Consider a four-year, default-free bond with an annual coupon rate of 4.5% and a face
value of $1000. The YTM on this bond is closest to:
A) 3.85%
B) 4.20%
C) 4.35%
D) 4.40%
Consider the following expected returns, volatilities, and correlations:
The volatility of a portfolio that is equally invested in Duke Energy and Microsoft is
closest to:
A) 8%
B) 9%
C) 11%
D) 6%
The idea that managers who perceive the firm’s equity is under-priced will have a
preference to fund investment using retained earnings, or debt, rather than equity is
known as the:
A) signaling theory of debt.
B) lemons principle.
C) pecking order hypothesis.
D) credibility principle.
Consider the following equation:
Pcum– Pex= Div ×
The term Ï„d is:
A) the price per share after a dividend is paid.
B) the price per share before a dividend is paid.
C) the personal tax rate for capital gains.
D) the personal tax rate for dividend.
Assume that the risk-free rate of interest is 3% and you estimate the market’s expected
return to be 9%.
Which firm has the least market risk?
A) Eenie
B) Meenie
C) Miney
D) Moe
Consider the following equation:
Dt = d ×
the term d in this equation is:
A) the firms target debt to value ratio.
B) the dollar amount of debt outstanding at time t.
C) the firms target debt to equity ratio.
D) the investment’s debt capacity.
Which of the following equations is INCORRECT?
A) E[RxCML] = rf+ x(E[RMkt] + rf)
B) ri= rf+ b(E[RMkt] – rf)
C) SD(RxCML) = xSD(RMkt)
D) E[RxCML] = (1 – x)rf+ xE[RMkt]
Off-balance sheet transactions are required to be disclosed:
A) in the management discussion and analysis.
B) in the auditor’s report.
C) in the Securities and Exchange Commission’s commentary.
D) in the statement of stockholders’ equity.
Kampgrounds Inc. is considering purchasing a parcel of wilderness land near a popular
historic site. Although this land will cost Kampgrounds $400,000 today, by renting out
wilderness campsites on this land, Kampgrounds expects to make $35,000 at the end of
every year indefinitely. If the appropriate discount rate is 8%, then the NPV of this new
wilderness campsite is closest to:
A) -$50,000
B) -$37,500
C) $37,500
D) $50,000
The volatility of the market portfolio is 10%, the expected return on the market is 12%,
and the risk-free rate of interest is 4%.
The Sharpe Ratio for the market portfolio is closest to:
A) 0.40
B) 0.48
C) 0.56
D) 0.80
Which of the following statements is FALSE?
A) The bond’s expected return, which is equal to the firm’s debt cost of capital, is less
than the yield to maturity if there is a risk of default.
B) The two best-known bond-rating companies are Standard & Poor’s and Dow Jones.
C) Bonds in the bottom five categories are often call speculative bonds, junk bonds, or
high-yield bonds.
D) Bond ratings encourage widespread investor participation and relatively liquid
markets.
The credit spread on B-rated corporate bonds is:
A) 1.0%
B) 1.5%
C) 2.6%
D) 4.1%
Which of the following statements regarding growing perpetuities is FALSE?
A) We assume that r < g for a growing perpetuity.
B) PV of a growing perpetuity =
C) To find the value of a growing perpetuity one cash flow at a time would take forever.
D) A growing perpetuity is a cash flow stream that occurs at regular intervals and grows
at a constant rate forever.
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax
rates shown are for financial assets held for one year. For assets held less than one year,
capital gains are taxed at the ordinary income tax rate (currently 35% for the highest
bracket); the same is true for dividends if the assets are held for less than 61 days.
The effective dividend tax rate for a one-year individual investor in 1999 is closest to:
A) 0%
B) 20%
C) 25%
D) 40%
The weighted average cost of capital for “Meenie” is closest to:
A) 10.5%
B) 7.4%
C) 10.0%
D) 8.8%
Consider the following information regarding corporate bonds:
Suppose that because of the large need for steel in building railroad infrastructure,
Taggart Transcontinental and Rearden Metal decide to form into one large
conglomerate. Your estimate of the asset beta for this new conglomerate is closest to:
A) 0.42
B) 0.59
C) 0.66
D) 0.68
Which of the following statements is FALSE?
A) Investors can alter the leverage choice of the firm to suit their personal tastes either
by borrowing and reducing leverage or by holding bonds and adding more leverage.
B) On the market value balance sheet the total value of all securities issued by the firm
must equal the total value of the firm’s assets.
C) The market value balance sheet captures the idea that value is created by a firm’s
choice of assets and investments.
D) One application of MM Proposition I is the useful device known as the market value
balance sheet of the firm.
Which of the following equations is INCORRECT?
A) Var(R) =
B) SD(R) =
C) Var(R) = PR× (R – E[R])2
D) E[R] = PR× R
Consider the following yields to maturity on various one-year zero-coupon securities:
The price (expressed as a percentage of the face value) of a one-year, zero-coupon
corporate bond with a AAA rating is closest to:
A) 94.70
B) 95.60
C) 94.16
D) 95.42
The price today of a three-year default-free security with a face value of $1000 and an
annual coupon rate of 4% is closest to:
A) $1002.78
B) $1003.31
C) $1028.50
D) $1028.61
Which of the following statements is FALSE?
A) The firm’s unlevered cost of capital is equal to its pre-tax weighted average cost of
capital’“that is, using the pre-tax cost of debt, rd, rather than its after-tax cost, rd (1 –
Ï„c ).
B) A firm’s levered cost of capital is a weighted average of its equity and debt costs of
capital.
C) When the firm maintains a target leverage ratio, its future interest tax shields have
similar risk to the project’s cash flows, so they should be discounted at the project’s
unlevered cost of capital.
D) The first step in the APV method is to calculate the value of free cash flows using
the project’s cost of capital if it were financed without leverage.
Consider the following list of projects:
Assume that your capital is constrained, so that you only have $500,000 available to
invest in projects. If you invest in the optimal combination of projects given your
capital constraint, then the total NPV for all the projects you invest in will be closest to:
A) $111,000
B) $69,000
C) $80,000
D) $58.000
Which of the following are subject to double taxation?
A) Corporation
B) Partnership
C) Sole proprietorship
D) A and B
Consider the following four corporate bonds that have semiannual compounding:
Consider a zero coupon bond with 20 years to maturity. The percentage change in the
price of the bond if its yield to maturity decreases from 7% to 5% is closest to:
A) 46%
B) 17%
C) 22%
D) 38%
Aardvark Industries is considering a project that will generate the following free cash
flows:
You are also provided with the following market value balance sheet and information
regarding Aardvark’s cost of capital:
Suppose that to fund this new project, Aardvark borrows $150 with the principal to be
paid in three equal installments at the end each year. Calculate the present value of
Aardvark’s interest tax shield.
Suppose that the risk-free rate is 5% and the market portfolio has an expected return of
13% with a volatility of 18%. Luther Industries has a volatility of 24% and a correlation
with the market of .5. If you assume that the CAPM assumptions hold, then what is the
expected return on Luther stock?
You currently own $100,000 worth of Wal-Mart stock. Suppose that Wal-Mart has an
expected return of 14% and a volatility of 23%. The market portfolio has an expected
return of 12% and a volatility of 16%. The risk-free rate is 5%. Assuming the CAPM
assumptions hold, what alternative investment has the highest possible expected return
while having the same volatility as Wal-Mart? What is the expected return of this
portfolio?
Using the income statement above and the following information:
Calculate Ideko’s Free Cash Flow to the Firm and Free Cash Flow to Equity in 2007.
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 equal to?
You expect DM Corporation to generate the following free cash flows over the next five
years:
Beginning with year six, you estimate that DM’s free cash flows will grow at 6% per
year and that DM’s weighted average cost of capital is 15%.
If DM has $500 million of debt and 14 million shares of stock outstanding, then what is
the price per share for DM Corporation?