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Chapter 10 Risks and Returns - Bobadilla
Chapter 10 Risks and Returns - Bobadilla
THEORIES:
1. The use of financial leverage by the firm has a potential impact on which of the
following?
(1) The risk associated with the firm
(2) The return experienced by the shareholder
(3) The variability of net income
(4) The degree of operating leverage
(5) The degree of financial leverage
A. 1, 3, 5
B. 2, 3, 4, 5
C. 1, 2, 3, 5
D. 1, 2, 5
1. If the pro form balance sheet shows that total assets must increase by P400,000 while
retaining a debt-equity ratio of .75 then:
A. debt must increase by P300,000.
B. equity must increase by the full P400,000
C. debt must increase by P171,428
D. equity must increase by P100,000
2. Leverage Corporation has a capital structure that consists of 65% and 35% debt. The
company expects to report P100 million in net income this year, and 67.5% of the net
income will be paid out as dividends. How large can the firm’s capital budget be this year
without having to include the cost of new common stock in its cost of capital analysis?
A. P100.0 million
B. P 67.5 million
C. P 50.0 million
D. P 32.5 million
3. The Equity Company projects the following for the upcoming year:
At what amount of financing will there be a break point in Cartel’s cost of capital?
A. P45 million
B. P20 million
C. P30 million
D. 18 million
7. Deep Sea Company expects next year’s after-tax income to be P7,500,000. The firm’s
debt ratio is currently 40%. Deep Sea Company has P6,000,000 of profitable investment
opportunities, and it wishes to maintain its existing debt ratio. According to the residual
dividend policy, what is the expected dividend payout ratio next year?
A. 52.0%
B. 75.0%
C. 48.0%
D. 25.0%
8. The Florida Co. has an equity cost of capital of 17%. The debt to equity ratio is 1.5 and a
cost of debt is 11%. What is the weighted average cost of capital of the firm? (Assume
tax rate of 33%)
A. 3.06%
B. 13.40%
C. 16.97%
D. 15.52%
9. Calculate the DFL for a firm with EBIT of P6,000,000, fixed cost of P3,000,000, interest
expense of P1,000,000, preferred stock dividends of 800,000, and a 40% tax rate
A. 6.0
B. 9.0
C. 1.43
D. 1.64
10. A firm is expected to generate P1.5 million in operating income and pay P250,000 in
interest. Ignoring taxes, this will generate P12.50 earnings per share. What will happen to
EPS if operating income increases to P2.0 million?
A. EPS increase to P15.63.
B. EPS increase to P16.67.
C. EPS increase to P17.50.
D. EPS increase to P20.00.
11. The board of directors of Moderate Company was unhappy with the current return on
common equity. Though the return on sales (profit margin) was impressively good at
12.5%, the asset turnover was 0.75. The present debt ratio is 0.40.
What debt ratio did Ms. Flor propose in order to raise the return on equity (ROE) to
150% of the present level?
A. 0.52
B. 0.68
C. 0.61
D. 0.72
12. Eclipse Company expects to generate P10 million internally which could be available for
financing part of its P12 million capital budget for this coming year. Eclipse’s
management believes that a debt-equity ratio of 40% is best for the firm. How much
should be paid in dividends if the target debt-equity ratio is to be maintained?
A. P2,800,000
B. P8,571,429
C. P1,428,571
D. P4,000,000
13. A five-year P1,000 par value bond pays 6.50% annual coupon. Given a YTM of 8.0%,
what is the price of the bond today?
A. P1,040
B. P 860
C. P 940
D. P1,000
14. Paramount Company’s stock is expected to generate a dividend and terminal value one
year from now of P57.00. The stock has a beta of 1.3, the risk-free interest rate is 6%, and
the expected return market return is 11%. What should the equilibrium price of investors;
stock in the market now?
A. P50.67
B. P43.85
C. P53.77
D. P41.22
15. The beach Corporation pays annual dividends of P6.00 on the cumulative preferred stock.
What is the current value of this stock if an investor requires a 10% annual rate of return?
A. P 60
B. P 6
C. P600
D. P 10
16. What is the current price of a share of stock when last year’s dividend was P3.00m the
growth rate is 6%, and the investors’ required rate of return is 12%?
A. P25.00
B. P26.50
C. P50.00
D. P53.50
17. What is the current price of a share of stock when the current dividend is P4.75, the
growth rate is 7%, and the investor’s require rate of return is 11%.
A. P118.75
B. P 43.16
C. P 46.20
D. P127.06
18. You are planning to invest in common stock of Eagle, Inc. Lately, the firm paid a
dividend of P7.80. You have projected that dividends will grow at a rate of 9.0% per year
indefinitely. If you want an annual return of 24%, what is the most you should pay for the
stock now?
A. P52.00
B. P56.68
C. P32.50
D. P35.43
19. Dangling, Inc. is a firm that is experiencing rapid growth. Lately, the firm paid a dividend
of 5.90. You believe that dividends will grow at a rate of 19.0% per year for three years,
and then at a rate of 7.0% per year thereafter. If you expect an annual rate of return of
12.0% on this investment and you plan to hold the stock indefinitely, what is the most
you would pay for the stock now?
A. P155.22
B. P171.45
C. P131.09
D. P185.60
20. OPQ Company is considering buying common shares in Oceanic Company. OPQ has
projected that the next dividend the company will pay will equal P4.00 and that dividends
will grow at a rate of 7.0% per year thereafter. The firm’s beta is 1.75, the risk0free rate
is 7.5%, and the market return is 11.3%. What is the most you should pay for the stock
now?
A. P30.25
B. P59.86
C. P55.94
D. P89.12
21. Filam’s Company expects to pay a dividend of P6 per share at the end of year one, P9 per
share at the end of the year two, and then be sold for P136 per share. If the required rate
on the stock is 20%, what is the current value of the stock?
A. P100.10
B. P105.69
C. P110.00
D. P120.29
22. Constantly Company is a no growth firm and has 2 million shares outstanding. It is
expected to earn a constant P20 million per year on its assets. If all earnings are paid out
as dividends and the cost of capital is 10%, calculate the current price per share for the
stock.
A. P200
B. P100
C. P150
D. P 50
23. Lion Company will pay a dividend of P1.50 per share at the end of next 12 months. The
required rate of return for Lion’s share is 10% and the constant growth is 5%.
The approximately current market price per common share of Lion stock is
A. P30.00
B. P10.00
C. P15.00
D. P26.23
24. Calculate the dividend payout ratio based on the following values for a listed company.
Dividend 2.28
P/E 19.00
Close 75.25
A. 57.6%
B. 23.3%
C. 12.0%
D. 3.0%
25. The current yield on a bond worth P900 with a par value of P1,000 and a current rate of
10% is:
A. 10.00%
B. 11.11%
C. 12.05%
D. 9.75%
26. The Lakeview Company’s bonds have 4 years remaining to maturity. Interest is paid
annually; the bonds have a P1,000 face value and the coupon interest rate is 9%.
A. 8.23%
B. 13.10%
C. 10.86%
D. 14.80%
27. What is the expected YTM on a bond that pays a P150 coupons annually, has a P1,000
par value, and matures in six years if the current price of the bond is P978?
A. 18.9%
B. 36.7%
C. 15.6%
D. 13.9%
28. You are considering the purchase of a bond with a 13% coupon rate paid and
compounded semi-annually. The bond will mature in 8 years, and has a P1,000 face
value. The bond currently sells for P867. Calculate the annual yield to maturity for this
bond. (Round to nearest percentage.)
A. 8%
B. 9%
C. 13%
D. 16%
29. What is the yield to maturity (APR) of a bond with the following characteristics?
Coupon rate: 8% with semi-annual payments
Current price: P960
Maturity: three years until maturity
A. 4.78%
B. 5.48%
C. 9.57%
D. 12.17%
30. What is the rate of return for an investor who pays P1,054.47 for a three-year bond with a
7% coupon and sells the bond one year late for P1,037.19?
A. 5.00%
B. 5.33%
C. 6.46%
D. 7.00%
31. Heidi Company plans to issue some P100 preferred stock with an 11% dividend. The
stock is selling on the market for P97, and Heidi must pay flotation costs of 5% of the
market price. The company is under the 40 % corporate tax rate.
A. 7.16%
B. 11.34%
C. 6.80%
D. 11.94%
32. If a share of stock provided a 14.0% nominal rate of return over the previous year while
the real rate of return was 6.0%, then the inflation rate was:
A. 1.89%
B. 7.55%
C. 8.00%
D. 9.12%
33. Milky Way, Inc. paid a cash dividend to its common shareholders over the past 12
months of P2.20 per share. The current market value of the common stock is P40 per
share and investors are anticipating the common dividend to grow at a rate of 6% per
annum. The cost to issue new common stock will be 5% of the market value. The
expected returns on retained earnings is
A. 12.14%
B. 11.83%
C. 11.79%
D. 14.05%
34. What is the estimated required rate of return for equity investors if a stock sells for 40
and will pay a P4.40 dividend that is expected to grow at a constant rate of 5%?
A. 7.6%
B. 12.0%
C. 12.6%
D. 16.0%
35. The earnings, dividends, and stock price of Sum Company are expected to grow at 7%
per year after this year. Sum Company’s common stock sells for P23 per share, its last
dividend was P2.00 and the company pay P2.14 at the end of the current year. Sum
Company should pay P2.50 flotation cost.
Using the dividend growth model, what is the expected cost of retained earnings for Sum
Company?
A. 10.44%
B. 16. 30%
C. 9.30%
D. 17.44%
36. The Wind Company’s last dividend was P3.00, its growth rate is 6% and the stock now
sells for P36. New stock can be sold to net the firm P32.40 per share.
If investors require a 9% return, what rate of growth must be expected for Platter?
A. 0 growth
B. 3.0%
C. 40.0%
D. 50.0%
38. Okkawa Company’s stock is currently selling for P120 a share. The firm is expected to
earn P10.80 per share and to pay a year-end dividend of P7.20. Investors require a 9%
return.
If the firm’s beta is 1.75, the risk-free rate is 8%, and the average return on the market is
12%, what will be the firm’s cost of equity using CAPM approach?
A. 16.05%
B. 15.00%
C. 14.27%
D. 14.00%
50. The following data are related to Samba stock:
56. The company cost of capital for a firm with a 60/40 debt/equity split, 7% cost of debt,
15% cost of equity, and 35% tax rate would be:
A. 7.02%
B. 9.12%
C. 10.80%
D. 13.80%
57. The nut Corporation finds that it is necessary to determine its marginal cost of capital.
Nut’s current capital structure calls for 45% debt, 15% preferred stock and 40% common
equity. The costs of the various sources of financing are as follows: debt, after-tax 5.6%;
preferred stock, 9%; retained earnings, 12%; and new common stock, 13.2%. If the firm
has P12 million retained earnings, and Nut has an opportunity to invest in an attractive
project that costs P45 million, what is the marginal cost of capital of Nut Corporation?
A. 8.83%
B. 8.91%
C. 9.95%
D. 12.40%
58. A firm has common stock with a market price of P100 per share and an expected
dividend of P5.61 per share at the end of 2007. A new issue of stock is expected to be
sold for P98, with a P2 per share representing the underpricing necessary in the
competitive capital market. Flotation costs are expected to total P1 per share. The
dividends paid on the outstanding stock last 5 years are:
Year Dividend
2002 P4.40
2003 4.28
2004 4.58
2005 4.90
2006 5.24
What is the expected return on the new issue of common stock in January 2006?
A. 5.8%
B. 7.7%
C, 10.8%
D. 12.8%
59. Silverwares Company is expecting their sales to decline due to the increased interest in
disposable wares. Thus, the company has announced that they will be reducing their
annual dividend by 4% a year for the next 4 years. After that, they will maintain a
constant dividend of P1 per share. Last year, the company paid P1.80 per share. What is
this stock worth to you if you require a 12% rate of return?
A. P9.29
B. P10.27
C. P11.30
D. P12.07
60. Home Builders, Inc. is a very cyclical type of business which reflected in their dividend
policy. The firm pays a P3.50 per share dividend every other year. The next dividend will
be paid end of this year. Four years from now, the company plans to pay P77 liquidating
dividend per share. What is the current market value of this stock if the market rate of
return is 18.5%?
A. P43.32
B. P44.11
C. P46.59
D. P48.37
61. Last week, Tutuban Company paid and annual dividend of P2.44 per share. The company
has been reducing the dividends by 15% each year. How much are you willing to pay to
purchase stock in this company if your required rate of return is 16%?
A. P6.69
B. P7.87
C. P36.60
D. P244.00
62. Peach Boutique recently paid P1.65 as an annual dividend. Future dividends are projected
at P1.68, P1.72, P1.76, and P1.80 over the next four years, respectively. Beginning five
years from now, the dividend is expected to increase by 2.5% annually.
What is one share of this stock worth to you if you require an 11% rate of return on
similar investments?
A. P18.49
B. P19.68
C. P21.33
D. P24.33
63. River Poker Company will pay annual dividend of P3.15 a share on their dividend
common stock end of this year. Last year, the company paid a dividend of P3.00 a share.
The company adheres a constant rate of growth dividend policy. What will one share of
this common stock be worth 10 years from now if the applicable discount rate is 12.5%?
A. P53.78
B. P65.16
C. P68.41
D. P71.83ained
The Solar Laboratories, Inc., a multinational company, is expanding its research and
production capacity to introduce a new line of products. Current plans call for the
expenditure of P100 million on four projects of equal size (25 million each), but different
returns. Project A is in blood clotting proteins and has an expected return of 18%. Project
B relates to a hepatitis vaccine and carries a potential return of 14%. Project C, dealing
with a cardiovascular compound, is expected to earn 11.8% and Project D, an investment
in orthopedic implants, is expected to show a 10.9% return.
The firm has P15 million in retained earnings. After a capital structure with P15 million
in retained earnings is reached (in which retained earnings represent 60% of the
financing), all additional equity financing must come in the form of new common stock.
Common stock is selling for P25 per share and underwriting costs are estimated at P3 id
new shares are issued. Dividends for the next year will be P.90 per share (D), and
earnings and dividends have grown consistently at 11%.
The yield on comparative bonds has been hovering at 11%. The investment banker feels
that the first P20 million of bonds could be sold to yield 11% while additional debt might
require a 2% premium and be sold to yield 13%. The corporate tax rate is 30%. Debt
represents 40% of the capital structure.