Your firm is considering building a new office complex. Your firm already owns land
suitable for the new complex. The current book value of the land is $100,000, however
a commercial real estate again has informed you that an outside buyer is interested in
purchasing this land and would be willing to pay $650,000 for it. When calculating the
NPV of your new office complex, ignoring taxes, the appropriate incremental cash flow
for the use of this land is:
A) $650,000
B) $0
C) $100,000
D) $750,000
Rockwood Industries has 100 million shares outstanding, a current share price of $25,
and no debt. Rockwood’s management believes that the shares are under-priced, and
that the true value is $30 per share. Rockwood plans to pay $250 million in cash to its
shareholders by repurchasing shares. Management expects that very soon new
information will come out that will cause investors to revise their opinion of the firm
and agree with Rockwood’s assessment of the firm’s true value.
Assume that Rockwood is not able to repurchase shares prior to the market becoming
aware of the new information regarding Rockwood’s true value. After the release of the
new information regarding the true value of Rockwood, and following the repurchase,
the firm’s share price is closest to:
A) $30.00
B) $30.60
C) $28.75
D) $31.50
Iota Industries is an all-equity firm with 50 million shares outstanding. Iota has $200
million in cash and expects future free cash flows of $75 million per year. Management
plans to use the cash to expand the firm’s operations, which in turn will increase future
free cash flows by 12%. Iota’s cost of capital is 10% and assume that capital markets are
perfect.
The value of Iota if they do not to use the $200 million to expand and hold the cash
instead is closest to:
A) $840 million
B) $825 million
C) $950 million
D) $688 million
Details of acquisitions, spin-offs, leases, taxes, and risk management activities are
given:
A) in the management discussion and analysis.
B) in the Securities and Exchange Commission’s commentary.
C) in the auditor’s report.
D) in the notes to the financial statements.
According to Figure 6.5, the percent of countries in default or restructuring debt:
A) hit an all-time high in 2000-2005.
B) peaked during World War II.
C) is high whenever Greece defaults.
D) is never more than 1/3.
The Sarbanes-Oxley Act (SOX) forced companies to validate their internal financial
control processes by:
A) putting strict limits on the amount of non-audit fees (consulting or otherwise) that an
accounting firm can earn from a firm that it audits.
B) requiring the CEO and CFO to return bonuses or profits from the sale of stock that
are later shown to be due to misstated financial reports.
C) requiring auditing firms to have long-standing relationships with their clients and
receive lucrative auditing and consulting fees from them.
D) requiring senior management and the boards of public companies to validate and
certify the process through which funds are allocated and controlled.
As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one
barrel of Alaska North Slope (ANS) crude oil. Because of its lower sulfur content, you
can produce $77 worth of unleaded gasoline from one barrel of West Texas
Intermediate (WTI) crude.
Another oil refiner is offering to trade you 10,150 Bbls of Alaska North Slope (ANS)
crude oil for 10,000 Bbls of West Texas Intermediate (WTI) crude oil. Assuming you
currently have 10,000 Bbls of WTI crude, the added benefits to you if you were to sell
the 10,000 Bbls of WTI crude and use the proceeds to purchase and refine ANS crude is
closest to:
A) $730,600
B) $770,000
C) $40,800
D) $43,308
Wildcat Drilling is an oil and gas exploration company that is currently operating two
active oil fields with a market value of $200 million dollars each. Unfortunately,
Wildcat Drilling has $500 million in debt coming due at the end of the year. A large oil
company has offered Wildcat drilling a highly speculative, but potentially very
valuable, oil and gas lease in exchange for one of their active oil fields. If Wildcat
accepts the trade, there is a 10% chance that Wildcat will discover a major new oil field
that would be worth $1.2 billion, a 15% that Wildcat will discover a productive oil field
that would be worth $600 million, and a 75% chance that Wildcat will not discover oil
at all.
What is the expected payoff to debt holders with the speculative oil lease deal?
A) $10 million
B) $275 million
C) $85 million
D) $160 million
You expect KT Industries (KTI) will have earnings per share of $3 this year and expect
that they will pay out $1.50 of these earnings to shareholders in the form of a dividend.
KTI’s return on new investments is 15% and their equity cost of capital is 12%. The
expected growth rate for KTI’s dividends is closest to:
A) 6.0%
B) 7.5%
C) 4.5%
D) 3.0%
Capital Structure and Unlevered Beta Estimates for Comparable Firms
If the risk-free rate of interest is 6% and the market risk premium has historically
averaged 5%, then the cost of capital for Luxottica is closest to:
A) 10.2%
B) 13.5%
C) 9.1%
D) 14.7%
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.
Your firm pays 40% of earnings in taxes and you decide to issue $25 million in new
debt and $25 million in new equity. You ownership stake in the firm following these
new issues of debt and equity is closest to:
A) 58%
B) 55%
C) 33%
D) 50%
Luther Corporation
Consolidated Balance Sheet
December 31, 2009 and 2008 (in $ millions)
What is Luther’s net working capital in 2008?
A) $12 million
B) $27 million
C) $39 million
D) $63.6 million
You expect Whirlpool Corporation (WHR)to have earnings per share of $6.10 over the
coming year. If Whirlpool stock is currently trading at $87.00 per share, then
Whirlpool’s P/E ratio is closest to:
A) 17.00
B) 13.50
C) 14.25
D) 7.00
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 a security with a risk-free cash flow of $1000 in one year trades for $909
today. If there are no arbitrage opportunities, then the current risk-free interest rate is
closest to:
A) 8%
B) 10%
C) 11%
D) 12%
Which of the following statements is FALSE?
A) We can improve the performance of our portfolio by selling stocks with negative
alphas.
B) The market portfolio is on the SML, and according to the CAPM, since all other
portfolios are inefficient they will not fall on the SML.
C) The difference between a stock’s expected return and its required return according to
the security market line is called the stock’s alpha.
D) The risk premium for any security is proportional to its beta with the market.
Consider the following four bonds that pay annual coupons:
Which of the four bonds is the most sensitive to a one percent increase in the YTM?
A) Bond A
B) Bond B
C) Bond C
D) Bond D
You are offered an investment that offers and effective annual rate of 8%. If this
investment offers continuous compounding, then the APR for this investment is closest
to:
A) 7.70%
B) 8.00%
C) 8.25%
D) 8.33%
Omicron Industries’ Market Value Balance Sheet ($ Millions)
and Cost of Capital
Omicron Industries New Project Free Cash Flows
Assume that this new project is of average risk for Omicron and that the firm wants to
hold constant its debt to equity ratio.
Omicron’s Unlevered cost of capital is closest to:
A) 8.75%
B) 7.10%
C) 9.60%
D) 7.50%
Which of the following statements is FALSE?
A) The most important insight regarding capital structure goes back to Modigliani and
Miller: With perfect capital markets, a firm’s security choice alters the risk of the firm’s
equity, but it does not change its value or the amount it can raise from outside investors.
B) When agency costs are significant, short-term debt may be the most attractive form
of external financing.
C) Too much debt can motivate managers and equity holders to take excessive risks or
over-invest in a firm.
D) Of all the different possible imperfections that drive capital structure, the most
clear-cut, and possibly the most significant, is taxes.
Rockwood Industries has 100 million shares outstanding, a current share price of $25,
and no debt. Rockwood’s management believes that the shares are under-priced, and
that the true value is $30 per share. Rockwood plans to pay $250 million in cash to its
shareholders by repurchasing shares. Management expects that very soon new
information will come out that will cause investors to revise their opinion of the firm
and agree with Rockwood’s assessment of the firm’s true value.
Assume that Rockwood is able to repurchase shares prior to the market becoming aware
of the new information regarding Rockwood’s true value. After the repurchase, and
following the release of the new information regarding the true value of Rockwood, the
firm’s share price is closest to:
A) $30.00
B) $31.50
C) $28.75
D) $30.60
*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 1999 is closest to:
A) 40%
B) 20%
C) 0%
D) 25%
The British government has a consol bond outstanding that pays ₤100 in interest each
year. Assuming that the current interest rate in Great Britain is 5% and that you will
receive your first interest payment one year from now, then the value of the consol bond
is closest to:
A) ₤1000
B) ₤1100
C) ₤2100
D) ₤2000
Various trading strategies appear to offer non-zero alphas when we examine real world
data. If indeed these alphas are positive, it could be explained by any of the following
EXCEPT:
A) Investors are systematically ignoring positive-NPV investment opportunities.
B) The market portfolio is inefficient, but the market portfolio proxy used to calculate
the alphas is efficient.
C) A stock’s beta with the market portfolio does not adequately measure a stock’s
systematic risk.
D) The positive alpha trading strategies contain risk that investors are unwilling to bear
but the CAPM does not capture.
Consider the following equation:
rwacc= rU– Ï„cdrD
The term d in this equation is:
A) the project’s unlevered cost of capital.
B) the project’s dollar amount of debt.
C) the firm’s unlevered cost of debt.
D) the project’s debt to value ratio.