Your son is about to start kindergarten in a private school. Currently, the tuition is
$12,000 per year, payable at the start of the school year. You expect annual tuition
increases to average 6% per year over the next 13 years. Assuming that you son remains
in this private school through high school and that your current interest rate is 7%, then
the present value of your son’s private school education is closest to:
A) $332,300
B) $137,900
C) $155,800
D) $156,000
Consider a project with free cash flows in one year of $90,000 in a weak economy or
$117,000 in a strong economy, with each outcome being equally likely. The initial
investment required for the project is $80,000, and the project’s cost of capital is 15%.
The risk-free interest rate is 5%.
Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the
risk free rate, then the cash flow that equity holders will receive in one year in a weak
economy is closest to:
A) $6,000
B) $10,000
C) $0
D) $33,000
Really Big Conglomerate (RBC) is considering acquiring POP, Inc. a smaller
unsuccessful Internet firm. POP has outstanding tax loss carry forwards of $320 million
from losses over the past six years. RBC has pre-tax income of $100 million per year, a
cost of capital of 10%, and pays 35% in taxes.
If RBC acquires POP, in what year will RBC be required to pay corporate taxes again?
A) 2 years
B) 3 years
C) 4 years
D) 5 years
Wyatt oil is considering drilling a new self sustaining oil well at a cost of $1,000,000.
This well will produce $100,000 worth of oil during the first year, but as oil is removed
from the well the amount of oil produced will decline by 2%, per year forever. If the
Wyatt oil’s appropriate interest rate is 8%, then the NPV of this oil well is closest to:
A) -$250,000
B) $0
C) $250,000
D) $1,000,000
The effective dividend tax rate in 1999 is closest to:
A) 0%
B) 20%
C) 25%
D) 30%
If the expected return on the market is 11% and the risk-free rate is 4%, then the
expected return of investing in IBM is closest to:
A) 9.1%
B) 10.3%
C) 11.0%
D) 12.0%
Which of the following statements is FALSE?
A) When a firm fails to make a required payment to debt holders, it is in bankruptcy.
B) With perfect capital markets, the risk of bankruptcy is not a disadvantage of
debt’”bankruptcy simply shifts the ownership of the firm from equity holders to debt
holders without changing the total value available to all investors.
C) Bankruptcy is a long and complicated process that imposes both direct and indirect
costs on the firm and its investors that the assumption of perfect capital markets
ignores.
D) Bankruptcy is rarely simple and straightforward’”equity holders don’t just “hand the
keys” to debt holders the moment the firm defaults on a debt payment.
Rearden Metals has a current stock price of $30 share, is expected to pay a dividend of
$1.20 in one year, and its expected price right after paying that dividend is $33.
Rearden’s expected capital gains yield is closest to:
A) 4.0%
B) 6.4%
C) 8.2%
D) 10.0%
Which of the following statements is FALSE?
A) A momentum strategy is one where you buy stocks that have had low past returns
and (short) sell stocks that have had high past returns.
B) Over the years since the discovery of the CAPM, it has become increasing clear to
researchers and practitioners alike that forming portfolios based on market
capitalization, book-to-market ratios, and past returns, one can construct trading
strategies that have a positive alpha.
C) Portfolios containing firms with the highest realized returns over the previous six
months have positive alphas over the next six months.
D) If the market portfolio is not efficient, then a portfolio of small stocks will likely
have positive alphas.
Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a 6%
interest rate to invest in the stock market. You invest the entire $20,000 in an exchange
traded fund (ETF) with a 12% expected return and a 20% volatility.You want to
maximize your expected return without increasing your risk. Without increasing your
volatility beyond its current 10%, the maximum expected return you could earn is
closest to:
A) .12.0%
B) 12.5%
C) 13.4%
D) 15.0%
If we use future value rather than present value to decide whether to make an
investment:
A) we will make a bad decision, since the future value will always be higher if the
discount rate is positive.
B) we will make a bad decision, since the future value will always be lower if the
discount rate is positive.
C) we will make the same decision using either future value or present value.
D) There is not enough information given to answer the question.
Which of the following statements is FALSE?
A) Firms adjust dividends relatively infrequently, and dividends are much less volatile
than earnings. This practice of maintaining relatively constant dividends is called
dividend signaling.
B) When a firm increases its dividend, it sends a positive signal to investors that
management expects to be able to afford the higher dividend for the foreseeable future.
C) The average size of the stock price reaction increases with the magnitude of the
dividend change, and is larger for dividend cuts.
D) When managers cut the dividend, it may signal that they have given up hope that
earnings will rebound in the near term and so need to reduce the dividend to save cash.
Using the average historical excess returns for both Wyatt Oil and the Market portfolio
estimate of Wyatt Oil’s Beta. When using this beta, the alpha for Wyatt oil in 2007 is
closest to:
A) -0.5000%
B) -0.0250%
C) -0.0125%
D) +0.0250%
*The current tax rates are set to expire in 2008 unless Congress extends them. The tax
rates shown are for financial assets held for one year. For assets held less than one year,
capital gains are taxed at the ordinary income tax rate (currently 35% for the highest
bracket); the same is true for dividends if the assets are held for less than 61 days.
The effective dividend tax rate for a pension fund in 2006 is closest to:
A) 20%
B) 0%
C) 25%
D) 15%
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 principal that Dagny will pay during the first month of her
mortgage is closest to:
A) $246
B) $446
C) $1,800
D) $2,245
Big Blue Banana (BBB) is a clothing retailer with a current share price of $10.00 and
with 25 million shares outstanding. Suppose that Big Blue Banana announces plans to
lower its corporate taxes by borrowing $100 million and using the proceeds to
repurchase shares.
Assuming perfect capital markets, the share price for BBB after this announcement is
closest to:
A) $11.40
B) $10.85
C) $10.00
D) $8.60