Use the table for the question(s) below.
Consider the following zero-coupon yields on default free securities:
The YTM of a 3 year default free security with a face value of $1000 and an annual
coupon rate of 6% is closest to:
A) 5.5%
B) 5.8%
C) 5.5%
D) 5.2%
Which of the following statements is false?
A) Expected return should rise proportionately with volatility.
B) Investors would not choose to hold a portfolio that is more volatile unless they
expected to earn a higher return.
C) Smaller stocks have lower volatility than larger stocks.
D) The largest stocks are typically more volatile than a portfolio of large stocks.
In January 2010, the U.S. Treasury issued a $1000 par. ten-year, inflation-indexed note
with a coupon of 4%. On the date of issue, the consumer price index (CPI) was 200. By
January 2020, the CPI had increased to 300. The principal payment that was made in
January 2020 is closest to:
A) $1000
B) $1020
C) $1030
D) $1500
Which of the following equations is incorrect?
A) Expected future spot interest rate = forward interest rate + risk premium
B) (1 +f1) x (1 +f2) x (1 +f3) x … x (1 + fn) = (1 + YTMn)n
C) fn = – 1
D) (1 + YTMn)n = (1 + YTMn– 1)n– 1(1 + fn)
Which of the following is not a section on the cash flow statement?
A) Income generating activities
B) Investing activities
C) Operating activities
D) Financing activities
Consider the following timeline:
If the current market rate of interest is 10%, then the future value of this timeline is
closest to:
A) $666
B) $500
C) $605
D) $650
Use the following information to answer the question(s) below.
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in
taxes. Assume that Google’s marginal tax rate is 35% and Google’s borrowing cost is
7%.
Assume that investors hold Google stock in retirement accounts that are free from
personal taxes. If Google were to issue sufficient debt to reduce its taxes by $600
million per year permanently, then the amount that Google needs to borrow is closest
to:
A) $14.25 billion
B) $22.00 billion
C) $24.50 billion
D) $40.75 billion
A firm’s net investment is
A) its capital expenditures in excess of depreciation.
B) its free cash flow net of increases in working capital.
C) its enterprise value in excess of debt owed.
D) the market value of equity plus debt.
Which of the following statements regarding perpetuities is false?
A) To find the value of a perpetuity one cash flow at a time would take forever.
B) A perpetuity is a stream of equal cash flows that occurs at regular intervals and lasts
forever.
C) PV of a perpetuity =
D) One example of a perpetuity is the British government bond called a consol.
When a private equity firm purchases the outstanding equity of a publicly traded firm,
thereby taking the company private, the transaction is called a(n)
A) private leveraged transaction.
B) leveraged buyout.
C) cash offer.
D) initial public offering.
The idea that once a manager makes a large investment, he should not abandon the
project is known as the
A) negative NPV fallacy.
B) abandonment fallacy.
C) sunk cost fallacy.
D) dependence fallacy.
Use the following information to answer the question(s) below.
(Please use a copy of the Cumulative Probabilities for the standard normal distribution
for these problems.)
Taggart Transcontinental’s stock has a volatility of 25% and a current stock price of $40
per share. Taggart pays no dividends. The risk-free interest rate is 4%.
The Black-Scholes Δ of a one-year, at-the-money call option on Taggart stock is closest
to:
A) 0.2850
B) 0.4840
C) 0.5160
D) 0.6141
Which of the following questions is false?
A) Sometimes management may believe that the securities they are issuing are priced at
less than (or more than) their true value. If so, the NPV of the transaction, which is the
difference between the actual money raised and the true value of the securities sold,
should not be included in the value of the project.
B) An alternative method of incorporating financial distress and agency costs is to first
value the project ignoring these costs, and then value the incremental cash flows
associated with financial distress and agency problems separately.
C) When the debt leveland, therefore, the probability of financial distressis high, the
expected free cash flow will be reduced by the expected costs associated with financial
distress and agency problems.
D) If the financing of the project involves an equity issue, and if management believes
that the equity will sell at a price that is less than its true value, this mispricing is a cost
of the project for the existing shareholders.
Use the tables for the question(s) below.
Estimated 2005 Income Statement and Balance Sheet Data for Ideko Corporation
The following are financial ratios for three comparable companies:
Based upon the average EV/Sales ratio of the comparable firms, if Ideko holds $6.5
million of cash in excess of its working capital needs, then Ideko’s target market value
of equity is closest to:
A) $165 million
B) $157 million
C) $193 million
D) $191 million
E) $155 million
Use the following information to answer the question(s) below.
d’Anconia Copper has $200 million in cash that it can use for a share repurchase.
Suppose instead that d’Anconia Copper invests the funds in an account paying 5%
interest for one year. Assume that the corporate tax rate is 35%, the individual capital
gains rate is 15% and the individual rate on ordinary income is 30%.
The amount of additional cash that d’Anconia Copper will have at the end of the year
net of corporate taxes is closest to:
A) $2.0 million
B) $5.5 million
C) $6.5 million
D) $7.0 million
Which of the following statements is false?
A) Project externalities are direct effects of the project that may increase of decrease the
profits of other business activities of the firm.
B) Incremental earnings are the amount by which the firm’s earnings are expected to
change as a result of the investment decision.
C) The average selling price of a product and its cost of production will generally
change over time.
D) Any money that has already been spent is a sunk cost and therefore irrelevant in the
capital budgeting process.
Use the table for the question(s) below.
Consider the following yields to maturity on various one-year zero-coupon securities:
The credit spread of the B corporate bond is closest to:
A) 1.6%
B) 0.8%
C) 1.0%
D) 1.4%
Bonds issued by a foreign company in a local market, intended for local investors, and
denominated in the local currency are known as
A) Domestic bonds.
B) Yankee bonds.
C) Eurobonds.
D) Foreign bonds.
Which of the following questions is false?
A) Net Working Capital = Current Assets – Current Liabilities.
B) Because depreciation is not a cash flow, we do not include it in the cash flow
forecast.
C) Tax loss carry backs allow corporations to take losses during the current year and
use them to offset income in future years.
D) Earnings are an accounting measure of firm performance.
In practice which market index is most widely used as a proxy for the market portfolio
in the CAPM?
A) Dow Jones Industrial Average
B) Wilshire 5000
C) S&P 500
D) U.S. Treasury Bill
Use the information for the question(s) below.
Consider the following tax rates:
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax
rates shown are for financial assets held for one year. For assets held less than one year,
capital gains are taxed at the ordinary income tax rate (currently 35% for the highest
bracket); the same is true for dividends if the assets are held for less than 61 days.
The effective dividend tax rate for a one-year individual investor in 2006 is closest to:
A) 20%
B) 15%
C) 35%
D) 0%
Consider the following balance sheet:
If in 2009 Luther has 10.2 million shares outstanding and these shares are trading at $16
per share, then what is Luther’s Enterprise Value?
A) -$63.3 million
B) $353.1 million
C) $389.7 million
D) $516.9 million
Pfizer Inc. (PFE) stock is currently trading on the NYSE with a quoted bid of $18.35
and an ask price of $18.40. At the same time NASDAQ dealers are posting for
following bid and ask prices for PHE:
Which of these NASDAQ represents an arbitrage opportunity when compared to the
NYSE quotes?
A) Only NASDAQ dealer #1
B) Only NASDAQ dealer #2
C) Only NASDAQ dealer #3
D) Both NASDAQ dealer #1 and dealer #3
E) None of the above
Which of the following statements is most correct?
A) An advantage to incorporation is that it allows for less regulation of the business.
B) An advantage of a corporation is that it is subject to double taxation.
C) Unlike a partnership, a disadvantage of a corporation is that has limited liability.
D) Corporations face more regulations when compared to partnerships.
Use the following information to answer the question(s) below.
The risk-free rate of interest is 3% and the market risk premium is 5%.
The value of the gas and convenience store division is closest to:
A) $4,500
B) $6,000
C) $8,600
D) $15,000
Consider the following timeline:
If the current market rate of interest is 8%, then the value as of year 1 is closest to:
A) $0
B) $1003
C) $540
D) $77
Use the following information to answer the question(s) below.
Rearden Metal has earnings per share of $2. It has 10 million shares outstanding and is
trading at $20 per share. Rearden Metal is thinking of buying Associated Steel, which
has earnings per share of $1.25, 4 million shares outstanding, and a price per share of
$15. Rearden Metal will pay for Associated Steel by issuing new shares. There are no
expected synergies from the transaction.
If Rearden offers an exchange ratio such that, at current pre-announcement share prices
for both firms, the offer represents a 20% premium to buy Associated Steel, then actual
premium Rearden will pay will be closest to:
A) 14.7%
B) 18.0%
C) 20.0%
D) 22.4%
Suppose that Rearden Metal currently has no debt and has an equity cost of capital of
12%. Rearden is considering borrowing funds at a cost of 6% and using these funds to
repurchase existing shares of stock. Assume perfect capital markets. If Taggart borrows
until they achieved a debt -to-equity ratio of 50%, then Rearden’s levered cost of equity
would be closest to:
A) 10.0%
B) 12.0%
C) 15.0%
D) 16.0%
Shepard Industries expects free cash flow of $10 million each year. Shepard’s corporate
tax rate is 35%, and its unlevered cost of equity is 10%. The firm also has outstanding
debt of $40 million and it expects to maintain amount of debt permanently.
The value of Shepard Industries with leverage is closest to:
A) $64 million
B) $100 million
C) $135 million
D) $114 million
Which of the following statements is false?
A) Financial transactions are not sources of value, but merely serve to adjust the timing
and risk of the cash flows to best suit the needs of the firm or its investors.
B) The NPV of trading a security in a normal market is zero.
C) We cannot separate a firm’s investment decision from the decision of how to finance
the investment.
D) In normal markets, trading securities neither creates nor destroys value.
Consider the following two projects:
The NPV for project beta is closest to:
A) $24.01
B) $16.92
C) $20.96
D) $14.41
Use the following information to answer the question(s) below.
(Please use a copy of the Cumulative Probabilities for the standard normal distribution
for these problems.)
Taggart Transcontinental’s stock has a volatility of 25% and a current stock price of $40
per share. Taggart pays no dividends. The risk-free interest rate is 4%.
The Black-Scholes value of a one-year European put option on Taggart stock with a
strike price of $50 is closest to:
A) $1.45
B) $3.15
C) $4.75
D) $9.50
Use the table for the question(s) below.
Consider the following returns:
The Correlation between Stock X’s and Stock Z’s returns is closest to:
A) 0.71
B) 0.60
C) 0.62
D) 0.05
Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to
generate additional free cash flows of $40 million per year in subsequent years and will
pay out these future free cash flows as regular dividends. Omicrons unlevered cost of
capital is 10% and there are 10 million shares outstanding. Omicron’s board is meeting
to decide whether to pay out its $50 million in excess cash as a special dividend or to
use it to repurchase shares of the firm’s stock.
Assume that you own 2500 shares of Omicron stock and that Omicron uses the entire
$50 million to repurchase shares. Suppose you are unhappy with Omicron’s decision
and would prefer that Omicron used the excess cash to pay a special dividend. The
number of shares that you would have to sell in order to receive the same amount of
cash as if Omicron paid the special dividend is closest to:
A) 275
B) 310
C) 125
D) 250
Suppose that you want to use the 10 year historical average return on the Index to
forecast the expected future return on the Index. The standard error of your estimate of
the expect return is closest to:
A) 19.4%
B) 3.8%
C) 8.8%
D) 1.95%
What is corporate governance?
KAHR Incorporated will have EBIT this coming year of $45 million. It will also spend
$18 million on total capital expenditures and increases in net working capital, and have
$9 million in depreciation expenses. KAHR is currently an all-equity firm with a
corporate tax rate of 35% and a cost of capital of 10% If the interest rate on new KAHR
debt is 8%, how much should KAHR borrow today if they want to maximize there
interest tax shield?
Luther Industries is offered a $1 million dollar loan for four months at an APR of 9%.
Luther’s bank requires that the firm maintain a compensating balance equal to 5% of the
loan amount in a non-interest bearing account and the bank charges a 1% origination
fee. Calculate the the effective annual rate EAR for this loan.
Consider two mutually exclusive projects with the following cash flows:
If the discount rate for project A is 16%, then what is the NPV for project A?
Use the information for the question(s) below.
Consider the following tax rates:
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax
rates shown are for financial assets held for one year. For assets held less than one year,
capital gains are taxed at the ordinary income tax rate (currently 35% for the highest
bracket); the same is true for dividends if the assets are held for less than 61 days.
Calculate the effective tax disadvantage for retaining cash in 1999, 2001, and 2005.
Use the table for the question(s) below.
Consider the following returns:
Calculate the correlation between Stock Y’s and Stock Z’s returns.
Use the information for the question(s) below.
Luther Industries, a U.S. Corporation, is considering a new project located in Great
Britain. The expected free cash flows from the project are detailed below:
You know that the spot exchange rate is S = 1.8862/. In addition, the risk-free interest
rate on dollars and pounds is 5.4% and 4.6% respectively. Assume that these markets
are internationally integrated and the uncertainty in the free cash flow is not correlated
with uncertainty in the exchange rate. You have determined that the dollar WACC for
these cash flows is 10.2%.
What is the dollar present value of the project?
Use the table for the question(s) below.
Consider the following realized annual returns:
Suppose that you want to use the 10 year historical average return on the Market to
forecast the expected future return on the Market. Calculate the 95% confidence
interval for your estimate of the expect return.
Use the table for the question(s) below.
Consider the following covariances between securities:
The variance on a portfolio that is made up of a $6000 investments in Microsoft and a
$4000 investment in Wal-Mart stock is closest to:
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. If this product line is of average
risk and Luther plans to maintain a constant debt-equity ratio, what after- tax amount
must it receive for the product line in order for the divestiture to be profitable?
What are some of the negative effects of increasing the sensitivity of managerial pay to
firm performance?
Use the information for the question(s) below.
Suppose the purchase price of a bulldozer is $90,000, its residual value in four years is
certain to be $15,000, and there is no risk that the lessee will default on the lease.
Assume that capital markets are perfect and the risk-free interest rate is 6% APR with
monthly compounding.
Calculate the monthly lease payments for a four year $1.00 out lease of the Bulldozer.
What are the four financial statements that all public companies must produce?
Calculate the NPV for Iota’s new project.
Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or
$117,000 in a strong economy, with each outcome being equally likely. The initial
investment required for the project is $80,000, and the project’s cost of capital is 15%.
The risk-free interest rate is 5%.
Suppose that to raise the funds for the initial investment the firm borrows $45,000 at the
risk free rate and issues new equity to cover the remainder. In this situation, calculate
the value of the firm’s levered equity from the project. What is the cost of capital for the
firm’s levered equity?
Rose Industries has a $20 million loan due at the end of the year and its assets will have
a market value of only $15 million when the loan comes due. Currently Rose has $2
million in cash. Rose is considering two possible alternative uses for this cash. One
possibility is to pay the $2 million out to shareholders in the form of a special dividend.
The second possibility is to invest the $2 million into a project that offers a $4 million
NPV. What are the payoffs to the debt and equity holders under each of the two
alternatives? Which alternative would equity holders prefer? Which alternative would
debt holders prefer? What is the economic term that describes this situation?
Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to
generate additional free cash flows of $40 million per year in subsequent years and will
pay out these future free cash flows as regular dividends. Omicrons unlevered cost of
capital is 10% and there are 10 million shares outstanding. Omicron’s board is meeting
to decide whether to pay out its $50 million in excess cash as a special dividend or to
use it to repurchase shares of the firm’s stock.
Assume that you own 4000 shares of Omicron stock and that Omicron uses the entire
$50 million to repurchase shares. Suppose you are unhappy with Omicron’s decision
and would have preferred that Omicron used the excess cash to pay a special dividend.
Detail exactly how you could create a homemade dividend that will provide you with
the same combination of cash and stock that you would have received if Omicron paid
the special dividend.
