A type of agency problem that results in shareholders gaining by choosing not to
finance new, positive-NPV projects is:
A) asset substitution.
B) debt overhang.
C) excessive risk-taking.
D) distress costs.
Consider the following information regarding corporate bonds:
Galt Industries has a market capitalization of $50 billion, $30 billion in BBB rated debt,
and $8 billion in cash. If Galt’s equity beta is 1.15, then Galt’s underlying asset beta is
closest to:
A) 0.83
B) 0.92
C) 1.00
D) 1.15
The firm’s revenues and expenses over a period of time are reported on the firm’s:
A) income statement or statement of financial performance.
B) income statement or statement of financial position.
C) balance sheet or statement of financial performance.
D) balance sheet or statement of financial position.
Suppose that Rearden Metal currently has no debt and has an equity cost of capital of
12%. Rearden is considering borrowing funds at a cost of 6% and using these funds to
repurchase existing shares of stock. Assume perfect capital markets. If Taggart borrows
until they achieved a debt -to-equity ratio of 50%, then Rearden’s levered cost of equity
would be closest to:
A) 10.0%
B) 12.0%
C) 15.0%
D) 16.0%
Consider the following three individuals portfolios consisting of investments in four
stocks:
Assuming that the risk-free rate is 4% and the expected return on the market is 12%,
then required return on Peter’s Portfolio is closest to:
A) 10%
B) 12%
C) 9%
D) 8%
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 asset beta (ie the beta of its operating assets) is closest to:
A) 1.1
B) 1.2
C) 1.3
D) 1.4
Which of the following statements is FALSE?
A) Because the cash flows promised by the bond are the most that bondholders can
hope to receive, the cash flows that a purchaser of a bond with credit risk expects to
receive may be less than that amount.
B) By consulting bond ratings, investors can assess the credit-worthiness of a particular
bond issue.
C) Because the yield to maturity for a bond is calculated using the promised cash flows,
the yield of bond’s with credit risk will be lower than that of otherwise identical
default-free bonds.
D) A higher yield to maturity does not necessarily imply that a bond’s expected return is
higher.
Which of the following statements is FALSE?
A) Margin investing is a risky investment strategy.
B) Because our return on the risk-free investments is fixed and does not move with (or
against) our portfolio, the correlation between the risk-free investment and the portfolio
is always equal to one.
C) Short selling the risk free investment is equivalent to borrowing money at the
risk-free interest rate through a standard loan.
D) Margin investing can provide higher expected returns than investing in the efficient
portfolio using only the funds we have available.
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.
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
Which of the following statements is FALSE?
A) We should use the general dividend discount model to value the stock of a firm with
rapid or changing growth.
B) As firms mature, their growth slows to rates more typical of established companies.
C) The dividend discount model values the stock based on a forecast of the future
dividends paid to shareholders.
D) The simplest forecast for the firm’s future dividends states that they will grow at a
constant rate, g, forever.
Which of the following statements is FALSE?
A) Bonds are a securities sold by governments and corporations to raise money from
investors today in exchange for promised future payments.
B) By convention the coupon rate is expressed as an effective annual rate.
C) Bonds typically make two types of payments to their holders.
D) The time remaining until the repayment date is known as the term of the bond.
Your firm needs to invest in a new delivery truck. The life expectancy of the delivery
truck is five years. You can purchase a new delivery truck for an upfront cost of
$200,000, or you can lease a truck from the manufacturer for five years for a monthly
lease payment of $4000 (paid at the end of each month). Your firm can borrow at 6%
APR with quarterly compounding.
The effective annual rate on your firm’s borrowings is closest to:
A) 6.00%
B) 6.14%
C) 6.25%
D) 6.30%
Galt Industries has 125 million shares outstanding and has a marginal corporate tax rate
of 35%. Galt announces that it will use $75 million in excess cash to investors
repurchase shares. Shareholders had previously assumed that Galt would retain this
excess cash permanently. The amount Galt’s share price can be expected to change upon
this announcement is closest to:
A) $0.21
B) $0.24
C) $0.36
D) $0.39
Which of the following statements is FALSE?
A) The firm deducts a fraction of the investments in plant, property, and equipment
each year as depreciation.
B) If securities are fairly priced, the net present value of a fixed set of cash flows is
independent of how those cash flows are financed.
C) Sunk cost fallacy is a term used to describe the tendency of people to ignore sunk
costs in capital budgeting analysis.
D) A good rule to remember is that if our decision does not affect a cash flow then the
cash flow should not affect our decision.
Which of the following is NOT an indirect cost of bankruptcy?
A) Loss of suppliers
B) Fire sales of assets
C) Costs of appraisers
D) Loss of employees
KD Industries has 30 million shares outstanding with a market price of $20 per share
and no debt. KD has had consistently stable earnings, and pays a 35% tax rate.
Management plans to borrow $200 million on a permanent basis through a leveraged
recapitalization in which they would use the borrowed funds to repurchase outstanding
shares.
The value of KD’s unlevered equity is closest to:
A) $600 million
B) $470 million
C) $390 million
D) $400 million