The Aardvark Corporation is considering launching a new product and is trying to
determine an appropriate discount rate for evaluating this new product. Aardvark has
identified the following information for three single division firms that offer products
similar to the one Aardvark is interested in launching:
The unlevered cost of capital for Antelope Incorporated is closest to:
A) 10.3%
B) 9.9%
C) 10.1%
D) 9.5%
Consider the following probability distribution of returns for Alpha Corporation:
The expected return for Alpha Corporation is closest to:
A) 6.67%
B) 5.00%
C) 10%
D) 0.00%
Rearden Metals is considering opening a strip mining operation to provide some of the
raw materials needed in producing Rearden metal. The initial purchase of the land and
the associated costs of opening up mining operations will cost $100 million today. The
mine is expected to generate $16 million worth of ore per year for the next 12 years. At
the end of the 12th year Rearden will need to spend $20 million to restore the land to its
original pristine nature appearance.
One of the IRR for Rearden’s mining operation is closest to:
A) 0%
B) 10.6%
C) 12.4%
D) 72.0%
Nielson Motors is considering an opportunity that requires an investment of $1,000,000
today and will provide $250,000 one year from now, $450,000 two years from now, and
$650,000 three years from now.
The Internal Rate of return of this project is closest to:
A) 10.2%
B) 12.2%
C) 14.2%
D) 16.2%
Consider the following equation for the Project WACC with a fixed debt schedule:
rwacc= rU– dÏ„c[rD + f(rU – rD)]
The term d in this equations represents:
A) a measure of the permanence of the debt level.
B) the annual adjustment percentage to the amount of debt.
C) the debt-to-value ratio.
D) the dollar amount of debt outstanding.
Which of the following statements is FALSE?
A) Although indirect costs of bankruptcy are difficult to measure accurately, they are
typically much smaller than the direct costs of bankruptcy.
B) Bankruptcy protection can be used by management to delay the liquidation of a firm
that should be shut down.
C) Because many aspects of the bankruptcy process are independent of the size of the
firm, the costs are typically higher, in percentage terms, for smaller firms.
D) Aside from the direct legal and administrative costs of bankruptcy, many other
indirect costs are associated with financial distress (whether or not the firm has formally
filed for bankruptcy).
Which of the following statements is FALSE?
A) The incremental IRR investment rule applies the IRR rule to the difference between
the cash flows of the two mutually exclusive alternatives.
B) When a manager must choose among mutually exclusive investments, the NPV rule
provides a straightforward answer.
C) The likelihood of multiple IRRs is greater with the regular IRR rule than with the
incremental IRR rule.
D) Problems can arise using the IRR method when the mutually exclusive investments
have differences in scale.
The DuPont Identity expresses the firm’s ROE in terms of:
A) profitability, asset efficiency, and leverage.
B) valuation, leverage, and interest coverage.
C) profitability, margins, and valuation.
D) equity, assets, and liabilities.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million,
and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff
has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35%
corporate tax bracket.
If Flagstaff currently maintains a debt to equity ratio of 1, then the value of Flagstaff as
an all equity firm would be closest to:
A) $73 million
B) $80 million
C) $115 million
D) $100 million
Which of the following statements is FALSE?
A) The equivalent after-tax interest rate is r – (Ï„ × r).
B) Interest rates vary based on the identity of the borrower.
C) The ability to deduct the interest expense increases the effective after-tax interest
rate paid on the loan.
D) For loans to borrowers other than the U.S. Treasury, the stated interest rate is the
maximum amount that investors will receive.
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 in excess cash to pay a special
dividend. The amount of the special dividend is closest to:
A) $5.00
B) $9.00
C) $4.00
D) $4.50
Shepard Industries expects free cash flow of $10 million each year. Shepard’s corporate
tax rate is 35%, and its unlevered cost of equity is 10%. The firm also has outstanding
debt of $40 million and it expects to maintain amount of debt permanently.
The value of Shepard Industries with leverage is closest to:
A) $64 million
B) $100 million
C) $135 million
D) $114 million
Which of the following is NOT considered a difficulty with regards to the CAPM?
A) Betas are not observed.
B) Expected returns are not observed.
C) The market proxy is not correct.
D) Investors risk preferences are not observed.
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.
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) $125 million
B) $111 million
C) $100 million
D) $116 million
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%.If the Krusty Krab’s opportunity cost of
capital is 12%, then the IRR for upgrading to the new grill is closest to:
A) 3.25%
B) 16.00%
C) 18.25%
D) 21.00%
The value of currently unused warehouse space that will be used as part of a new
capital budgeting project is:
A) an opportunity cost.
B) irrelevant to the investment decision.
C) an overhead expense.
D) a sunk cost.
Taggart Transcontinental has a divided yield of 2.5%. Taggart’s equity cost of capital is
10%, and its dividends are expected to grow at a constant rate. Based on this
information, Taggart’s constant growth rate in dividends is closest to:
A) 2.5%
B) 5.0%
C) 10.0%
D) 7.5%
Which of the following statements is FALSE?
A) Given a forecast of future interest payments, we can determine the interest tax shield
and compute its present value by discounting it at a rate that corresponds to its risk.
B) The total value of the unlevered firm exceeds the value of the firm with leverage due
to the present value of the tax savings from debt.
C) To compute the increase in the firm’s total value associated with the interest tax
shield, we need to forecast how a firm’s debt’”and therefore its interest payments.
D) There is an important tax advantage to the use of debt financing.
The JRN Corporation will pay a constant dividend of $3 per share, per year, in
perpetuity. Assume that all investors pay a 20% tax on dividends and that there is no
capital gains tax. The cost of capital for investing in JRN stock is 12%.
The price of a share of JRN’s stock is closest to:
A) $20.00
B) $24.00
C) $25.00
D) $18.00
Consider the following two projects:
The payback period for project B is closest to:
A) 2.5 years
B) 2.0 years
C) 2.2 years
D) 2.4 years