Nielson Motors (NM) has no debt. Its assets will be worth $600 million in one year if
the economy is strong, but only $300 million if the economy is weak. Both events are
equally likely. The market value today of Nielson’s assets is $400 million.Suppose the
risk-free interest rate is 4%. If Nielson borrows $150 million today at this rate and uses
the proceeds to pay an immediate cash dividend, then according to MM, the market
value of its equity just after the dividend is paid would be closest to:
A) $0 million
B) $150 million
C) $250 million
D) $400 million
Suppose the current zero-coupon yield curve for risk-free bonds is as follows:
The price per $100 face value of a three-year, zero-coupon, risk-free bond is closest to:
A) $93.80
B) $90.06
C) $89.16
D) $86.39
You are offered an investment opportunity in which you will receive $23,750 today in
exchange for paying $25,000 in one year. Suppose the risk-free interest rate is 6% per
year. Should you take this project? The NPV for this project is closest to:
A) Yes; NPV = $165
B) No; NPV = $165
C) Yes; NPV = -$165
D) No; NPV = -$165
Which of the following statements is FALSE?
A) Leverage can reduce the degree of managerial entrenchment because managers are
more likely to be fired when a firm faces financial distress.
B) When a firm is highly levered, creditors themselves will closely monitor the actions
of managers, providing an additional layer of management oversight.
C) According to the empire building hypothesis, leverage increases firm value because
it commits the firm to making future interest payments, thereby reducing excess cash
flows and wasteful investment by managers.
D) Managers of large firms tend to earn higher salaries, and they may also have more
prestige and garner greater publicity than managers of small firms. As a result,
managers may expand (or fail to shut down) unprofitable divisions, pay too much for
acquisitions, make unnecessary capital expenditures, or hire unnecessary employees.
The Sisyphean Company has a bond outstanding with a face value of $1000 that
reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate
for this bond is 8% and that the coupon payments are to be made semiannually.
Assuming the appropriate YTM on the Sisyphean bond is 7.5%, then this bond will
trade at
A) par.
B) a discount.
C) a premium.
D) None of the above
Consider the following equation:
Pcum– Pex= Div ×
The term Ï„g is:
A) the personal tax rate for dividend.
B) the personal tax rate for capital gains.
C) the price per share before a dividend is paid.
D) the price per share after a dividend is paid.
Which of the following statements is FALSE?
A) If some security were not part of the efficient portfolio, then every investor would
want to own it, and demand for this security would increase causing its expected return
to fall until it is no longer an attractive investment.
B) The efficient portfolio, the portfolio that all investors should hold, must be the same
portfolio as the market portfolio of all risky securities.
C) Because every security is owned by someone, the sum of all investors’ portfolios
must equal the portfolio of all risky securities available in the market.
D) If all investors demand the efficient portfolio, and since the supply of securities is
the market portfolio, then two portfolios must coincide.
Ford Motor Company is considering launching a new line of Plug-in Electric SUVs.
The heavy advertising expenses associated with the new SUV launch would generate
operating losses of $35 million next year. Without the new SUV, Ford expects to earn
pre-tax income of $80 million from operations next year. Ford pays a 30% tax rate on
its pre-tax income.
The amount that Ford Motor Company owe in taxes next year without the launch of the
new SUV is closest to:
A) $24.0 million
B) $56.0 million
C) $31.5 million
D) $13.5 million
At an annual interest rate of 7%, the present value of $5,000 received in five years is
closest to:
A) $3,565
B) $6,750
C) $7,015
D) $7,035
A project you are considering is expected to provide benefits worth $225,000 in one
year. If the risk-free rate of interest (rf) is 8%, then the value of the benefits of this
project today are closest to:
A) $190,333
B) $208,333
C) $225,000
D) $243,000
Suppose that the risk-free rate is 5% and the market portfolio has an expected return of
13% with a volatility of 18%. Monsters Inc. has a 24% volatility and a correlation with
the market of .60, while California Gold Mining has a 32% volatility and a correlation
with the market of -.7. Assume the CAPM assumptions hold.Suppose that California
Gold Mining’s expected return is 2%. Then California Gold Mining’s alpha is closest to:
A) -3%
B) -13%
C) 7%
D) -11%
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in
taxes. Assume that Google’s marginal tax rate is 35% and Google’s borrowing cost is
7%.
Assume that investors in Google pay a 15% tax rate on income from equity and a 35%
tax rate on interest income. If Google were to issue sufficient debt to reduce its taxes by
$1 billion per year permanently, then the effective tax advantage of this debt would be
closest to:
A) 10%
B) 15%
C) 25%
D) 30%
The idea that claims in one’s self-interest are credible only if they are supported by
actions that would be too costly to take if the claims were untrue is known as the:
A) pecking order hypothesis.
B) credibility principle.
C) lemons principle.
D) signaling theory of debt.
Suppose all possible investment opportunities in the world are limited to the four stocks
list in the table below:
The weight on Wyatt Oil stock in the market portfolio is closest to:
A) 15%
B) 20%
C) 25%
D) 30%
Two years ago the Krusty Krab Restaurant purchased a grill for $50,000. The owner,
Eugene Krabs, has learned that a new grill is available that will cook Krabby Patties
twice as fast as the existing grill. This new grill can be purchased for $80,000 and
would be depreciated straight line over 8 years, after which it would have no salvage
value. Eugene Krab expects that the new grill will produce EBITDA of $50,000 per
year for the next eight years while the existing grill produces EBITDA of only $35,000
per year. The current grill is being depreciated straight line over its useful life of 10
years after which it will have no salvage value. All other operating expenses are
identical for both grills. The existing grill can be sold to another restaurant now for
$30,000. The Krusty Krab’s tax rate is 35%.The incremental after tax cash flow that the
Krusty Krab will receive from selling the existing grill is closest to:
A) 19,500
B) 30,000
C) 33,500
D) 50,000
Which of the following equations is INCORRECT?
A) P0=
B) V0= + + … + +
C) Free Cash Flow = EBIT × (1 – Ï„c) + Depreciation – Capital Expenditures – DNWC
D) Enterprise Value = Market Value of Equity + Debt – Cash
Wyatt Oil is considering an investment in a new project with an unlevered cost of
capital of 11%. Wyatt’s marginal corporate tax rate is 35% and its debt cost of capital is
6%. The project has free cash flows of $25 million per year which are expected to
decline by 3% per year.
If Wyatt adjusts its debt continuously to maintain a constant debt-equity ratio of 50%,
then the value of this new project is closest to:
A) $188 million
B) $188.5 million
C) $320 million
D) $340 million
The Sisyphean Company has a bond outstanding with a face value of $1000 that
reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate
for this bond is 8% and that the coupon payments are to be made semiannually.
Assuming that this bond trades for $903, then the YTM for this bond is closest to:
A) 8.0%
B) 6.8%
C) 9.9%
D) 9.2%
Which of the following statements is FALSE?
A) Zero-coupon bonds are also called pure discount bonds.
B) The IRR of an investment opportunity is the discount rate at which the NPV of the
investment opportunity is equal to zero.
C) The yield to maturity for a zero-coupon bond is the return you will earn as an
investor from holding the bond to maturity and receiving the promised face value
payment.
D) When prices are quoted in the bond market, they are conventionally quoted in
increments of $1000.
The unlevered cost of capital for “Eenie” is closest to:
A) 6.0%
B) 5.5%
C) 7.5%
D) 6.5%
Suppose the term structure of interest rates is shown below:
The present value of receiving $1000 per year with certainty at the end of the next three
years is closest to:
A) $2,737
B) $2,723
C) $2,733
D) $2,744
Suppose the current zero-coupon yield curve for risk-free bonds is as follows:
The price per $100 face value of a four-year, zero-coupon, risk-free bond is closest to:
A) $90.06
B) $89.16
C) $86.39
D) $84.66