Nielson Motors has a debt-equity ratio of 1.8, an equity beta of 1.6, and a debt beta of
0.20. It is currently evaluating the following projects, none of which would change
Nielson’s volatility.
(All amounts are in $millions.)
Which of the following projects should Nielson Motors accept?
A) 1 only
B) 1, 2, and 3 only
C) 1 and 4 only
D) 2, 3, and 5 only
Which of the following statements is FALSE?
A) The terminal of continuation value of the project represents the market value (as of
the last forecast period) of the free cash flow from the project at all future dates.
B) The incremental effect of a project on the firm’s available cash is the project’s free
cash flow.
C) (1 – Ï„c) × Depreciation is called the depreciation tax shield.
D) To evaluate a capital budgeting decision, we must determine its consequences for the
firm’s available cash.
Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a 6%
interest rate to invest in the stock market. You invest the entire $20,000 in an exchange
traded fund (ETF) with a 12% expected return and a 20% volatility.
The expected return on your of your investment is closest to:
A) 18%
B) 20%
C) 12%
D) 24%
Omicron Industries’ Market Value Balance Sheet ($ Millions)
and Cost of Capital
Omicron Industries New Project Free Cash Flows
Assume that this new project is of average risk for Omicron and that the firm wants to
hold constant its debt to equity ratio.
Omicron’s weighted average cost of capital is closest to:
A) 7.10%
B) 7.50%
C) 9.60%
D) 8.75%
A project that you are considering today is expected to provide benefits worth $168,000
in one year. If the risk-free rate of interest (rf) is 4.5%, then the value of the benefits of
this project today are closest to:
A) $160,440
B) $160,766
C) $168,000
D) $175,560
Which of the following statements regarding limited partnerships is TRUE?
A) There is no limit on a limited partner’s liability.
B) A limited partner’s liability is limited by the amount of their investment.
C) A limited partner is not liable until all the assets of the general partners have been
exhausted.
D) A general partner’s liability is limited by the amount of their investment.
Which of the following statements is FALSE?
A) As long as investors can borrow or lend at the same interest rate as the firm,
homemade leverage is a perfect substitute for the use of leverage by the firm.
B) When investors use leverage in their own portfolios to adjust the leverage choice
made by the firm, we say that they are using homemade leverage.
C) The value of the firm is determined by the present value of the cash flows from its
current and future investments.
D) The investor can re-create the payoffs of unlevered equity by borrowing and using
the proceeds to purchase the equity of the firm.
Rearden Metal has no debt, and maintains a policy of holding $50 million in excess
cash reserves, invested in risk free treasury securities currently yielding 4%. If Rearden
is in the 40% marginal tax bracket, the cost of permanently maintaining this $50 million
reserve is closest to:
A) $0.8 million
B) $1.2 million
C) $20.0 million
D) $30.0 million
The Sisyphean Corporation is considering investing in a new cane manufacturing
machine that has an estimated life of three years. The cost of the machine is $30,000
and the machine will be depreciated straight line over its three-year life to a residual
value of $0.
The cane manufacturing machine will result in sales of 2,000 canes in year 1. Sales are
estimated to grow by 10% per year each year through year three. The price per cane that
Sisyphean will charge its customers is $18 each and is to remain constant. The canes
have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will
require an increase in various net working capital accounts. It is estimated that the
Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual
sales in accounts receivable, 9% of its annual sales in inventory, and 6% of its annual
sales in accounts payable. The firm is in the 35% tax bracket, and has a cost of capital
of 10%.
The change in Net working capital from year one to year two is closest to:
A) A decrease of $360
B) An increase of $360
C) An increase of $396
D) A decrease of $396
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 depreciation tax shield for Shepard Industries project in year one is closest to:
A) $84
B) $168
C) $96
D) $72
All amounts are in millions.
If the risk-free rate is 3% and the market risk premium is 5%, then the CAPM’s
predicted expected return for Wyatt Oil is closest to:
A) 7.0%
B) 8.5%
C) 9.0%
D) 9.5%
Luther Corporation
Consolidated Balance Sheet
December 31, 2009 and 2008 (in $ millions)
Luther Corporation’s cash ratio for 2009 is closest to:
Luther Corporation’s total sales for 2009 were $610.1, and gross profit was $109.0.
Inventory days for 2009 is closest to:
A) 27.5
B) 33.4
C) 153.7
D) 10.9
Luther’s earnings before interest, taxes, depreciation, and amortization (EBITDA) for
the year ending December 31, 2009 is closest to:
A) 19.7 million
B) 37.6 million
C) 41.2 million
D) 44.8 million
Consider the following equation:
Pretain = Pcum ×
The term Pretain in this equation represents:
A) the price of the stock if it retains and invests the cash.
B) the percentage of net income retained or reinvested back into the firm.
C) the percentage of net income paid out as a cash dividend.
D) the price of the stock if it retains cash to use in a share repurchase.
Which of the following statements is FALSE?
A) According to the provisions of the 1978 Bankruptcy Reform Act, U.S. firms can file
for two forms of bankruptcy protection: Chapter 11 or Chapter 13.
B) The Chapter 11 reorganization plan specifies the treatment of each creditor of the
firm. In addition to cash payment, creditors may receive new debt or equity securities of
the firm. The value of cash and securities is generally less than the amount each creditor
is owed, but more than the creditors would receive if the firm were shut down
immediately and liquidated.
C) In the more common form of bankruptcy for large corporations, Chapter 11
reorganization, all pending collection attempts are automatically suspended, and the
firm’s existing management is given the opportunity to propose a reorganization plan.
D) While developing a Chapter 11 reorganization plan, management continues to
operate the business.
Suppose that the market portfolio is equally likely to increase by 24% or decrease by
8%. Security “X” goes up on average by 29% when the market goes up and goes down
by 11% when the market goes down. Security “Y” goes down on average by 16% when
the market goes up and goes up by 16% when the market goes down. Security “Z” goes
up on average by 4% when the market goes up and goes up by 4% when the market
goes down.
The expected return on security with a beta of 0.8 is closest to:
A) 0.0%
B) 3.2%
C) 6.4%
D) 7.2%