Rockwood Enterprises is currently an all equity firm and has just announced plans to
expand their current business. In order to fund this expansion, Rockwood will need to
raise $100 million in new capital. After the expansion, Rockwood is expected to
produce earnings before interest and taxes of $50 million per year in perpetuity.
Rockwood has already announced the planned expansion, but has not yet determined
how best to fund the expansion. Rockwood currently has 16 million shares outstanding
and following the expansion announcement these shares are trading at $25 per share.
Rockwood has the ability to borrow at a rate of 5% or to issue new equity at $25 per
share.
If Rockwood finances their expansion by issuing $100 million in debt at 5%, what will
Rockwood’s cost of equity capital be?
A) 11.25%
B) 10.70%
C) 12.50%
D) 12.00%
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 appropriate WACC for this new project is closest to:
A) 7.5%
B) 8.6%
C) 10.3%
D) 10.8%
Which of the following statements is FALSE?
A) Because all investors should hold the risky securities in the same proportions as the
efficient portfolio, their combined portfolio will also reflect the same proportions as the
efficient portfolio.
B) When the CAPM assumptions hold, choosing an optimal portfolio is relatively
straightforward: it is the combination of the risk-free investment and the market
portfolio.
C) Graphically, when the tangent line goes through the market portfolio, it is called the
security market line (SML).
D) A portfolio’s risk premium and volatility are determined by the fraction that is
invested in the market.
The free cash flow to the firm in 2010 is closest to:
A) 10,684
B) 11,559
C) 23,698
D) 26,394
Consider two firms, Chihuahua Corporation and Bernard Industries that are each
expected to pay the same $1.5 million dollar dividend every year in perpetuity.
Chihuahua Corporation is riskier and has an equity cost of capital of 15%. Bernard
Industries is not as shaky as Chihuahua, so Bernard has an equity cost of capital of only
10%. Assume that the market portfolio is not efficient. Both stocks have the same beta
and the CAPM would assign them both an expected return of 12% to both.
The alpha for Bernard is closest to:
A) +5%
B) -2%
C) -3%
D) +2%
Shepard Industries is evaluating a proposal to expand its current distribution facilities.
Management has projected the project will produce the following cash flows for the
first two years (in millions).
The incremental unlevered net income Shepard Industries in year two is closest to:
A) $355
B) $415
C) $600
D) $510
As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one
barrel of Alaska North Slope (ANS) crude oil. Because of its lower sulfur content, you
can produce $77 worth of unleaded gasoline from one barrel of West Texas
Intermediate (WTI) crude.
Another oil refiner is offering to trade you 10,150 Bbls of Alaska North Slope (ANS)
crude oil for 10,000 Bbls of West Texas Intermediate (WTI) crude oil. Another oil
refiner is offering to trade you 10,150 Bbls of Alaska North Slope (ANS) crude oil for
10,000 Bbls of West Texas Intermediate (WTI) crude oil. Assuming you currently have
10,000 Bbls of WTI crude, what should you do?
A) Sell 10,000 Bbls WTI crude on the market and use the proceeds to purchase and
refine ANS crude.
B) Do nothing, refine the 10,000 Bbls of WTI crude.
C) Trade the 10,000 Bbls WTI crude with the other refiner and refine the 10,150 Bbls of
ANS crude.
D) Trade the 10,000 Bbls WTI crude with the other refiner and then sell the 10,150 Bbls
of ANS crude.
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.
Omicron’s enterprise value is closest to:
A) $500 million
B) $900 million
C) $450 million
D) $400 million
Consider the following returns:
The Volatility on Stock X’s returns is closest to:
A) 35%
B) 10%
C) 13%
D) 42%
Which of the following statements regarding the income statement is INCORRECT?
A) The income statement shows the earnings and expenses at a given point in time.
B) The income statement shows the flow of earnings and expenses generated by the
firm between two dates.
C) The last or “bottom” line of the income statement shows the firm’s net income.
D) The first line of an income statement lists the revenues from the sales of products or
services.
If it is managed efficiently, Luther industries will have assets with market value of $100
million, $300, million, or $500 million next year, with each outcome being equally
likely. Managers may, however, engage in wasteful empire building which will reduce
the firm’s market value by $20 million in all cases. Managers may also increase the risk
of the firm, changing the probability of each outcome to 50%, 20%, and 30%
respectively.
Assume that EGI decides to raise the $100 million through the issuance of new shares
prior to the release of the new video game. The number of new shares that EGI will
issue is closest to:
A) 5.0 million
B) 6.25 million
C) 10 million
D) 1.6 million
Consider the following realized annual returns:
The geometric average annual return on Stock A from 2000 to 2009 is closest to:
A) 12.4%
B) 16.7%
C) 13.2%
D) 17.8%
Rearden Metal is evaluating a project that requires an investment of $150 million today
and provides a single cash flow of $180 million for sure one year from now. Rearden
decides to use 100% debt financing for this investment. The risk-free rate is 5% and
Rearden’s corporate tax rate is 40%. Assume that the investment is fully depreciated at
the end of the year.The WACC for this project is closest to:
A) 3.0%
B) 5.0%
C) 7.0%
D) 8.2%
Shepard Industries is evaluating a proposal to expand its current distribution facilities.
Management has projected the project will produce the following cash flows for the
first two years (in millions).
The incremental EBIT for Shepard Industries in year two is closest to:
A) $415
B) $875
C) $595
D) $510
As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one
barrel of Alaska North Slope (ANS) crude oil. Because of its lower sulfur content, you
can produce $77 worth of unleaded gasoline from one barrel of West Texas
Intermediate (WTI) crude.
Another oil refiner is offering to trade you 10,150 Bbls of Alaska North Slope (ANS)
crude oil for 10,000 Bbls of West Texas Intermediate (WTI) crude oil. Assuming you
currently have 10,000 Bbls of WTI crude, the added benefit (cost) to you if you take the
trade is closest to:
A) ($1,400)
B) $1,400
C) ($3,908)
D) $3,908