Use the following information to answer the question(s) below.
Galt Industries is trading for $20 per share and has 25 million shares outstanding. Galt
Industries has a debt-equity ratio of 0.4 and its debt is zero coupon debt with a ten year
maturity and a yield to maturity of 8%.
In describing Galt’s equity as a call option, the strike price of the call option is:
A) $200 million
B) $300 million
C) $500 million
D) $700 million
Answer:
Use the information for the question(s) below.
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.
Suppose that BBB pays corporate taxes of 35% and that shareholders expects the
change in debt to be permanent. Assuming that capital markets are perfect except for
the existence of corporate taxes, the share price for BBB after this announcement is
closest to:
A) $10.00
B) $10.85
C) $8.60
D) $11.40
Answer:
Use the table for the question(s) below.
Consider the following zero-coupon yields on default free securities:
The price of a five-year, zero-coupon, default-free security with a face value of $1000 is
closest to:
A) $754
B) $772
C) $776
D) $791
Answer:
The Principal-Agent Problem arises
A) because managers have little incentive to work in the interest of shareholders when
this means working against their own self-interest.
B) because of the separation of ownership and control in a corporation.
C) Both A and B
D) None of the above
Answer:
If the current rate of interest is 8%, then the future value 20 years from now of an
investment that pays $1000 per year and lasts 20 years is closest to:
A) $45,762
B) $36,725
C) $9,818
D) $93,219
Answer:
Which of the following statements is false?
A) Because of the higher and uncompensated risk involved, no investor should choose a
portfolio with a negative alpha.
B) Because the average portfolio of all investors is the market portfolio, the average
alpha for all investors is zero.
C) The market portfolio can be inefficient if a significant number of investors
misinterpret information and believe they are earning a positive alpha when they are
actually earning a negative alpha.
D) If no investor earns a positive alpha, then no investor can earn a negative alpha, and
the market portfolio must be efficient.
Answer:
If the risk-free rate of interest (rf) is 6%, then you should be indifferent between
receiving $250 in one year or
A) $235.85 today.
B) $250.00 today.
C) $265.00 today.
D) None of the above
Answer:
What kind of unsecured corporate debt has a maturity of less than 10 years?
A) Mortgage bonds
B) Asset-backed bonds
C) Debentures
D) Notes
Answer:
Assume that you purchased Ford Motor Company stock at the closing price on
December 31, 2008 and sold it at the closing price on December 30, 2009. Your realized
annual return for the year 2009 is closest to:
A) -45.1%
B) -44.5%
C) -48.5%
D) -47.3%
Answer:
Use the table for the question(s) below.
Pro Forma Income Statement for Ideko, 2005-2010
The amount of net working capital for Ideko in 2008 is closest to:
A) $35,195
B) $26,420
C) $22,170
D) $30,510
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%.
Assume that you are not able to sell the plant, but you are able to shut down the plant at
no cost at any time. Given the embedded option to abandon production the value of
your plant will be closest to:
A) $8.0 million
B) $4.0 million
C) $5.0 million
D) $6.5 million
Answer:
An individual’s desire for intense risk-taking experiences is known as
A) phenomenon seeking.
B) herd seeking.
C) sensation seeking.
D) rational expectations seeking.
Answer:
Use the information for the question(s) below.
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 $40,000 at the
risk free rate and issues new equity to cover the remainder. In this situation, the cost of
capital for the firm’s levered equity is closest to:
A) 23%
B) 25%
C) 15%
D) 18%
Answer:
Wyatt Oil is contemplating issuing a 20-year bond with semiannual coupons, a coupon
rate of 7%, and a face value of $1000. Wyatt Oil believes it can get a BBB rating from
Standard and Poor’s for this bond issue. If Wyatt Oil is successful in getting a BBB
rating, then the issue price for these bonds would be closest to:
A) $800
B) $891
C) $901
D) $1,000
Answer:
Suppose the current exchange rate is $1.62/, the interest rate in the united states is
5.25%, the interest rate in the United Kingdom is 4%, and the volatility of the $/
exchange rate is 18%. Using the Black-Scholes formula, the price of a six-month
European call option on the British pound with a strike price of $1.60/ will be closest
to:
A) $0.040/
B) $0.059/
C) $0.078/
D) $0.097/
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.
Wyatt Oil’s current stock price is closest to:
A) $11.00
B) $12.50
C) $14.00
D) $17.50
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 not awarded the government contract and your sales decrease by 25%, then
the value of your plant will be closest to:
A) -$1 million
B) $5 million
C) $8 million
D) $0
Answer:
Which of the following statements is false?
A) Bond ratings encourage widespread investor participation and relatively liquid
markets.
B) Bonds in the top four categories are often referred to as investment grade bonds.
C) A bond’s rating depends on the risk of bankruptcy as well as the bondholder’s ability
to lay claim to the firm’s assets in the event of a bankruptcy.
D) Debt issues with a low-priority claim in bankruptcy will have a better rating than
issues from the same company that have a higher priority in bankruptcy.
Answer:
Use the tables for the question(s) below.
Pro Forma Income Statement for Ideko, 2005-2010
Pro Forma Balance Sheet for Ideko, 2005-2010
Assuming that Ideko has a EBITDA multiple of 8.5, then the continuation EV/Sales
ratio of Ideko in 2010 is closest to:
A) 1.7
B) 1.9
C) 1.6
D) 1.8
Answer:
Consider the following equation:
the term rD(1 – τc) in this equation is
A) the required rate of return on debt.
B) the dollar amount of equity.
C) the after tax required rate of return on debt.
D) the required rate of return on equity.
Answer:
Use the information for the question(s) below.
Omicron Industries’ Market Value Balance Sheet ($ 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 interest tax shield provided by Omicron’s new project in year 1 is closest to:
A) $3.00
B) $1.05
C) $50.25
D) $17.60
Answer:
Use the following information to answer the question(s) below.
John Galt is a mutual fund manager at Atlas Asset Management. He can generate an
alpha of 2% a year up to $500 million of invested capital. After that amount his skills
are spread too thin, so he cannot add value and his alpha is zero for all investments over
$500 million. Atlas Asset Management charges a fee of 0.80% on the total amount of
money under management. Assume that there are always investors looking for positive
alpha investments and no investor would invest in a fund with a negative alpha. Assume
that the fund is in equilibrium, meaning that no investor either takes out money or
wishes to invest new money into the fund.
The expected return for the fad follower’s portfolio is closest to:
A) -0.9%
B) 0.0%
C) 3.6%
D) 6.0%
Answer:
Use the information for the question(s) below.
You are evaluating a new project and need an estimate for your project’s beta. You have
identified the following information about three firms with comparable projects:
The unlevered beta for Blinkin is closest to:
A) 0.95
B) 1.10
C) 1.00
D) 0.90
Answer:
The depreciation tax shield for the Sisyphean Corporation’s project in the first year is
closest to:
A) $8,000
B) $3,500
C) $2,800
D) $5,200
Answer:
The idea that claims in one’s self-interest are credible only if they are supported by
actions that would be too costly to take if the claims were untrue is known as the
A) pecking order hypothesis.
B) credibility principle.
C) lemons principle.
D) signaling theory of debt.
Answer:
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 equivalent annual benefit of project A is closest to:
A) $21.70
B) $5.05
C) $24.00
D) $3.40
Answer:
Which of the following statements is false?
A) To estimate a firm’s enterprise value, we compute the present value of the free cash
flows (FCF) that the firm has available to pay equity holders.
B) The NPV of any individual project represents its contribution to the firm’s enterprise
value.
C) When using the total payout model, we discount total dividends and share
repurchases, and use the growth rate in earnings when forecasting the growth of the
firm’s payout.
D) In the total payout model, we first value the firm’s equity, rather than just a single
share.
Answer:
In November 2009, Perrigo Co. (PRGO) had a share price of $39.20. They had 91.33
million shares outstanding, a market-to-book ratio of 3.76. In addition, PRGO had
$845.01 million in outstanding debt, $163.82 million in net income, and cash of
$257.09 million.
Perrigo’s price-earnings ratio (P/E) is closest to:
A) 15.96
B) 21.85
C) 29.77
D) 35.64
Answer:
Bubba Ho-Tep Company reported net income of $300 million for the most recent fiscal
year. The firm had depreciation expenses of $125 million and capital expenditures of
$150 million. Although they had no interest expense, the firm did have an increase in
net working capital of $20 million. What is Bubba Ho-Tep’s free cash flow?
A) $170 million
B) $255 million
C) $150 million
D) $5 million
Answer:
Which of the following statements is false?
A) Financing part or all of the permanent working capital with short-term debt is known
as an aggressive financing policy.
B) When the yield curve is downward sloping, the interest rate on short-term debt is
lower than the rate on long-term debt. In that case, short-term debt may appear cheaper
than long-term debt.
C) The value of short-term debt is less sensitive to the firm’s credit quality than
long-term debt; therefore, its value will be less affected by management’s actions or
information.
D) Permanent working capital is the amount that a firm must keep invested in its
short-term assets to support its continuing operations.
Answer:
Use the following information to answer the question(s) below.
d’Anconia Copper is considering issuing one year debt, and has come up with the
following estimates of the value of the interest tax shield and the probability of distress
for different levels of debt:
If in the event of distress, the present value of distress costs is equal to $25 million, then
the optimal level of debt for d’Anconia Copper is:
A) $50 million
B) $60 million
C) $70 million
D) $80 million
Answer:
If the risk-free rate of interest (rf) is 6%, then you should be indifferent between
receiving $250 today or
A) $235.85 in one year.
B) $250.00 in one year.
C) $265.00 in one year.
D) None of the above
Answer:
The market price of an option is called the
A) American premium.
B) European premium.
C) option premium.
D) exercising premium.
Answer:
If the value of security “C” is $180, then what must be the value of security “A”?
A) $80
B) $90
C) $100
D) Unable to determine without the risk-free rate.
Answer: