The volatility of the market portfolio is 10%, the expected return on the market is 12%,
and the risk-free rate of interest is 4%The Sharpe Ratio for Rearden Metal is closest to:
A) 0.40
B) 0.56
C) 0.80
D) 1.00
Luther Industries has $5 million in excess cash and 1 million shares outstanding. Luther
is considering investing the cash in one-year treasury bills that are currently paying 5%
interest, and then using the cash to pay a dividend next year. Alternatively, Luther can
pay the cash out as a dividend immediately and the shareholders can invest in the
treasury bills themselves. Assume that capital markets are perfect.
In 2006, Luther Incorporated paid a special dividend of $5 per share for the 100 million
shares outstanding. If Luther has instead retained that cash permanently and invested it
into treasury bills earning 5%, then the present value of the additional taxes paid by
Luther would be closest to:
A) $35 million
B) $290 million
C) $175 million
D) $585 million
Consider the following zero-coupon yields on default free securities:
A 4 year default free security with a face value of $1000 and an annual coupon rate of
5.25% will trade
A) at a premium.
B) at par.
C) at a discount.
D) There is insufficient information provided to answer this question.
Consider the following zero-coupon yields on default free securities:
The price today of a 3 year default free security with a face value of $1000 and an
annual coupon rate of 6% is closest to:
A) $1000
B) $1021
C) $1013
D) $1005
Anyone who purchases the stock on or after the ________ date will not receive the
dividend.
A) distribution
B) record
C) ex-dividend
D) declaration
Consider the following stock price and shares outstanding data:
Assume that you have $100,000 to invest and you are interested in creating a
value-weighted portfolio of these four stocks. The percentage of the shares outstanding
of Boeing that you would hold in your portfolio is closest to:
A) .000018%
B) .000020%
C) .000024%
D) .000031%
Wyatt Oil just reported that a major fire destroyed one of its oil production facilities in
Colorado. While the facility was fully insured, the loss of oil production will decrease
Wyatt’s free cash flow by $120 million at the end of this year and by $80 million at the
end of next year. Wyatt has 50 million shares outstanding and has a weighted average
cost of capital of 9%. Assuming the value of Wyatt’s debt is not affected by this event,
the expected decrease in Wyatt’s stock price is closest to:
A) $2.00
B) $3.55
C) $3.87
D) $4.00
Which of the following statements is FALSE?
A) We can use the law of one price to compute the price of a coupon bond from the
prices of zero-coupon bonds.
B) The plot of the yields of coupon bonds of different maturities is called the
coupon-paying yield curve.
C) It is possible to replicate the cash flows of a coupon bond using zero-coupon bonds.
D) Because the coupon bond provides cash flows at different points in time, the yield to
maturity of a coupon bond is the simple average of the yields of the zero-coupon bonds
of equal and shorter maturities.
Which of the following statements is FALSE?
A) Beta differs from volatility.
B) The risk premium investors can earn by holding the market portfolio is the
difference between the market portfolio’s expected return and the risk-free interest rate.
C) Stocks in cyclical industries, in which revenues tend to vary greatly over the
business cycle, are likely to be more sensitive to systematic risk and have higher betas
than stocks in less sensitive industries.
D) If we assume that the market portfolio (or the S&P 500) is efficient, then changes in
the value of the market portfolio represent unsystematic shocks to the economy.
Larry the Cucumber has been offered $14 million to star in the lead role of the next
three Larry Boy adventure movies. If Larry takes this offer, he will have to forgo acting
in other Veggie movies that would pay him $5 million at the end of each of the next
three years. Assume Larry’s personal cost of capital is 10% per year.
The NPV of Larry’s three movie Larry Boy offer is closest to:
A) 3.5 million
B) -1.6 million
C) 1.6 million
D) -1.0 million
KD Industries has 30 million shares outstanding with a market price of $20 per share
and no debt. KD has had consistently stable earnings, and pays a 35% tax rate.
Management plans to borrow $200 million on a permanent basis through a leveraged
recapitalization in which they would use the borrowed funds to repurchase outstanding
shares.
After the recapitalization, the total value of KD as a levered firm is closest to:
A) $470 million
B) $730 million
C) $670 million
D) $530 million
Which of the following statements is FALSE?
A) Rather than set debt according to a target debt-equity ratio or interest coverage level,
a firm may adjust its debt according to a fixed schedule that is known in advance.
B) When we relax the assumption of a constant debt-equity ratio, the equity cost of
capital and WACC for a project will change over time as the debt-equity ratio changes.
C) When we relax the assumption of a constant debt-equity ratio, the APV and FTE
methods are difficult to implement.
D) If a firm is using leverage to shield income from corporate taxes, then it will adjust
its debt level so that its interest expenses grow with its earnings.
The volatility of the market portfolio is 10%, the expected return on the market is 12%,
and the risk-free rate of interest is 4%The expected return on the portfolio of the three
stocks is closest to:
A) 10.0%
B) 11.4%
C) 11.8%
D) 12.0%
Dagny Taggart has just purchased a home and taken out a $400,000 mortgage. The
mortgage has a 30-year term with monthly payments and has an APR of 5.4%.
The total amount of interest that Dagny will pay during the first three months of her
mortgage is closest to:
A) $1,345
B) $5,380
C) $5,395
D) $6,740
Larry the Cucumber has been offered $14 million to star in the lead role of the next
three Larry Boy adventure movies. If Larry takes this offer, he will have to forgo acting
in other Veggie movies that would pay him $5 million at the end of each of the next
three years. Assume Larry’s personal cost of capital is 10% per year.
The IRR for Larry’s three movie deal offer is closest to:
A) 3.5%
B) 1.6%
C) -3.5%
D) -1.6%
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 $9,000 in
Rearden Metal. The amount that you have invested in Nielson Motors is closest to:
A) $6,000
B) $7,715
C) $9,000
D) $10,500
An exchange traded fund (ETF) is a security that represents a portfolio of individual
stocks. Consider an ETF for which each share represents a portfolio of two shares of
International Business Machines (IBM), three shares of Merck (MRK), and three shares
of Citigroup Inc. (C). Suppose the current market price of each individual stock are
shown below:
Suppose that the ETF is trading for $362.36; you should
A) sell the EFT and buy 2 shares of IBM, 3 shares of MRK, and 3 shares of C.
B) sell the EFT and buy 3 shares of IBM, 2 shares of MRK, and 3 shares of C.
C) buy the EFT and sell 2 shares of IBM, 3 shares of MRK, and 3 shares of C.
D) do nothing, no arbitrage opportunity exists.
Which alternative offers you the highest effective rate of return?
A) Investment A
B) Investment B
C) Investment C
D) Investment D
Cash is a:
A) long-term asset.
B) current asset.
C) current liability.
D) long-term liability.
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 monthly discount rate that you should use to evaluate the truck lease is
closest to:
A) 0.487%
B) 0.498%
C) 1.500%
D) 1.535%
Assume that the risk-free rate of interest is 3% and you estimate the market’s expected
return to be 9%.
The equity cost of capital for “Miney” is closest to:
A) 6.30%
B) 7.50%
C) 9.30%
D) 9.75%
If it is managed efficiently, Luther industries will have assets with market value of $100
million, $300, million, or $500 million next year, with each outcome being equally
likely. Managers may, however, engage in wasteful empire building which will reduce
the firm’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%, 20%, and 30%
respectively.
Assume that EGI decides to raise the $100 million through the issuance of new shares
prior to the release of the new video game. EGI’s share price following the release of
the new video game will be closest to:
A) $18.00
B) $19.00
C) $20.00
D) $16.00
Raceway Products has a market debt-to-equity ratio of .60, a corporate tax rate of 40%,
and pays 8% interest on its debt. The interest tax shield on Raceway’s debt lowers its
WACC by what amount?
The Grant Corporation is considering permanently adding $500 million of debt to its
capital structure. Grant’s corporate tax rate is 35% and investors pay a tax rate of 40%
on their interest income and 20% on their income from capital gains and dividends.
Calculate the present value of the interest tax shield provided by this new debt.
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 except for the existence of corporate taxes and
that your firm pays 35% of earnings in taxes. If you want to maintain ownership of at
least a 50%, then calculate the minimum amount of debt that you must issue to fund the
expansion.
Consider the following four bonds that pay annual coupons:
Assume that the YTM increases by 1% for each of the four bonds listed. Rank the
bonds based upon the sensitivity of their prices from least to most sensitive.
What is the market portfolio?
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 that this bond trades for $1,035.44, then the YTM for this bond is equal to:
Suppose that security C had a risk premium of 30%, describe what arbitrage
opportunity exists and how you would exploit it.
Advanced Micro Devices (NYSE: AMD) is currently trading at $20.75 on the NYSE.
Advanced Micro Devices is also listed on NASDAQ and assume it is currently trading
on NASDAQ at $20.50. Does an arbitrage opportunity exists and if so how would you
exploit it and how much would you make on a block trade of 1000 shares?
Consider the following list of projects:
You are given a budget of only $1,800,000 to invest in projects. Which projects will
you select, in what order will you select them, and why?
