Suppose all possible investment opportunities in the world are limited to the four stocks
list in the table below:
Suppose that you are holding a market portfolio and you have invested $9,000 in
Rearden Metal. The amount that you have invested in Nielson Motors is closest to:
A) $6,000
B) $7,715
C) $9,000
D) $10,500
Use the table for the question(s) below.
Consider the following three individuals portfolios consisting of investments in four
stocks:
Assuming that the risk-free rate is 4% and the expected return on the market is 12%,
then required return on Peter’s portfolio is closest to:
A) 20%
B) 22%
C) 18%
D) 16%
What conclusions can you make about the degree of international integration between
the U.S. and Argentine markets?
A) The markets are integrated since the PV of investing dollars today and converting
them with a forward contract is less than converting into Pesos today and investing
those Pesos for six months.
B) The markets are integrated since the PV of investing dollars today and converting
them with a forward contract is greater than converting into Pesos today and investing
those Pesos for six months.
C) The markets are integrated since the PV of investing dollars today and converting
them with a forward contract is approximately equal to converting into Pesos today and
investing those Pesos for six months.
D) The markets are not integrated since the PV of investing dollars today and
converting them with a forward contract is greater than converting into Pesos today and
investing those Pesos for six months.
Which of the following statements is false?
A) Leverage decreases the risk of the equity of a firm.
B) Because the cash flows of the debt and equity sum to the cash flows of the project,
by the Law of One Price the combined values of debt and equity must be equal to the
cash flows of the project.
C) Franco Modigliani and Merton Miller argued that with perfect capital markets, the
total value of a firm should not depend on its capital structure.
D) It is inappropriate to discount the cash flows of levered equity at the same discount
rate that we use for unlevered equity.
Use the following information to answer the problems below.
Consider two banks. Bank A has 1000 loans outstanding each for $100,000, that it
expects to be fully repaid today. Each of Bank A’s loans have a 6% probability of
default, in which case the bank will receive $0 for each of the defaulting loans. Bank B
has 100 loans of $1 million outstanding, which it also expects to be fully repaid today.
Each of Bank B’s loans have a 5% probability of default, in which case the bank will
receive $0 for each of the defaulting loans. The chance of default is independent across
all the loans.
The expected overall payoff to Bank A is:
A) $5,000,000
B) $6,000,000
C) $94,000,000
D) $95,000,000
Which of the following statements is false?
A) As a general rule, the WACC method is the easiest to use when the firm will
maintain a fixed debt-to-value ratio over the life of the investment.
B) The FTE method is typically used only in complicated settings for which the values
of other securities in the firm’s capital structure or the interest tax shield are themselves
difficult to determine.
C) For alternative leverage policies, the FTE method is usually the most straightforward
approach.
D) When used consistently, the WACC, APV, and FTE methods produce the same
valuation for the investment.
Use the following information to answer the question(s) below.
Galt Industries has 50 million shares outstanding and a market capitalization of $1.25
billion. It also has $750 million in debt outstanding. Galt Industries has decided to
delever the firm by issuing new equity and completely repaying all the outstanding
debt. Assume perfect capital markets.
The number of shares that Galt must issue is closest to:
A) 15 million
B) 25 million
C) 30 million
D) 40 million
Use the information for the question(s) below.
Luther Industries needs to raise $25 million to fund a new office complex. The
company plans on issuing ten-year bonds with a face value of $1000 and a coupon rate
of 7.0% (annual payments). The following table summarizes the YTM for similar
ten-year corporate bonds of various credit ratings:
What rating must Luther receive on these bonds if they want the bonds to be issued at
par?
A) A
B) B
C) BBB
D) AA
Which of the following is/are not corporate monitors?
A) Security analysts
B) Lenders
C) Securities and Exchange Commission
D) All of the above are monitors.
Use the information for the question(s) below.
Luther Industries currently has 5 million shares outstanding and it stock is currently
trading at $40 per share.
Assuming Luther issues a 5:2 stock split, then Luther’s new share price is closest to:
A) $32.00
B) $16.00
C) $24.00
D) $30.00
Which of the following statements is false?
A) It is important to keep in mind that good governance is value enhancing and so, in
principle, is something investors in the firm should strive for.
B) Corporate governance is a system of checks and balances that trades off costs and
benefits.
C) Because good governance is based upon a basic set of principals, like those detailed
in the Cadbury Commission’s findings, one should expect all firms to display similar
governance structures.
D) The costs and benefits of a corporate governance system also depend on cultural
norms.
Use the information for the question(s) below.
KT Enterprises, a U.S. import-export trading, is considering its international tax
situation. Currently KT is U.S. tax rate is 35%. KT has significant operations in both
Japan and Ireland. In Japan the current exchange rate is 118.4/$ and earnings in Japan
are taxed at 41%. In Ireland the current exchange rate is $1.27/€ and earnings in Ireland
are taxed at 12.5%. KT’s profits, which are fully and immediately repatriated, and
foreign taxes paid for the current year are shown here (in millions):
After the Irish taxes are paid, the amount of the earnings before interest and after taxes
in dollars from the Ireland operations is closest to:
A) $5.1 million
B) $20.5 million
C) $35.6 million
D) $29.5 million
Kinston Industries just announced that it will cut its dividend from $3.00 to $2.00 per
share and use the extra funds to expand its operations. Kinston’s dividends were
expected to grow at a 2% rate, and its share price was $37.50. With the new expansion,
Kinston dividends are expected to grow at a 5% rate. Kinston’s share price following
this announcement should be:
A) $20.00
B) $30.00
C) $37.50
D) $40.00
Wyatt oil presently pays no dividend. You anticipate Wyatt Oil will pay an annual
dividend of $0.56 per share two years from today and you expect dividends to grow by
4% per year thereafter. In Wyatt Oil’s equity cost of capital is 12%, then the value of a
share of Wyatt oil today is:
A) $4.67
B) $5.00
C) $6.25
D) $7.00
Use the following information to answer the question(s) below.
Nielson Motors (NM) has no debt. Its assets will be worth $600 million in one year if
the economy is strong, but only $300 million if the economy is weak. Both events are
equally likely. The market value today of Nielson’s assets is $400 million.
The expected return for Nielson Motors stock without leverage is closest to:
A) -25.0%
B) -17.5%
C) -12.5%
D) 12.5%
Use the information for the question(s) below.
Suppose that in the coming year, you expect Exxon-Mobil stick to have a volatility of
42% and a beta of 0.9, and Merck’s stock to have a volatility of 24% and a beta of 1.1.
The risk free interest rate is 4% and the markets expected return is 12%.
Which stock has the highest systematic risk?
A) Merck since it has a higher Beta
B) Exxon-Mobil since it has a lower beta
C) Exxon-Mobil since it has a higher volatility
D) Merck since it has a lower volatility
Which of the following statements is false?
A) Because the WACC incorporates the tax savings from debt, we can compute the
levered valueof an investment, which is its value including the benefit of interest tax
shields given the firm’s leverage policy, by discounting its future free cash flow using
the WACC.
B) The WACC incorporates the benefit of the interest tax shield by using the firm’s
before-taxcost of capital for debt.
C) When the market risk of the project is similar to the average market risk of the firm’s
investments, then its cost of capital is equivalent to the cost of capital for a portfolio of
all of the firm’s securities; that is, the project’s cost of capital is equal to the firm’s
weighted average cost of capital (WACC).
D) A project’s cost of capital depends on its risk.
Which of the following adjustments is not correct if you are trying to calculate cash
flow from financing activities?
A) Add dividends paid
B) Add any increase in long term borrowing
C) Add any increase in short-term borrowing
D) Add proceeds from the sale of stock
Rearden Metals is considering opening a strip mining operation to provide some of the
raw materials needed in producing Rearden metal. The initial purchase of the land and
the associated costs of opening up mining operations will cost $100 million today. The
mine is expected to generate $16 million worth of ore per year for the next 12 years. At
the end of the 12th year Rearden will need to spend $20 million to restore the land to its
original pristine nature appearance.
The number of potential IRRs that exist for Rearden’s mining operation is equal to:
A) 0
B) 1
C) 2
D) 12
Which of the following statements regarding international projects is false?
A) Interest rates and costs of capital will likely be different in the foreign country as a
result of the macroeconomic environment.
B) The project will most likely generate foreign currency cash flows, although the firm
cares about the foreign currency value of the project.
C) Under internationally integrated capital markets, the value of an investment does not
depend on the currency we use in the analysis.
D) The firm will probably face a different tax rate in the foreign country and will be
subject to both foreign and domestic tax codes.
Use the table for the question(s) below.
Consider the following expected returns, volatilities, and correlations:
The volatility of a portfolio that is consists of a long position of $10000 in Wal-Mart
and a short position of $2000 in Microsoft is closest to:
A) 9%
B) 14%
C) 11%
D) 12%
Explanation: B) Var(Rp) = x1
2(.14)2 + (- 25)2(.24)2 + 2(1.25)(-.25)(0.7)(.14)(.24)
Which of the following money market investments is a short-term debt obligations of
the U.S. government?
A) Treasury Bill
B) Repurchase Agreement
C) Commercial Paper
D) Certificates of Deposit (CD)
E) Banker’s Acceptance
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 cost of capital for the oil refining division is closest to:
A) 6.5%
B) 7.0%
C) 8.5%
D) 10.0%
Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the
risk free rate, then the cash flow that equity holders will receive in one year in a weak
economy is closest to:
A) $6,000
B) $10,000
C) $0
D) $33,000
Which of the following statements is false?
A) Other benefits from deferral arise because the firm effectively gains a real option to
repatriate income at times when repatriation might be cheaper.
B) By pooling foreign income, the firm effectively pays the combined tax rate on all
foreign income.
C) In years in which the U.S. tax rate exceeds the combined tax rate on all foreign
income, the repatriation of additional income does not incur an additional U.S. tax
liability, so the earnings can be repatriated tax free.
D) Deferring repatriation of earnings lowers the overall tax burden in much the same
way as deferring capital gains lowers the tax burden imposed by the capital gains tax.
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, at-the-money call option on Taggart stock is
closest to:
A) $1.45
B) $3.15
C) $4.75
D) $9.50
U.S. public companies are required to file their annual financial statements with the
U.S. Securities and Exchange Commission on which form?
A) 10-A
B) 10-K
C) 10-Q
D) 10-SEC
Which of the following is not a real option?
A) A stock option
B) An abandonment option
C) An investment timing option
D) An expansion option
Use the following information to answer the question(s) below.
Suppose that Merck (MRK) stock is trading for $36.70 per share with 2.11 billion
shares outstanding while Boeing (BA) has 697.5 million shares outstanding and a
market capitalization of $38.223 billion. Assume that you hold the market portfolio.
If you hold 1,000 shares of Merck, then the number of shares of Boeing that your hold
is closest to:
A) 240 shares
B) 330 shares
C) 510 shares
D) 780 shares
Henry Rearden is saving for retirement and has determined that to live comfortably he
must save $3 million by his 65 birthday. Henry just turned 30 today, and he has decided
that starting today and continuing on every birthday up to and including his 65th
birthday, he will deposit the same amount into an individual retirement account (IRA).
If Henry can earn 8% on his IRA, then the amount he must set aside each year to make
sure that he will have $3 million in his account on his 65th birthday is closest to:
A) $16,035
B) $17,410
C) $83,335
D) $85,715
On the balance sheet, current maturities of long-term debt debt appears
A) in the Stockholders’ Equity section.
B) in the Operating Expenses section.
C) in the Current Assets section.
D) in the Current Liabilities section.
Which of the following statements is false?
A) Under the Modigliani-Miller assumptions of perfect capital markets, the amounts of
payables and receivables are irrelevant.
B) One factor that contributes to the length of a firm’s receivables and payables is the
delay between the time a bill is paid and the cash is actually received.
C) Collection floatis the amount of time it takes before payments to suppliers actually
result in a cash outflow for the firm.
D) The credit that the firm is extending to its customer is known as trade credit.
Use the following information to answer the question(s) below.
The effective dividend tax rate in 1989 is closest to:
A) 0%
B) 20%
C) 25%
D) 30%
You have an investment opportunity in the United Kingdom that requires an investment
of $500,000 today and will produce a cash flow of 320,000 in one year with no risk.
Suppose the risk-free rate of interest in the U.K is 6% and the current competitive
exchange rate is $1.70/. What is the NPV of this project? Would you take the project?
Consider the following list of projects:
You are given a budget of only $1,800,000 to invest in projects. Which projects will
you select, in what order will you select them, and why?
Your firm is preparing to open a new retail strip mall and you have multiple businesses
that would like lease space in it. Each business will pay a fixed amount of rent each
month plus a percentage of the gross sales generated each month. The cash flows from
each of the businesses has approximately the same amount of risk. The business names,
square footage requirements, and monthly expected cash flows for each of the
businesses that would like to lease space in your strip mall are provided below:
If your new strip mall will have 16,000 square feet of retail space available to be leased,
to which businesses should you lease and why?
What is an opportunity cost? Should it be included in the incremental cash flows for a
project? Why or why not?
Use the information for the question(s) below.
Aardvark Industries is considering a project that will generate the following free cash
flows:
You are also provided with the following market value balance sheet and information
regarding Aardvark’s cost of capital:
Suppose that to fund this new project, Aardvark borrows $150 with the principal to be
paid in three equal installments at the end each year. Calculate the The levered value of
Aardvark’s new project.
Use the information for the question(s) below.
Iota Industries is an all-equity firm with 50 million shares outstanding. Iota has $200
million in cash and expects future free cash flows of $75 million per year. Management
plans to use the cash to expand the firm’s operations, which in turn will increase future
free cash flows by 12%. Iota’s cost of capital is 10% and assume that capital markets are
perfect.
A member of Iota’s board of directors suggests that Iota’s stock price would be higher if
they used the $200 million to repurchase shares instead of funding the expansion. If you
were advising the board, what course of action would you recommend, expansion or
repurchase? Which provides the higher stock price?
In December 2005, the spot exchange rate for the British Pound was $1.7188/. Suppose
that at the same time the on-year interest rate in the United States was 4.85% and the
one-year interest rate in Great Britain was 3.15%. Based on these rates, what forward
exchange rate is consistent with no arbitrage.
What is a sunk cost? Should it be included in the incremental cash flows for a project?
Why or why not?
Use the information for the question(s) below.
Two years ago you purchased a new SUV. You financed your SUV for 60 months (with
payments made at the end of the month) with a loan at 5.9% APR. You monthly
payments are $617.16 and you have just made your 24th monthly payment on your
SUV.
Assuming that you have made all of the first 24 payments on time, then how much
interest have you paid over the first two years of your loan?
Use the table for the question(s) below.
Consider the following expected returns, volatilities, and correlations:
Consider a portfolio consisting of only Microsoft and Wal-Mart stock. Calculate the
volatility of such a portfolio when the weight on Microsoft stock is 0%, 25%, 50%,
75%, and 100%
What strategies are available to shareholders to help ensure that managers are motivated
to act in the interest of the shareholders rather than their own interest?
What is the purpose of the sensitivity analysis?
Goldsboro Industries has an average accounts payable balance of $680,000. Its annual
cost of goods sold is $4,500,000, and it receives terms of 1/10, net 40 from its suppliers.
Goldsboro chooses to forgo this discount. Is Goldsboro managing its accounts payables
well?
Use the table for the question(s) below.
Consider the following covariances between securities:
What is the variance on a portfolio that has $3000 invested in Duke Energy, $4000
invested in Microsoft, and $3000 invested in Wal-Mart stock?
Sisyphean Bolder Movers Incorporated has no debt, a total equity capitalization of $50
billion, and a beta of 2.0. Included in Sisyphean’s assets are $12 billion in cash and
risk-free securities. Calculate Sisyphean’s enterprise value and unlevered cost of equity
considering the fact that Sisyphean’s cash is risk-free.
Two separate firms are considering investing in this project. Firm unlevered plans to
fund the entire $80,000 investment using equity, while firm levered plans to borrow
$45,000 at the risk-free rate and use equity to finance the remainder of the initial
investment. Calculate the expected returns for both the levered and unlevered firm.
An exchange traded fund (ETF) is a security that represents a portfolio of individual
stocks. Consider an ETF for which each share represents a portfolio of two shares of
International Business Machines (IBM), three shares of Merck (MRK), and three shares
of Citigroup Inc. (C). Suppose the current market price of each individual stock are
shown below:
Assume that the ETF is trading for $366.00, what (if any) arbitrage opportunity exists?
What (if any) trades would you make?
Luther Industries does not pay dividend and is currently trading at $25 per share. The
current risk-free rate of interest is 5%. Calculate the price of a call option on Luther
Industries with a strike price of $30 that expires in 75 days when N(d1) = .639 and
N(d2) = .454.
Explain why the expected return of a corporate bind does not equal its yield to
maturity?
Suppose the interest rate on Russian government bonds is 7.8%, and the current
exchange rate is 26.8 rubles per dollar. If the forward exchange rate is 27.2 rubles per
dollar, and the current U.S. risk-free interest rate is 4.6%, what is the implied credit
spread for the Russian government bonds?
