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Learn and Earn Company is financed entirely by common stock that is priced to offer a
20% expected rate of return. The stock price is $60 and the earnings per share are $12.
The company wishes to repurchase 50% of the stock and substitutes an equal value of
debt yielding 8%. Suppose that before refinancing, an investor owned 100 shares of
Learn and Earn common stock. What should he do if he wishes to ensure that risk and
expected return on his investment are unaffected by refinancing?
A. Borrow $3,000 and buy 50 more shares
B. Continue to hold 100 shares
C. Sell 50 shares and purchase $3,000 debt (bonds)
D. None of the above
Calculate the value of d2: (approximately)
A. -0.02766
B. +0.02766
C. +0.2027
D. -0.2027
Calculate the value of d2 (approximately).
A. +0.0656
B. -0.0656
C. +0.5656
D. -0.5656
Which of the following statements about the relationship between interest rates and
bond prices is true?
I) There is an inverse relationship between bond prices and interest rates.
II) There is a direct relationship between bond prices and interest rates.
III) The price of short-term bonds fluctuates more than the price of long-term bonds for
a given change in interest rates. (Assuming that coupon rate is the same for both)
IV) The price of long-term bonds fluctuates more than the price of short-term bonds for
a given change in interest rates. (Assuming that the coupon rate is the same for both)
A. I and IV only
B. I and III only
C. II and III only
D. None of the given statements are true
If the volatility (variance) of the underlying stock increases then the: [Assume
everything else remaining the same]
A. Value of the put option increases and that of the call option decreases
B. Value of the put option decreases and that of the call option increases
C. Value of both the put option and the call option increases
D. Value of both the put option and the call option decreases
One important implication of the efficient markets hypothesis is that:
A. investors should hold a diversified portfolio and avoid active trading.
B. investors can benefit by engaging in day trading.
C. investors should trade actively help to ensure the highest overall gain in their
portfolios.
D. all of the above.
Stock A has an expected return of 10% per year and stock B has an expected return of
20%. If 40% of the funds are invested in stock A, and the rest in stock B, what is the
expected return on the portfolio of stock A and stock B?
A. 10%
B. 20%
C. 16%
D. None of the above
Which of the following methods of evaluating capital investment projects incorporates
the time value of money concept?
I) Payback Period, II) Discounted Payback Period, III) Net Present Value (NPV), IV)
Internal Rate of Return
A. I, II, and III only
B. II, III, and IV only
C. III and IV only
D. I, II, III, and IV
If you receive $1,000 payment at the end each year for the next five years, what type of
cash flow do you have?
A. Uneven cash flow stream
B. An annuity
C. An annuity due
D. None of the above
This book is mainly about:
A. financial decisions made by households
B. financial decisions made by corporations
C. financial decisions made by governments
D. none of the above
Company X has 100 shares outstanding. It earns $1,000 per year and expects to pay all
of it as dividends. If the firm expects to maintain this dividend forever, Calculate the
stock price today. (The required rate of return is 10%)
A. $110
B. $90
C. $100
D. None of the above
For project Z, year-5 inventories increase by $6,000, accounts receivables by $4,000
and accounts payables by $3,000. Calculate the increase or decrease in working capital
for year-5.
A. Increases by $6,000
B. Decreases by $4,000
C. Increases by $7,000
D. Decreases by $7,000
The dividend yield reported as Yld. % in The Wall Street Journal quotation is calculated
as follows:
A. (dividends/hi)
B. (dividends/lo)
C. (dividends/close)
D. None of the above
If a corporation cannot use its interest payments to get tax shield for a particular year
because it has suffered a loss, it is still possible to get the tax shield because of the:
I) carry back provision that allows corporations to carry back the loss and receive a tax
refund up to the amount of taxes paid in the previous two years.
II) carry forward provision that allows corporations to carry forward the loss and use it
to shield income in subsequent years.
A. I only
B. II only
C. I and II
D. none of the above
Which of the following simulation outputs is likely to be most useful and easy to
interpret? The output shows the distribution(s) of the project:
A. Earnings
B. Internal rate of return
C. Cash flows
D. Profits
Generally, a firm is able to find positive NPV opportunities with:
I) Financing decisions
II) Capital investment decisions
III) Short-term borrowing decisions
A. I only
B. I and III only
C. III only
D. II only
Ms. Newcastle has $60,000 income this year and $40,000 next year. The market interest
rate is 10% per year. Suppose Ms. Newcastle wishes to consume $62,000 next year.
What will be her consumption this year?
A. $60,000
B. $40,000
C. $70,000
D. $19,000
The cost of capital for a firm, rWACC, in a tax-free environment is:
A. Equal to the expected EBIT divided by market value of the unlevered firm
B. Equal to rA, the rate of return for that business risk class
C. Equal to the overall rate of return required on the levered firm
D. All of the above
Florida Company (FC) and Minnesota Company (MC) are both service companies.
Their historical return for the past three years are: FC: - 5%, 15%, 20%; MC: 8%, 8%,
20%.
Calculate the correlation coefficient between the return of FC and MC.
A. 0.0
B. -0.655
C. +0.655
D. None of the above
Suppose ABCD's stock price is currently $50. In the next six months it will either fall to
$40 or rise to $60. What is the current value of a six-month call option with an exercise
price of $50? The six-month risk-free interest rate is 2% (periodic rate).
A. $5.39
B. $15.00
C. $25
D. $09
Profitability index is useful under:
A. Capital rationing
B. Mutually exclusive projects
C. Non-normal projects
D. None of the above
Mr. Thomas has $100 income this year and zero income next year. The market interest
rate is 10% per year. Mr. Thomas also has an investment opportunity in which he can
invest $50 this year and receive $80 next year. Suppose Mr. Thomas consumes $50 this
year and invests in the project. What will be his consumption next year?
A. $55
B. $80
C. $50
D. None of the above
A firm is using $30 million in debt, $10 million in preferred stock and $60 million in
common equity to finance its assets. If the before tax cost of debt is 8%, cost of
preferred stock is 10%, and the cost of common equity is 15%; calculate the weighted
average cost of capital for the firm assuming a tax rate of 35%.
A. 12.4%
B. 11.56%
C. 10.84%
D. None of the above
A project requires an initial investment of $200,000 and is expected to produce a cash
flow before taxes of 120,000 per year for two years. [i.e. cash flows will occur at t = 1
and t = 2]. The corporate tax rate is 30%. The assets will be depreciated using MACRS
- 3 year schedule: (t=1, 33%); (t = 2: 45%); (t = 3: 15%); (t = 4: 7%). The company's
tax situation is such that it can make use of all applicable tax shields. The opportunity
cost of capital is 12%. Assume that the asset can be sold for book value. Calculate the
NPV of the project: (Approximately)
A. $22,463
B. $19,315
C. $16,244
D. None of the above
What is the net present value of the following cash flow at a discount rate of 11%?
A. $69,108.03
B. $231,432.51
C. $80,000
D. None of the above
If the present value annuity factor at 8% APR for 10 years is 6.71, what is the
equivalent future value annuity factor?
A. 3.108
B. 14.487
C. 2.159
D. None of the above
Given the following data: EBIT = 400; Tax = 100; Sales = 3000; Average Total Assets =
1500, calculate the ROA (Return on Assets):
A. 10%
B. 20%
C. 7.5%
D. None of the above
By combining lending and borrowing at the risk-free rate with the efficient portfolios,
we can I) extend the range of investment possibilities
II) change efficient set of portfolios from being curvilinear to a straight line.
III) provide a higher expected return for any level of risk except the tangential portfolio
A. I only
B. I and II only
C. I, II, and III
D. none of the above
The following are some of the actions shareholders can take if the corporation is not
performing well:
A. Replace the board of directors in an election.
B. Force the board of directors to change the management team.
C. Sell their shares of stock in the corporation.
D. Any of the above
If a bond is paying interest semi-annually, then:
A. interest is paid once a year
B. interest is paid every six moths
C. interest is paid every three months
D. none of the above
