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
a levered firm is closest to:
A) $114 million
B) $100 million
C) $111 million
D) $140 million
Which of the following is NOT a diversifiable risk?
A) The risk that oil prices rise, increasing production costs
B) The risk of a product liability lawsuit
C) The risk that the CEO is killed in a plane crash
D) The risk of a key employee being hired away by a competitor
After your grandmother retired, she purchased an annuity contract for $250,000 that
will pay her $25,000 at the end of every year until she dies. The appropriate interest rate
for this annuity is 8%. The number of years that your grandmother must live in order to
get more value out of the annuity than what she paid for it is closest to:
A) 21
B) 16
C) 8
D) 10
Assuming that Novartis AG (NVS) has an EPS of $3.35, based upon the price-to-book
ratios for its competitors, the lowest expected stock price for Novartis is closest to:
A) $7.47
B) $13.00
C) $22.95
D) $31.86
When all investors correctly interpret and use their own information, as well as
information that can be inferred from market prices or the trades of others, they are said
to have:
A) sensation seeking expectations.
B) positive expectations.
C) rational expectations.
D) confident expectations.
Sisyphean industries is seeking to raise capital from a large group of investors to fund a
new project. Suppose that the efficient portfolio has an expected return of 14% and a
volatility of 20%. Sisyphean’s new project is expected to have a volatility of 40% and a
70% correlation with the efficient portfolio. The risk-free rate is 4%.The required return
for Sisyphean’s new project is closest to:
A) 24%
B) 14%
C) 18%
D) 10%
Consider the following expected returns, volatilities, and correlations:
The volatility of a portfolio that is consists of a long position of $10000 in Wal-Mart
and a short position of $2000 in Microsoft is closest to:
A) 9%
B) 14%
C) 11%
D) 12%
2Var(R1) + x2
2Var(R2) + 2X1X2Corr(R1,R2)SD1SD2
If the risk-free rate of interest (rf) is 3.5%, then you should be indifferent between
receiving $1000 in one-year or:
A) $965.00 today.
B) $966.18 today.
C) $1000.00 today.
D) $1035.00 today.
Taggart Transcontinental currently has no debt and an equity cost of capital of 16%.
Suppose that Taggart decides to increase its leverage and maintain a market
debt-to-value ratio of 1/3. Suppose Taggart’s debt cost of capital is 9% and its corporate
tax rate is 35%. Assuming that Taggart’s pre-tax WACC remains constant, then with the
addition of leverage its effective after-tax WACC will be closest to:
A) 12.9%
B) 13.0%
C) 15.0%
D) 16.0%
Consider the following average annual returns:
What is the excess return for the portfolio of small stocks?
A) 10.0%
B) 15.7%
C) 18.4%
D) 17.0%
Suppose all possible investment opportunities in the world are limited to the four stocks
list in the table below:
Suppose that you are holding a market portfolio and you have invested $18,000 in
Taggart Transcontinental. The number of shares of Rearden Metal that you hold is
closest to:
A) 780 shares
B) 925 shares
C) 1,730 shares
D) 2,075 shares
Capital Structure and Unlevered Beta Estimates for Comparable Firms
If the risk-free rate of interest is 6% and the market risk premium has historically
averaged 5%, then the cost of capital for Nike is closest to:
A) 14.7%
B) 10.2%
C) 9.1%
D) 13.5%
Consider the following list of projects:
Assuming that your capital is constrained, what is the fifth project that you should
invest in?
A) Project H
B) Project I
C) Project B
D) Project A
Wyatt Oil, an all-equity financed firm, has just reported EPS of $4.00 per share. Despite
an economic downturn, Wyatt is confident regarding its current investment
opportunities, but due to the current financial crisis, Wyatt does not wish to fund these
investments externally. Wyatt’s board has therefore decided to suspend its stock
repurchase plan and cut its dividend to $1 per share (from its current level of $2 per
share) and retain these funds instead. The firm just paid its current dividend of $1.00
per share and expects to keep its dividend at $1 per share next year as well. In
subsequent years, it expects its growth opportunities to slow, and it will still be able to
fund its growth internally with a target 40% dividend payout ratio, and reinitiating its
stock repurchase plan for a total payout rate of 60%. All dividends and repurchases
occur at the end of each year.
Wyatt’s existing operations are expected to generate the current level of earnings per
share in the future. Assume that the return on new investments is 16% and that
reinvestments will account for all future earnings growth. Wyatt’s current equity cost of
capital is 12%.
Wyatt’s current stock price is closest to:
A) $51.23
B) $54.00
C) $49.11
D) $61.38
You are evaluating a new project and need an estimate for your project’s beta. You have
identified the following information about three firms with comparable projects:
Based upon the three comparable firms, what asset beta would you recommend using
for your firm’s new project?
If the interest rate is 7%, the alternative with the highest NPV is:
A) Alternative #1 with an NPV of approximately $350,000
B) Alternative #2 with an NPV of approximately $370,561
C) Alternative #3 with an NPV of approximately $357,196
D) Alternative #2 with an NPV of approximately $380,561
The highest effective rate of return you could earn on any of these investments is
closest to:
A) 6.250%
B) 6.267%
C) 6.295%
D) 6.310%
Consider the price paths of the following stocks over a six-month period:
None of these stocks pay dividends.
Assume that you are an investor with the disposition effect and you bought each of
these stocks in January. Suppose that it is currently the end of June, which stocks are
you most inclined to sell?
1. Taggart Transcontinental
2. Rearden Metal
3. Wyatt Oil
4. Nielson Motors
A) 1 only
B) 1 and 3 only
C) 2 only
D) 1, 2, and 3 only