The Sisyphean Corporation is considering investing in a new cane manufacturing
machine that has an estimated life of three years. The cost of the machine is $30,000
and the machine will be depreciated straight line over its three-year life to a residual
value of $0.
The cane manufacturing machine will result in sales of 2,000 canes in year 1. Sales are
estimated to grow by 10% per year each year through year three. The price per cane that
Sisyphean will charge its customers is $18 each and is to remain constant. The canes
have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will
require an increase in various net working capital accounts. It is estimated that the
Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual
sales in accounts receivable, 9% of its annual sales in inventory, and 6% of its annual
sales in accounts payable. The firm is in the 35% tax bracket, and has a cost of capital
of 10%.
The Sisyphean Company is considering a new project that will have an annual
depreciation expense of $2.5 million. If Sisyphean’s marginal corporate tax rate is 40%
and their average corporate tax rate is 30%, then what is the value of the depreciation
tax shield on their new project?
A) $750,000
B) $1,000,000
C) $1,500,000
D) $1,750,000
Monsters Incorporated (MI) in ready to launch a new product. Depending upon the
success of this product, MI will have a value of either $100 million, $150 million, or
$191 million, with each outcome being equally likely. The cash flows are unrelated to
the state of the economy (i.e. risk from the project is diversifiable) so that the project
has a beta of 0 and a cost of capital equal to the risk-free rate, which is currently 5%.
Assume that the capital markets are perfect.
Suppose that MI has zero-coupon debt with a $125 million face value due next year.
The yield to maturity of MI’s debt is closest to:
A) 12.5%
B) 7.8%
C) 25.0%
D) 5.0%
Which of the following statements is FALSE?
A) We begin the capital budgeting process by determining the incremental earnings of a
project.
B) The marginal corporate tax rate is the tax rate the firm will pay on an incremental
dollar of pre-tax income.
C) Investments in plant, property, and equipment are directly listed as expense when
calculating earnings.
D) The opportunity cost of using a resource is the value it could have provided in its
best alternative use.
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 two is closest to:
A) $345
B) $455
C) $275
D) -$5
Which of the following investments offered the lowest overall return over the past
eighty years?
A) Small stocks
B) Treasury Bills
C) S&P 500
D) Corporate bonds
If the risk-free rate of interest (rf) is 6%, then you should be indifferent between
receiving $250 in one year or
A) $235.85 today.
B) $250.00 today.
C) $265.00 today.
D) None of the above
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 bondholders expected loss rate in the event of
default is 50%. 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%
Big Cure and Little Cure are both pharmaceutical companies. Big Cure presently has a
potential “blockbuster” drug before the Food and Drug Administration (FDA) waiting
for approval. If approved, Big Cure’s blockbuster drug will produce $1 billion in net
income for Big Cure. Little Cure has 10 separate less important drugs before the FDA
waiting for approval. If approved, each of Little Cure’s drugs would produce $100
million in net income for Little Cure. The probability of the FDA approving a drug is
50%.
Which pharmaceutical company faces less risk?
Consider an ETF that is made up of one share each of IBM, MRK, and C. The
minimum ask price for this ETF in a normal market is closest to:
A) $162.85
B) $163.00
C) $168.00
D) $168.10
Your firm needs to invest in a new delivery truck. The life expectancy of the delivery
truck is five years. You can purchase a new delivery truck for an upfront cost of
$200,000, or you can lease a truck from the manufacturer for five years for a monthly
lease payment of $4000 (paid at the end of each month). Your firm can borrow at 6%
APR with quarterly compounding.
The effective annual rate for a credit card that charges a 19.9% APR compounded daily
is closest to:
A) 18.15%
B) 19.9%
C) 22.0%
D) 24.2%
Nielson Motors (NM) is a newly public firm with 25 million shares outstanding. You
are doing a valuation analysis of Nielson and you estimate its free cash flow in the
coming year to be $40 million. You expect the firm’s free cash flows to grow by 4% per
year in subsequent years. Because the firm has only been listed on the stock exchange
for a short time, you do not have an accurate assessment of Nielson’s equity beta.
However, you do have the following data for another firm in the same industry:
Nielson has a much lower debt-equity ratio of .5, which is expected to remain stable,
and Nielson’s debt is risk free. Nielson’s corporate tax rate is 40%, the risk-free rate is
5%, and the expected return on the market portfolio is 10%.
Nielson’s share price is closest to:
A) $20.80
B) $24.40
C) $27.50
D) $31.20
Which of the following statements is FALSE?
A) The project’s free cash flow to equity shows the expected amount of additional cash
the firm will have available to pay dividends (or conduct share repurchases) each year.
B) The value of the project’s FCFE should be identical to the NPV computed using the
WACC and APV methods.
C) The value of the project’s FCFE represents the gain to shareholders from the project.
D) Because interest payments are deducted before taxes, we adjust the firm’s FCF by
their before-tax cost.
Define the following terms:
(a) perpetuity
(b) annuity
(c) growing perpetuity
(d) growing annuity
Consider the following expected returns, volatilities, and correlations:
Consider a portfolio consisting of only Duke Energy and Microsoft.The expected return
of a portfolio that is equally invested in Duke Energy and Microsoft is closest to:
A) 28%
B) 29%
C) 24%
D) 23%
Which of the following statements is FALSE?
A) Since the publication of their original paper, Modigliani and Miller’s ideas have
greatly influenced finance research and practice.
B) Proposition I was one of the first arguments to show that the Law of One Price could
have strong implications for security prices and firm values in a competitive market; it
marks the beginning of the modern theory of corporate finance.
C) The conservation of value principle extends far beyond questions of debt versus
equity
or even capital structure.
D) The conservation of value principle for financial markets states that with perfect
capital markets, financial transactions neither add nor destroy value, but instead
represent a repackaging of risk (and therefore return).
You have an $8,000 balance on your credit card, which charges 18% interest annually
(1% per month). If you can afford to pay $100 per month, how many months will it take
to pay the credit card in full?
A) 170 months
B) 14 months
C) 162 months
D) You will never get the card paid off at that rate.
Which of the following statements regarding net income transferred to retained earnings
is correct?
A) Net income = net income transferred to retained earnings – dividends
B) Net income transferred to retain earnings = net income + dividends
C) Net income = net income transferred to retain earnings + dividends
D) Net income transferred to retain earnings – net income = dividends
The British government has a consol bond outstanding that pays ₤100 in interest each
year If the current rate of interest is 8%, then the future value 20 years from now of an
investment that pays $1000 per year and lasts 20 years is closest to:
A) $45,762
B) $36,725
C) $9,818
D) $93,219
The most senior financial manager in a corporation is usually called:
A) the chief executive officer.
B) the chief financial officer.
C) the chief operating officer.
D) the chairman of the board.