Use the information for the question(s) below.
Your firm faces an 8% chance of a potential loss of $50 million next year. If your firm
implements new safety policies, it can reduce the chance of this loss to 3%, but the new
safety policies have an upfront cost of $250,000. Suppose that the beta of the loss is 0
and the risk-free rate of interest is 5%.
If your firm is fully insured, the NPV of implementing the new safety policies is closest
to:
A) $2.15 million
B) $2.5 million
C) $2.25 million
D) -$.25 million
Which of the following investments offered the highest overall return over the past
eighty years?
A) Treasury Bills
B) S&P 500
C) Small stocks
D) Corporate bonds
Use the following information to answer the question(s) below.
The owner of the Krusty Krab is considering selling his restaurant and retiring. An
investor has offered to buy the Krusty Krab for $350,000 whenever the owner is ready
for retirement. The owner is considering the following three alternatives:
1. Sell the restaurant now and retire.
2. Hire someone to manage the restaurant for the next year and retire. This will require
the owner to spend $50,000 now, but will generate $100,000 in profit next year. In one
year the owner will sell the restaurant.
3. Scale back the restaurant’s hours and ease into retirement over the next year. This will
require the owner to spend $40,000 on expenses now, but will generate $75,000 in
profit at the end of the year. In one year the owner will sell the restaurant.
If the discount rate is 15%, the alternative with the highest NPV is:
A) #1 with an NPV of approximately $350,000
B) #2 with an NPV of approximately $341,300
C) #3 with an NPV of approximately $329,570
D) #2 with an NPV of approximately $400,000
E) None of the above
The constant annuity payment over the life of a project that is equivalent to receiving
the NPV today is the
A) annualized annuity.
B) independent annual benefit.
C) equivalent annual profitability.
D) equivalent annual benefit.
Use the table for the question(s) below.
Consider the following mutually exclusive projects:
ProjectYear 0
C/FYear 1
C/FYear 2
C/FYear 3
C/FYear 4
C/FYear 5
C/FYear 6
C/FYear 7
C/FDiscount
RateA-792025303540N/AN/A15%B-802525252525252515%
The NPV of project B is closest to:
A) $18.10
B) $21.70
C) $24.00
D) $16.90
Your firm purchases goods from its supplier on terms of 2/10, net 40. The effective
annual cost to your firm if it chooses not to take advantage of the trade discount offered
and stretches the accounts payable to 60 days is closest to:
A) 20.1%
B) 15.9%
C) 13.0%
D) 11.1%
Consider the following balance sheet:
If in 2009 Luther has 10.2 million shares outstanding and these shares are trading at $16
per share, then using the market value of equity, the debt to equity ratio for Luther in
2009 is closest to:
A) 1.47
B) 1.78
C) 2.31
D) 4.07
Which of the following statements is false?
A) There may be reasons to exclude certain historical data as anomalous when
estimating beta.
B) Many practitioners use adjusted betas, which are calculated by averaging the
estimated beta with 1.0.
C) The beta estimated we obtain from linear regression can be very sensitive to outliers,
which are returns of unusually small magnitude.
D) If we use very old data to when estimating beta, they data may be unrepresentative
of the current market risk of the security.
Use the information for the question(s) below.
Consider an economy with two types of firms, S and I. S firms always move together,
but I firms move independently of each other. For both types of firms there is a 70%
probability that the firm will have a 20% return and a 30% probability that the firm will
have a -30% return.
The standard deviation for the return on an individual firm is closest to:
A) 23.0%
B) 5.25%
C) 15.0%
D) 10.0%
Consider a project with the following cash flows:
Assume the appropriate discount rate for this project is 15%. The profitability index for
this project is closest to:
A) .14
B) .22
C) .60
D) .15
Use the following information to answer the question(s) below.
Nielson Motors is considering an opportunity that requires an investment of $1,000,000
today and will provide $250,000 one year from now, $450,000 two years from now, and
$650,000 three years from now.
If the appropriate interest rate is 10%, then Nielson Motors should:
A) Invest in this opportunity since the NPV is positive.
B) Do Not Invest in this opportunity since the NPV is positive.
C) Invest in this opportunity since the NPV is negative.
D) Do Not Invest in this opportunity since the NPV is negative.
Which of the following statements is false?
A) Stocks generally trade in lots of 1000 shares, and in any case do not trade in units
less than one share.
B) Non-cash special dividends are commonly used to spin off assets or a subsidiary as a
separate company.
C) The typical motivation for a stock split is to keep the share price in a range thought
to be attractive to small investors.
D) If a company declares a 10% stock dividend, each shareholder will receive one new
share of stock for every 10 shares already owned.
Use the following information to answer the question(s) below.
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.)
If Nielson Motors invests in only those projects which are beneficial to the
stockholders, then the total debt overhang associated with accepting these project(s) is
closest to:
A) $22.5 million
B) $36.0 million
C) $38.0 million
D) $57.5 million
Which of the following statements is false?
A) The covariance and correlation allow us to measure the co-movement of returns.
B) Correlation is the expected product of the deviations of two returns.
C) Because the prices of the stocks do not move identically, some of the risk is
averaged out in a portfolio.
D) The amount of risk that is eliminated in a portfolio depends on the degree to which
the stocks face common risks and their prices move together.
Use the following information to answer the question(s) below.
Wyatt Oil is considering an investment in a new project with an unlevered cost of
capital of 11%. Wyatt’s marginal corporate tax rate is 35% and its debt cost of capital is
6%. The project has free cash flows of $25 million per year which are expected to
decline by 3% per year.
If Wyatt adjusts its debt once per year to maintain a constant debt-equity ratio of 50%,
then the value of this new project is closest to:
A) $240 million
B) $320 million
C) $340 million
D) $445 million
Use the information for the question(s) below.
Two years ago you purchased a new SUV. You financed your SUV for 60 months (with
payments made at the end of the month) with a loan at 5.9% APR. You monthly
payments are $617.16 and you have just made your 24th monthly payment on your
SUV.
The amount of your original loan is closest to:
A) $14,808
B) $22,212
C) $32,000
D) $37,020
Consider the following income statement and other information:
Luther’s EBIT coverage ratio for the year ending December 31, 2008 is closest to:
A) 1.64
B) 1.78
C) 1.98
D) 2.19
Which of the following statements regarding growing annuities is false?
A) A growing annuity is a stream of N growing cash flows, paid at regular intervals.
B) We assume that g < r when using the growing annuity formula.
C) PV of a growing annuity = C x
D) A growing annuity is like a growing perpetuity that never comes to an end.
Use the following information to answer the question(s) below.
The price today of a three-year default-free security with a face value of $1000 and an
annual coupon rate of 4% is closest to:
A) $1002.78
B) $1003.31
C) $1028.50
D) $1028.61
Which of the following equations is incorrect?
A)
B) Rp = ΣixiRi
C) Rp = x1R1 + x2R2 + … + xnRn
D) E[Rp} = E[ΣixiRi]
Which of the following statements is false?
A) The hurdle rate rule for projects with the option to delay uses a lower discount rate
than the cost of capital to compute the NPV, but then applies the regular NPV rule:
Invest whenever the NPV calculated using this lower discount rate is positive.
B) While using a hurdle rate rule for deciding when to invest might be a cost-effective
way to make investment decisions, it is important to remember that this rule does not
provide an accurate measure ofvalue.
C) When the cash flows are constant and perpetual, and the reason to wait derives
solely from interest rate uncertainty, the hurdle rate rule of thumb is always exact.
However, when these conditions are not satisfied, the rule of thumb merely
approximates the correct decision.
D) When a firm faces the same uncertainty for most of its investment decisions, using a
single profitability index criterion for all projects can provide a useful rule of thumb to
account for cash flow uncertainty.
Use the following information to answer the question(s) below.
Taggart Transcontinental is considering a $250 million investment to launch a new rail
line. The project is expected to generate a free cash flow of $32 million per year, and its
unlevered cost of capital is 8%. Taggart’s marginal corporate tax rate is 35%.
Assume that to fund the investment Taggart will take on $150 million in permanent debt
with the remainder of the investment funded by a cut in dividends. Assuming Taggart
will incur a 2% underwriting fee on the new debt issue, the NPV of Taggart’s new rail
line is closest to:
A) $195 million
B) $200 million
C) $235 million
D) $240 million
You are trying to decide between three mutually exclusive investment opportunities.
The most appropriate tool for identifying the correct decision is
A) NPV.
B) Profitability index.
C) IRR.
D) Incremental IRR.
Use the following information to answer the question(s) below.
Galt Industries is expected to generate free cash flows of $24 million per year. Galt has
permanent debt of $80 million, a corporate tax rate of 40%, and an unlevered cost of
capital of 12% and its cost of debt capital is 6%.
Galt’s WACC is closest to:
A) 6.0%
B) 9.6%
C) 10.3%
D) 10.7%
Use the following information to answer the question(s) below.
Consider the price paths of the following stocks over a six-month period:
None of these stocks pay dividends.
Assume that you are an investor with the disposition effect and you bought each of
these stocks in January. Suppose that it is currently the end of June, which stocks are
you most inclined to hold?
1. Taggart Transcontinental
2. Rearden Metal
3. Wyatt Oil
4. Nielson Motors
A) 1 only
B) 4 only
C) 1 & 3 only
D) 2 & 4 only
Use the table for the question(s) below.
Consider the following Price and Dividend data for General Electric Company:
Assume that you purchased General Electric Company stock at the closing price on
December 31, 2008 and sold it after the dividend had been paid at the closing price on
January 26, 2009. Your capital gains rate (yield) for this period is closest to:
A) 0.75%
B) 0.70%
C) -8.80%
D) -8.15%
Use the following information to answer the question(s) below.
Taggart Transcontinental is considering a $250 million investment to launch a new rail
line. The project is expected to generate a free cash flow of $32 million per year, and its
unlevered cost of capital is 8%. Taggart’s marginal corporate tax rate is 35%.
Assume that to fund the investment Taggart will take on $150 million in permanent debt
with the remainder of the investment funded through issuance of new equity. Assume
Taggart will incur a 2% underwriting fee on the new debt issue and a 5% underwriting
fee on the issuance of new equity. If management believes Taggart’s current share price
of $25 is $3 less than its true value, then the NPV of Taggart’s new rail line is closest to:
A) $185 million
B) $195 million
C) $200 million
D) $235 million
Which of the following statements is false?
A) When a firm faces financial distress, shareholders have an incentive not to invest
and to withdraw money from the firm if possible.
B) Because top managers often hold shares in the firm and are hired and retained with
the approval of the board of directors, which itself is elected by shareholders, managers
will generally make decisions that increase the value of the firm’s equity.
C) An over-investment problem occurs when shareholders have an incentive to invest in
risky positive-NPV projects.
D) A negative-NPV project destroys value for the firm overall.
Rearden Metal can invest in a risk-free technology that requires an up-front investment
of $1 million. Rearden’s managers are hesitant to invest because of uncertainty over
future interest rates. Suppose that all interest rates will be either 8% or 4% in one year
and remain there forever. The risk-neutral probability that interest rates will drop to 4%
is 40%. The one-year risk-free interest rate is 5% and today’s rate on a risk-free
perpetual bond is 6%. The rate on an equivalent perpetual bond that is repayable at any
time (the callable annuity rate) is 7.65%.
Assuming that this project will provide Rearden with perpetual annual cash flows of
$55,000, the NPV of investing in using the hurdle rate is closest to:
A) -281,000
B) -150,000
C) -83,000
D) +83,000
E) +281,000
Use the information for the question(s) below.
The current price of KD Industries stock is $20. In the next year the stock price will
either go up by 20% or go down by 20%. KD pays no dividends. The one year risk-free
rate is 5% and will remain constant.
Using the binomial pricing model, the calculated price of a one-year put option on KD
stock with a strike price of $20 is closest to:
A) -7.7
B) 2.4
C) 4.6
D) -1.8