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.Suppose that Rearden Metal made a surprise announcement that it
would do a share repurchase rather than pay a special dividend, the net tax savings per
share for an investor that would result from this decision is closest to:
A) $1.25
B) $3.75
C) $4.00
D) $5.00
The Free Cash Flow-to-Equity (FCFE) for the acquisition in year 1 is closest to:
A) $4.7 million
B) $6.5 million
C) $8.3 million
D) $6.8 million
If managed effectively, Rearden Metal will have assets with a market value of $200
million, $300 million, or $400 million next year, with each outcome being equally
likely. Managers, however, may decided to engage in wasteful empire building, which
will reduce Rearden’s market value by $20 million in all cases. Managers may also
increase the risk of the firm, changing the probability of each outcome to 50%, 5%, and
45% respectively.
Suppose that the managers at Rearden Metal will engage in empire building unless that
behavior increases the likelihood of bankruptcy. If Rearden has $180 million in debt
due in one year, then the expected value of Rearden’s assets is closest to:
A) $265 million
B) $280 million
C) $295 million
D) $300 million
If the risk-free rate of interest (rf) is 6%, then you should be indifferent between
receiving $250 today or
A) $235.85 in one year.
B) $250.00 in one year.
C) $265.00 in one year.
D) None of the above
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million,
and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff
has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35%
corporate tax bracket.
If Flagstaff currently maintains a .5 debt to equity ratio, then the value of Flagstaff’s
interest tax shield is closest to:
A) $11 million
B) $18 million
C) $10 million
D) $24 million
Nielson Motors has no debt, and maintains a policy of holding $80 million in excess
cash reserves, invested in risk free treasury securities currently yielding 3%. If Nielson
is in the 35% marginal tax bracket, the cost of permanently maintaining this $80 million
reserve is closest to:
A) $0.85 million
B) $1.6 million
C) $24.0 million
D) $28.0 million
Consider the following top federal tax rates in the United States:
Personal Tax Rates
In 2005, the effective tax rate for debt holders was closest to:
A) 58%
B) 35%
C) 40%
D) 65%
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 in Google pay a 15% tax rate on income from equity and a 25%
tax rate on interest income. If Google were to issue sufficient debt to reduce its taxes by
$600 million per year permanently, then the effective tax advantage of this debt would
be closest to:
A) 10%
B) 15%
C) 25%
D) 30%
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
You are purchasing a new home and need to borrow $250,000 from a mortgage lender.
The mortgage lender quotes you a rate of 6.25% APR for a 30-year fixed rate mortgage.
The mortgage lender also tells you that if you are willing to pay 2 points, they can offer
you a lower rate of 6.0% APR for a 30-year fixed rate mortgage. One point is equal to
1% of the loan value. So if you take the lower rate and pay the points you will need to
borrow an additional $5000 to cover points you are paying the lender.
Assuming you don’t pay the points and borrow from the mortgage lender at 6.25%, then
your monthly mortgage payment (with payments made at the end of the month) will be
closest to:
A) $694
B) $708
C) $1540
D) $1600
Glucose Scan Incorporated (GSI) currently sells its latest glucose monitor, the
Glucoscan 3000, to diabetic patients for $129. GSI plans on lowering their price next
year to $99 per unit. The cost of goods sold for each Glucoscan unit is $50, and GSI
expects to sell 100,000 units over the next year.
Suppose that if GSI drops the price on the Glucoscan 3000 immediately, it can increase
sales over the next year by 30% to 130,000 units. Also suppose that for each Glucoscan
monitor sold, GSI expects additional sales of $100 per year on glucose testing strips and
these strips have a gross profit margin of 75%. Considering the increase in the sale of
testing strips, the incremental impact of this price drop on the firms EBIT is closest to:
A) a decline of 1.5 million.
B) a decline of 0.7 million.
C) an increase of 0.7 million.
D) an increase of 1.5 million.
Which of the following statements is FALSE?
A) The expected return is the return is the return that actually occurs over a particular
time period.
B) If you hold the stock beyond the date of the first dividend, then to compute you
return you must specify how you invest any dividends you receive in the interim.
C) The average annual return of an investment during some historical period is simply
the average of the realized returns for each year.
D) The realized return is the total return we earn from dividends and capital gains,
expressed as a percentage of the initial stock price.
Suppose that the risk-free rate is 5% and the market portfolio has an expected return of
13% with a volatility of 18%. Monsters Inc. has a 24% volatility and a correlation with
the market of .60, while California Gold Mining has a 32% volatility and a correlation
with the market of -.7. Assume the CAPM assumptions hold.
Monsters’ beta with the market is closest to:
A) 1.3
B) 1.0
C) 0.6
D) 0.8
Which of the following statements is FALSE?
A) A value-weighted portfolio is an equal-ownership portfolio: We hold an equal
fraction of the total number of shares outstanding of each security in the portfolio.
B) When buying a value-weighted portfolio, we end up purchasing the same percentage
of shares of each firm.
C) To maintain a value-weighted portfolio, we do not need to trade securities and
rebalance the portfolio unless the number of shares outstanding of some security
changes.
D) In a value weighted portfolio the fraction of money invested in any security
corresponds to its share of the total number of shares outstanding of all securities in the
portfolio.
Capital Structure and Unlevered Beta Estimates for Comparable Firms
The unlevered beta for Nike is closest to:
A) 0.70
B) 1.00
C) 1.50
D) 0.60
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%
Which of the following statements is FALSE?
A) If there is uncertainty regarding EBIT, then with a higher interest expense there is a
greater risk that interest will exceed EBIT.
B) Even for a firm with positive earnings, growth will affect the optimal leverage ratio.
C) From a tax perspective, the firm’s optimal level of debt is proportional to its current
earnings.
D) The optimal proportion of debt in the firm’s capital structure will be higher, the
higher the firm’s growth rate.
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
Interest on James Taggart’s credit card balances are compounded daily at an effect
annual rate of 14.91%. The APR on his credit card is closest to:
A) 13.90%
B) 13.95%
C) 14.91%
D) 16.08%
Assuming that Novartis AG (NVS) has an EPS of $3.35, based upon the P/E ratios for
its competitors, the highest expected stock price for Novartis is closest to:
A) $31.86
B) $44.35
C) $51.09
D) $62.60
Which of the following statements regarding arbitrage is the most correct?
A) Any situation in which it is possible to make a profit without taking any risk is
known as an arbitrage opportunity.
B) Any situation in which it is possible to make a profit without making any investment
is known as an arbitrage opportunity.
C) We call a competitive market in which there are no arbitrage opportunities an
arbitrage market.
D) The practice of buying and selling equivalent goods in different markets to take
advantage of a price difference is known as arbitrage.