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 Wyatt Oil is closest to:
A) 0.40
B) 0.48
C) 0.56
D) 0.80
Estimated 2005 Income Statement and Balance Sheet Data for Ideko Corporation
The following are financial ratios for three comparable companies:
Based upon the average EV/Sales ratio of the comparable firms, if Ideko holds $6.5
million of cash in excess of its working capital needs, then Ideko’s target market value
of equity is closest to:
A) $165 million
B) $157 million
C) $193 million
D) $191 million
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to
generate additional free cash flows of $40 million per year in subsequent years and will
pay out these future free cash flows as regular dividends. omicrons unlevered cost of
capital is 10% and there are 10 million shares outstanding. Omicron’s board is meeting
to decide whether to pay out its $50 million in excess cash as a special dividend or to
use it to repurchase shares of the firm’s stock.
Assume that Omicron uses the entire $50 million to repurchase shares. The amount of
the regular yearly dividends in the future is closest to:
A) $9.00
B) $5.00
C) $4.50
D) $4.00
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.
Rose’s unlevered cost of capital is closest to:
A) 8.0%
B) 7.5%
C) 7.0%
D) 9.0%
Which of the following statements is FALSE?
A) One disadvantage of using leverage is that it does not allow the original owners of
the firm to maintain their equity stake.
B) The separation of ownership and control creates the possibility of management
entrenchment; facing little threat of being fired and replaced, managers are free to run
the firm in their own best interests.
C) Managers also have their own personal interests, which may differ from those of
both equity holders and debt holders.
D) The costs of reduced effort and excessive spending on perks are another form of
agency cost.
Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and
interest expense of $3 million. FBNA’s marginal corporate tax rate is 40%.IF FBNA
increases leverage so that its interest expense rises by $1 million, then the amount its
net income will change is closest to:
A) -$400,000
B) -$600,000
C) $400,000
D) $600,000
Consider the following zero-coupon yields on default free securities:
The price today of a 4 year default free security with a face value of $1000 and an
annual coupon rate of 5.25% is closest to:
A) $1000
B) $1003
C) $1008
D) $987
Consider the following four bonds that pay annual coupons:
The amount that the price of bond “B” will change if its yield to maturity increases from
7% to 8% is closest to:
A) -$36
B) $9
C) $36
D) $39
KD Industries has 30 million shares outstanding with a market price of $20 per share
and no debt. KD has had consistently stable earnings, and pays a 35% tax rate.
Management plans to borrow $200 million on a permanent basis through a leveraged
recapitalization in which they would use the borrowed funds to repurchase outstanding
shares.
After the recapitalization, the value of a share of KD’s stock is closest to:
A) $22.35
B) $22.00
C) $22.65
D) $23.50
Consider two banks. Bank A has 1000 loans outstanding each for $100,000, that it
expects to be fully repaid today. Each of Bank A’s loans have a 6% probability of
default, in which case the bank will receive $0 for each of the defaulting loans. Bank B
has 100 loans of $1 million outstanding, which it also expects to be fully repaid today.
Each of Bank B’s loans have a 5% probability of default, in which case the bank will
receive $0 for each of the defaulting loans. The chance of default is independent across
all the loans.
The standard deviation of the overall payoff to Bank B is closest to:
A) $751,000
B) $2,179,000
C) $2,375,000
D) $21,794,000
Ideko Sales and Operating Cost Assumptions
Based upon Ideko’s Sales and Operating Cost Assumptions, what production capacity
will Ideko require in 2009?
A) 1,505 units
B) 1,115 units
C) 1,323 units
D) 1,702 units
The Sarbanes-Oxley Act (SOX) overhauled incentives and the independence in the
auditing process by:
A) requiring the CEO and CFO to return bonuses or profits from the sale of stock that
are later shown to be due to misstated financial reports.
B) imposing large compliance costs on small companies.
C) requiring auditing firms to have long-standing relationships with their clients and
receive lucrative auditing and consulting fees from them.
D) putting strict limits on the amount of non-audit fees (consulting or otherwise) that an
accounting firm can earn from a firm that it audits.
Which of the following statements is FALSE?
A) FV =
B) PV =
C) FV = Cn× (1 + r)n
D) Most investment opportunities have multiple cash flows that occur at different points
in time.
Which of the following statements is FALSE?
A) The Sharpe ratio measures the ratio of volatility-to-reward provided by a portfolio.
B) Borrowing money to invest in stocks is referred to as buying stocks on margin.
C) The Sharpe ratio is the number of stand deviations the portfolio’s return would have
to fall to under-perform the risk-free investment.
D) The slope of the line through a given portfolio is often referred to as the Sharpe ratio
of the portfolio.
d’Anconia Copper is an all-equity firm with 60 million shares outstanding, which are
currently trading at $20 per share. Last month, d’Anconia announced that it will change
its capital structure by issuing $300 million in debt. The $200 million raised by this
issue, plus another $200 million in cash that d’Anconia already has, will be used to
repurchase existing shares of stock. Assume that capital markets are perfect.
Suppose you are a shareholder in d’Anconia Copper holding 500 shares, and you
disagree with the decision to lever the firm. You can undo the effect of this decision by:
A) borrowing $2,000 and buying 100 shares of stock.
B) selling 100 shares of stock and lending $2,000.
C) borrowing $1,200 and buying 60 shares of stock.
D) selling 60 shares of stock and lending $1,200.
Pro Forma Income Statement for Ideko, 2005-2010
The amount of the increase in net working capital for Ideko in 2007 is closest to:
A) $4,090
B) $4,685
C) $3,665
D) $5,230
Luther Industries has $5 million in excess cash and 1 million shares outstanding. Luther
is considering investing the cash in one-year treasury bills that are currently paying 5%
interest, and then using the cash to pay a dividend next year. Alternatively, Luther can
pay the cash out as a dividend immediately and the shareholders can invest in the
treasury bills themselves. Assume that capital markets are perfect.
If Luther decides to pay the dividend immediately the dividend per share will be closest
to:
A) $1.05
B) $5.25
C) $5.00
D) $4.75
Consider the following three individuals portfolios consisting of investments in four
stocks:
Assuming that the risk-free rate is 4% and the expected return on the market is 12%,
then required return on Peter’s portfolio is closest to:
A) 20%
B) 22%
C) 18%
D) 16%
Epiphany Industries is considering a new capital budgeting project that will last for
three years. Epiphany plans on using a cost of capital of 12% to evaluate this project.
Based on extensive research, it has prepared the following incremental cash flow
projects:
The NPV for Epiphany’s Project is closest to:
A) $4,825
B) $39,000
C) $11,946
D) $20,400
If the market risk premium is 6% and the risk-free rate is 4%, then the expected return
of investing in Merck is closest to:
A) 5.4%
B) 9.4%
C) 10.0%
D) 10.4%
Which of the following statements is FALSE?
A) Firm specific news is good or bad news about the company itself.
B) Firms are affected by both systematic and firm-specific risk.
C) When firms carry both types of risk, only the firm-specific risk will be diversified
when we combine many firms’ stocks into a portfolio.
D) The risk premium for a stock is affected by its idiosyncratic risk.
Defenestration Industries plans to pay a $4.00 dividend this year and you expect that the
firm’s earnings are on track to grow at 5% per year for the foreseeable future.
Defenestration’s equity cost of capital is 13%.
Suppose that Defenestration decides to pay a dividend of only $2 per share this year and
use the remaining $2 per share to repurchase stock. If Defenestration’s payout rate
remains constant, then Defenestration’s stock price is closest to:
A) $50.00
B) $22.25
C) $32.30
D) $30.75
Consider the following information regarding corporate bonds:
Your estimate of the debt beta for Nielson Motors would be:
A) 0.10
B) 0.17
C) 1.00
D) 1.68
Consider the following equation:
rwacc= rE+ rD(1 – Ï„c)
the term rD(1 – Ï„c) in this equation is:
A) the required rate of return on debt.
B) the dollar amount of equity.
C) the after tax required rate of return on debt.
D) the required rate of return on equity.