Which of the following statements is false?
A) The techniques of the binomial option pricing model are specific to European call
and put options.
B) We can summarize the payoffs for the Binomial Option Pricing Model in a binomial
tree a timeline with two branches at every date that represent the possible events that
could happen at those times.
C) We define the state in which the stock price goes up as the upstate and the state in
which the stock price goes down as the downstate.
D) When using the Binomial Option Pricing Model, by the Law of One Price, the price
of the option today must equal the current market value of the replicating portfolio.
Answer:
Use the information for the question(s) below.
You own a small manufacturing plant that currently generates revenues of $2 million
per year. Next year, based upon a decision on a long-term government contract, your
revenues will either increase by 20% or decrease by 25%, with equal probability, and
stay at that level as long as you operate the plant. Other costs run $1.6 million dollars
per year. You can sell the plant at any time to a large conglomerate for $5 million and
your cost of capital is 10%.
If you are awarded the government contract and your sales increase by 20%, then the
value of your plant will be closest to:
A) $5 million
B) $8 million
C) $0
D) $4 million
Answer:
Use the following information to answer the question(s) below.
Wyatt Oil has assets with a market value of $600 million, $70 million of which are
cash. It has debt of $250 million, and 20 million shares outstanding. Assume perfect
capital markets.
If Wyatt Oil distributes the $70 million as a dividend, then its debt-to-equity ratio after
the dividend will be closest to:
A) 0.7
B) 0.9
C) 1.0
D) 1.1
Answer:
Sarah Palin reportedly was paid a $11 million advance to write her book Going Rogue.
The book took one year to write. In the time she spent writing, Palin could have been
paid to give speeches and appear on TV news as a political commentator. Given her
popularity, assume that she could have earned $8 million over the year (paid at the end
of the year) she spent writing the book. Assume that she was able to write the book
while simultaneously fulfilling her media commitments of appearing on TV news as a
political commentator and give speeches.
The IRR of Palin’s book deal is closest to:
A) -27.25%
B) -37.50%
C) 27.25%
D) 37.50%
Answer:
Consider the following tax rates:
*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 tax disadvantage for retaining cash in 2000 is closest to:
A) 15.00%
B) 13.35%
C) 14.75%
D) 35.00%
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.
Assume that in addition to 1.25 billion common shares outstanding, Luther has stock
options given to employees valued at $2 billion. The market value of Luther’s non-cash
assets is closest to:
A) $22 billion
B) $20 billion
C) $25 billion
D) $18 billion
Answer:
Use the information for the question(s) below.
Monsters Incorporated (MI) in ready to launch a new product. Depending upon the
success of this product, MI will have a value of either $100 million, $150 million, or
$191 million, with each outcome being equally likely. The cash flows are unrelated to
the state of the economy (i.e. risk from the project is diversifiable) so that the project
has a beta of 0 and a cost of capital equal to the risk-free rate, which is currently 5%.
Assume that the capital markets are perfect.
Suppose that MI has zero-coupon debt with a $125 million face value due next year.
The initial value of MI’s debt is closest to:
A) $125 million
B) $111 million
C) $100 million
D) $116 million
Answer:
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%.
If Galt’s debt cost of capital is 6%, then Galt’s equity cost of capital is closest to:
A) 11.2%
B) 12.0%
C) 14.8%
D) 15.2%
Answer:
An extremely lucrative severance package that is guaranteed to a firm’s senior managers
in the event that the firm is taken over and the managers are let go is called a
A) golden parachute.
B) white knight.
C) poison pill.
D) classified board.
Answer:
Directors who are employees, former employees, or family members of employees are
called
A) managing directors.
B) independent directors.
C) inside directors.
D) gray directors.
Answer:
Which of the following questions regarding risk arbitrage is false?
A) Once a tender offer is announced, the uncertainty about whether the takeover will
succeed reduces the volatility of the stock price. This uncertainty creates an opportunity
for investors to speculate on the outcome of the deal without bearing the risk of
volatility.
B) Traders known as risk-arbitrageurs, who believe that they can predict the outcome of
a deal, take positions based on their beliefs.
C) A potential profit arises from the difference between the target’s stock price and the
implied offer price, and is referred to as the merger-arbitrage spread.
D) However, it is not a true arbitrage opportunity because there is a risk that the deal
will not go through. If the takeover did not ultimately succeed, the risk-arbitrageur
would eventually have to unwind his position at whatever market prices prevailed.
Answer:
Assuming that this project will provide Rearden with perpetual annual cash flows of
$80,000, Rearden should
A) invest today since the NPV is positive.
B) invest today since the NPV is negative.
C) invest today since the NPV using the hurdle rate is positive.
D) delay investing since the NPV using the hurdle rate is negative.
E) delay investing since the NPV using the hurdle rate is positive.
Answer:
Use the following information to answer the question(s) below.
Rearden Metal has earnings per share of $2. It has 10 million shares outstanding and is
trading at $20 per share. Rearden Metal is thinking of buying Associated Steel, which
has earnings per share of $1.25, 4 million shares outstanding, and a price per share of
$15. Rearden Metal will pay for Associated Steel by issuing new shares. There are no
expected synergies from the transaction.
If Rearden offers an exchange ratio such that, at current pre-announcement share prices
for both firms, the offer represents a 20% premium to buy Associated Steel, then the
price per share of the Rearden immediately after the announcement will be closest to:
A) $15.00
B) $17.20
C) $18.60
D) $19.10
Answer:
Use the information for the question(s) below.
Suppose that the risk-free rate is 5% and the market portfolio has an expected return of
13% with a volatility of 18%. Monsters Inc. has a 24% volatility and a correlation with
the market of .60, while California Gold Mining has a 32% volatility and a correlation
with the market of -.7. Assume the CAPM assumptions hold.
California Gold Mining’s required return is closest to:
A) -5%
B) 13%
C) 15%
D) 5%
Answer:
Consider a zero-coupon bond with a $1000 face value and 10 years left until maturity.
If the YTM of this bond is 10.4%, then the price of this bond is closest to:
A) $1000
B) $602
C) $1040
D) $372
Answer:
Use the table for the question(s) below.
Pro Forma Income Statement for Ideko, 2005-2010
With the proper changes it is believed that Ideko’s credit policies will allow for an
account receivables days of 60. The forecasted accounts receivable for Ideko in 2008 is
closest to:
A) $14,525
B) $19,690
C) 22,710
D) $16,970
Answer:
Use the table for the question(s) below.
The quarterly working capital levels for Hasbeen Toys are presented in the following
table (in $ millions):
In which quarter are Hasbeen’s seasonal working capital needs the greatest?
A) 4
B) 2
C) 3
D) 1
Answer:
Use the following information to answer the question(s) below.
Using just the return data for 2008, your estimate of Wyatt Oil’s Beta is closest to:
A) 0.85
B) 0.87
C) 1.00
D) 1.17
Answer:
Use the following information to answer the question(s) below.
Assume that the economy has three types of people. 20% are fad followers, 75% are
passive investors, and 5% are informed traders. The portfolio consisting of all informed
traders has a beta of 1.4 and an expected return of 16%. The market has an expected
return of 10% and the risk-free rate is 4%.
The expected return for the fad follower’s portfolio is closest to:
A) 11.5%
B) 12.4%
C) 13.6%
D) 16.0%
Answer:
Use the following information to answer the question(s) below.
Wyatt Oil has assets with a market value of $600 million, $70 million of which are
cash. It has debt of $250 million, and 20 million shares outstanding. Assume perfect
capital markets.
If Wyatt Oil distributes the $70 million as a share repurchase, then its debt-to-equity
ratio after the share repurchase will be closest to:
A) 0.9
B) 1.0
C) 1.1
D) 1.4
Answer:
Consider the following equation:
In this equation, the term S represents
A) the current price of the stock.
B) the stock price at expiration.
C) the annual volatility of the stock.
D) strike price for the option.
Answer:
Use the information for the question(s) below.
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.
If it is managed efficiently, then the expected market value of Luther’s assets is closest
to:
A) $300 million
B) $260
C) $240
D) $280 million
Answer:
Which of the following statements regarding sinking fund provisions is false?
A) With a sinking fund, if a bond is trading at below its face value, because the bonds
are repurchased at par the decision as to which bonds to repurchase is made by lottery.
B) With a sinking fund, instead of repaying the entire principal balance on the maturity
date, the company makes regular payments into a sinking fund administered by a
trustee over the life of the bond.
C) Sinking fund provisions usually specify a minimum rate at which the issuer must
contribute to the fund.
D) Because the sinking fund allows the issuer to repurchase the bonds at par, the option
to accelerate the payments is another form of call provision.
Answer:
Which of the following statements is false?
A) The expected return is the return is the return that actually occurs over a particular
time period.
B) If you hold the stock beyond the date of the first dividend, then to compute you
return you must specify how you invest any dividends you receive in the interim.
C) The average annual return of an investment during some historical period is simply
the average of the realized returns for each year.
D) The realized return is the total return we earn from dividends and capital gains,
expressed as a percentage of the initial stock price.
Answer:
Use the following information to answer the question(s) below.
d’Anconia Copper has $200 million in cash that it can use for a share repurchase.
Suppose instead that d’Anconia Copper invests the funds in an account paying 5%
interest for one year. Assume that the corporate tax rate is 35%, the individual capital
gains rate is 15% and the individual rate on ordinary income is 30%.
Net of ordinary income taxes, the amount that investors would have if they invested the
$200 million on their own is closest to:
A) $5.5 million
B) $6.5 million
C) $7.0 million
D) $10.0 million
Answer:
A lease that gives the lessee the option to purchase the asset at its fair market value at
the termination of the lease is called a
A) fair market value cap lease.
B) fair market value lease.
C) $1.00 out lease.
D) fixed price lease.
Answer:
Taggart Transcontinental has a value of $500 million if it continues to operate, but has
outstanding debt of $600 million. If Taggart declares bankruptcy, bankruptcy costs will
equal $50 million, and the remaining $450 million will go to creditors. Instead of
declaring bankruptcy, Taggart proposes to exchange the firm’s debt for a fraction of its
equity in a workout. The minimum fraction of the firm’s equity that Taggart would need
to offer to its creditors for the workout to be successful is closest to:
A) 50%
B) 75%
C) 83%
D) 90%
Answer:
You are considering investing in a security that will pay you $80 in interest at the end of
each of the next 10 years. If this security is currently selling for $588.81, then the IRR
for investing in this security is closest to:
A) 6.0%
B) 7.0%
C) 6.5%
D) 5.0%
Answer:
Use the following information to answer the question(s) below.
Galt Industries has no debt, total equity capitalization of $600 million, and an equity
beta of 1.2. Included in Galt’s assets is $90 million in cash and risk-free securities.
Assume the risk-free rate is 4% and the market risk premium is 6%.
Galt’s enterprise value is closest to:
A) $90 million
B) $510 million
C) $600 million
D) $690 million
Answer:
Which of the following statements is false?
A) An important consequence of leverage is the risk of bankruptcy.
B) Whether default occurs depends on the cash flows, not on the relative values of the
firm’s assets and liabilities.
C) Economic distress is a significant decline in the value of a firm’s assets, whether or
not it experiences financial distress due to leverage.
D) Modigliani and Miller’s results continue to hold in a perfect market even when debt
is risky and the firm may default.
Answer:
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
$65,000, the NPV of investing in the project next year is closest to:
A) -281,000
B) +46,000
C) +83,000
D) +143,000
E) +238,000
Answer:
Which of the following statements is false?
A) The one advantage of a cash offer is that the underwriter takes on a larger role and,
therefore, can credibly certify the issue’s quality.
B) SEO underwriting fees average about 5% of the proceeds of the issue and, as with
IPOs, the variation across issues of different sizes is relatively small.
C) As with IPOs, evidence suggests that companies over perform following a seasoned
offering.
D) Often the value destroyed by the price decline can be a significant fraction of the
new money raised with a SEO.
Answer:
Use the information for the question(s) below.
Omicron Industries’ Market Value Balance Sheet ($ 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.
The NPV for Omicron’s new project is closest to:
A) $23.75
B) $27.50
C) $28.75
D) $25.75
Answer:
Use the table for the question(s) below.
Consider the following returns:
The Volatility on Stock Y’s returns is closest to:
A) 35%
B) 31%
C) 42%
D) 18%
Answer:
Use the table for the question(s) below.
Luther Industries currently has the following balance sheet (in Thousands of dollars):
Luther is about to add a new fleet of delivery trucks. The price of the fleet is $1.5
million.
If Luther acquires the new fleet of delivery trucks using an operating lease, Luther’s
Debt to Equity ratio will be closest to:
A) 2.0
B) 1.5
C) 0.80
D) 0.66
Answer:
