Which of the following statements is FALSE?
A) In general, the IRR rule works for a stand-alone project if all of the project’s positive
cash flows precede its negative cash flows.
B) There is no easy fix for the IRR rule when there are multiple IRRs.
C) The payback rule is primarily used because of its simplicity.
D) No investment rule that ignores the set of alternative investment alternatives can be
optimal.
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.
Assuming that in the event of default, 20% of the value of MI’s assets will be lost in
bankruptcy costs, the initial value of MI’s equity without leverage is closest to:
A) $150 million
B) $147 million
C) $140 million
D) $133 million
Consider the following equation:
E + D = U = A
The U in this equation represents:
A) the value of the firm’s equity.
B) the market value of the firm’s assets.
C) the value of the firm’s unlevered equity.
D) the value of the firm’s debt.
Luther Corporation
Consolidated Balance Sheet
December 31, 2009 and 2008 (in $ millions)
Luther Corporation’s cash ratio for 2009 is closest to:
Luther Corporation’s stock price is $39 per share and the company has 20 million shares
outstanding. Its Debt -Capital Ratio for 2009 is closest to:
A) 0.696
B) 0.37
C) 1.89
D) 0.654
Hugh Akston took out a 30-year mortgage with an EAR of 5.9%. If Hugh borrowed
$300,000 to buy his home, then his monthly payment will be closest to:
A) $835
B) $1,750
C) $1,780
D) $10,240
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
The free cash flow to equity in 2008 is closest to:
A) -5,005
B) -1,755
C) 5,575
D) 9,995
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 $18,000 in
Taggart Transcontinental. The number of shares of Wyatt Oil that you hold is closest to:
A) 90 shares
B) 460 shares
C) 615 shares
D) 770 shares
Which of the following formulas is INCORRECT?
A) Capital Gains Rate =
B) Dividend Yield =
C) P0= +
D) rE= Capital Gains Rate + Dividend Yield
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.
Suppose that all capital gains are taxed at a 20% rate, and that the dividend tax rate is
40%. Rearden Metal is currently trading for $40 per share, and is about to pay a $5
special dividend.The effective dividend tax rate for an investor in Rearden Metal is
closest to:
A) 0%
B) 20%
C) 25%
D) 30%
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 EV/Sales
ratio of Ideko in 2010 is closest to:
A) 1.9
B) 1.7
C) 1.6
D) 1.8
Nielson Motors has a debt-equity ratio of 1.8, an equity beta of 1.6, and a debt beta of
0.20. It is currently evaluating the following projects, none of which would change
Nielson’s volatility.
(All amounts are in $millions.)
The total debt overhang associated with accepting project 1, is closest to:
A) $0 million
B) $12.5 million
C) $14.4 million
D) $22.5 million
In a surprise announcement, NASA released details of a major contract with
Lockheed-Martin (LMT) that would increase LMT’s market value by $7.5 billion. It
was widely expected by the market that this contract would be awarded to LMT’s major
competitor Boeing (BA). Assume that Boeing has 800 million shares outstanding and
Lockheed Martin has 425 million shares outstanding. Prior to this announcement, the
market felt that the probability of Boeing winning the contract was 90% and that
Lockheed-Martin’s chance was only about 10%.
What do you anticipate will happen to Lockheed-Martin and Boeing’s stock prices are a
result of this surprise announcement?
Tom’s portfolio consists solely of an investment in Merck stock. Merck has an expected
return of 13% and a volatility of 25%. The market portfolio has an expected return of
12% and a volatility of 18%. The risk-free rate is 4%. Assume that the CAPM
assumptions hold in the market.
Assuming that Tom wants to maintain the current volatility of his portfolio, then the
amount that Tom should invest in the market portfolio to maximize his expected return
is closest to:
A) 72%
B) 92%
C) 110%
D) 140%
You own your own firm and you need to raise $50 million to fund an expansion.
Following the expansion, your firm will be worth $75 million in its unlevered form.
You want to go ahead with the expansion, but you are concerned that you may not be
able to maintain ownership of over 50% of your firm’s equity. In other words, you are
concerned that if you use equity to finance the expansion, you may lose control of your
firm.
Assume that capital markets are perfect, you issue $30 million in new debt, and you
issue $20 million in new equity. You ownership stake in the firm following these new
issues of debt and equity is closest to:
A) 58%
B) 50%
C) 33%
D) 55%
Suppose that Luther’s beta is 0.9. If the market risk premium is 8% and the risk-free
interest rate is 4%, then then expected return for Luther stock is?
A) 7.6%
B) 11.6%
C) 11.2%
D) 12.9%