Which of the following formulas is incorrect?
A) g = retention rate x return on new investment
B) Divt = EPSt x Dividend Payout Rate
C) P0 =
D) rE = + g
Answer:
Use the information for the question(s) below.
Luther is a successful logistical services firm that currently has $5 billion in cash.
Luther has decided to use this cash to repurchase shares from its investors, and has
already announced the stock repurchase plan. Currently Luther is an all equity firm with
1.25 billion shares outstanding. Luther’s shares are currently trading at $20 per share.
The market value of Luther’s non-cash assets is closest to:
A) $20 billion
B) $19 billion
C) $25 billion
D) $24 billion
Answer:
Which of the following questions is false?
A) With perfect capital markets, all securities are fairly priced and issuing securities is a
zero-NPV transaction.
B) The fees associated with the financing of the project are independent of the project’s
required cash flows and should be ignored when calculating the NPV of the project.
C) When a firm borrows funds, a mispricing scenario arises if the interest rate charged
differs from the rate that is appropriate given the actual risk of the loan.
D) The WACC, APV, and FTE methods determine the value of an investment
incorporating the tax shields associated with leverage.
Answer:
Use the following information to answer the question(s) below.
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.
What is the expected value of Rearden’s assets if it were run efficiently?
A) $265 million
B) $280 million
C) $295 million
D) $300 million
Answer:
Which of the following statements is false?
A) All investors should demand the same efficient portfolio of securities in the same
proportions.
B) The Capital Asset Pricing Model (CAPM) allows corporate executives to identify the
efficient portfolio (of risky assets) by using knowledge of the expected return of each
security.
C) If investors hold the efficient portfolio, then the cost of capital for any investment
project is equal to its required return calculated using its beta with the efficient
portfolio.
D) The CAPM identifies the market portfolio as the efficient portfolio.
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 10 if they elect to
manufacture armatures in house is closest to:
A) 40,000
B) 335,000
C) 375,000
D) 415,000
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 NPV for Boulderado’s snowboard project is closest to:
A) $228,900
B) $46,900
C) $51,600
D) $23,800
Answer:
Which of the following formulas is incorrect?
A) Invoice price = dirty price
B) Clean price = dirty price – accrued interest
C) Accrued interest = coupon amount x
D) Cash price = clean price + accrued interest
Answer:
The following equation:
can be used to calculate all of the following except
A) the cost of capital for the firm’s assets.
B) the levered cost of equity.
C) the unlevered cost of equity.
D) the weighted average cost of capital.
Answer:
Use the table for the question(s) below.
Consider the following realized annual returns:
The variance of the returns on Stock A from 2000 to 2009 is closest to:
A) .3145
B) .0990
C) .1100
D) .9890
Answer:
Use the information for the question(s) below.
JR Industries has a $20 million loan due at the end of the year and under its current
business strategy its assets will have a market value of only $15 million when the loan
comes due. JR is considering a new much riskier business strategy. While this new
riskier strategy can be implemented using JR’s existing assets without any additional
investment, the new strategy has only a 40% probability of succeeding. If the new
strategy is a success, the market value of JR’s assets will be $30, but if the strategy fails
the assets will be worth only $5 million.
What is the overall expected payoff to Wildcat from the speculative oil lease deal?
A) $360 million
B) $275 million
C) $85 million
D) $160 million
Answer:
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.)
Nielson Motors should accept those projects with profitability ratios greater than:
A) 0.15
B) 0.175
C) 0.20
D) 0.225
Answer:
You are looking for a new truck and see the following advertisement. “Own a new
truck! No money down. Just five easy annual payments of $8000.” You know that you
can get the same truck from the dealer across town for only $31,120. The interest rate
for the deal advertised is closest to:
A) 9%
B) 8%
C) 8.5%
D) 10%
Answer:
The Sisyphean Company is considering a new project that will have an annual
depreciation expense of $2.5 million. If Sisyphean’s marginal corporate tax rate is 40%
and their average corporate tax rate is 30%, then what is the value of the depreciation
tax shield on their new project?
A) $750,000
B) $1,000,000
C) $1,500,000
D) $1,750,000
Answer:
Use the table for the question(s) below.
Consider the following realized annual returns:
The average annual return on Stock A from 2000 to 2009 is closest to:
A) 29.9%
B) 16.40%
C) 18.2%
D) 18.7%
Answer:
Which of the following formulas is incorrect?
A) τ*retain
B) Pretain
C) Pretain = Pcum
D) Pretain = Pcum x (1 – τ*retain)
Answer:
Use the information for the question(s) below.
Assume that Rose Corporation’s (RC) EBIT is not expected to grow in the future and
that all earnings are paid out as dividends. RC is currently an all equity firm. It expects
to generate earnings before interest and taxes (EBIT) of $6 million over the next year.
Currently RC has 5 million shares outstanding and its stock is trading for a price of
$12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the
proceeds to repurchase shares at the current price of $12.00.
Following the borrowing of $12 and subsequent share repurchase, the value of a share
for RC is closest to:
A) $14.00
B) $13.20
C) $12.00
D) $10.80
Answer:
An agency problem can be alleviated by:
A) requiring all firms to be sole proprietorships.
B) compensating managers in such a way that acting in the best interest of shareholders
is also in the best interest of managers.
C) asking managers to take on more risk than they are comfortable taking.
D) A and B.
Answer:
Which of the following statements is false?
A) In bankruptcy, management is given the opportunity to reorganize the firm and
renegotiate with debt holders.
B) Because a corporation is a separate legal entity, when it fails to repay its debts, the
people who lent to the firm, the debt holders are entitled to seize the assets of the
corporation in compensation for the default.
C) As long as the corporation can satisfy the claims of the debt holders, ownership
remains in the hands of the equity holders.
D) If the corporation fails to satisfy debt holders’ claims, debt holders may lose control
of the firm.
Answer:
The term moral hazard refers to
A) the chance the firm will default and impose losses on its debtholders.
B) the under-investment problem.
C) the over-investment problem.
D) the idea that individuals will change their behavior if they are not fully exposed to
its consequences.
Answer:
Use the following information to answer the question(s) below:
If Ideko’s future expected growth rate is 5% and its WACC is 9%, then the continuation
value in 2010 is closest to:
A) 164,200
B) 278,775
C) 280,450
D) 303,425
E) 482,850
Answer:
The quarterly working capital levels for Hasbeen Toys are presented in the following
table (in $ millions):
The permanent working capital needs for Hasbeen Toys is closest to:
A) $1,100 million
B) $2,435 million
C) $1,275 million
D) $770 million
Answer:
Use the following information to answer the question(s) below.
Nielson Motors (NM) has no debt. Its assets will be worth $600 million in one year if
the economy is strong, but only $300 million if the economy is weak. Both events are
equally likely. The market value today of Nielson’s assets is $400 million.
Suppose the risk-free interest rate is 4%. If Nielson borrows $150 million today at this
rate and uses the proceeds to pay an immediate cash dividend, then according to MM,
the expected return of Nielson’s stock just alter the dividend is paid would be closest to:
A) -17.5%
B) -12.5%
C) 12.5%
D) 17.5%
Answer:
An independent film maker is considering producing a new movie. The initial cost for
making this movie will be $20 million today. Once the movie is completed, in one year,
the movie will be sold to a major studio for $25 million. Rather than paying for the $20
million investment entirely using its own cash, the film maker is considering raising
additional funds by issuing a security that will pay investors $11 million in one year.
Suppose the risk-free rate of interest is 10%.
Assuming that the film maker issues the new security, the npv for this project is closest
to what amount? Should the film maker make the investment?
A) $1.7 million; Yes
B) $1.7 million; No
C) $2.7 million; Yes
D) $2.7 million; No
Answer:
If an investment providing a nominal return of 12.25% only offers a real rate of return
of 5.70%, then the inflation rate is closest to:
A) 5.70%
B) 6.20%
C) 6.55%
D) 12.25%
Answer:
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.)
In order for Nielson Motor’s to be willing to invest, project 3 must have an NPV greater
than:
A) $12.5 million
B) $15.0 million
C) $22.5 million
D) $27.0 million
Answer:
Suppose that the post IPO value of Wyatt is its fair market value. Suppose Wyatt could
have issued shares directly to investors at their fair market value, in a perfect market
with no underwriting spread and no under pricing. If you raise the same amount of
funds that you would have with the investment banker handling the underwriting, the
share price in this case is closest to:
A) $35
B) $37
C) $46
D) $61
E) $73
Answer:
d’Anconia Copper expects to produce 500 million pounds of copper next year, with
production costs of $0.75 per pound. Depending upon the economic conditions over the
next year, d’Anconia Copper expects the price of copper next year to be either $1.40,
$1.50, or $1.60 per pound, with each outcome being equally likely. d’Anconia Copper
expects to sell all of its copper at the going price.
If d’Anconia Copper enters into a contract to supply copper to end users at an average
price of $1.48 per pound, then d’Anconia Copper’s operating profit next year will be
closest to:
A) $325 million
B) $365 million
C) $375 million
D) $425 million
Answer:
Use the equation for the question(s) below.
Consider the following factor model:
E[Rs] – rf =
(E[RMkt] – rf) + E[RSMB] + E[RHML] + E[RPR1 YR]
The term measures the sensitivity of the securities returns to
A) momentum.
B) the overall market.
C) book to market.
D) size.
Answer:
Which of the following statements is false?
A) When we refer to the “risk-free interest rate,” we mean the rate on U.S. Treasuries.
B) Interest rates vary with the investment horizon.
C) All borrowers, besides the U.S. Treasury, have some risk of default.
D) When interest on a loan is tax deductible, the effective after-tax interest rate is τ (1 –
r).
Answer:
Which of the following statements is false?
A) The IRR of an investment in a zero-coupon bond is the rate of return that investors
will earn on their money if they buy a default free bond at its current price and hold it to
maturity.
B) The yield to maturity of a bond is the discount rate that sets the future value of the
promised bond payments equal to the current market price of the bond.
C) Financial professionals also use the term spot interest rates to refer to the
default-free zero-coupon yields.
D) When we calculate a bond’s yield to maturity by solving the formula, Price of an
n-period bond = + + … + , the yield we
compute will be a rate per coupon interval.
Answer:
Which of the following statements is false?
A) The principal or face value of a bond is the notional amount we use to compute the
interest payments.
B) Payments are made on bonds until a final repayment date, called the term date of the
bond.
C) The coupon rate of a bond is set by the issuer and stated on the bond certificate.
D) The promised interest payments of a bond are called coupons.
Answer:
Use the information for the question(s) below.
Von Bora Corporation is expected pay a dividend of $1.40 per share at the end of this
year and a $1.50 per share at the end of the second year. You expect Von Bora’s stock
price to be $25.00 at the end of two years. Von Bora’s equity cost of capital is 10%
The price you would be willing to pay today for a share of Von Bora stock, if you plan
to hold the stock for two years is closest to:
A) $23.15
B) $20.65
C) $21.95
D) $21.90
Answer:
Use the table for the question(s) below.
Consider the following top federal tax rates in the United States:
Personal Tax Rates
In 2005, assuming an average dividend payout ratio of 50%, the effective tax advantage
for debt (τ*) was closest to:
A) 24%
B) 18%
C) 35%
D) 15%
Answer: