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FIN 534 Week 6 Quiz 1. Which of the following statements is CORRECT? 2. Deeble Construction Co.’s 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? 3. Which of the following statements is CORRECT? 4. An option that gives the holder the right to sell a stock at a specified price at some future time is 5. GCC Corporation is planning to issue options to its key employees, and it is now discussing the terms to be set on those options. Which of the following actions would decrease the value of the options, other things held constant? 6. Which of the following statements is CORRECT? 7. Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the 8. Warner Motors’ 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? 9. Suppose you believe that Delva Corporation's stock price is going to decline from its current level of $82.50 sometime during the next 5 months. For $510.25 you could buy a 5-month put option giving you the right to sell 100 shares at a price of $85 per share. If you bought this option for $510.25 and Delva's stock price actually dropped to $60, what would your pre-tax net profit be? 10. Which of the following statements is CORRECT? 11. Call options on XYZ Corporation’s common stock trade in the market. Which of the following statements is most correct, holding other things constant? 12. An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options? 13. Suppose you believe that Johnson Company's stock price is going to increase from its current level of $22.50 sometime during the next 5 months. For $310.25 you can buy a 5-month call option giving you the right to buy 100 shares at a price of $25 per share. If you buy this option for $310.25 and Johnson's stock price actually rises to $45, what would your pretax net profit be? 14. 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 binominal model, what is the option's value? 15. Which of the following statements is CORRECT? 16. The MacMillen Company has equal amounts of low-risk, average-risk, and high-risk projects. The firm's overall WACC is 12%. The CFO believes that this is the correct WACC for the company’s average-risk projects, but that a lower rate should be used for lower-risk projects and a higher rate for higher-risk projects. The CEO disagrees, on the grounds that even though projects have different risks, the WACC used to evaluate each project should be the same because the company obtains capital for all projects from the same sources. If the CEO’s position is accepted, what is likely to happen over time? 17. Which of the following statements is CORRECT? 18. Which of the following statements is CORRECT? 19. Which of the following statements is CORRECT? 20. Which of the following statements is CORRECT? 21. Which of the following statements is CORRECT? 22. Which of the following statements is CORRECT? 23. For a company whose target capital structure calls for 50% debt and 50% common equity, which of the following statements is CORRECT? 24. Safeco Company and Risco Inc are identical in size and capital structure. However, the riskiness of their assets and cash flows are somewhat different, resulting in Safeco having a WACC of 10% and Risco a WACC of 12%. Safeco is considering Project X, which has an IRR of 10.5% and is of the same risk as a typical Safeco project. Risco is considering Project Y, which has an IRR of 11.5% and is of the same risk as a typical Risco project. Now assume that the two companies merge and form a new company, Safeco/Risco Inc. Moreover, the new company's market risk is an average of the pre-merger companies' market risks, and the merger has no impact on either the cash flows or the risks of Projects X and Y. Which of the following statements is CORRECT? 25. Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A’s cost of capital is 10.0%, Division B’s cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A’s projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept? 26. When working with the CAPM, which of the following factors can be determined with the most precision?
27. Firm M's earnings and stock price tend to move up and down with other firms in the S&P 500, while Firm W's earnings and stock price move counter cyclically with M and other S&P companies. Both M and W estimate their costs of equity using the CAPM, they have identical market values, their standard deviations of returns are identical, and they both finance only with common equity. Which of the following statements is CORRECT? 28. Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting? 29. Which of the following statements is CORRECT? 30. If a typical U.S. company 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