FC 95578 | Course Paper

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Which of the following statements is false?

A) The value of a firm is equal to the amount of money the firm can raise by issuing

securities.

B) By reducing a firm’s corporate tax liability, debt allows the firm to pay more of its

cash flows to investors.

C) Equity investors must pay taxes on dividends but not capital gains.

D) For individuals, interest payments received from debt are taxed as income.

Answer:

You are considering adding a microbrewery on to one of your firm’s existing

restaurants. This will entail an increase in inventory of $8,000, an increase in Accounts

payable of $2,500, and an increase in property, plant, and equipment of $40,000. All

other accounts will remain unchanged. The change in net working capital resulting from

the addition of the microbrewery is:

A) $45,500

B) $10,500

C) $6,500

D) $5,500

Answer:

Consider a zero coupon bond with 20 years to maturity. The percentage change in the

price of the bond if its yield to maturity decreases from 7% to 5% is closest to:

A) 46%

B) 17%

C) 22%

D) 38%

Answer:

You are thinking about investing in a mine that will produce $10,000 worth of ore in the

first year. As the ore closest to the surface is removed it will become more difficult to

extract the ore. Therefore, the value of the ore that you mine will decline at a rate of 8%

per year forever. If the appropriate interest rate is 6%, then the value of this mining

operation is closest to:

A) $71,429

B) $500,000

C) $166,667

D) This problem cannot be solved.

Answer:

Due to a pre-existing contract, Recycle America Inc. has the opportunity to acquire

10,000 pounds of scrap aluminum and 2,500 pounds of scrap lead for $10,750. If the

current market price for scrap aluminum is $0.83 per pound and the current market

price for lead is $1.06 per pound, then the added benefit (cost) to you if you acquire this

metal is?

A) ($200)

B) $200

C) ($1,925)

D) $1,925

Answer:

Which of the following statements is false?

A) The incremental IRR investment rule applies the IRR rule to the difference between

the cash flows of the two mutually exclusive alternatives.

B) When a manager must choose among mutually exclusive investments, the NPV rule

provides a straightforward answer.

C) The likelihood of multiple IRRs is greater with the regular IRR rule than with the

incremental IRR rule.

D) Problems can arise using the IRR method when the mutually exclusive investments

have differences in scale.

Answer:

Use the following timeline to answer the question(s) below.

0 1 2 3

$600 $1,200 $1,800

At an annual interest rate of 7%, the future value of this timeline in year 2 is closest to:

A) $3,080

B) $3,525

C) $3,770

D) $4,035

Answer:

Which of the following statements is false?

A) The actual cash flow that the investor will get to keep will be reduced by the amount

of any tax payments.

B) The equivalent after-tax interest rate is r(1 – τ).

C) The right discount rate for a cash flow is the rate of return available in the market on

other investments of comparable risk and term.

D) To compensate for the risk that they will receive less if the firm defaults, investors

demand a lower interest rate than the rate on U.S. Treasuries.

Answer:

Use the information for the question(s) below.

You founded your own firm three years ago. You initially contributed $200,000 of your

own money and in return you received 2 million shares of stock. Since then, you have

sold an additional 1 million shares of stock to angel investors. You are now considering

raising capital from a venture capital firm. This venture capital firm would invest $5

million and would receive 2 million newly issued shares in return.

Assuming that this is the venture capitalist’s first investment in your firm, the

post-money valuation of your shares are closest to:

A) $5.0 million

B) $12.5 million

C) $4.0 million

D) $2.5 million

Answer:

Use the information for the question(s) below.

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.

Assume that in the event of default, 20% of the value of MI’s assets will be lost in

bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face

value due next year. The total value of MI with leverage is closest to:

A) $140 million

B) $100 million

C) $125 million

D) $134 million

Answer:

Use the information for the question(s) below.

Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a

corporate tax rate of 35%.

If Rosewood had no interest expense, its net income would be closest to:

A) $405 million

B) $160 million

C) $450 million

D) $290 million

Answer:

You are considering investing in a start up project at a cost of $100,000. You expect the

project to return $500,000 to you in seven years. Given the risk of this project, your cost

of capital is 20%.

The NPV for this project is closest to:

A) $29,200

B) $39,500

C) $129,200

D) $139,500

Answer:

Use the information for the question(s) below.

The Sisyphean Company has a bond outstanding with a face value of $1000 that

reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate

for this bond is 8% and that the coupon payments are to be made semiannually.

Assuming the appropriate YTM on the Sisyphean bond is 9.0%, then the price that this

bond trades for will be closest to:

A) $946

B) $919

C) $1,086

D) $1,000

Answer:

Use the table for the question(s) below.

Consider the following four bonds that pay annual coupons:

The amount that the price of bond “D” will change if its yield to maturity increases

from 8% to 9% is closest to:

A) -$36

B) -$39

C) $36

D) $9

Answer:

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 overall asset beta for Wyatt Oil is closest to:

A) 0.95

B) 1.05

C) 1.15

D) 1.25

Answer:

Which of the following statements is false?

A) The expected return of a portfolio is equal to the weighted average expected return,

but the volatility of a portfolio is less than the weighted average volatility.

B) Each security contributes to the volatility of the portfolio according to its volatility,

scaled by its covariance with the portfolio, which adjusts for the fraction of the total

risk that is common to the portfolio.

C) Nearly half of the volatility of individual stocks can be eliminated in a large

portfolio as a result of diversification.

D) The overall variability of the portfolio depends on the total co-movement of the

stocks within it.

Answer:

Which of the following is / are an advantage of incorporation?

A) Access to capital markets

B) Limited liability

C) Unlimited life

D) All of the above

Answer:

Boulderado has come up with a new composite snowboard. Development will take

Boulderado four years and cost $250,000 per year, with the first of the four equal

investments payable today upon acceptance of the project. Once in production the

snowboard is expected to produce annual cash flows of $200,000 each year for 10

years. Boulderado’s discount rate is 10%.

The IRR for Boulderado’s snowboard project is closest to:

A) 10.4%

B) 10.0%

C) 11.0%

D) 15.1%

Answer:

In a world with taxes, which of the following is the rate we should use to evaluate an

all-equity financed project with the same risk as the firm?

A) The weighted-average cost of capital

B) The pre-tax WACC

C) The cost of equity

D) The cost of debt

Answer:

Which of the following statements is false?

A) Long-term supply contracts such contracts cannot be entered into anonymously; the

buyer and seller know each other’s identity. This lack of anonymity may have strategic

disadvantages.

B) A futures contract is an agreement to trade an asset on some future date, at a price

that is locked in today.

C) An alternative to vertical integration or storage is a long-term supply contract.

D) Long-term supply contracts are unilateral contracts negotiated by a seller.

Answer:

Which of the following statements is false?

A) Once investors know the recap will occur, the share price will rise immediately to a

level that reflects the value of the interest tax shield that the firm will receive from its

recapitalization.

B) When securities are fairly priced, the original shareholders of a firm capture the full

benefit of the interest tax shield from an increase in leverage.

C) In the presence of corporate taxes, we do not include the interest tax shield as one of

the firm’s assets on its market value balance sheet.

D) We can analyze the recapitalization using the market value balance sheet; it states

that the total market value of a firm’s securities must equal the total market value of the

firm’s assets.

Answer:

Consider the following information regarding corporate bonds:

Galt Industries has a market capitalization of $50 billion, $30 billion in BBB rated debt,

and $8 billion in cash. If Galt’s equity beta is 1.15, then Galt’s underlying asset beta is

closest to:

A) 0.84

B) 0.92

C) 1.00

D) 1.15

Answer:

Use the following information to answer the question(s) below.

Galt Motors currently produces 500,000 electric motors a year and expects output levels

to remain steady in the future. It buys armatures from an outside supplier at a price of

$2.50 each. The plant manager believes that it would be cheaper to make these

armatures rather than buy them. Direct in-house production costs are estimated to be

only $1.80 per armature. The necessary machinery would cost $700,000 and would be

obsolete in 10 years. This investment would be depreciated to zero for tax purposes

using a 10-year straight line depreciation. The plant manager estimates that the

operation would require additional working capital of $40,000 but argues that this sum

can be ignored since it is recoverable at the end of the ten years. The expected proceeds

from scrapping the machinery after 10 years are estimated to be $10,000. Galt Motors

pays tax at a rate of 35% and has an opportunity cost of capital of 14%.

The incremental cash flow that Galt Motors will incur in year 4 if they elect to

manufacture armatures in house is closest to:

A) 25,000

B) 350,000

C) 375,000

D) 1,250,000

Answer:

Use the following information to answer the question(s) below.

Assuming that Novartis AG (NVS) has an EPS of $3.35, based upon the average

price-to-book ratio for its competitors, Novartis’ stock price is closest to:

A) $13.00

B) $22.95

C) $39.70

D) $44.35

Answer: