FC 81427 | Course Paper

Unlock access to all the studying documents.

View Full Document

An increase in the stock price results in an increase in the call option price.

According to the authors, a reasonable range for the risk premium in the United States

is 5% to 8%.

The “law of conservation of value” is not applicable to the mix of debt securities.

Personal taxes on interest income and equity income will always increase the advantage

of debt to a firm.

The yield to maturity on a bond is really its internal rate of return.

In drawing a decision tree, a square represents a decision point, and a triangle

represents a decision point for fate.

The opportunity cost of capital is higher for safe investments than for risky ones.

Modigliani and Miller Proposition I states that the market value of any firm is

independent of its capital structure.

Behavioral finance and technical analysis are basically the same theory.

Adjusted present value is equal to base-case NPV plus the sum of the present values of

any financing side effects.

“Accept investments that offer rates of return in excess of opportunity cost of capital”.

Indexed bonds were completely unknown in the U.S. before 1997.

The distribution of daily returns for a stock would be closely related to the lognormal

distribution.

An equal-payment home mortgage is an example of an annuity.

The managers of the firm set the dividend paid to the shareholders.

The Black-Scholes model is a discrete time model.

According to Proposition II, the cost of equity increases as more debt is issued, but the

weighted average cost of capital remains unchanged.

1 + upside change = u = e^()(h).

A majority of research supports the theory that past stock movements can predict future

asset prices.

According to the Du Pont system:

Risk premium is the difference between the security return and the Treasury bill return.

MM’s Proposition I corrected for corporate taxes states that: Value of levered firm =

Value (all equity financed) + PV tax shield.

Investors require higher returns on levered equity than on equivalent unlevered equity.

Expected return on assets depends on several factors including the firm’s capital

structure.

The controller’s responsibilities include banking relations and cash management.

Firms that use break-even on an accounting basis are really losing the opportunity cost

of capital on their investments.

Working capital is needed additional investment in the project and should considered

for cash flow estimation.

The internal rate of return is the discount rate that makes the PV of a project’s cash

inflows equal to zero.

Depreciation is not included in sources of cash because it is an expense.

Beta of a well-diversified portfolio is equal to the value weighted average beta of the

securities

included in the portfolio.

The term structure of interest rate is the relationship between yield to maturity and

maturity.

Strategy C implies a short-term cash surplus.

The constant growth formula for stock valuation does not work for firms with negative

growth (declining) rates in dividends.

It is possible to replicate an investment in a call option by a levered investment in the

underlying asset.

A large percentage of the total value of a growth stock comes from the growth

opportunity.

The value of a levered firm is given by:

Value of levered firm = Value (all equity financed) + (TC) * (D) This assumes that the

debt is perpetual debt.

In the case of a growing perpetuity, the present value of the cash flow is given by:

[C1/(r – g)] where r > g.

Defaulted bonds often pay some level of residual?

A safe dollar is always worth less than a risky dollar because the rate of return on a safe

investment is generally low and the rate of return on a risky investment is generally

high.

“Accept investments that have positive net present values” is called the net present

value rule.

A firm has a total market value of $10 million and debt has a market value of $4

million. What is the after-tax weighted average cost of capital if the before – tax cost of

debt is 10%, the cost of equity is 15% and the tax rate is 35%?

A. 13%

B. 11.6%

C. 8.75%

D. None of the given answers

The historical returns data for the past four years for Stock C and the stock market

portfolio returns are: Stock C: 10%, 30%, 20%, 20%; Market Portfolio: 5%, 15%, 25%,

15%. If the risk-free rate of return is 5%, calculate the required rate of return on the

Stock C using CAPM.

A. 5%

B. 10%

C. 15%

D. none of the above

What would best explain the reluctance of General Motors to eliminate its dividend in

2008, only a few months before its financial collapse and eventual government

takeover?

A. Clientele effect

B. Leftist theory

C. Rightest theory

D. Signaling hypothesis

A bond with a face value of $1,000, coupon rate of 0%, yield to maturity of 9%, and ten

years to maturity. This bond’s duration is:

A. 6.7 years

B. 7.5 years

C. 9.6 years

D. 10.0 years

If the beta of Amazon.com is 2.2, risk-free rate is 5.5% and the market risk premium is

8%, calculate the expected rate of return for Amazon.com stock:

A. 15.8%

B. 14.3%

C. 2%

D. 23.1%

Super Computer Company’s stock is selling for $100 per share today. It is expected that

this stock will pay a dividend of 6 dollars per share, and then be sold for $114 per share

at the end of one year. Calculate the expected rate of return for the shareholders.

A. 20%

B. 15%

C. 10%

D. 25%

Short-term financial plan models are offered by:

I) banks

II) accounting firms

III) management consultants

IV) specialized computer software firms

A. I only

B. I and II only

C. I, II and III only

D. I, II III and IV

Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the

construction of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain

constant. The price of oil is $50/bbl and the extraction costs are $20/bbl. The quantity

of oil Q = 200,000 bbl per year forever. The risk-free rate is 10% per year, which is also

the cost of capital (Ignore taxes). Calculate the NPV to invest today.

A. +10,000,000

B. +6,000,000

C. +4,000,000

D. none of the above

Market risk is also called:

I) systematic risk, II) undiversifiable risk, III) firm specific risk.

A. I only

B. II only

C. III only

D. I and II only

For $10,000 you can purchase a 5-year annuity that will pay $2358.65 per year for five

years. The payments are made at the beginning of each year. Calculate the effective

annual interest rate implied by this arrangement: (approximately)

A. 8%

B. 9%

C. 10%

D. none of the above

If the market risk premium is (rm – rf) is 8%, then according to the CAPM, the risk

premium of a stock with beta value of 1.7 must be:

A. less than 12%

B. 12%

C. greater than 12%

D. cannot be determined

Given a book value per share of $10 and a market value of $24, what is the market

capitalization of a firm with 2,000,000 outstanding shares?

A. $2,000,000

B. $20,000,000

C. $28,000,000

D. $48,000,000

A project will have only one internal rate of return if:

A. The net present value is positive

B. The net present value is negative

C. The cash flows decline over the life of the project

D. There is a one sign change in the cash flows

(p. 300) Given the following net future values for harvesting trees (one time harvest):

If the cost of capital is 15%, calculate the optimal year to harvest:

A. Year 1

B. Year 2

C. Year 3

D. Year 4

Assume the corporate tax rate is 30%. The firm has no debt in its capital structure. It is

valued at $100 million. What would be the value of the firm if it issued $50 in perpetual

debt and repurchased the equity?

A. $65

B. $115

C. $100

D. None of the above

Muscle Company is investing in a giant crane. It is expected to cost 6.5 million in initial

investment and it is expected to generate an end of year cash flow of 3.0 million each

year for three years. Calculate the IRR approximately.

A. 14.6 %

B. 16.4 %

C. 18.2 %

D. 22.1%

N(d1) in the Black-Scholes model represents

I) call option delta

II) hedge ratio

III) probability

A. I only

B. II only

C. III only

D. I, II, and III

One key assumption of the Miller and Modigliani (MM) dividend irrelevance argument

is that:

A. Future stock prices are certain

B. There are no capital gains taxes

C. All investments are risk-free

D. New shares are sold at a fair price

Given the following data: Stock price = $50; Exercise price = $45; Risk-free rate = 6%;

variance = 0.2 ; Expiration = 3 months. Calculate value of a European call option: [Use

Black-Scholes Formula]

A. $7.62

B. $7.90

C. $5.00

D. none of the above

Inventory consists of:

A. finished goods

B. raw material and finished goods

C. raw material, work in process, and finished goods

D. none of the above

The following are examples of real assets:

I) Machinery; II) Office buildings; III) Warehouse; IV) Common stock

A. I, II, and III only

B. I and II only

C. IV only

D. I only

The Sarbanes-Oxley Act of 2002 (SOX) was passed largely in response to:

A. the corporate accounting scandals of the previous years

B. the increase in the budget deficits

C. the increase in the trade deficits

D. none of the above

When a firm has no debt, then such a firm is known as:

I) an unlevered firm

II) a levered firm

III) an all-equity firm

A. I only

B. II only

C. III only

D. I and III only

If investors have a marginal tax rate of 20% and a firm has announced a dividend of $5;

A. The price of stock should decrease by $4 on the ex-dividend date

B. The price of the stock should decrease by $5 on the ex-dividend date

C. The price of the stock should increase by $5 on the ex-dividend date

D. The price of the stock should increase by $4 on the ex-dividend date

What is the current value of a six-month call option with an exercise price of $12? The

six-month risk-free interest rate (periodic rate) is 5%. [Use the risk-neutral valuation

method]

A. $9.78

B. $10.28

C. $16.88

D. $13.33

Dividends are decided by:

I) The managers of a firm

II) The government

III) The board of directors

A. I only

B. II only

C. III only

D. I and II only

Suppose an investor buys one share of stock and a put option on the stock and

simultaneously sells a call option on the stock with the same exercise price. What will

be the value of his investment on the final exercise date?

A. Above the exercise price if the stock price rises and below the exercise price if it

falls

B. Equal to the exercise price regardless of the stock price

C. Equal to zero regardless of the stock price

D. Below the exercise price if the stock price rises and above if it falls

Last year Foley Inc. reported total assets of $500, equity of $200, net income of $120,

dividends of $70 and earnings retained in the period of $50. What is Foley Inc.’s

internal growth rate?

A. 17.5%

B. 30.0%

C. 10.0%

D. 12.5%

The costs of financial distress depend on the:

I) probability of financial distress

II) corporate and personal tax rates

III) the magnitude of costs encountered if financial distress occurs

A. I only

B. I and II only

C. I, II and III

D. I and III only

The statement that stock prices follow a random walk implies that:

I) The correlation coefficient between successive price changes (auto correlation) is not

significantly different from zero.

II) Successive price changes are positively related.

III) Successive price changes are negatively related.

IV) The autocorrelation coefficient is positive.

A. I only

B. II only

C. II and III only

D. IV only

What is the present value of $5000 per year annuity at a discount rate of 10% for 6

years?

A. $21,776.30

B. $3,371.91

C. $16,760.78

D. None of the above

What is the present value of $1000 per year annuity for five years at an interest rate of

12%?

A. $6,352.85

B. $3,604.78

C. $567.43

D. None of the above

The net present value of a project depends upon:

A. company’s choice of accounting method

B. manager’s tastes and preferences

C. project’s cash flows and opportunity cost of capital

D. all of the above

Discuss some of the disadvantages of the payback rule.

Explain why international stock may have high standard deviation but low betas.

Briefly explain how the formulas that are used for valuing common stocks can also be

used to value businesses.

Which is the most often used method by managers to make decisions?

Briefly explain the “capital asset pricing model.”

Explain what implied volatility, as measured by the VIX, may mean to the overall stock

market.

Briefly explain the cash flows associated with a bond to the investor.

Briefly explain the concept of risk.

Briefly discuss the usefulness of Monte Carlo simulation in project analysis.

Briefly discuss the risk adjusted discount rate approach to estimating the NPV of a

project.

Discuss the reasons why a company should prepare a cash budget.

Discuss the importance of conducting post audits.

What is the relationship between spot and forward rates?

Briefly explain the acronym MACRS.

Discuss some of the advantages of using the payback method.

Briefly describe the middle-of-the-roaders’ position.

Briefly explain how interest tax shields contribute to the value of stockholders’ equity.

Explain the term efficient portfolios.

What is the beta of a portfolio with a large number of randomly selected stocks?