1. Diversification works because
I. unsystematic risk exists
II. forming stocks into a portfolio reduces the standard deviation of each stock in the portfolio
III. firm-specific risk can be dramatically reduced if not eliminated
A.I only
B.III only
C.I and II only
D.I and III only
E.I, II, and III


2. Ed Lawrence has $100,000 invested. Of that, $30,000 is invested in IBM stock, $25,000 is invested in T-bills, and the remainder is invested in corporate bonds. Which of the following is NOT correct regarding his portfolio weights? (All values are current market values.)
A.Ed has 30% of his portfolio invested in stocks
B.Ed has 45% of his portfolio invested in corporate bonds
C.Ed has 70% of his portfolio invested in assets other than stocks
D.Ed's portfolio has a beta of one
E.If Ed liquidates his corporate bonds and buys GM stock with the proceeds, he will end up with 75% of his portfolio invested in stocks


3. Asset A has an expected return of 15%. The expected market return is 14% and the risk-free rate is 4%. What is Asset A's beta?
A..50
B..75
C.1.1
D.1.8
E.2.0


4. Anthony's Antiques, Inc. has preferred stock outstanding which pays a dividend of $4 per share a year. The current price is $32 per share. What is its cost of preferred stock?
A.8.0%
B.9.0%
C.10.0%
D.11.0%
E.12.5%


5. Suppose you are considering a project that costs $300 and has expected cash flows of $110, $121 and $133.10 over the next three years. If the appropriate discount rate for the project's cash flows is 10%, what is the net present value of this project?
A.The NPV is negative
B.$0.00
C.$0.71
D.$19.79
E.$64.10


6. What is the IRR of the following project and what is the maximum number of IRRs that may exist?
YearCash Flow
0-$50,000
1-$5,000
2$50,000
3$50,000
4-$25,000
A.0; 0
B.16.2%; 1
C.16.2%; 2
D.17.1%; 1
E.17.1%; 2


7. What is the payback period of a $40,000 investment with the following cash flows?
YearCash Flow
120,000
225,000
310,000
410,000
55,000
A.1 year
B.1.8 years
C.2 years
D.2.25 years
E.3.5 years


8. KCE Corporation is currently operating at its target capital structure with market values of $110,000,000 in equity and $175,000,000 in debt outstanding. KCE plans to finance a new $32 million project using the same relative weights of debt and equity. How much new debt must be issued to fund the project?
A.$12.4 million
B.$18.5 million
C.$19.6 million
D.$24.8 million
E.$32.0 million


9. Asset A has an expected return of 22% and a beta of 1.8. The expected market return is 14%. What is the risk-free rate?
A.0.6%
B.1.2%
C.3.0%
D.4.0%
E.6.0%


10. Your required return is 15%. Should you accept a project with the following cash flows?
YearCash Flow
0-$85
140
240
335
A.No, because the IRR is 13.9%
B.No, because the IRR is 14.7%
C.Yes, because the IRR is 16.19%
D.Yes, because the IRR is 17.2%
E.Yes, because the IRR is 19.2%


11. You are considering two investments. You note that the return on investment A tends to vary quite widely from its average, definitely more so than investment B does. Based on this you believe that
A.A has a lower variance than B
B.A has a lower standard deviation than B
C.A has a higher inflation premium than B
D.A has a higher return volatility than B
E.A must be stock in one of the 500 largest U.S. firms while B must be stock in one of the smallest firms listed on the NYSE


12. Which of the following formulas correctly describes the cost of equity capital?
A.R*BE = D*B0 /P*B0 + g
B.R*BE = D*B1 + g/P*B0
C.R*BE = D*B1 /P*B0 + g
D.R*BE = R*Bf - b (R*Bf - R*Bm )
E.R*BE = R*Bf + b (R*Bm + R*Bf )


13. Rattle me Bones, Inc.'s common stock is currently selling for $66.25 per share. You expect the next dividend to be $5.30 per share. If the firm has a dividend growth rate of 4%, what is its cost of equity?
A.12.0%
B.12.3%
C.13.5%
D.13.9%
E.14.1%


14. Given the following information, what is the average annual dividend growth rate?
YearDividend
19912.50
19922.60
19932.65
19942.78
19952.89
19963.05
A.3.0%
B.3.8%
C.4.0%
D.4.6%
E.5.4%


15. Treasury bills currently have a return of 3.5% and the market risk premium is 8%. If a firm has a beta of 1.6, what is its cost of equity?
A.8.8%
B.10.7%
C.12.8%
D.16.3%
E.18.8%


16. Rattle me Bones, Inc. sold a 20-year bond issue 12 years ago. It pays an 8% annual coupon and has a $1,000 face value. If the current price per bond is $893.30, what is the firm's cost of debt?
A.8.0%
B.9.2%
C.9.5%
D.10.0%
E.10.5%


17. You purchased a bond on January 1 that has a $1000 face value and an 8% annual coupon. You paid $839.67 and you can sell the bond for $842.33 on December 31. What is your total dollar return for the year?
A.$2.66
B.$10.66
C.$72.66
D.$77.34
E.$82.66


18. You purchased 200 shares of preferred stock on January 1 for $42.27 per share. The stock pays an annual dividend of $5 per share. On December 31, the market price is $43.88 per share. What is your percentage return for the year if you hold on to the stock?
A.4.9%
B.8.0%
C.14.9%
D.15.1%
E.15.6%


19. Given the following historical returns, what is the variance? Year 1 = 8%; year 2 = -12%; year 3 = 6%; year 4 = 1%; and year 5 = -19%.
A..0063
B..0089
C..0139
D..0394
E..1178


20. Which form(s) of market efficiency is (are) generally considered to hold in well-organized markets?
I. Strong-form efficiency
II. Semistrong-form efficiency
III. Weak-form efficiency
A.I only
B.II only
C.III only
D.I and II only
E.II and III only



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