Question

1-If the fair value of a stock is greater than its market value, it means that: A. The stock has a low level of risk B. The stock offers a high dividend C. The market is undervaluing the stock. D. The market is overvaluing the stock

2-A profitability index of .85 for a project means that: A-The present value of benefits is 85% greater than the project's costs. B. The project's NPV is greater than zero. C. The project returns 85 cents in present value for each current dollar invested. D. The payback period is less than one year.

3-if the PI of a project is less than 1, its NPV should be less than 0. A. True B. False

4-In calculating the costs of sources of fund, the tax rate is important to which of the following source of fund? A. Common shares B. Retained earnings C. Bonds D. Preferred shares

5-The diversification effect on the portfolio is greatest when the correlation between assets is lowest. A. True B. False

6-Bonds are considered a riskier investment than common stock for investors. A. True B. False

7-Investors generally do not require a higher rate of return on bonds. A. True B. False

Answer 1

1. C

Exp - If Market Value < Fair Value then the stock is underpriced

2. C

Profitability Index = PV of Future cash flows/ Initial Outlay

If PI = 0.85, PV of Future cash flows = 0.85 * (Initial Outlay)

3. A

If PI < 1; Initial outlay > PV of future cash flows

NPV = PV of future cash flows - Initial Outlay < 0

4. C

Cost of debt = Kd * Wd * (1-t)

Only cost of debt has tax rate as an input for computation as debt is tax deductible

5. A

If the stocks have high correlation it means that their prices move similarly in the market reducing the effect of diversification.

6. B

Bonds are fixed income securities with a fixed rate of return and the interest payments from bonds are obligations to the borrower. Therefore they are less riskier

7. A

Yes, compared to Preferred stocks and common equity investors require less rate of return on bonds as they are less risky.