Question 1

Using the above information,calculate Zonk's weighted-average cost of capital:
A) 11.5%
B) 7.97%
C) 7.48%
D) 10.90%

Accepted Answer

WACC (Zonk)= [.217 * .115 * (1 - .35)] + (.783 * .1189)=[.210*.105*(1-.35)+(.7900*.0828)=

Question 2

Under the cash-flow-based valuation approach,free cash flows can be used instead of dividends as the expected future payoffs to the investor in the numerator of the general valuation model because:
A) this approach focuses on earnings as a measure of the capital that a firm creates.
B) over the life of the firm,the free cash flows into the firm and cash flows paid out of the firm in dividends to shareholders will be equivalent.
C) over the life of the firm,the free cash flows out of the firm for investments and cash flows paid into the firm in dividends from these investments will be equivalent.
D) this approach focuses on wealth distribution to shareholders.

Accepted Answer

Free cash flows represent the money available to all investors (debt and equity) after a firm has made all necessary investments to maintain and grow its operations. Over the life of the firm, the sum of free cash flows that come into the firm will be equivalent to the sum of cash flows paid out of the firm in dividends to shareholders. Therefore, free cash flows can be used instead of dividends as the expected future payoffs to the investor in the numerator of the general valuation model.

Question 3

Investors typically accept a lower risk-adjusted rate of return on debt capital than on equity capital because:
A) debt is typically less risky because fixed claims bear less residual risk than equity claims.
B) equity bears less residual risk than debt.
C) equity capital costs are tax deductible.
D) the yield to maturity on equity is inversely related to its market value.

Accepted Answer

Debt is typically less risky than equity because it involves fixed claims that have priority in the event of liquidation or bankruptcy. This means that debt holders bear less residual risk than equity holders. As a result, investors are willing to accept a lower risk-adjusted rate of return on debt capital.

Question 4

The historical discount rate of the firm may be a good indicator of the appropriate discount rate to apply to the firm in the future,when all of the following conditions hold true except:
A) The current risk of the firm is the same as the expected future risk of the firm.
B) Expected future interest rates are likely to equal current interest rates.
C) The existing capital structure of the firm is the same as the expected future capital structure of the firm.
D) The current mix of debt and equity financing is equal.

Accepted Answer

The current mix of debt and equity financing being equal does not necessarily ensure that the historical discount rate will be appropriate for the future, as it does not directly relate to the risk or interest rate conditions.

Question 5

If a firm has a market beta of 0.9,is subject to an income tax rate of 35 percent,has a risk-free rate of 6 percent,a market risk premium of 7 percent,and has a market value of debt to market value of equity ratio of 60 percent,what does the market expect the firm to generate in terms of equity returns using CAPM?
A) 6%
B) 7%
C) 12.3%
D) 13%

Accepted Answer

12.3% = [.06 + (0.9 x .07)]

Question 6

Assume that Zonk is a potential leveraged buyout candidate.Assume that the buyer intends to put in place a capital structure that has 70 percent debt with a pretax borrowing cost of 14 percent and 30 percent common equity.Compute the revised equity beta for Zonk based on the new capital structure.
A) 4.35
B) 4.77
C) 4.34
D) 3.91

Accepted Answer

Levered market equity beta = unlevered market equity beta (1 + (1-t)[MV debt\MV equity])
==1.13*(1+(1-.35)[.70/.30]=4.35

Question 7

Equity-based valuation models are based on all metrics except:
A) dividends
B) cash flow
C) working capital
D) earnings

Accepted Answer

Equity-based valuation models are typically based on metrics such as assets, debt, pre-tax borrowing, common equity (including both book value and market value), income tax rate, and market equity beta. Working capital, on the other hand, is more relevant to the assessment of a company's short-term liquidity and operational efficiency. Therefore, choice C is the best answer.

Question 8

With respect to dividends and priority in liquidation,what has priority over common stock?
A) treasury stock
B) debt capital
C) preferred stock
D) nonconvertible common equity

Accepted Answer

Preferred stock has priority over common stock in receiving dividends and in the event of liquidation.

Question 9

Returns on systematic risk-free securities (like U.S.Treasury securities)should exhibit what type of correlation with returns on a diversified market wide portfolio of stocks?
A) Nearly perfect correlation
B) Perfect correlation
C) No correlation
D) Unable to tell without specifics about the portfolio

Accepted Answer

Returns on systematic risk-free securities like U.S. Treasury securities are not related to the returns on a diversified market-wide portfolio of stocks. Hence, there is no correlation between them.

Question 10

Firm-specific factors that increase the firm's nondiversifiable risk include all of the following except:
A) Exposure to interest rate changes
B) Exposure to inflation
C) Exposure to management competence
D) Exposure to cyclicality

Accepted Answer

Exposure to management competence is not a firm-specific factor that increases nondiversifiable risk. Nondiversifiable risk, also known as systematic risk, is caused by external factors that affect the entire market, such as changes in interest rates, inflation, and economic cycles. Factors that increase a firm's specific risk include industry competition, product obsolescence, and dependence on key customers or suppliers.

Question 11

Equity valuation models based on dividends,cash flows,and earnings have been the topic of many theoretical and empirical research studies in recent years.All of the following are true regarding these studies except:
A) Share prices in the capital markets generally correlate closely with share value.
B) Share prices do not always equal share values.
C) Temporary deviations of price from value occur.
D) Unexpected changes in earnings,dividends,and cash flows do not correlate closely
With changes in stock prices.

Accepted Answer

The statement "Unexpected changes in earnings, dividends, and cash flows do not correlate closely with changes in stock prices" is not true. These changes have a significant impact on stock prices and are considered important factors in equity valuation models.

Question 12

All of the following are steps in the analysis and valuation framework used to understand the fundamentals of a business and determine estimates of its value except:
A) Analyze the firm's strategy in terms of the competition.
B) Assess the quality of the firm's accounting and financial reporting.
C) Derive forecasts of future earnings from the firm's projected financial statements.
D) Obtain the national ranking of the firm's external auditors.

Accepted Answer

Obtaining the national ranking of the firm's external auditors is not a step in the analysis and valuation framework used to understand the fundamentals of a business and determine estimates of its value. The other three options are important steps in the process.

Question 13

Zonk Corp.
The following data pertains to Zonk Corp. ,a manufacturer of ball bearings (dollar amounts in millions): 
-Determine the weight on equity capital that should be used to calculate Zonk's weighted-average cost of capital:
A) 79.00%
B) 78.3%
C) 41.8%
D) 50%

Accepted Answer

11eaa0b8_3b3f_b969_80dc_fbaeb14d1bbb_TB2249_00

Question 14

In theory,the value of a share of common equity is the present value of ____________________________________________________________.

Accepted Answer

The answer of In theory,the value of a share of...

Question 15

When deriving the equity value of a firm,an analyst forecasts the real dividends expected to be paid in the future.In this case,which discount rate should be used?
A) The nominal rate of return
B) The real rate of return
C) The risk-free rate of return
D) The risk adjusted rate of return

Accepted Answer

When forecasting real dividends, the analyst should use the real rate of return as the discount rate. The nominal rate of return includes expected inflation, which would double-count inflation if used to discount real dividends. The risk-free rate of return and risk-adjusted rate of return may be used for other valuation methods, but not when specifically forecasting real dividends.

Question 16

Zonk Corp.
The following data pertains to Zonk Corp. ,a manufacturer of ball bearings (dollar amounts in millions): 
-Assuming that riskless rate is 4.6% and the market premium is 7.3%,calculate Zonk's cost of equity capital:
A) 10.4%
B) 7.69%
C) 11.89%
D) 8.28%

Accepted Answer

cost of equity capital = .046+1.13(.073)= 8.28

Question 17

Which of the following is not a with using a dividend-based valuation formula?
A) Dividends are arbitrarily established.
B) Dividends represent a transfer of wealth to shareholders.
C) Some firms do not pay a regular periodic dividend.
D) It is a challenge to forecast the final liquidating dividend.

Accepted Answer

Dividends representing a transfer of wealth to shareholders is not a problem with using a dividend-based valuation formula; rather, it is a fundamental aspect of dividends. The other options highlight challenges or limitations associated with dividend-based valuation.

Question 18

One rationale for using expected dividends in valuation is:
A) Dividends are a necessary payment in order for a firm to have value.
B) Dividends are paid in cash,and cash serves as a measurable common denominator for comparing the future benefits of alternative investment opportunities.
C) Dividends are the most reliable measure of value because most companies payout dividends to shareholders.
D) Dividend payout ratios are set based on profitability.

Accepted Answer

Expected dividends are used in valuation because they are paid in cash, which can be compared to the future benefits of alternative investment opportunities. Cash is a measurable common denominator that can be used to compare different investments, making it a useful tool for valuation.

Question 19

Zonk Corp.
The following data pertains to Zonk Corp. ,a manufacturer of ball bearings (dollar amounts in millions): 
-Determine the weight on debt capital that should be used to calculate Zonk's weighted-average cost of capital:
A) 21.7%
B) 21.00%
C) 50%
D) 58.2%

Accepted Answer

11eaa0b8_3b3f_9258_80dc_195d53613880_TB2249_00

Question 20

Assume that Zonk is a potential leveraged buyout candidate.Assume that the buyer intends to put in place a capital structure that has 70 percent debt with a pretax borrowing cost of 14 percent and 30 percent common equity.Compute the weighted average cost of capital for Zonk based on the new capital structure.
A) 8.85%
B) 12.56%
C) 13.01%
D) 9.94%

Accepted Answer

New WACC = [.70*.14*(1-.35)]+(.30*.0828)= 8.85%

Quiz 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach

Using the above information,calculate Zonk's weighted-average cost of capital:

Under the cash-flow-based valuation approach,free cash flows can be used instead of dividends as the expected future payoffs to the investor in the numerator of the general valuation model because:

Investors typically accept a lower risk-adjusted rate of return on debt capital than on equity capital because:

The historical discount rate of the firm may be a good indicator of the appropriate discount rate to apply to the firm in the future,when all of the following conditions hold true except:

Assume that Zonk is a potential leveraged buyout candidate.Assume that the buyer intends to put in place a capital structure that has 70 percent debt with a pretax borrowing cost of 14 percent and 30 percent common equity.Compute the revised equity beta for Zonk based on the new capital structure.

Equity-based valuation models are based on all metrics except:

With respect to dividends and priority in liquidation,what has priority over common stock?

Returns on systematic risk-free securities (like U.S.Treasury securities) should exhibit what type of correlation with returns on a diversified market wide portfolio of stocks?

Firm-specific factors that increase the firm's nondiversifiable risk include all of the following except:

Equity valuation models based on dividends,cash flows,and earnings have been the topic of many theoretical and empirical research studies in recent years.All of the following are true regarding these studies except:

All of the following are steps in the analysis and valuation framework used to understand the fundamentals of a business and determine estimates of its value except:

Zonk Corp. The following data pertains to Zonk Corp. ,a manufacturer of ball bearings (dollar amounts in millions) : -Determine the weight on equity capital that should be used to calculate Zonk's weighted-average cost of capital:

In theory,the value of a share of common equity is the present value of ____________________________________________________________.

When deriving the equity value of a firm,an analyst forecasts the real dividends expected to be paid in the future.In this case,which discount rate should be used?

Zonk Corp. The following data pertains to Zonk Corp. ,a manufacturer of ball bearings (dollar amounts in millions) : -Assuming that riskless rate is 4.6% and the market premium is 7.3%,calculate Zonk's cost of equity capital:

Which of the following is not a with using a dividend-based valuation formula?

One rationale for using expected dividends in valuation is:

Zonk Corp. The following data pertains to Zonk Corp. ,a manufacturer of ball bearings (dollar amounts in millions) : -Determine the weight on debt capital that should be used to calculate Zonk's weighted-average cost of capital: