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. If the risk-free interest rate is 3% per year and the perfectly-diversified-market-portfolio
pays an expected return of 5% per year, then a stock with a beta equal to 1.5 should pay
an expected return of:
a.
b.
c.
d.
e.
7.5%
4.5%
6%
6.5%
3.5%
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