Puckett Inc. risk-adjusts its WACC to account for project risk. It uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects. Which of the following independent projects should Puckett accept, assuming that the company uses the NPV method when choosing projects?
A. Project B, which has below-average risk and an IRR = 8.5%.
B. All of these projects should be accepted.
C. Project A, which has average risk and an IRR = 9%.
D. Without information about the projects’ NPVs we cannot determine which project(s) should be accepted.
E. Project C, which has above-average risk and an IRR = 11%.
4. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one cash outflow at t = 0 followed by a series of positive cash flows.
A. A project’s MIRR is always less than its regular IRR.
B. A project’s MIRR is always greater than its regular IRR.
C. To find a project’s MIRR, the textbook procedure compounds cash inflows at the WACC and then finds the discount rate that causes the PV of the terminal value to equal the initial cost.
D. To find a project’s MIRR, we compound cash inflows at the regular IRR and then find the discount rate that causes the PV of the terminal value to equal the initial cost.
E. If a project’s IRR is greater than its WACC, then its MIRR will be greater than the IRR.
Weatherall Enterprises has no debt or preferred stock?it is an all-equity firm?and has a beta of 2.0. The chief financial officer is evaluating a project with an expected return of 14%, before any risk adjustment. The risk-free rate is 5%, and the market risk premium is 4%. The project being evaluated is riskier than an average project, in terms of both its beta risk and its total risk. Which of the following statements is CORRECT?
A. The project should definitely be accepted because its expected return (before any risk adjustments) is greater than its required return.
B. Capital budgeting projects should be evaluated solely on the basis of their total risk. Thus, insufficient information has been provided to make the accept/reject decision.
C. Riskier-than-average projects should have their expected returns increased to reflect their higher risk. Clearly, this would make the project acceptable regardless of the amount of the adjustment.
D. The accept/reject decision depends on the firm’s risk-adjustment policy. If Weatherall’s policy is to increase the required return on a riskier-than-average project to 3% over rS, then it should reject the project.
E. The project should definitely be rejected because its expected return (before risk adjustment) is less than its required return.
Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? X YPrice $30 $30Expected growth (constant) 6% 4%Required return 12% 10%
A. Stock Y has a higher capital gains yield.
B. Stock Y has a higher dividend yield than Stock X.
C. Stock X has the higher expected year-end dividend.
D. One year from now, Stock X’s price is expected to be higher than Stock Y’s price.
E. Stock X has a higher dividend yield than Stock Y.
Which of the following statements is CORRECT?
A. To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and then we discount the TV at the WACC to find the PV.
B. For a project with normal cash flows, any change in the WACC will change both the NPV and the IRR.
C. If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the higher IRR probably has more of its cash flows coming in the later years.
D. The NPV and IRR methods both assume that cash flows can be reinvested at the WACC. However, the MIRR method assumes reinvestment at the MIRR itself.
E. If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the lower IRR probably has more of its cash flows coming in the later years.
Which of the following bonds has the greatest interest rate price risk?
A. A 10-year, $1,000 face value, zero coupon bond.
B. A 10-year, $1,000 face value, 10% coupon bond with annual interest payments.
C. A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.
D. All 10-year bonds have the same price risk since they have the same maturity.
Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true, according to the CAPM?
A. If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.
B.Stock Y’s return has a higher standard deviation than Stock X.
C.Stock Y’s realized return during the coming year will be higher than Stock X’s return.
D.If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
E. If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.
Which of the following statements is CORRECT?
A. If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.
B. If the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock’s price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.
C. Call options generally sell at a price less than their exercise value.
D. Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.
E. Call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.
With its current financial policies, Flagstaff Inc. will have to issue new common stock to fund its capital budget. Since new stock has a higher cost than reinvested earnings, Flagstaff would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock?
A. Increase the percentage of debt in the target capital structure.
B. Increase the proposed capital budget.
C. Increase the dividend payout ratio for the upcoming year.
D. Reduce the amount of short-term bank debt in order to increase the current ratio.
E. Reduce the percentage of debt in the target capital structure.
Laramie Labs uses a risk-adjustment when evaluating projects of different risk. Its overall (composite) WACC is 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Laramie evaluates low-risk projects with a WACC of 8%, average-risk projects at 10%, and high-risk projects at 12%. The company is considering the following projects:Project Risk Expected ReturnA High 15%B Average 12%C High 11%D Low 9%E Low 6%
A. A, B, C, D, and E.
B. A, B, and C.
C. A and B.
D. A, B, C, and D.
E. A, B, and D.