capitalist.

retains a portion of the firm’s equity.

provides incentive to expend effort

 

Which one of the following methods may be particularly cost-effective to smaller issuers of securities?

Multiple Choice

Seasoned offerings

Private placement

General cash offer

Best efforts underwriting

 

Stock that is sold through a rights issue:

Multiple Choice

is offered for cash to the general investing public.

will not affect the market price of the shares.

is limited to sales to existing shareholders.

must be sold on a firm commitment basis.

 

If a corporation’s management, with its superior knowledge of proposed investments, considers a security issue to be underpriced, it may react by:

Multiple Choice

forgoing the security issuance and investment.

lowering the price of the existing shares to equal the new shares.

increasing the number of shares to be sold.

adopting shelf registration, which automatically raises the issue price.

 

Plasti-tech Inc. has decided to go public and has sold 2 million of its shares to its underwriter for $20 per share. The underwriter then sold them to the public for $22 each. Plasti-tech also encountered $0.5 million in administrative fees. Soon after the issue, the stock price rose to $25. Find Plasti-tech Inc.’s total cost of this issue including any underpricing.

Multiple Choice

$4.5 million

$9.5 million

$10.5 million

$14.5 million

 

An investor can earn 20% on underpriced IPOs, but will lose 10% on overpriced IPOs. If he is awarded $2,000 worth of shares in an overpriced IPO, how much of the underpriced issue must he be awarded in order to gain $500 total?

Multiple Choice

$1,500

$2,500

$3,500

$10,000

 

Firms go public primarily to:

Multiple Choice

raise additional capital.

diversify public debt holders’ risk.

maintain ownership control.

increase their financial leverage.