Exam
Name___________________________________
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
Use the information for the question(s) below.
You are evaluating a new project and need an estimate for your project’s beta. You have identified the following information
about three firms with comparable projects:
Firm
Name
Equity
Beta
Debt
Beta
Debt to
Equity Ratio
Lincoln 1.25 00.25
Blinkin 1.6 0.2 1
Nod 2.3 0.3 1.5
1)
The unlevered beta for Blinkin is closest to:
1)
A)
0.90
B)
1.00
C)
0.95
D)
1.10
2)
Which of the following is not one of Modigliani and Miller’s set of conditions referred to as perfect
capital markets?
2)
A)
All investors hold the efficient portfolio of assets.
B)
Investors and firms can trade the same set of securities at competitive market prices equal to
the present value of their future cash flows.
C)
There are no taxes, transaction costs, or issuance costs associated with security trading.
D)
A firm’s financing decisions do not change the cash flows generated by its investments, nor do
they reveal new information about them.
Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each
outcome being equally likely. The initial investment required for the project is $80,000, and the project’s cost of capital is
15%. The risk–free interest rate is 5%.
3)
Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free
rate, then the value of the firm‘s levered equity from the project is closest to:
3)
A)
$8,600
B)
$0
C)
$10,000
D)
$6,000
4)
Which of the following statements is false?
4)
A)
As long as the firm’s choice of securities does not change the cash flows generated by its
assets, the capital structure decision will not change the total value of the firm or the amount
of capital it can raise.
B)
If securities are fairly priced, then buying or selling securities has an NPV of zero and,
therefore, should not change the value of a firm.
C)
An investor who would like more leverage than the firm has chosen can lend and add
leverage to his or her own portfolio.
D)
The future repayments that the firm must make on its debt are equal in value to the amount
of the loan it receives up front.
Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each
outcome being equally likely. The initial investment required for the project is $80,000, and the project’s cost of capital is
15%. The risk–free interest rate is 5%.
5)
Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free
rate and issues new equity to cover the remainder. In this situation, the cost of capital for the firm’s
levered equity is closest to:
5)
A)
15%
B)
25%
C)
23%
D)
18%
6)
Which of the following statements is false?
6)
A)
The unlevered beta measures the market risk of the firm’s business activities, ignoring any
additional risk due to leverage.
B)
When a firm changes its capital structure without changing its investments, its levered beta
will remain unaltered, however, its asset beta will change to reflect the effect of the capital
structure change on its risk.
C)
If a firm holds $1 in cash and has $1 of risk–free debt, then the interest earned on the cash will
equal the interest paid on the debt. The cash flows from each source cancel each other, just as
if the firm held no cash and no debt.
D)
The unlevered beta measures the market risk of the firm without leverage, which is
equivalent to the beta of the firm’s assets.
Use the information for the question(s) below.
Assume that Rose Corporation’s (RC) EBIT is not expected to grow in the future and that all earnings are paid out as
dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million
over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC
is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of
$12.00.
7)
Prior to any borrowing and share repurchase, RC’s EPS is closest to:
7)
A)
$1.00
B)
$1.20
C)
$0.60
D)
$0.50
Use the information for the question(s) below.
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to
repurchase shares from its investors, and has already announced the stock repurchase plan. Currently Luther is an all equity
firm with 1.25 billion shares outstanding. Luther‘s shares are currently trading at $20 per share.
8)
After the repurchase how many shares will Luther have outstanding?
8)
A)
0.75 billion
B)
1.1 billion
C)
1.2 billion
D)
1.0 billion
D
B
Use the information for the question(s) below.
Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all–equity
firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12
million dollars in debt at an interest rate of 5%.
9)
Assume that MM’s perfect capital markets conditions are met and that you can borrow and lend at
the same 5% rate as with. You have $5000 of your own money to invest and you plan on buying
Without stock. Using homemade leverage you borrow enough in your margin account so that the
payoff of your margined purchase of Without stock will be the same as a $5000 investment in with
stock. The number of shares of Without stock you purchased is closest to:
9)
A)
825
B)
425
C)
1650
D)
2000
Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each
outcome being equally likely. The initial investment required for the project is $80,000, and the project’s cost of capital is
15%. The risk–free interest rate is 5%.
10)
Suppose that to raise the funds for the initial investment, the project is sold to investors as an
all–equity firm. The equity holders will receive the cash flows of the project in one year. The
market value of the unlevered equity for this project is closest to:
10)
A)
$94,100
B)
$86,250
C)
$90,000
D)
$98,600
Use the information for the question(s) below.
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to
repurchase shares from its investors, and has already announced the stock repurchase plan. Currently Luther is an all equity
firm with 1.25 billion shares outstanding. Luther‘s shares are currently trading at $20 per share.
11)
Assume that in addition to 1.25 billion common shares outstanding, Luther has stock options given
to employees valued at $2 billion. After the repurchase how many shares will Luther have
outstanding?
11)
A)
1.0 billion
B)
1.1 billion
C)
0.75 billion
D)
1.2 billion
Use the information for the question(s) below.
Assume that Rose Corporation’s (RC) EBIT is not expected to grow in the future and that all earnings are paid out as
dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million
over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC
is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of
$12.00.
12)
Prior to any borrowing and share repurchase, the equity cost of capital for RC is closest to:
12)
A)
10%
B)
9%
C)
12%
D)
10%
13)
Following the borrowing of $12 and subsequent share repurchase, the expected earnings per share
for RC is closest to:
13)
A)
$1.44
B)
$1.20
C)
$1.40
D)
$1.32
14)
Consider the following equation:
U=E
E+DE+D
E+DD
The term E
E+D in the equation is
14)
A)
the same as the beta of the firm‘s assets.
B)
the proportion of the firm financed with equity.
C)
equal to zero if the firm’s debt is riskless.
D)
the required return on the firm’s equity.
Use the information for the question(s) below.
Rockwood Enterprises is currently an all equity firm and has just announced plans to expand their current business. In order
to fund this expansion, Rockwood will need to raise $100 million in new capital. After the expansion, Rockwood is expected
to produce earnings before interest and taxes of $50 million per year in perpetuity. Rockwood has already announced the
planned expansion, but has not yet determined how best to fund the expansion. Rockwood currently has 16 million shares
outstanding and following the expansion announcement these shares are trading at $25 per share. Rockwood has the ability
to borrow at a rate of 5% or to issue new equity at $25 per share.
15)
If Rockwood finances their expansion by issuing new stock, what will Rockwood’s cost of equity
capital be?
15)
A)
15%
B)
12%
C)
8%
D)
10%
Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each
outcome being equally likely. The initial investment required for the project is $80,000, and the project’s cost of capital is
15%. The risk–free interest rate is 5%.
16)
Suppose that you borrow only $30,000 in financing the project. According to MM proposition II,
the firm’s equity cost of capital will be closest to:
16)
A)
21%
B)
25%
C)
20%
D)
15%
Use the information for the question(s) below.
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to
repurchase shares from its investors, and has already announced the stock repurchase plan. Currently Luther is an all equity
firm with 1.25 billion shares outstanding. Luther‘s shares are currently trading at $20 per share.
17)
Assume that in addition to 1.25 billion common shares outstanding, Luther has stock options given
to employees valued at $2 billion. The market value of Luther’s non–cash assets is closest to:
17)
A)
$25 billion
B)
$20 billion
C)
$18 billion
D)
$22 billion
18)
Equity in a firm with no debt is called
18)
A)
riskless equity.
B)
risky equity.
C)
levered equity.
D)
unlevered equity.
19)
Which of the following statements is false?
19)
A)
Holding cash has the opposite effect of leverage on risk and return.
B)
Since the WACC does not change with the use of leverage, the value of the firm’s free cash
flow evaluated using the WACC does not change, and so the enterprise value of the firm does
not depend on its financing choices.
C)
We use the market value of the firm‘ net debt when computing its WACC and unlevered beta
to measure the cost of capital and market risk of the firm’s business assets.
D)
Even if the firm’s capital structure is more complex, the WACC is calculated by computing
the weighted average cost of only the firm’s debt and equity.
Use the information for the question(s) below.
Luther Industries has no debt, a total equity capitalization of $20 billion, and a beta of 1.8. Included in Luther’s assets are $4
billion in cash and risk–free securities.
20)
What is Luther’s enterprise value?
20)
A)
$24 billion
B)
$16 billion
C)
$20 billion
D)
$10.5 billion
Use the information for the question(s) below.
Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all–equity
firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12
million dollars in debt at an interest rate of 5%.
21)
Assume that MM’s perfect capital markets conditions are met and that you can borrow and lend at
the same 5% rate as with. You have $5000 of your own money to invest and you plan on buying
Without stock. Using homemade leverage, how much do you need to borrow in your margin
account so that the payoff of your margined purchase of Without stock will be the same as a $5000
investment in With stock?
21)
A)
$10,000
B)
$0
C)
$5000
D)
$2,500
22)
Consider the following equation:
U=E
E+DE+D
E+DD
The term U in the equation is?
22)
A)
the proportion of the firm financed with equity.
B)
equal to zero if the firm’s debt is riskless.
C)
the same as the beta of the firm‘s assets.
D)
the required return on the firm’s equity.
Use the information for the question(s) below.
Assume that Rose Corporation’s (RC) EBIT is not expected to grow in the future and that all earnings are paid out as
dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million
over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC
is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of
$12.00.
23)
Following the borrowing of $12 and subsequent share repurchase, the value of a share for RC is
closest to:
23)
A)
$13.20
B)
$14.00
C)
$10.80
D)
$12.00
Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each
outcome being equally likely. The initial investment required for the project is $80,000, and the project’s cost of capital is
15%. The risk–free interest rate is 5%.
24)
Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free
rate, then the cost of capital for the firm’s levered equity is closest to:
24)
A)
45%
B)
95%
C)
25%
D)
15%
25)
Which of the following statements is false?
25)
A)
In general, as long as the firm sells the new shares of equity at a fair price, there will be no
gain or loss to shareholders associated with the equity issue itself.
B)
Because the firm’s earnings per share and price–earnings ratio are affected by leverage
implies that we can always reliably compare these measures across firms with different
capital structures.
C)
The money taken in by the firm as a result of the share issue exactly offsets the dilution of the
shares.
D)
Most analysts prefer to use performance measures and valuation multiples that are based on
the firm’s earnings before interest has been deducted.
Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each
outcome being equally likely. The initial investment required for the project is $80,000, and the project’s cost of capital is
15%. The risk–free interest rate is 5%.
26)
Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free
rate, then the cash flow that equity holders will receive in one year in a strong economy is closest to:
26)
A)
$0
B)
$10,000
C)
$33,000
D)
$6,000
Use the information for the question(s) below.
Luther Industries has no debt, a total equity capitalization of $20 billion, and a beta of 1.8. Included in Luther’s assets are $4
billion in cash and risk–free securities.
27)
Considering the fact that Luther’s Cash is risk–free,Luther’s unlevered beta is closest to:
27)
A)
1.50
B)
1.90
C)
1.45
D)
2.25
28)
Which of the following statements is false?
28)
A)
Although debt has a lower cost of capital than equity, leverage does not lower a firm’s
WACC.
B)
As the firm borrows at the low cost of capital for debt, its equity cost of capital rises, but the
net effect is that the firm’s WACC is unchanged.
C)
With no debt, the WACC is equal to the unlevered equity cost of capital.
D)
With perfect capital markets, a firm’s WACC is dependent of its capital structure and is equal
to its equity cost of capital only the firm it is unlevered.
29)
Which of the following statements is false?
29)
A)
The value of the firm is determined by the present value of the cash flows from its current and
future investments.
B)
The investor can re–create the payoffs of unlevered equity by borrowing and using the
proceeds to purchase the equity of the firm.
C)
As long as investors can borrow or lend at the same interest rate as the firm, homemade
leverage is a perfect substitute for the use of leverage by the firm.
D)
When investors use leverage in their own portfolios to adjust the leverage choice made by the
firm, we say that they are using homemade leverage.
Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each
outcome being equally likely. The initial investment required for the project is $80,000, and the project’s cost of capital is
15%. The risk–free interest rate is 5%.
30)
Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free
rate and issues new equity to cover the remainder. In this situation, the cash flow that equity
holders will receive in one year in a strong economy is closest to:
30)
A)
$75,000
B)
$117,000
C)
$0
D)
$50,000
31)
Consider the following equation:
U=E
E+DE+D
E+DD
The term D in the equation is?
31)
A)
the proportion of the firm financed with equity.
B)
equal to zero if the firm’s debt is riskless.
C)
the required return on the firm’s equity.
D)
the same as the beta of the firm‘s assets.
The investor can re–create the payoffs of levered equity by borrowing and using
32)
Which of the following statements is false?
32)
A)
It is inappropriate to discount the cash flows of levered equity at the same discount rate that
we use for unlevered equity.
B)
Because the cash flows of the debt and equity sum to the cash flows of the project, by the Law
of One Price the combined values of debt and equity must be equal to the cash flows of the
project.
C)
Franco Modigliani and Merton Miller argued that with perfect capital markets, the total value
of a firm should not depend on its capital structure.
D)
Leverage decreases the risk of the equity of a firm.
Use the information for the question(s) below.
Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all–equity
firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12
million dollars in debt at an interest rate of 5%.
33)
Assume that MM’s perfect capital markets conditions are met and that you can borrow and lend at
the same 5% rate as with. You have $5000 of your own money to invest and you plan on buying
With stock. Using homemade (un)leverage, how much do you need to invest at the risk–free rate
so that the payoff of your account will be the same as a $5000 investment in Without stock?
33)
A)
$4,000
B)
$2,500
C)
$0
D)
$5000
34)
Consider the following equation:
E+ D =U=A
The A in this equation represents
34)
A)
the value of the firm’s debt.
B)
the value of the firm’s equity.
C)
the market value of the firm’s assets.
D)
the value of the firm’s unlevered equity.
35)
Which of the following statements is false?
35)
A)
When a firm issues new shares that account for a significant percentage of its outstanding
shares, the transaction is called a leveraged recapitalization.
B)
Holding fixed the cash flows generated by the firm’s assets, however, the choice of capital
structure does not change the value of the firm.
C)
MM Proposition I applies to capital structure decisions made at any time during the life of the
firm.
D)
By choosing positive–NPV projects that are worth more than their initial investment, the firm
can enhance its value.
Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each
outcome being equally likely. The initial investment required for the project is $80,000, and the project’s cost of capital is
15%. The risk–free interest rate is 5%.
36)
Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free
rate and issues new equity to cover the remainder. In this situation, the cash flow that equity
holders will receive in one year in a weak economy is closest to:
36)
A)
$50,000
B)
$90,000
C)
$0
D)
$48,000
Use the information for the question(s) below.
Assume that Rose Corporation’s (RC) EBIT is not expected to grow in the future and that all earnings are paid out as
dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million
over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC
is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of
$12.00.
37)
Following the borrowing of $12 and subsequent share repurchase, the number of shares that RC
will have outstanding is closest to:
37)
A)
4.0 million
B)
4.5 .million
C)
6.0 million
D)
4.9 million
Use the information for the question(s) below.
You are evaluating a new project and need an estimate for your project’s beta. You have identified the following information
about three firms with comparable projects:
Firm
Name
Equity
Beta
Debt
Beta
Debt to
Equity Ratio
Lincoln 1.25 00.25
Blinkin 1.6 0.2 1
Nod 2.3 0.3 1.5
38)
The unlevered beta for Lincoln is closest to:
38)
A)
1.05
B)
1.00
C)
0.90
D)
0.95
Use the information for the question(s) below.
Assume that Rose Corporation’s (RC) EBIT is not expected to grow in the future and that all earnings are paid out as
dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million
over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC
is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of
$12.00.
39)
Following the borrowing of $12 and subsequent share repurchase, the equity cost of capital for RC
is closest to:
39)
A)
9%
B)
12%
C)
11.0%
D)
10%
Use the information for the question(s) below.
Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all–equity
firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12
million dollars in debt at an interest rate of 5%.
40)
According to MM Proposition 1, the stock price for With is closest to:
40)
A)
$24.00
B)
$12.00
C)
$8.00
D)
$6.00
D
C
41)
Equity in a firm with debt is called
41)
A)
risky equity.
B)
riskless equity.
C)
unlevered equity.
D)
levered equity.
42)
Which of the following statements is false?
42)
A)
When evaluating any potential investment project, we must use a discount rate that is
appropriate given the risk of the project’s free cash flow.
B)
We can calculate the cost of capital of the firm’s assets by computing the weighted average of
the firm’s equity and debt cost of capital, which we refer to as the firm’s weighted average
cost of capital (WACC).
C)
The portfolio of a firm’s equity and debt replicates the returns we would earn if the firm were
unlevered.
D)
If we can identify a comparison firm whose assets have the same risk as the project being
evaluated, and if the comparison firm is levered, then we can use its equity cost of capital as
the cost of capital for the project.
Use the information for the question(s) below.
Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to
repurchase shares from its investors, and has already announced the stock repurchase plan. Currently Luther is an all equity
firm with 1.25 billion shares outstanding. Luther‘s shares are currently trading at $20 per share.
43)
With perfect capital markets, what is the market value of Luther’s equity after the share
repurchase?
43)
A)
$15 billion
B)
$25 billion
C)
$10 billion
D)
$20 billion
Use the information for the question(s) below.
Rockwood Enterprises is currently an all equity firm and has just announced plans to expand their current business. In order
to fund this expansion, Rockwood will need to raise $100 million in new capital. After the expansion, Rockwood is expected
to produce earnings before interest and taxes of $50 million per year in perpetuity. Rockwood has already announced the
planned expansion, but has not yet determined how best to fund the expansion. Rockwood currently has 16 million shares
outstanding and following the expansion announcement these shares are trading at $25 per share. Rockwood has the ability
to borrow at a rate of 5% or to issue new equity at $25 per share.
44)
If Rockwood finances their expansion by issuing $100 million in debt at 5%, what will Rockwood’s
cost of equity capital be?
44)
A)
12.50%
B)
10.70%
C)
12.00%
D)
11.25%
45)
Which of the following equations would not be appropriate to use in a firm with risky debt?
45)
A)
U=E
E+DE+D
E+DD
B)
U=E+D
E(U–D)
C)
E=U+D
E(U–D)
D)
E=U+D
EU