# QUESTION 1 In order to accurately assess the capital structure of a firm *

Question

QUESTION 1

In order to accurately assess the capital structure of a firm, it is necessary to convert its balance sheet figures from historical book values to market values. KJM Corporation’s balance sheet (book values) as of today is as follows: The bonds have a 7.7% coupon rate, payable semiannually, and a par value of $1,000. They mature exactly 10 years from today. The yield to maturity is 11%, so the bonds now sell below par. What is the current market value of the firm’s debt?

Long-term debt (bonds, at par) $23,500,000

Preferred stock 2,000,000

Common stock ($10 par) 10,000,000

Retained earnings 4,000,000

Total debt and equity $39,500,000

$17,734,265

$23,394,137

$18,866,239

$16,602,290

$19,054,902

5 points

QUESTION 2

Niendorf Corporation’s 5-year bonds yield 6.75%, and 5-year T-bonds yield 4.80%. The real risk-free rate is r* = 2.75%, the inflation premium for 5-year bonds is IP = 1.65%, the default risk premium for Niendorf’s bonds is DRP = 1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) ? 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Niendorf’s bonds?

0.49%

0.55%

0.61%

0.68%

0.75%

5 points

QUESTION 3

Nagel Equipment has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 13.25%. Using the SML, what is the firm’s required rate of return?

10.20%

13.03%

14.50%

12.29%

11.18%

5 points

QUESTION 4

The Isberg Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future. The company’s beta is 1.15, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is the company’s current stock price, P0?

$18.62

$19.08

$19.56

$20.05

$20.55

5 points

QUESTION 5

Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield 8.90%. Also, corporate bonds have a 0.25% liquidity premium versus a zero liquidity premium for T-bonds, and the maturity risk premium on both Treasury and corporate 10-year bonds is 1.15%. What is the default risk premium on corporate bonds?

4.12%

3.35%

3.12%

3.08%

2.95%

5 points

QUESTION 6

Carter’s preferred stock pays a dividend of $1.00 per quarter. If the price of the stock is $57.50, what is its nominal (not effective) annual rate of return?

7.86%

8.14%

7.72%

7.37%

6.96%

5 points

QUESTION 7

Grossnickle Corporation issued 20-year, noncallable, 6.3% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 19 years to maturity?

$1,136.58

$950.79

$1,289.58

$1,049.15

$1,092.86

5 points

QUESTION 8

Moerdyk Corporation’s bonds have a 10-year maturity, a 6.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 4.75%, based on semiannual compounding. What is the bond’s price?

1,063.09

1,090.35

1,118.31

1,146.27

1,174.93

5 points

QUESTION 9

Jill Angel holds a $200,000 portfolio consisting of the following stocks. The portfolio’s beta is 0.875. If Jill replaces Stock A with another stock, E, which has a beta of 1.85, what will the portfolio’s new beta be?

Stock Investment Beta

A $50,000 0.50

B $50,000 0.80

C $50,000 1.00

D $50,000 1.20

Total $200,000

0.92

1.21

1.30

1.14

1.35

5 points

QUESTION 10

Kristina Raattama holds a $200,000 portfolio consisting of the following stocks. The portfolio’s beta is 0.875. If Kristina replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio’s new beta be?

Stock Investment Beta

A $50,000 0.50

B 50,000 0.80

C 50,000 1.00

D 50,000 1.20

Total $200,000

1.07

1.13

1.18

1.24

1.30

5 points

QUESTION 11

Grossnickle Corporation issued 20-year, noncallable, 8.1% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 19 years to maturity?

$1,132.57

$1,223.69

$1,301.80

$1,353.87

$1,314.82

5 points

QUESTION 12

Suppose the yield on a 10-year T-bond is currently 5.05% and that on a 10-year Treasury Inflation Protected Security (TIPS) is 1.30%. Suppose further that the MRP on a 10-year T-bond is 0.90%, that no MRP is required on a TIPS, and that no liquidity premium is required on any T-bond. Given this information, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

3.45%

3.33%

2.85%

2.82%

3.51%

5 points

QUESTION 13

The Isberg Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future. The company’s beta is 1.35, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is the company’s current stock price, P ?

$15.83

$14.02

$11.61

$18.84

$15.07

5 points

QUESTION 14

Kay Corporation’s 5-year bonds yield 6.20% and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the default risk premium for Kay’s bonds is DRP = 1.30% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Kay’s bonds?

0.52%

0.61%

0.38%

0.50%

0.56%

5 points

QUESTION 15

In order to accurately assess the capital structure of a firm, it is necessary to convert its balance sheet figures to a market value basis. KJM Corporation’s balance sheet as of today is as follows: The bonds have a 4.0% coupon rate, payable semiannually, and a par value of $1,000. They mature exactly 10 years from today. The yield to maturity is 12%, so the bonds now sell below par. What is the current market value of the firm’s debt?

Long-term debt (bonds, at par) $10,000,000

Preferred stock 2,000,000

Common stock ($10 par) 10,000,000

Retained earnings 4,000,000

Total debt and equity $26,000,000

$5,276,731

$5,412,032

$5,547,332

$7,706,000

$7,898,650

5 points

QUESTION 16

Crockett Corporation’s 5-year bonds yield 6.35%, and 5-year T-bonds yield 4.75%. The real risk-free rate is r* = 2.20%, the default risk premium for Crockett’s bonds is DRP = 1.00% versus zero for T-bonds, the liquidity premium on Crockett’s bonds is LP = 0.90% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What inflation premium (IP) is built into 5-year bond yields?

2.02%

2.49%

2.43%

2.11%

2.15%

5 points

QUESTION 17

Mulherin’s stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

10.36%

10.62%

10.88%

11.15%

11.43%

5 points

QUESTION 18

Koy Corporation’s 5-year bonds yield 9.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Koy’s bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Koy’s bonds?

2.36%

3.10%

2.64%

2.70%

3.69%

5 points

QUESTION 19

The Francis Company is expected to pay a dividend of D = $1.25 per share at the end of the year, and that dividend is expected to grow at a constant rate of 6.00% per year in the future. The company’s beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is the company’s current stock price?

$22.83

$27.99

$27.17

$22.01

$24.18

5 points

QUESTION 20

Company A has a beta of 0.70, while Company B’s beta is 1.30. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A’s and B’s required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)

4.74%

4.05%

3.77%

4.94%

4.70%