1 If you assume beta is greater than 1, then which of these will increase the cost of equity capital according to CAPM? I. Increase in the risk-free rate; II. Decrease in the risk-free rate; III. Increase in the market rate of return; IV. Decrease in the market rate of return
A) III only
B) I and III only
C) I and IV only
D) II and IV only
E) II and III only
2) Firms A and B are identical except for their capital structures. Firm A is an all-equity firm while Firm B is levered. Given this, you can assume that Firm B’s equity beta will be ____
A) Less than Firm A’s beta
B) Equal to zero
C) Equal to Firm A’s beta
D) Equal to 1
E) Greater than Firm A’s beta
3) A firm with high operating leverage is best defined as a firm that has:
A) A high debt-to-equity ratio
B) High fixed costs relative to variable costs
C) A low, relatively stable beta
D) High variable costs relative to fixed costs
E) A high sales/assets ratio
4) To calculate beta you divide the ____ of the stock with the market portfolio by the ____ of the market portfolio.
A) Covariance; variance
B) Variance; covariance
C) Standard deviation; variance
D) Expected return; variance
E) Covariance; standard deviation
5) Which one of these statements related to beta is correct?
A) The beta of a risk-free security is set at 1.
B) The higher the beta the lower the risk of a security
C) Beta measures the risk of a single security if held in a large, diversified portfolio
D) Beta measures the total risk of a single security held independently
E) A stock with a high standard deviation will also have a high beta
6) Which of these may occur if a firm uses its overall cost of capital as the discount rate for all projects? I. Profitable low-risk projects may be incorrectly rejected; II. Only projects with risks similar to the current firm will be accepted; III. Too many high-risk projects may be accepted; IV. Only low-risk projects will be accepted.
7) The S&P 500 has a dividend yield of 2.4 percent. Analysts expect overall dividends to grow at 5.2 percent annually and the Treasury bills yield 3.2 percent. The expected market rate of return is ____ percent.
A) 10.8
B) 7.6
C) 4.4
D) 8.10
E) 9.32
8) The beta of a firm is more likely to be high under which two conditions?
A) High cyclical business activity and high operating leverage
B) High cyclical business activity and low operating leverage
C) Low cyclical business activity and low financial leverage
D) Low cyclical business activity and low operating leverage
E) Low operating and financial leverage
9) The use of debt is called:
A) Financial leverage
B) Production leverage
C) Operating leverage
D) Total asset turnover risk
E) Business risk
10) DimSum Industries is a multi-product firm operating in a number of industries. Assume the firm is analyzing a new project that has risks unrelated to those of the current firm’s product. When computing the net present value of the new project the cash flows should be discounted using:
A) A rate based on a beta of one since the firm is well diversified
B) A rate based on the firm’s current beta
C) The risk-free rate of return
D) The market rate of return
E) A rate commensurate with the risk level of the proect