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Cost of Capital based on CAPM – Multiple Choice questions

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1. The risk-free rate, rRF, is 6%. The overall stock market has an expected return of 12%. Hazlett, Inc. has a beta of 1.2. What is the required return of Hazlett, Inc. stock?

  1. 12.0%
  2. 12.2%
  3. 12.8%
  4. 13.2%
  5. 13.5%

2. A stock has a required return of 12.25%. The beta of the stock is 1.15 and the risk-free rate is 5%. What is the market risk premium?

  1. 1.30%
  2. 6.50%
  3. 15.00%
  4. 6.30%
  5. 7.25%

3. Partridge Plastic's stock has an estimated beta of 1.4, and its required return is 13%. Cleaver Motors' stock has a beta of 0.8, and the risk-free rate is 6%. What is the required return on Cleaver Motors' stock?

  1. 7.0%
  2. 10.4%
  3. 12.0%
  4. 11.0%
  5. 10.0%

4. Hahn Manufacturing is expected to pay a dividend of $1.00 per share at the end of the year (D1 = $1.00). The stock sells for $40 per share, and its required rate of return is 11%. The dividend is expected to grow at a constant rate, g, forever. What is Hahn's expected growth rate?

  1. 8.00%
  2. 8.50%
  3. 9.00%
  4. 9.50%
  5. 10.00%

5. The Ehrhardt Company's last dividend was $2.00. The dividend growth rate is expected to be constant at 3% for 2 years, after which dividends are expected to grow at a rate of 8% forever. Erhardt's required return (rs) is 12%. What is Erhardt's current stock price?

  1. $49.20
  2. $51.40
  3. $53.80
  4. $55.10
  5. $57.30

6. If a stock's expected return exceeds its required return, this suggests that

  1. The stock is experiencing supernormal growth.
  2. The stock should be sold.
  3. The company is probably not trying to maximize price per share.
  4. The stock is probably a good buy.
  5. Dividends are not being declared.

7. If a stock's dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT?

  1. The expected return on the stock is 5% a year.
  2. The stock's dividend yield is 5%.
  3. The stock's price one year from now is expected to be 5% higher.
  4. The stock's required return must be equal to or less than 5%.
  5. The price of the stock is expected to decline in the future.

8. Which of the following statements is CORRECT?

  1. If a company has two classes of common stock, Class A and Class B, the stocks may pay different dividends, but the two classes must have the same voting rights.
  2. An IPO occurs whenever a company buys back its stock on the open market.
  3. The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of common stock.
  4. The stock valuation model, P0 = D1/ (rs g), cannot be used for firms that have negative growth rates.
  5. The stock valuation model, P0 = D1/ (rs g), can be used only for firms whose growth rates exceed their required return.

9. Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT?

  1. All common stocks fall into one of three classes: A, B, and C.
  2. All firms have several classes of common stock.
  3. All common stocks, regardless of class, must have the same voting rights.
  4. All common stock, regardless of class, must pay the same dividend.
  5. Some class or classes of common stock may be entitled to more votes per share than other classes.

10. A stock is not expected to pay a dividend over the next four years. Five years from now, the company anticipates that it will establish a dividend of $1.00 per share (i.e., D5 = $1.00). Once the dividend is established, the market expects that the dividend will grow at a constant rate of 5% per year forever. The risk-free rate is 5%, the company's beta is 1.2, and the market risk premium is 5%. The required rate of return on the company's stock is expected to remain constant. What is the current stock price?

  1. $ 7.36
  2. $ 8.62
  3. $ 9.89
  4. $10.98
  5. $11.53

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