Which of the following statements is FALSE?
A) If the market portfolio is efficient, then all securities and portfolios must plot on the
SML, not just individual stocks.
B) For most stocks the standard errors of the alpha estimates are large, so it is
impossible to conclude that the alphas are statistically different from zero.
C) It is not difficult to find individual stocks that, in the past have not plotted on the
SML.
D) Small stocks (those with lower market capitalization) have lower average returns.
Luther Corporation
Consolidated Balance Sheet
December 31, 2009 and 2008 (in $ millions)
When using the book value of equity, the debt to equity ratio for Luther in 2009 is
closest to:
A) 0.43
B) 2.29
C) 2.98
D) 3.57
Taggart Transcontinental shares are currently trading at $200 per share. The split ratio
need to brink the stock price down to $80 is:
A) 2:1
B) 3:1
C) 2:5
D) 5:2
Pro Forma Income Statement for Ideko, 2005-2010
The amount of net working capital for Ideko in 2008 is closest to:
A) $35,195
B) $26,420
C) $22,170
D) $30,510
Two years ago you purchased a new SUV. You financed your SUV for 60 months (with
payments made at the end of the month) with a loan at 5.9% APR. You monthly
payments are $617.16 and you have just made your 24th monthly payment on your
SUV.
The amount of your original loan is closest to:
A) $14,808
B) $22,212
C) $32,000
D) $37,020
Which of the following statements is FALSE?
A) By convention, practitioners always plot the yield of the most senior issued bonds,
termed the on-the-run-bonds.
B) We can determine the no-arbitrage price of a coupon bond by discounting its cash
flows using the zero-coupon yields.
C) If the zero coupon yield curve is upward sloping, the resulting yield to maturity
decreases with the coupon rate of the bond.
D) The yield to maturity of a coupon bond is a weighted average of the yields on the
zero-coupon bonds.
Consider the following income statement for Kroger Inc. (all figures in $ Millions):
The income that would be available to equity holders in 2005 if Kroger was not levered
is closest to:
A) $290 million
B) $745 million
C) $847 million
D) $550 million
Luther is a successful logistical services firm that currently has $5 billion in cash.
Luther has decided to use this cash to repurchase shares from its investors, and has
already announced the stock repurchase plan. Currently Luther is an all equity firm with
1.25 billion shares outstanding. Luther’s shares are currently trading at $20 per share.
With perfect capital markets, what is the market value of Luther’s equity after the share
repurchase?
A) $15 billion
B) $10 billion
C) $25 billion
D) $20 billion
Which of the following statements is FALSE?
A) About 75% of firms surveyed used the NPV rule for making investment decisions.
B) If you are unsure of your cost of capital estimate, it is important to determine how
sensitive your analysis is to errors in this estimate.
C) To decide whether to invest using the NPV rule, we need to know the cost of capital.
D) NPV is positive only for discount rates greater than the internal rate of return.
Which of the following statements is FALSE?
A) The existence of the momentum trading strategy has been widely known for at least
ten years.
B) The information required to implement a momentum strategy is not readily available
to investors.
C) If the market portfolio is not efficient, then a stock’s beta with the market is not an
adequate measure of its systematic risk.
D) If the market portfolio is not efficient, then the so-called profits from a positive
alpha trading strategy are really returns for bearing risk that investors are averse to and
the CAPM doesn’t capture.
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.
The Free Cash Flow to Equity (FCFE) for the acquisition in year 0 is closest to:
A) $5 million
B) $100 million
C) -$100 million
D) -$50 million
Which of the following statements regarding the Law of One Price is INCORRECT?
A) At any point in time, the price of two equivalent goods trading in different
competitive markets will be the same.
B) One useful consequence of the Law of One Price is that when evaluating costs and
benefits to compute a net present value, we can use any competitive price to determine
a cash value, without checking the price in all possible markets.
C) If equivalent goods or securities trade simultaneously in different competitive
markets, then they will trade for the same price in both markets.
D) An important property of the Law of One Price is that it holds even in markets where
arbitrage is not possible.
Which of the following is NOT a financial statement that every public company is
required to produce?
A) Income Statement
B) Statement of Sources and Uses of Cash
C) Balance Sheet
D) Statement of Stockholders’ Equity
Pro Forma Income Statement for Ideko, 2005-2010
With the proper changes it is believed that Ideko’s credit policies will allow for an
account receivables days of 60. The forecasted accounts receivable for Ideko in 2008 is
closest to:
A) $14,525
B) $19,690
C) 22,710
D) $16,970
Wyatt Oil has assets with a market value of $600 million, $70 million of which are
cash. It has debt of $250 million, and 20 million shares outstanding. Assume perfect
capital markets.
Wyatt Oil’s current stock price is closest to:
A) $11.00
B) $12.50
C) $14.00
D) $17.50
You have an investment opportunity in Germany that requires an investment of
$250,100 today and will produce a cash flow of €208,650 in one year with no risk.
Suppose the risk-free rate of interest in Germany is 7% and the current competitive
exchange rate is €0.78 to $1.00. What is the NPV of this project? Would you take the
project?
A) NPV = -$100; No
B) NPV = $100; Yes
C) NPV = $2,358; Yes
D) NPV = $3,650; Yes
You are considering investing in a start up project at a cost of $100,000. You expect the
project to return $500,000 to you in seven years. Given the risk of this project, your cost
of capital is 20%.
The decision you should take regarding this project is
A) reject the project since the NPV is negative.
B) reject the project since the NPV is positive.
C) accept the project since the IRR < 20%.
D) accept the project since the IRR > 20%.
Accounts payable is a:
A) long-term liability.
B) current asset.
C) long-term asset.
D) current liability.
Consider the following regression model:
Rs– rf= as+ (RF1– rf) + (RF2– rf) + e
The term asis a(n):
A) error term that has an expectation of zero and is uncorrelated with either factor.
B) measure of the expected percent change in the excess return of a security for a 1%
change in the excess return of the first factor portfolio.
C) measure of the expected percent change in the excess return of a security for a 1%
change in the excess return of the second factor portfolio.
D)
constant term.
Consider the following four corporate bonds that have semiannual compounding:
Suppose you purchase a 20-year treasury bond with a 6% annual coupon ten years ago
at par. Today the bond’s yield to maturity has risen to 8% (EAR).
If you hold this bond to maturity, the internal rate of return you will earn on your
investment will be closest to:
A) 5.0%
B) 5.6%
C) 6.0%
D) 8.0%
Which of the following statements is FALSE?
A) If the profit opportunities from having private information are large, other
individuals will attempt to gain the expertise and devote the resources needed to acquire
it.
B) When private information is relegated to the hands of a relatively small number of
investors, these investors may be able to profit by trading on their information.
C) When a buyer seeks to buy a stock, the willingness of other parties to sell the same
stock suggests that they value the stock differently.
D) Since stock markets aggregate the information and view of many different investors,
we expect the stock price to react slowly to new publicly available information as the
investors continue to trade until a consensus is reached as to the new value of the stock.
Which of the following statements is FALSE?
A) The most familiar stock index in the United States is the Dow Jones Industrial
Average (DJIA).
B) A portfolio in which each security is held in proportion to its market capitalization is
called a price-weighted portfolio.
C) The Dow Jones Industrial Average (DJIA) consists of a portfolio of 30 large
industrial stocks.
D) The Dow Jones Industrial Average (DJIA) is a price-weighted portfolio.
Which of the following formulas is INCORRECT?
A) i = – 1
B) 1 + rr=
C) rr≈ i – r
D) rr=
Iota Industries is an all-equity firm with 50 million shares outstanding. Iota has $200
million in cash and expects future free cash flows of $75 million per year. Management
plans to use the cash to expand the firm’s operations, which in turn will increase future
free cash flows by 12%. Iota’s cost of capital is 10% and assume that capital markets are
perfect.
A member of Iota’s board of directors suggests that Iota’s stock price would be higher if
they used the $200 million to repurchase shares instead of funding the expansion. If you
were advising the board, what course of action would you recommend, expansion or
repurchase? Which provides the higher stock price?
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 2009.
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 .8 debt to equity ratio, then
calculate the value of Flagstaff’s interest tax shield.
Consider an ETF that is made up of one share each of IBM, MRK, and C. The current
quote for this ETF currently is $162.75 (bid) $162.80 (ask). What should you do?
Luther Corporation
Consolidated Balance Sheet
December 31, 2009 and 2008 (in $ millions)
If on December 31, 2008 Luther has 8 million shares outstanding trading at $15 per
share, then what is Luther’s market-to-book ratio?
Suppose that a young couple has just had their first baby and they wish to ensure that
enough money will be available to pay for their child’s college education. Currently,
college tuition, books, fees, and other costs, average $12,500 per year. On average,
tuition and other costs have historically increased at a rate of 4% per year.
Assuming that college costs continue to increase an average of 4% per year and that all
her college savings are invested in an account paying 7% interest, then the amount of
money she will need to have available at age 18 to pay for all four years of her
undergraduate education is closest to:
What is the effective after-tax rate of each instrument, expressed as an EAR?
What does the existence of a positive alpha investment strategy imply?
Rose Industries has a $20 million loan due at the end of the year and its assets will have
a market value of only $15 million when the loan comes due. Currently Rose has $2
million in cash. Rose is considering two possible alternative uses for this cash. One
possibility is to pay the $2 million out to shareholders in the form of a special dividend.
The second possibility is to invest the $2 million into a project that offers a $4 million
NPV. What are the payoffs to the debt and equity holders under each of the two
alternatives? Which alternative would equity holders prefer? Which alternative would
debt holders prefer? What is the economic term that describes this situation?
What is the efficient frontier and how does it change when more stocks are used to
construct portfolios?