Options written on volatile assets are worth more than options written on safer assets.
The weighted average cost of capital (WACC) on an after-tax basis is calculated as:
WACC = (rD) (1 – TC ) (D/V) + (rE) (E/V) where: V = D + E
Each project should be evaluated at its own opportunity cost of capital. The true cost of
capital depends on the use to which the capital is put.
For a corporation, financing decisions are harder to reverse than investment decisions.
Options can have a value even when the stock is worthless.
An annuity is an asset that pays a fixed sum each year for a specified number of years.
The rate of return on any perpetuity is equal to the cash flow multiplied by the price.
The rule for comparing machines with different lines is to select the machine with the
greatest equivalent annual cost (EAC).
A firm’s overall value belongs entirely to the shareholders.
In drawing a decision tree, it is important to include all possible eventualities.
Soft rationing may be used to control managerial behavior.
Financial distress occurs when promises to creditors are not honored or honored with
great difficulty.
It is generally more accurate to estimate an “industry beta” for a portfolio of companies
in the same industry than to estimate beta for a single company.
The profitability index will always be below 1.
The only payoff to the owners of common stocks is in the form cash dividends.
Miller and Modigliani’s argument for dividend irrelevance assumes an efficient market.
If capital markets are efficient, then the purchase or sale of any security at the
prevailing market price is never a positive-NPV transaction.
Beta measures the marginal contribution of a stock to the risk of a well-diversified
portfolio.
The payback rule ignores all cash flows after the cutoff date.
Everyone regards Microsoft as an income stock and Cummins as a growth stock.
The duration of any bond is the same as its maturity.
The distribution of annual returns for a stock would be closely related to the normal
distribution.
A knock-in barrier option might be used if the investor is looking to reduce the cost of
buying a call option.
Net working capital is equal to total assets minus total liabilities.
The discounted-cash-flow formulas that is used to value common stocks can also be
used to value entire businesses.
In a competitive market, security prices follow a random walk.
Indexed bonds were completely unknown in the U.S. before 1997.
An investor can get downside protection by buying a stock and a put option.
Syndicated loans are subsequently resold to other institutions.
Since the investment and financing decisions are analyzed separately, the financial
manager can completely ignore investors and financial markets when analyzing capital
investment projects.
In the MACRS system of depreciation most industrial equipment fall into the ten- and
fifteen-year classes.
Behavioral finance deals with the idea that individual investors have built-in biases and
misconceptions that can drive prices away from fair values.
Present values have value adding-up property.
When calculating the WACC for a firm, one should only use the book values of debt
and equity.
A firm with excess cash can at best generate zero NPV by investing in marketable
securities.
The MFC Corporation has decided to build a new facility. The cost of the facility is
estimated to be $9.7 million. MFC wishes to finance this project using its traditional
debt-to-equity ratio of 1.5. The issue cost of equity is 6% and the issue cost of debt is
1%. What is the total floatation cost of raising funds?
A. $300,000
B. $100,000
C. $600,000
D. None of the above
A call option on the ABCD stock, with an exercise price of $50, is selling for $5.00 and
the stock price is also $50. The call option has a delta of 0.3. If within a short period of
time the stock price increases to $52, what would be the change in the price of the call
option?
A. increases by $0.60
B. decreases by $0.60
C. increases by $2.00
D. decreases by $2.00
The following entities issue bonds to raise long-term loans except:
A. The federal government
B. State and local governments
C. Companies
D. Individuals
Risk shifting implies:
A. When faced with bankruptcy, managers tend to invest in high risk, high return
projects
B. When faced with bankruptcy, managers do not invest more equity capital
C. When faced with bankruptcy; managers may make accounting changes to conceal
the true extent of the problem
D. All of the above
The cash cycle is represented by the following sequence:
A. Cash, raw materials, finished goods, and receivables, cash
B. Cash, receivables, finished goods, and raw materials, cash
C. Cash, raw material, receivables, finished goods, cash
D. None of the above
The purchase of real assets is also referred to as the:
A. Capital decision
B. CFO decision
C. Financing decision
D. Investment decision
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%. If FC and MC are combined in a portfolio with 50% of the funds invested in each,
calculate the expected return on the portfolio.
A. 12%
B. 10%
C. 11%
D. None of the above.
If the average annual rate of return for common stocks is 11.7%, and for treasury bills it
is 4.0%, what is the market risk premium?
A. 8%
B. 4.1%
C. 7.7%
D. None of the above
Calculate the present value of the horizon value:
A. $90.4 millions
B. $104 millions
C. $78.1 millions
D. none of the above
Which of the following statements is true?
I) The spot interest rate is a weighted average of yields to maturity
II) Yield to maturity is the weighted average of spot interest rates and estimated forward
rates
III) The yield to maturity is always higher than the spot rates
A. I only
B. II only
C. III only
D. I and III only
Profitability index is the ratio of:
A. Future value of cash flows to investment
B. Net present value of cash flows to investment
C. Net present value of cash flows to IRR
D. Present value of cash flows to IRR
An investment at 10.47% effective rate compounded monthly is equal to a nominal
(annual) rate of:
A. 10.99%
B. 9.57%
C. 10%
D. None of the above
If the 3-year spot rate is 10.5% and the 2-year spot rate is 10%, what is the one-year
forward rate of interest two years from now?
A. 3.7%
B. 9.5%
C. 11.5%
D. None of the above
A firm can achieve a higher growth rate without raising external capital by: (within
limits)
A. Increasing the proportion of debt in its capital structure
B. Increasing its current ratio
C. Decreasing its inventory turnover
D. Increasing its plowback ratio
The APV method to value a project should be used:
A. When the project’s level of debt is known over the life of the project
B. When the project’s target debt to value ratio is constant over the life of the project
C. When the project’s debt financing is unknown over the life of the project
D. None of the above
The various lessons of market efficiency are:
I) Markets have no memory
II) Trust market prices
III) Read the entrails
IV) There are no financial illusions
V) The do-it yourself alternative
VI) Seen one stock, seen them all
A. I and II only
B. I, II, III and IV only
C. I, II, III, IV and V only
D. I, II, III, IV, V and VI
What is the present value of $10,000 per year perpetuity at an interest rate of 10%?
A. $10,000
B. $100,000
C. $200,000
D. None of the above
Which of the following countries allow firms to keep two separate sets of books, one
for the stockholders and one for the tax authorities like the Internal Revenue Service?
I) U.S.A., II) Japan, and III) France
A. I only
B. I and II only
C. I, II, and III only
D. None of the above
The Flow-to-equity method:
I) uses cash flows to equity, after interest and after taxes
II) uses cost of equity capital as the discount rate
III) uses weighted average cost of capital for discount rate
IV) uses after-tax cash flows without considering interest and dividend payments
A. I and II only
B. II and III only
C. I and III only
D. II and IV only
The following are examples of intangible assets except:
A. Building
B. Trademarks
C. Patents
D. Technical expertise
According to Strategy A, a firm should:
A. Maintain a high ratio of current assets to sales
B. Use high levels of short-term debt and low levels of long-term financing
C. Use more short-term debt and less long-term financing
D. Have surplus cash that can be invested in short-term securities
The following are anomalies associated with market efficiency except:
I) the small-firm effect
II) the earnings announcement puzzle
III) the new-issue puzzle
IV) trading rules based on patterns
A. I only
B. I and II only
C. I, II, and III only
D. IV only
Given the following data: Cost of debt = rD = 6%; Cost of equity = rE = 12.1%;
Marginal tax rate = 35%; and the firm has 50% debt and 50% equity. Calculate the
after-tax weighted average coat of capital (WACC):
A. 8%
B. 7.1%
C. 9.05%
D. None of the given values
Given the following data:
FCF1 = $20 million; FCF2 = $20 million; FCF3 = $20 million; free cash flow grows at a
rate of 5% for year 4 and beyond. If the weighted average cost of capital is 12%,
calculate the value of the firm.
A. $300 million
B. $261.57 million
C. $213.53 million
D. None of the above
Informational efficiency in financial markets result in stock prices being:
A. higher
B. lower
C. fairer
D. none of the above
You are planning to produce a new action figure called “Hillary”. However, you are
very uncertain about the demand for the product. If it is a hit, you will have net cash
flows of $50 million per year for 3 years (starting next year). If it fails, you will only
have net cash flows of $10 million per year for 2 years (starting next year). There is an
equal chance that it will be a hit or failure (probability = 50%). You will not know
whether it is a hit or a failure until the first year’s cash flows are in. You have to spend
$80 million immediately for equipment and the rights to produce the figure. If you can
sell your equipment for $60 million once the first year’s cash flows are received,
calculate the value of the abandonment option. (The discount rate is 10%)
A. -9.15
B. +13.99
C. +23.14
D. None of the above
If the one-year discount factor is 0.8333, what is the discount rate (interest rate) per
year?
A. 10%
B. 20%
C. 30%
D. None of the above
Lowering debt-equity ratio of a firm can change:
I) financing proportions
II) cost of equity
III) cost of debt
IV) effective tax rate
A. II and III only
B. I only
C. I, II, and III only
D. I, II, III and IV
A large firm is receiving a loan guarantee from the government. Because of the
guarantee, the firm is able to borrow $50 million for five years at 8% interest rate per
year instead of 10% per year. Calculate the value of the guarantee to the firm. (Ignore
taxes.)
A. +$53.79 million
B. +$3.79 million
C. -$3.79 million
D. None of the above
The semi-strong form of efficiency deals with the following type of information:
A. insider information
B. publicly available information
C. privileged information
D. all of the above
State the strong form of market efficiency.
Under what circumstances would MM’s proposition is violated? Briefly discuss.
Discuss the term “price-earnings (P/E) ratio.”
What is the relationship between interest rates and bond prices?
Briefly explain some of the institutional arrangements that ensure that managers work
toward increasing the value of a firm.
Briefly explain the term “real options.”
What are puzzles and anomalies?
Briefly explain the concept of value additivity.
Briefly explain the relationship between accounting standards and the legal traditions.
Briefly explain how current tax laws favor capital gains?
Briefly explain how the decision to replace an existing machine is made?
Define the term “call option.”
Rightists argue that increasing a firm’s dividend will increase its value. State some key
points in their assertion.
Briefly explain the trade-off theory of capital structure.
Discuss the concept of duration.
Briefly explain how position diagrams are useful?
Briefly describe the leftists’ point of view on dividends and taxes.
How are “uses and sources” of funds are calculated?