FIN 534 Week 6 Questions And Answers( Complete Solution)

• Question 1 4 out of 4 points An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options? Answer Selected Answer: Covered Correct Answe ...

• Question 1 4 out of 4 points An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options? Answer Selected Answer: Covered Correct Answer: Covered • Question 2 4 out of 4 points Which of the following statements is most correct, holding other things constant, for XYZ Corporation's traded call options? Answer Selected Answer: The price of these call options is likely to rise if XYZ's stock price rises. Correct Answer: The price of these call options is likely to rise if XYZ's stock price rises. • Question 3 4 out of 4 points An option that gives the holder the right to sell a stock at a specified price at some future time is Answer Selected Answer: a put option. Correct Answer: a put option. • Question 4 4 out of 4 points Cazden Motors' stock is trading at $30 a share. Call options on the company's stock are also available, some with a strike price of $25 and some with a strike price of $35. Both options expire in three months. Which of the following best describes the value of these options? Answer Selected Answer: If Cazden's stock price rose by $5, the exercise value of the options with the $25 strike price would also increase by $5. Correct Answer: If Cazden's stock price rose by $5, the exercise value of the options with the $25 strike price would also increase by $5. • Question 5 4 out of 4 points The current price of a stock is $50, the annual risk-free rate is 6%, and a 1-year call option with a strike price of $55 sells for $7.20. What is the value of a put option, assuming the same strike price and expiration date as for the call option? Answer Selected Answer: $9.00 Correct Answer: $9.00 • Question 6 4 out of 4 points Braddock Construction Co.'s stock is trading at $20 a share. Call options that expire in three months with a strike price of $20 sell for $1.50. Which of the following will occur if the stock price increases 10%, to $22 a share? Answer Selected Answer: The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%. Correct Answer: The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%. • Question 7 4 out of 4 points Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the Answer Selected Answer: All of the above. Correct Answer: All of the above. • Question 8 4 out of 4 points Which of the following statements is CORRECT? Answer Selected Answer: If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit. Correct Answer: If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit. • Question 9 4 out of 4 points Which of the following statements is CORRECT? Answer Selected Answer: Call options generally sell at prices above their exercise value, but for an inthe-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be. Correct Answer: Call options generally sell at prices above their exercise value, but for an inthe-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be. • Question 10 4 out of 4 points Which of the following statements is CORRECT? Answer Selected Answer: The market value of an option depends in part on the option's time to maturity and also on the variability of the underlying stock's price. Correct Answer: The market value of an option depends in part on the option's time to maturity and also on the variability of the underlying stock's price. • Question 11 4 out of 4 points Suppose you believe that Florio Company's stock price is going to decline from its current level of $82.50 sometime during the next 5 months. For $5.10 you could buy a 5- month put option giving you the right to sell 1 share at a price of $85 per share. If you bought this option for $5.10 and Florio's stock price actually dropped to $60, what would your pre-tax net profit be? Answer Selected Answer: $19.90 Correct Answer: $19.90 • Question 12 4 out of 4 points Which of the following statements is CORRECT? Answer Selected Answer: If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit. Correct Answer: If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit. • Question 13 4 out of 4 points Which of the following statements is CORRECT? Answer Selected Answer: An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend. Correct Answer: An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend. • Question 14 4 out of 4 points Suppose you believe that Basso Inc.'s stock price is going to increase from its current level of $22.50 sometime during the next 5 months. For $3.10 you can buy a 5- month call option giving you the right to buy 1 share at a price of $25 per share. If you buy this option for $3.10 and Basso's stock price actually rises to $45, what would your pre-tax net profit be? Answer Selected Answer: $16.90 Correct Answer: $16.90 • Question 15 4 out of 4 points The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1- year call option on the stock, with an exercise price of $22, is available. Based on the binomial model, what is the option's value? (Hint: Use daily compounding.) Answer Selected Answer: $2.99 Correct Answer: $2.99 • Question 16 4 out of 4 points Which of the following statements is CORRECT? Answer Selected Answer: If a company's tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall. Correct Answer: If a company's tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall. • Question 17 4 out of 4 points With its current financial policies, Flagstaff Inc. will have to issue new common stock to fund its capital budget. Since new stock has a higher cost than reinvested earnings, Flagstaff would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock? Answer Selected Answer: Increase the percentage of debt in the target capital structure. Correct Answer: Increase the percentage of debt in the target capital structure. • Question 18 4 out of 4 points Which of the following statements is CORRECT? Answer Selected Answer: There is an "opportunity cost" associated with using reinvested earnings, hence they are not "free." Correct Answer: There is an "opportunity cost" associated with using reinvested earnings, hence they are not "free." • Question 19 4 out of 4 points You have been hired as a consultant by Feludi Inc.'s CFO, who wants you to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30. Based on the CAPM approach, what is the cost of common from reinvested earnings? Answer Selected Answer: 10.93% Correct Answer: 10.93% • Question 20 4 out of 4 points To help them estimate the company's cost of capital, Smithco has hired you as a consultant. You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% (constant). Based on the DCF approach, what is the cost of common from reinvested earnings? Answer Selected Answer: 12.94% Correct Answer: 12.94% • Question 21 4 out of 4 points Which of the following statements is CORRECT? Assume a company's target capital structure is 50% debt and 50% common equity. Answer Selected Answer: The cost of equity is always equal to or greater than the cost of debt. Correct Answer: The cost of equity is always equal to or greater than the cost of debt. • Question 22 4 out of 4 points Which of the following statements is CORRECT? Answer Selected Answer: If a company assigns the same cost of capital to all of its projects regardless of each project's risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject. Correct Answer: If a company assigns the same cost of capital to all of its projects regardless of each project's risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject. • Question 23 4 out of 4 points Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting? Answer Selected Answer: Accounts payable. Correct Answer: Accounts payable. • Question 24 4 out of 4 points Which of the following statements is CORRECT? Answer Selected Answer: When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation. Correct Answer: When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation. • Question 25 4 out of 4 points A company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock? Answer Selected Answer: 9.10% Correct Answer: 9.10% • Question 26 4 out of 4 points Burnham Brothers Inc. has no retained earnings since it has always paid out all of its earnings as dividends. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? Answer Selected Answer: The market risk premium declines. Correct Answer: The market risk premium declines. • Question 27 4 out of 4 points Suppose Acme Industries correctly estimates its WACC at a given point in time and then uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely Answer Selected Answer: become more risky and also have an increasing WACC. Its intrinsic value will not be maximized. Correct Answer: become more risky and also have an increasing WACC. Its intrinsic value will not be maximized. • Question 28 4 out of 4 points Which of the following statements is CORRECT? Answer Selected Answer: A firm's cost of reinvesting earnings is the rate of return stockholders require on a firm's common stock. Correct Answer: A firm's cost of reinvesting earnings is the rate of return stockholders require on a firm's common stock. • Question 29 4 out of 4 points Which of the following statements is CORRECT? Answer Selected Answer: If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline. Correct Answer: If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline. • Question 30 4 out of 4 points Adams Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05. What is the firm's cost of common from reinvested earnings based on the CAPM? Answer Selected Answer: 11.30% Correct Answer: 11.30%