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BUS 330 Fall 2016 Quiz 3-1/2 Instructions: Select the ONE BEST response to each question below. 1. The priority of payment of dividends on preferred stock is _____ than the payments on debt and _____ than the payment of dividends on common stock. The payment of dividends on preferred stock _____ treated as an expense of the firm for tax purposes. a. b. c. d. e. Higher Higher Lower Lower Higher lower lower higher higher higher is is not is is not is not 2. Suppose a firm’s debt costs 3% per year, and the required return on the firm’s shares is 6% per year. The firm’s balance sheet currently shows that it has obtained 1/3 of its financing from debt and two thirds of its financing from shares. If it is evaluating whether to replace its worn-out capital equipment with similar new capital, the rate of return it should require the new capital to earn is: a. b. c. d. e. 3% 4% 6% 5% 9% 3. When a firm issues preferred stock, it combines the disadvantages of equity finance with the disadvantages of debt finance. The disadvantage that preferred stock shares with equity (compared to debt finance) is: a. The dividends paid to preferred shareholders are paid out of the firm’s after-tax income, while interest payments are an expense that is deducted before the tax is computed. b. The firm is forced into bankruptcy proceedings if it is unable to pay the scheduled dividend on preferred stock. c. The returns that can be paid to common shareholders are diluted by the increase in dividends paid to preferred shareholders if the firm’s profits rise. d. Increasing the reliance on preferred shares will increase the firm’s weighed-averagecost-of-capital (WACC). e. Preferred shareholders may vote to support a hostile takeover attempt. 4. Suppose a firm initially has a “beta” equal to 1.5, and has $100 of assets, $50 of debt, and $50 of equity. The firm sells another $50 of equity and uses the cash to retire (pay off) all of its debt. The new value of beta for the firm will be: a. b. c. d. e. 1.5 2.0 0.75 0 None of the above. 5. The value of beta for a particular firm Z’s shares can be estimated statistically by running a least squares regression (the “LINEST” function) with _____ being the “y” variable and _____ being the “x” variable. a. b. c. d. The return on shares of Z; the return on a diversified market asset The dividend on shares of Z; the price of shares of asset Z The price of shares of Z; the price/earnings ratio of shares of Z The price/earnings ratio of shares of Z; the price/earnings ratio of shares of an industry competitor. e. The variance of the returns on Z; the risk premium on shares of Z. 6. The Capital Asset Pricing Model concludes that an investor can get a risk premium only for holding risk that: a. b. c. d. e. Is unsystematic. Is greater than the amount of risk in the perfectly-diversified-market-portfolio. Does not disappear when the investor diversifies his assets holdings. Does not add anything to the expected return of the portfolio. Is negatively correlated with the risk on the diversified market portfolio. EXTRA CREDIT: 7. Below are photos or images of Alexander Hamilton, Salmon Chase, Charles Ponzi, Bernie Madoff, and my dog. Which is which? a. b. c. d. e. (1) Chase; (2) dog; (3) Hamilton; (4) Madoff; (5) Ponzi (1) dog; (2) Hamilton; (3) Madoff; (4) Ponzi; (5) Chase (1) Hamilton; (2) Madoff; (3) Ponzi; (4) Chase; (5) dog (1) Madoff; (2) Ponzi; (3) Chase; (4) dog; (5) Hamilton (1) Ponzi; (2) Chase; (3) dog; (4) Hamilton; (5) Madoff