If the risk-free rate is 5% and the expected return of investing in Merck is 11.3%, then
the expected return on the market must be:
A) 8.0%
B) 10.0%
C) 10.4%
D) 12.0%
Nielson Motors has a share price of $50.00. Its dividend was $2.50, and you expect
Nielson Motors to raise its dividend by approximately 6% per year in perpetuity.
Given Nielson’s current share price, if Nielson’s equity cost of capital is 13%, then
Nielson’s expected growth rate is closest to:
A) 5%
B) 6%
C) 7%
D) 8%
Consider an ETF that is made up of one share each of IBM, MRK, and C. The
minimum bid price for this ETF in a normal market is closest to:
A) $162.85
B) $163.00
C) $168.00
D) $168.10
Using just the return data for 2008, your estimate of Wyatt Oil’s Beta is closest to:
A) 0.85
B) 0.87
C) 1.00
D) 1.17
Which of the following statements is FALSE?
A) The imperfections in the CAPM may be critical in the context of capital budgeting
and corporate finance, where errors in estimating the cost of capital are likely to be far
more important than small discrepancies in the project cash flows.
B) To estimate the expected market risk premium we can look at the historical average
excess return of the market over the risk free interest rate.
C) The highest beta stocks have tended to under perform what the CAPM predicts.
D) Given an assessment of an index’s future cash flows, we can estimate the expected
return of the market by solving for the discount rate that is consistent with the current
level of the index.
Which of the following statements is FALSE?
A) Unlike with capital structure, taxes are not an important market imperfection that
influence a firm’s decision to pay dividends or repurchase shares.
B) If dividends are taxed at a higher rate than capital gains, which has been true until
the most recent change to the tax code, shareholders will prefer share repurchases to
dividends.
C) Shareholders typically must pay taxes on the dividends they receive. They must also
pay capital gains taxes when they sell their shares.
D) But because long-term investors can defer the capital gains tax until they sell, there
is still a tax advantage for share repurchases over dividends.
Tom’s portfolio consists solely of an investment in Merck stock. Merck has an expected
return of 13% and a volatility of 25%. The market portfolio has an expected return of
12% and a volatility of 18%. The risk-free rate is 4%. Assume that the CAPM
assumptions hold in the market.Assuming that Tom wants to maintain the current
volatility of his portfolio, then the maximum expected return that Tom could achieve by
investing in the market portfolio and risk-free investment is closest to:
A) 13%
B) 15%
C) 16%
D) 12%
Suppose that the market portfolio is equally likely to increase by 24% or decrease by
8%. Security “X” goes up on average by 29% when the market goes up and goes down
by 11% when the market goes down. Security “Y” goes down on average by 16% when
the market goes up and goes up by 16% when the market goes down. Security “Z” goes
up on average by 4% when the market goes up and goes up by 4% when the market
goes down.
The expected return on security with a beta of 0 is closest to:
A) -4.0%
B) 0.0%
C) 3.2%
D) 4.0%
Consider the following information regarding corporate bonds:
Wyatt Oil has a bond issue outstanding with seven years to maturity, a yield to maturity
of 7.0%, and a BBB rating. The corresponding risk-free rate is 3% and the market risk
premium is 5%. Assuming a normal economy, the expected return on Wyatt Oil’s debt is
closest to:
A) 3.0%
B) 3.5%
C) 4.9%
D) 5.5%
Nielson Motors is currently an all equity financed firm. It expects to generate EBIT of
$20 million over the next year. Currently Nielson has 8 million shares outstanding and
its stock is trading at $20.00 per share. Nielson is considering changing its capital
structure by borrowing $50 million at an interest rate of 8% and using the proceeds to
repurchase shares. Assume perfect capital markets.
Nielson’s EPS if they change their capital structure is closest to:
A) $2.00
B) $2.30
C) $2.50
D) $2.90
The effective annual rate (EAR) for a loan with a stated APR of 10% compounded
quarterly is closest to:
A) 9.65%
B) 10.00%
C) 10.38%
D) 12.50%
Tom’s portfolio consists solely of an investment in Merck stock. Merck has an expected
return of 13% and a volatility of 25%. The market portfolio has an expected return of
12% and a volatility of 18%. The risk-free rate is 4%. Assume that the CAPM
assumptions hold in the market.Assuming that Tom wants to maintain the current
expected return on his portfolio, then the amount that Tom should invest in the market
portfolio to minimize his volatility is closest to:
A) 100%
B) 90%
C) 125%
D) 110%
Suppose that Texas Trucking (TT) has earnings per share of $3.45 and EBITDA of $45
million. TT also has 5 million shares outstanding and debt o $150 million (net of cash).
You believe that Oklahoma Logistics and Transport (OLT) is comparable to TT in terms
of its underlying business, but OLT has no debt. OLT has a P/E of 12.5 and an
enterprise value to EBITDA multiple of 7.
Based upon the price earnings multiple, the value of a share of Texas Trucking is closest
to:
A) $49.30
B) $43.10
C) $24.15
D) $27.60
Which of the following statements is FALSE?
A) The variance increases with the magnitude of the deviations from the mean.
B) The variance is the expected squared deviation from the mean.
C) Two common measures of the risk of a probability distribution are its variance and
standard deviation.
D) If the return is riskless and never deviates from its mean, the variance is equal to
one.
Monsters Incorporated (MI) in ready to launch a new product. Depending upon the
success of this product, MI will have a value of either $100 million, $150 million, or
$191 million, with each outcome being equally likely. The cash flows are unrelated to
the state of the economy (i.e. risk from the project is diversifiable) so that the project
has a beta of 0 and a cost of capital equal to the risk-free rate, which is currently 5%.
Assume that the capital markets are perfect.
Assume that in the event of default, 20% of the value of MI’s assets will be lost in
bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face
value due next year. The initial value of MI’s debt is closest to:
A) $110 million
B) $105 million
C) $125 million
D) $111 million
Suppose that Rose Industries is considering the acquisition of another firm in its
industry for $100 million. The acquisition is expected to increase Rose’s free cash flow
by $5 million the first year, and this contribution is expected to grow at a rate of 3%
every year there after. Rose currently maintains a debt to equity ratio of 1, its marginal
tax rate is 40%, its cost of debt rD is 6%, and its cost of equity rE is 10%. Rose
Industries will maintain a constant debt-equity ratio for the acquisition.
Given that Rose issues new debt of $50 million initially to fund the acquisition, the total
value of this acquisition using the APV method is closest to:
A) $100 million
B) $120 million
C) $124 million
D) $115 million