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 increase risk to maximize the
expected payoff to equity holders. If Rearden has $230 million in debt due in one year,
then the expected value of Rearden’s assets are closest to:
A) $280 million
B) $295 million
C) $300 million
D) $900 million
Answer:
Consider the following two projects:
The incremental IRR of Project B over Project A is closest to:
A) 12.6%
B) 23.3%
C) 1.7%
D) 17.3%
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 free cash flow from Shepard Industries project in year one is closest to:
A) $240
B) $300
C) -$5
D) $390
Answer:
Von Bora Corporation (VBC) is expected to pay a $2.00 dividend at the end of this year.
If you expect VBC’s dividend to grow by 5% per year forever and VBC’s equity cost of
capital is 13%, then the value of a share of VBS stock is closest to:
A) $25.00
B) $40.00
C) $15.40
D) $11.10
Answer:
Which of the following statements is false?
A) Because expected returns are not easy to estimate, each portfolio that is added to a
multifactor model increases the difficulty of implementing the model.
B) The self-financing portfolio made from high minus low book-to-market stocks is
called the high-minus-low (HML) portfolio.
C) The FFC factor specification was identified a little more than ten years ago.
Although it is widely used in academic literature to measure risk, much debate persists
about whether it really is a significant improvement over the CAPM.
D) A trading strategy that each year short sells portfolio S (small stocks) and uses this
position to buy portfolio B (big stocks) has produced positive risk adjusted returns
historically. This self-financing portfolio is widely known as the small minus big
(SMB) portfolio.
Answer:
Which of the following statements is false?
A) If the foreign tax rate exceeds the U.S. tax rate, companies must pay this higher rate
on foreign earnings.
B) U.S. tax policy allows companies to apply the part of the tax credit that is not used to
offset domestic taxes owed, so this extra tax credit is not wasted.
C) If the foreign tax rate is less than the U.S. tax rate, the company pays total taxes
equal to the U.S. tax rate on its foreign earnings.
D) A full tax credit is given for foreign taxes paid up tothe amount of the U.S. tax
liability.
Answer:
Use the following information to answer the question(s) below.
Galt Industries is trading for $20 per share and has 25 million shares outstanding. Galt
Industries has a debt-equity ratio of 0.4 and its debt is zero coupon debt with a ten year
maturity and a yield to maturity of 8%.
In describing Galt’s debt as a put option, the strike price of the put option is:
A) $200 million
B) $300 million
C) $500 million
D) $700 million
Answer:
Which of the following statements is false?
A) If the U.S. tax rate exceeds the combined tax rate on all foreign income, it is valid to
assume that the firm pays the same tax rate on all income no matter where it is earned.
B) Firms can lower their taxes by pooling multiple foreign projects and accelerating the
repatriation of earnings.
C) Under U.S. tax law, multinational corporations may use any excess tax credits
generated in high-tax foreign countries to offset their net U.S. tax liabilities on earnings
in low-tax foreign countries.
D) If the foreign tax rate exceeds the U.S. tax rate, because the U.S. tax credit exceeds
the amount of U.S. taxes owed, no tax is owed in the United States.
Answer:
Common risk is also called
A) diversifiable risk.
B) correlated risk.
C) uncorrelated risk.
D) independent risk.
Answer:
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.
Answer:
Which of the following firms is likely to maintain low levels of debt?
A) An electric utility
B) A tobacco company
C) An Internet firm
D) A mature restaurant chain
Answer:
Which of the following statements is false?
A) An investor will be willing to pay up to the point at which the current price of a
share of stock equals the present value of the expected future dividends an expected
future sale price.
B) The expected total return of a stock should equal the expected return of other
investments available in the market with equivalent risk.
C) The total amount received in dividends and from selling the stock will depend on the
investor’s investment horizon.
D) If the current stock price were greater than P0 = , it would be a positive
NPV investment, and we would expect investors to rush in and buy it, driving up the
stocks price.
Answer:
Consider the following two projects:
The profitability index for project A is closest to:
A) 0.12
B) 21.65
C) 0.17
D) 12.04
Answer:
Equity in a firm with debt is called
A) levered equity.
B) riskless equity.
C) unlevered equity.
D) risky equity.
Answer:
Use the following information to answer the question(s) below.
Taggart Transcontinental is considering a $250 million investment to launch a new rail
line. The project is expected to generate a free cash flow of $32 million per year, and its
unlevered cost of capital is 8%. Taggart’s marginal corporate tax rate is 35%.
Assuming that to fund the investment Taggart will take on $250 million in permanent
debt and ignoring issuance costs, the NPV of Taggart’s new rail line is closest to:
A) $195 million
B) $200 million
C) $235 million
D) $240 million
Answer:
Use the information for the question(s) below.
Von Bora Corporation is expected pay a dividend of $1.40 per share at the end of this
year and a $1.50 per share at the end of the second year. You expect Von Bora’s stock
price to be $25.00 at the end of two years. Von Bora’s equity cost of capital is 10%
Suppose you plan to hold Von Bora stock for only one year. Your capital gain rate from
holding Von Bora stock for the first year is closest to:
A) 3.5%
B) 4.0%
C) 6.0%
D) 4.5%
Answer:
Suppose you will receive $500 in one year and the risk-free interest rate (rf) is 5%. The
equivalent value today is closest to:
A) $475
B) $476
C) $500
D) $525
Answer:
Which of the following statements is false?
A) When a firm issues new shares that account for a significant percentage of its
outstanding shares, the transaction is called a leveraged recapitalization.
B) MM Proposition I applies to capital structure decisions made at any time during the
life of the firm.
C) By choosing positive-NPV projects that are worth more than their initial investment,
the firm can enhance its value.
D) Holding fixed the cash flows generated by the firm’s assets, however, the choice of
capital structure does not change the value of the firm.
Answer:
A limited liability company is essentially
A) a limited partnership without limited partners.
B) a limited partnership without a general partner.
C) just another name for a limited partnership.
D) just another name for a corporation.
Answer:
Rearden Metal is considering the purchase of a new blast furnace costing a total of $5
million dollars. This furnace will qualify for accelerated depreciation: 20% can be
expense immediately, followed by 32%, 19.2%, 11.52%, 11.52% and 5.76% over the
next five years. However, because of Rearden’s substantial tax loss carry forwards,
Rearden estimates its marginal tax rate to be only 10% over the next five years. Since
Rearden will get very little tax benefit from the depreciation expense, they consider
leasing the furnace instead. Suppose that Rearden and the lessor face the same 8%
borrowing rate, but the lessor has a 40% marginal tax rate. Assume that the furnace is
worthless after five years, the lease term is five years, and a lease would qualify as a
true tax lease.
Assuming that Rearden’s annual lease payments are $1.2 million, then the amount of the
lease-equivalent loan is closest to:
A) $3.8 million
B) $3.9 million
C) $4.0 million
D) $4.2 million
Answer:
Use the figure for the question(s) below.
Consider the following graph of the security market line:
Which of the following statements regarding portfolio “C” is/are correct?
1. Portfolio “C” has a negative alpha.
2. Portfolio “C” is overpriced.
3. Portfolio “C” is less risky than the market portfolio.
4. Portfolio “C” should not exist if the market portfolio is efficient.
A) 1 and 3
B) 2 and 4
C) 1, 3, and 4
D) 3 only
Answer:
Consider the following timeline detailing a stream of cash flows:
If the current market rate of interest is 6%, then the future value of this stream of cash
flows is closest to:
A) $1,723
B) $1,500
C) $1,626
D) $1,288
Answer:
Use the tables for the question(s) below.
Pro Forma Income Statement for Ideko, 2005-2010
Pro Forma Balance Sheet for Ideko, 2005-2010
Assuming that Ideko has a EBITDA multiple of 9.4, then the continuation levered P/E
ratio of Ideko in 2010 is closest to:
A) 17.2
B) 14.5
C) 19.0
D) 16.4
Answer:
Which of the following statements is false?
A) Commercial banks, finance companies, and factors, which are firms that purchase
the receivables of other companies, are the most common sources for secured
short-term loans.
B) The factoring arrangement may be without recourse, in which case the lender bears
the risk of bad-debt losses.
C) In a floating lien, general lien, or blanket lienarrangement, specific inventory is used
to secure the loan.
D) If a firm sells its goods on terms of net 30, then the factor will pay the firm the face
value of its receivables, less a factor’s fee, at the end of 30 days.
Answer:
Which of the following questions is false?
A) The method of payment (cash or stock) affects how the value of the target’s assets is
recorded for tax purposes and it affects the combined firm’s financial statements for
financial reporting.
B) The combined firm must mark up the value assigned to the target’s assets on the
financial statements by allocating the purchase price to target assets according to their
fair market value.
C) Any goodwill created in a merger deal can be amortized for tax purposes over 15
years.
D) Many transactions are carried out as acquisitive reorganizations under the tax code.
These structures allow the target shareholders to defer their tax liability on the part of
the payment made in acquirer stock but they do not allow the acquirer to step up the
book value of the target assets.
Answer:
Consider the following information regarding corporate bonds:
Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to
maturity of 8.6%, and a B rating. The corresponding risk-free rate is 3% and the market
risk premium is 6%. Assuming a normal economy, the expected return on Rearden
Metal’s debt is closest to:
A) 0.6%
B) 1.6%
C) 4.6%
D) 6.0%
Answer:
Which of the following statements is false?
A) Because investors are risk averse, they will demand a risk premium to hold
unsystematic risk.
B) Over any given period, the risk of holding a stock is that the dividends plus the final
stock price will be higher or lower than expected, which makes the realized return risky.
C) The risk premium for diversifiable risk is zero, so investors are not compensated for
holding firm-specific risk.
D) Because investors can eliminate firm-specific risk “for free” by diversifying their
portfolios, they will not require a reward or risk premium for holding it.
Answer:
The largest stock market in the world is
A) the London Stock Exchange.
B) NASDAQ.
C) the American Stock Exchange.
D) the New York Stock Exchange.
Answer:
Use the following information for ECE incorporated:
Perrigo’s book value of equity is closest to:
A) $952.16 million
B) $3,580.14 million
C) $4,168.06 million
D) $4,425.15 million
Answer:
Use the information for the question(s) below.
Assume that you are 30 years old today, and that you are planning on retirement at age
65. Your current salary is $45,000 and you expect your salary to increase at a rate of 5%
per year as long as you work. To save for your retirement, you plan on making annual
contributions to a retirement account. Your first contribution will be made on your 31st
birthday and will be 8% of this year’s salary. Likewise, you expect to deposit 8% of
your salary each year until you reach age 65. Assume that the rate of interest is 7%.
The future value at retirement (age 65) of your savings is closest to:
A) $497,530
B) $928,895
C) $1,263,236
D) $108,000
Answer:
Which of the following statements is false?
A) If there is uncertainty regarding EBIT, then with a higher interest expense there is a
greater risk that interest will exceed EBIT.
B) Even for a firm with positive earnings, growth will affect the optimal leverage ratio.
C) From a tax perspective, the firm’s optimal level of debt is proportional to its current
earnings.
D) The optimal proportion of debt in the firm’s capital structure will be higher, the
higher the firm’s growth rate.
Answer: