The WACC formula does not change when preferred stock is included.
The smaller the time periods used in the binomial model the closer it will come to
approximating the Black-Scholes model price.
The risk that cannot be eliminated by diversification is called market risk.
Government loan guarantees for firms may increase APV by reducing bankruptcy risk.
Discounting at the WACC assumes that debt is rebalanced every period to maintain a
constant ratio of debt to market value of the firm.
A corporation has a legal existence of its own and is based on “articles of
incorporation.”
Risky projects can be evaluated by discounting the expected cash flows at a
risk-adjusted discount rate.
It is not possible to value a firm with supernormal (variable) growth rate for the first
few years of its life.
An increase in the exercise price results in an equal increase in the call option price.
The firm’s debt beta is usually approximately 1.0.
Projects with high fixed costs have lower break-even points.
Managers try to avoid reducing the dividend.
The expectations theory implies that the only reason for a declining term structure is
that investors expect spot interest rates to fall.
Strategy A implies a permanent need for short-term borrowing.
MM’s proposition is violated when the firm, by imaginative design of its capital
structure, can offer some financial service that meets the need of such a clientele.
The present value of a future cash flow can be found by dividing it by an appropriate
discount factor.
If two investments offer the same expected return, most investors would prefer the one
with higher variance.
Monte Carlo simulation should be used to get the distribution of NPV values for a
project.
When calculating cash flows, it is important to consider all incidental effects.
Short-term and long-term interest rates always move in parallel.
Most firms make a permanent investment in net working capital.
Most firms keep track of the progress of projects by conducting postaudits shortly after
the projects have begun to operate.
It is possible to replicate an investment in a call option by a levered investment in the
underlying asset.
The cost of equity equals the dividend yield minus the growth rate in dividends for a
constant dividend growth stock.
The risk that cannot be eliminated by diversification is called unique risk.
The small-firm effect is cited as evidence against market efficiency.
When (1 – Tp) = (1 – TpE)(1 – TC), corporate and personal taxes cancel to make debt
policy irrelevant.
The writer of a put option loses if the stock price declines.
You should replace a machine when the EAC of continuing to operate it exceeds the
EAC of the new machine.
Financial planning models are generated using spreadsheet programs.
Portfolios that offer the highest expected return for a given variance or standard
deviation are known as efficient portfolios.
In the amortization of a mortgage loan with equal payments, the fraction of each
payment devoted to interest steadily increases over time and the fraction devoted to
reducing the loan decreases steadily.
There can never be more than one value of IRR for any cash flow.
Tangible assets usually have higher abandonment value than intangible ones.
The payback period rule accepts all projects for which the payback period is:
A. Greater than the cut-off value
B. Less than the cut-off value
C. Is positive
D. An integer
Calculate the value of the firm:
A. $90.4 millions
B. $104 millions
C. $82.6 millions
D. none of the above
The delta of a put option is always equal to:
A. The delta of an equivalent call option
B. The delta of an equivalent call option with a negative sign
C. The delta of an equivalent call option minus one
D. None of the above
Suppose you buy a call and lend the present value of its exercise price. You could match
the payoffs of this strategy by:
A. Buying the underlying stock and selling a call
B. Selling a put and lending the present value of the exercise price
C. Buying the underlying stock and buying a put
D. Buying the underlying stock and selling a put
The security market line (SML) is the graph of:
A. Expected rate on investment (Y-axis) vs. variance of return
B. Expected return on investment vs. standard deviation of return
C. Expected rate of return on investment vs. beta
D. A and B
John House has taken a $250,000 mortgage on his house at an interest rate of 6% per
year. If the mortgage calls for twenty equal annual payments, what is the amount of
each payment?
A. $21,796.14
B. $10,500.00
C. $16,882.43
D. None of the above
Project Y has following cash flows: C0 = -800; C1 = +5,000; C2 = -5,000;
Calculate the IRRs for the project:
A. 25% & 400%
B. 125% & 500%
C. -44% & 11.6%
D. None of the above
For every dollar of operating income paid out as equity income, the shareholder
realizes:
A. (1 – Tp)
B. (1 – TpE) (1 – TC)
C. (1 – TC)
D. None of the above
Shareholders of a corporation may be, among others:
I) Individuals; II) Pension Funds; III) Insurance Companies
A. I only
B. I and II only
C. II only
D. I, II and III
Sun Corporation has had returns of -6%, 16%, 18%, and 28% for the past four years.
Calculate the standard deviation of the returns.
A. 11.6%
B. 14.3%
C. 13.4 %
D. None of the above
Which of the following is not a common function of the firm’s chief financial officer?
A. Hiring CEO
B. Hiring controller
C. Investing capital
D. Paying dividends
For a two-stock portfolio, the maximum reduction in risk occurs when the correlation
coefficient between the two stocks is:
A. +1
B. -0.5
C. -1
D. 0
The following are examples of foreign-based corporations except:
I) British Petroleum; II) General Electric; III) Sony; IV) Volkswagen
A. I only
B. II only
C. II and III only
D. I, II, & IV only
If the depreciable investment is $600,000 and the MACRS 5-Year class schedule is:
Year-1: 20%; Year-2: 32%; Year-3: 19.2%; Year-4: 11.5%; Year-5: 11.5% and Year-6:
5.8%
Calculate the depreciation for Year-2.
A. $120,000
B. $192,000
C. $96,000
D. $115,200
A four-year bond has an 8% coupon rate and a face value of $1000. If the current price
of the bond is $878.31, calculate the yield to maturity of the bond (assuming annual
interest payments).
A. 8%
B. 10%
C. 12%
D. 6%
A project has an initial investment of 100. You have come up with the following
estimates of the projects with cash flows.
If the cash flows are perpetuities and the cost of capital is 10%. What does a sensitivity
analysis of NPV (no taxes) show?
A. -50, 20, +100
B. -100, -50, +80
C. -50, +50, +70
D. None of the above
Mr. Hopper is expected to retire in 30 years and he wishes accumulate $1,000,000 in his
retirement fund by that time. If the interest rate is 12% per year, how much should Mr.
Hopper put into the retirement fund each year in order to achieve this goal?
A. $4,143.66
B. $8,287.32
C. $4,000
D. None of the above
You are considering the purchase of one of two machines required in your production
process. Machine A has a life of two years. Machine A costs $50 initially and then $70
per year in maintenance. Machine B has an initial cost of $90. It requires $40 in
maintenance for each year of its 3 year life. Either machine must be replaced at the end
of its life. Which is the better machine for the firm? The discount rate is 15% and the
tax rate is zero.
A. Machine A as EAC for Machine A is $100.76
B. Machine B as EAC for Machine B is $79.42
C. Machine A as PV of costs for Machine A is $163.80
D. Machine B as PV of costs for Machine B is $181.33
The quickest way to calculate the internal rate of return (IRR) of a project is by:
A. Trial and error method
B. Using the graphical method
C. Using a financial calculator
D. Guessing the IRR
Florida Company (FC) and Minnesota Company (MC) are both service companies.
Their historical return for the past three years are: FC: – 5%, 15%, 20%; MC: 8%, 8%,
20%.
Calculate the mean of returns for each company.
A. FC: 12%, MC: 6%
B. FC: 10%, MC: 12%
C. FC: 20%, MC: 32%
D. None of the above
Lake Co. has paid a dividend $3 per share out of earnings of $5 per share. If the book
value per share is $40, what is the expected growth rate in dividends?
A. 7.5%
B. 8%
C. 12.5%
D. 5%
Present Value of $100,000 that is, expected, to be received at the end of one year at a
discount rate of 25% per year is:
A. $80,000
B. $125,000
C. $100,000
D. None of the above
One key assumption of the Miller and Modigliani (MM) dividend irrelevance is that:
A. Future stock prices are certain
B. There are no capital gains taxes
C. Capital markets are efficient
D. All investments are risk-free
Beta of Treasury bills is:
A. +1.0
B. +0.5
C. -1.0
D. 0
Floatation costs are incorporated into the APV framework by:
A. Adding them into the all equity value of the project.
B. Subtracting them from all equity value of the project.
C. Incorporating them into the WACC.
D. Disregarding them.
The type of bonds where the identities of bonds’ owners are recorded and the coupon
interest payments are sent automatically are called:
A. Bearer bonds
B. Government bonds
C. Registered bonds
D. None of the above
The trade-off theory of capital structure predicts that:
A. Unprofitable firms should borrow more than profitable ones
B. Safe firms should borrow more than risky ones
C. Rapidly growing firms should borrow more than mature firms
D. Increasing leverage increases firm value
Firms often calculate a project’s break-even sales using book earnings. Generally,
break-even sales based on NPV is:
A. Higher than the one calculated using book earnings
B. Lower than the one calculated using book earnings
C. Equal to the one calculated using book earnings
D. None of the above
Which of the following is a statement of weak form efficiency?
I) If markets are efficient in the weak form, then it is impossible to make consistently
superior profits by using trading rules based on past returns
II) If the markets are efficient in the weak form, then prices will adjust immediately to
public information
III) If the markets are efficient in the weak form, then prices reflect all information
A. I only
B. II only
C. II and III only
D. III only
The following are important functions of financial markets:
I) Source of financing; II) Provide liquidity; III) Reduce risk; IV) Source of information
A. I only
B. I and II only
C. I, II, III, and IV
D. IV only
The two principal options exchanges in the U.S.A. are:
I) International Securities Exchange
II) New York Stock Exchange
III) NASDAQ
IV) Chicago Board of Options Exchange
A. II and III only
B. I and II only
C. I and IV only
D. III and IV only
State the important differences between investment decisions and financing decisions.
What are some of the disadvantages of using the IRR method?
Briefly explain how an option holder gains from the volatility of the underlying stock
price.
Why would an option holder almost never exercise an option early?
Explain the impact of government loan guarantees on corporate financing.
Discuss the process of preparing a short-term financing plan.
Explain the term ‘secondary market.”
Give an example of an option equivalent investment using common stock and
borrowing.
Briefly explain the chronology of dividend payment.
Briefly explain how to choose the up and down values for the binomial method.
Briefly explain the term “hard rationing.”
How do you calculate the external capital required?
State the “rate of return rule.”
What are some of the important points to remember while estimating the cash flows of
a project?
Under what circumstances would it be better to use the Adjusted Present Value
approach?
Briefly discuss how taxes are taken into consideration in countries like Japan.