Which of the following is not a direct cost of bankruptcy?
A) Costs to creditors
B) Investment banking costs
C) Costs of accounting experts
D) Legal costs and fees
Answer:
Use the following information to answer the question(s) below.
The price today of a two-year default-free security with a face value of $1000 and an
annual coupon rate of 5% is closest to:
A) $1002.78
B) $1003.31
C) $1028.50
D) $1028.61
Answer:
Use the information for the question(s) below.
LCMS Industries has $70 million in debt outstanding. The firm will pay only interest on
this debt (the debt is perpetual). LCMS’ marginal tax rate is 35% and the firm pays a
rate of 8% interest on its debt.
Assuming that the risk is the same as the loan, the present value of LCMS’ interest tax
shield is closest to:
A) $45.5 million
B) $20.0 million
C) $24.5 million
D) $35.0 million
Answer:
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.
Answer:
Which of the following statements is false?
A) The payback rule is useful in cases where the cost of making an incorrect decision
might not be large enough to justify the time required for calculating the NPV.
B) The payback rule is reliable because it considers the time value of money and
depends on the cost of capital.
C) For most investment opportunities expenses occur initially and cash is received later.
D) Fifty percent of firms surveyed reported using the payback rule for making
decisions.
Answer:
Which of the following statements is false?
A) To determine the true tax benefit of leverage, we need to evaluate the combined
effect of both corporate and personal taxes.
B) A personal tax disadvantage for debt causes the WACC to decline more slowly with
leverage than it otherwise would.
C) Personal taxes have an indirect effect on the firm’s weighted average cost of capital.
D) In the United States and many other countries, capital gains from equity have
historically been taxed more heavily than interest income.
Answer:
Which of the following equations is incorrect?
A) – 1= APR
B) Equivalent n-Period Discount Rate = (1 + r)n – 1
C) 1 + EAR =
D) Interest Rate per Compounding Period =
Answer:
Which of the following is not an assumption used in deriving the Capital Asset Pricing
Model (CAPM)?
A) Investors have homogeneous expectations regarding the volatilities, correlation, and
expected returns of securities.
B) Investors have homogeneous risk adverse preferences toward taking on risk.
C) Investors hold only efficient portfolios of traded securities that are portfolios that
yield the maximum expected return for the given level of volatility.
D) Investors can buy and sell all securities at competitive market prices without
incurring taxes or transactions cost and can borrow and lend at the risk-free interest
rate.
Answer:
Use the following information to answer the question(s) below.
Really Big Conglomerate (RBC) is considering acquiring POP, Inc. a smaller
unsuccessful Internet firm. POP has outstanding tax loss carry forwards of $320 million
from losses over the past six years. RBC has pre-tax income of $100 million per year, a
cost of capital of 10%, and pays 35% in taxes.
If RBC acquires POP, in what year will RBC be required to pay corporate taxes again:
A) 2 years
B) 3 years
C) 4 years
D) 5 years
Answer:
Which of the following statements is false?
A) Even though firms have not issued new equity, the market value of equity has risen
over time as firms have grown.
B) While firms seem to prefer debt when raising external funds, not all investment is
externally funded.
C) To receive the full tax benefits of leverage a firm needs to use 100% debt financing.
D) If bankruptcy is costly, these costs might offset the tax advantages of debt financing.
Answer:
Use the following information to answer the question(s) below.
If managed effectively, Rearden Metal will have assets with a market value of $200
million, $300 million, or $400 million next year, with each outcome being equally
likely. Managers, however, may decided to engage in wasteful empire building, which
will reduce Rearden’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%, 5%, and
45% respectively.
Suppose that the managers at Rearden Metal will engage in empire building unless that
behavior increases the likelihood of bankruptcy. If Rearden has $190 million in debt
due in one year, then the expected value of Rearden’s assets are closest to:
A) $265 million
B) $280 million
C) $295 million
D) $300 million
Answer:
Which of the following is not an indirect cost of bankruptcy?
A) Loss of suppliers
B) Fire sales of assets
C) Costs of appraisers
D) Loss of employees
Answer:
Use the following information to answer the question(s) below.
Rearden Metal, a U.S. manufacturer, has made a purchase of from d’Anconia Copper
and is expecting a cash outflow of 2 million ARS (Argentine Pesos) in six months. The
currency spot rate is $0.2500/ARS and the six-month forward rate is F6months =
$0.2470/ARS. The appropriate annual discount rate for the Argentine Peso is 6.5% and
the annual discount rate for the U.S. dollar is 4%.
The present value of Rearden Metal’s cash outflow computed by first discounting the
cash flow at the appropriate Argentine Peso rate and then converting to dollars is closest
to:
A) $469,500
B) $475,000
C) $481,000
D) $484,500
Answer:
Use the information for the question(s) below.
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
Answer:
Use the equation for the question(s) below.
Consider the following linear regression model:
(Ri – rf) = ai + bi(RMkt – rf) + ei
The ai in the regression
A) measures the sensitivity of the security to market risk.
B) measures the deviation from the best fitting line and is zero on average.
C) measures the diversifiable risk in returns.
D) measures the historical performance of the security relative to the expected return
predicted by the SML.
Answer:
Use the following timeline to answer the question(s) below.
0 1 2 3
$600 $1,200 $1,800
At an annual interest rate of 7%, the future value of this timeline in year 3 is closest to:
A) $3,295
B) $3,600
C) $3,770
D) $4,035
Answer:
Use the following information to answer the question(s) below.
Consider the following four corporate bonds that have semiannual compounding:
If the YTM of these bonds increased to 9%, which bond’s price would be most sensitive
to this change in YTM?
A) #1
B) #2
C) #3
D) #4
Answer:
According to a survey of 392 CFOs conducted by John Graham and Campbell Harvey,
the most common method used in corporate America to estimate the cost of capital is
A) the CAPM.
B) multifactor models.
C) characteristic models.
D) the dividend discount model.
Answer:
Which of the following statements is false?
A) The profitability index rule of thumb raises the bar on the NPV to take into account
the option to wait.
B) In practice, correctly modeling the sources of uncertainty and the appropriate
dynamic decisions usually requires an extensive amount of time and financial expertise.
C) Some firms use the following rule of thumb: Invest whenever the profitability index
is below a specified level.
D) Instead of raising the bar on the NPV, the hurdle rate rule raises the discount rate.
Answer:
Use the information for the question(s) below.
Kinston Enterprises has no debt and a debt obligation of $47 million that is due now.
The market value of Kinston’s assets is $102 million, and the firm has no other
liabilities. Assume that capital markets are perfect and that Kinston has 5 million shares
outstanding.
The number of new shares that Kinston must issue to raise the capital needed to pay its
debt obligation is closest to:
A) 4.3 million
B) 4.7 million
C) 5.0 million
D) 4.0 million
Answer:
Use the table for the question(s) below.
If the risk-free interest rate is 10%, then the NPV for Moe is closest to:
A) -3.64
B) 2.73
C) 3.18
D) 3.64
Answer:
Sarah Palin reportedly was paid a $11 million advance to write her book Going Rogue.
The book took one year to write. In the time she spent writing, Palin could have been
paid to give speeches and appear on TV news as a political commentator. Given her
popularity, assume that she could have earned $8 million over the year (paid at the end
of the year) she spent writing the book. Assume that she was able to write the book
while simultaneously fulfilling her media commitments of appearing on TV news as a
political commentator and give speeches.
Assuming that Palin’s cost of capital is 10%, then the NPV of her book deal is closest
to:
A) $2.00 million
B) $2.20 million
C) $3.00 million
D) $3.75 million
Answer:
Consider the following formula:
The term τcD represents
A) the present value of the interest tax shield.
B) the value of firm with leverage.
C) the preset value of the future interest payments.
D) the interest tax shield each year.
Answer:
Use the following information to answer the question(s) below.
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.
If the appropriate interest rate is 10%, then the NPV of this opportunity is closest to:
A) ($88,000)
B) $88,000
C) $300,000
D) $1,300,000
Answer:
Consider the following information for the question(s) below.
Hammond Motors had sales of $35 million in 2009 with a cost of goods sold of $20
million. A simplified balance sheet for Hammond appears below:
Hammond’s cash conversion cycle in 2009 is closest to:
A) 22 days
B) 44 days
C) 58 days
D) 66 days
Answer:
If you want to value a firm that consistently pays out its earnings as dividends, the
simplest model for you to use is the
A) enterprise value model.
B) total payout model.
C) dividend discount model.
D) discounted free cash flow model.
Answer:
Which of the following statements is false?
A) Because the cash flows promised by the bond are the most that bondholders can
hope to receive, the cash flows that a purchaser of a bond with credit risk expects to
receive may be less than that amount.
B) By consulting bond ratings, investors can assess the credit-worthiness of a particular
bond issue.
C) Because the yield to maturity for a bond is calculated using the promised cash flows,
the yield of bond’s with credit risk will be lower than that of otherwise identical
default-free bonds.
D) A higher yield to maturity does not necessarily imply that a bond’s expected return is
higher.
Answer:
Which of the following statements is false?
A) Because all other risk is diversifiable, it is an investment’s beta with respect to the
efficient portfolio that measures its sensitivity to systematic risk, and therefore
determines its cost of capital.
B) If a security’s expected return exceeds its required return given our current portfolio,
then we can improve the performance of our portfolio by adding more of the security.
C) The appropriate risk premium for an investment can be determined from its beta
with the efficient portfolio.
D) As we buy shares of a security i, its correlation with our portfolio P will increase,
ultimately raising its required return until E[Ri] = Rp.
Answer:
Use the following information to answer the question(s) below.
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
Answer:
Use the information for the question(s) below.
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 two is closest to:
A) $84
B) $196
C) $72
D) $96
Answer:
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.
Answer:
Use the following information to answer the question(s) below.
The Market’s excess return for 2008 is closest to:
A) -40.0%
B) -38.5%
C) -37.0%
D) -34.1%
Answer:
Treasury securities that are standard coupon bonds where the outstanding principal is
adjusted for inflation are called
A) Treasury notes.
B) Treasury bonds.
C) TIPS.
D) Treasury bills.
Answer:
Use the information for the question(s) below.
Suppose Luther Industries is considering divesting one of its product lines. The product
line is expected to generate free cash flows of $2 million per year, growing at a rate of
3% per year. Luther has an equity cost of capital of 10%, a debt cost of capital of 7%, a
marginal tax rate of 35%, and a debt-equity ratio of 2. This product line is of average
risk and Luther plans to maintain a constant debt-equity ratio.
Luther’s Unlevered cost of capital is closest to:
A) 8.0%
B) 8.5%
C) 9.0%
D) 6.4%
Answer:
You are considering investing in a zero coupon bond that will pay you its face value of
$1000 in ten years. If the bond is currently selling for $485.20, then the IRR for
investing in this bond is closest to:
A) 12%
B) 8.0%
C) 7.5%
D) 10%
Answer: