For a price of $100, Carol will sell you a 5 year bond paying semi-annual coupons of 16% pa. The face value of the bond is $100. Other bonds with similar risk, maturity and coupon characteristics trade at a yield of 12% pa.

Diversification is achieved by investing in a large amount of stocks. What type of risk is reduced by diversification?

A project's NPV is positive. Select the most correct statement:

A mature firm has constant expected future earnings and dividends. Both amounts are equal. So earnings and dividends are expected to be equal and unchanging.

Which of the following statements is **NOT** correct?

**Question 416** real estate, market efficiency, income and capital returns, DDM, CAPM

A residential real estate investor believes that house prices will grow at a rate of **5**% pa and that rents will grow by **2**% pa forever.

All rates are given as nominal effective annual returns. Assume that:

- His forecast is true.
- Real estate is and always will be fairly priced and the capital asset pricing model (CAPM) is true.
- Ignore all costs such as taxes, agent fees, maintenance and so on.
- All rental income cash flow is paid out to the owner, so there is no re-investment and therefore no additions or improvements made to the property.
- The non-monetary benefits of owning real estate and renting remain constant.

Which one of the following statements is **NOT** correct? Over time:

**Question 419** capital budgeting, NPV, interest tax shield, WACC, CFFA, CAPM, no explanation

Project Data | ||

Project life | 1 year | |

Initial investment in equipment | $6m | |

Depreciation of equipment per year | $6m | |

Expected sale price of equipment at end of project | 0 | |

Unit sales per year | 9m | |

Sale price per unit | $8 | |

Variable cost per unit | $6 | |

Fixed costs per year, paid at the end of each year | $1m | |

Interest expense in first year (at t=1) | $0.53m | |

Tax rate | 30% | |

Government treasury bond yield | 5% | |

Bank loan debt yield | 6% | |

Market portfolio return | 10% | |

Covariance of levered equity returns with market | 0.08 | |

Variance of market portfolio returns | 0.16 | |

Firm's and project's debt-to-assets ratio |
50% | |

**Notes**

- Due to the project, current assets will increase by $
**5**m now (t=0) and fall by $**5**m at the end (t=1). Current liabilities will not be affected.

**Assumptions**

- The debt-to-assets ratio will be kept constant throughout the life of the project. The amount of interest expense at the end of each period has been correctly calculated to maintain this constant debt-to-equity ratio.
- Millions are represented by 'm'.
- All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
- All rates and cash flows are real. The inflation rate is 2% pa.
- All rates are given as effective annual rates.
- The 50% capital gains tax discount is not available since the project is undertaken by a firm, not an individual.

What is the net present value (NPV) of the project?

A firm is considering a business project which costs $**10**m now and is expected to pay a single cash flow of $**12.1**m in two years.

Assume that the initial $**10**m cost is funded using the firm's **existing cash** so no new equity or debt will be raised. The cost of capital is **10**% pa.

Which of the following statements about net present value (NPV), internal rate of return (IRR) and payback period is **NOT** correct?

A firm has a debt-to-equity ratio of 25%. What is its debt-to-assets ratio?

Which of the following statements about the Basel 3 minimum capital requirements is **NOT** correct? Common equity tier 1 (CET1) comprises the highest quality components of capital that fully satisfy all of the following characteristics: