Consider the following income statement for Kroger Inc. (all figures in $ Millions):
The total amount available to payout to all the investors in Kroger in 2006 is closest to:
A) $990 million
B) $1,525 million
C) $1,500 million
D) $2,035 million
Which of the following is true of asset betas?
A) Asset betas are expected to vary greatly within firms in the same industry.
B) Businesses that are less sensitive to market and economic conditions tend to have
higher asset betas than more cyclical industries.
C) Businesses that are less sensitive to market and economic conditions tend to have
lower asset betas than more cyclical industries.
D) A and B are correct.
Consider the following Price and Dividend data for General Electric Company:
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%
Wildcat Drilling is an oil and gas exploration company that is currently operating two
active oil fields with a market value of $200 million dollars each. Unfortunately,
Wildcat Drilling has $500 million in debt coming due at the end of the year. A large oil
company has offered Wildcat drilling a highly speculative, but potentially very
valuable, oil and gas lease in exchange for one of their active oil fields. If Wildcat
accepts the trade, there is a 10% chance that Wildcat will discover a major new oil field
that would be worth $1.2 billion, a 15% that Wildcat will discover a productive oil field
that would be worth $600 million, and a 75% chance that Wildcat will not discover oil
at all.
What is the expected payoff to equity holders with the speculative oil lease deal?
A) $10 million
B) $160 million
C) $275 million
D) $85 million
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.
Assume that in the event of default, 20% of the value of MI’s assets will be lost in
bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face
value due next year. The initial value of MI’s equity is closest to:
A) $30 million
B) $29 million
C) $15 million
D) $24 million
Google Corporation has no debt on its balance sheet in 2008, but paid $1.6 billion in
taxes. Assume that Google’s marginal tax rate is 35% and Google’s borrowing cost is
7%.
Assume that investors in Google pay a 15% tax rate on income from equity and a 35%
tax rate on interest income. If Google were to issue sufficient debt to reduce its
corporate taxes by $1 billion per year permanently, then the value that would be created
is closest to:
A) $6.1 billion
B) $10.2 billion
C) $12.2 billion
D) $14.3 billion
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 earnings per share (EPS) is closest to:
A) $0.19
B) $1.79
C) $2.81
D) $3.76
You are considering investing in a start up project at a cost of $100,000. You expect the
project to return $500,000 to you in seven years. Given the risk of this project, your cost
of capital is 20%.
The NPV for this project is closest to:
A) $29,200
B) $39,500
C) $129,200
D) $139,500
Suppose that the market portfolio is equally likely to increase by 24% or decrease by
8%. Security “X” goes up on average by 29% when the market goes up and goes down
by 11% when the market goes down. Security “Y” goes down on average by 16% when
the market goes up and goes up by 16% when the market goes down. Security “Z” goes
up on average by 4% when the market goes up and goes up by 4% when the market
goes down.
The beta for security “X” is closest to:
A) 0
B) 0.80
C) 1.00
D) 1.25
In which years were dividends tax disadvantaged?
A) 1987 – 2002
B) 1987, 1993 – 2002
C) 1987, 1991 – 2002
D) 1988 – 1990, 2003 – 2009
NoGrowth industries presently pays an annual dividend of $1.50 per share and it is
expected that these dividend payments will continue indefinitely. If NoGrowth’s equity
cost of capital is 12%, then the value of a share of NoGrowth’s stock is closest to:
A) $10.00
B) $15.00
C) $14.00
D) $12.50
The distinguishing feature of a corporation is that:
A) their is no legal difference between the corporation and its owners.
B) it is a legally defined, artificial being, separate from its owners.
C) it spreads liability for its corporate obligations to all shareholders.
D) provides limited liability only to small shareholders.
Galt Motors currently produces 500,000 electric motors a year and expects output levels
to remain steady in the future. It buys armatures from an outside supplier at a price of
$2.50 each. The plant manager believes that it would be cheaper to make these
armatures rather than buy them. Direct in-house production costs are estimated to be
only $1.80 per armature. The necessary machinery would cost $700,000 and would be
obsolete in 10 years. This investment would be depreciated to zero for tax purposes
using a 10-year straight line depreciation. The plant manager estimates that the
operation would require additional working capital of $40,000 but argues that this sum
can be ignored since it is recoverable at the end of the ten years. The expected proceeds
from scrapping the machinery after 10 years are estimated to be $10,000. Galt Motors
pays tax at a rate of 35% and has an opportunity cost of capital of 14%.
What decision should Galt Motors take regarding manufacturing the armatures in
house?
A) Proceed with in house manufacture since NPV is negative
B) Proceed with in house manufacture since NPV is positive
C) Reject in-house manufacture since NPV is negative
D) Reject in-house manufacture since IRR is greater than 14%
Luther Industries has a dividend yield of 4.5% and and a cost of equity capital of 12%.
Luther Industries dividends are expected to grow at a constant rate indefinitely. The
grow rate of Luther’s dividends are closest to:
A) 7.5%
B) 5.5%
C) 16.5%
D) 12%
) Consider the following two projects:
The NPV of project B is closest to:
A) 12.6
B) 23.3
C) 12.0
D) 15.0
d’Anconia Copper is an all-equity firm with 60 million shares outstanding, which are
currently trading at $20 per share. Last month, d’Anconia announced that it will change
its capital structure by issuing $300 million in debt. The $200 million raised by this
issue, plus another $200 million in cash that d’Anconia already has, will be used to
repurchase existing shares of stock. Assume that capital markets are perfect.
At the conclusion of this transaction, the number of shares that d’Anconia Copper will
have outstanding is closest to:
A) 5 million
B) 15 million
C) 20 million
D) 40 million
The JRN Corporation will pay a constant dividend of $3 per share, per year, in
perpetuity. Assume that all investors pay a 20% tax on dividends and that there is no
capital gains tax. The cost of capital for investing in JRN stock is 12%.
Assume that management makes a surprise announcement that JRN will no longer pay
dividends but will use the cash to repurchase stock instead. The price of a share of
JRN’s stock is now closest to:
A) $20.00
B) $25.00
C) $18.00
D) $24.00
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 enterprise
value of Ideko in 2010 is closest to:
A) $152.8 million
B) $272.8 million
C) $301.7 million
D) $181.7 million
Which of the following statements is FALSE?
A) From an accounting perspective, dividends generally reduce the firm’s current (or
accumulated) retained earnings.
B) The way a firm chooses between paying dividends and retaining earnings is referred
to as its payout policy.
C) Most companies that pay dividends pay them semiannually.
D) Occasionally, a firm may pay a one-time, special dividend that is usually much
larger than a regular dividend.
The British government has a consol bond outstanding that pays ₤100 in interest each
year. Assuming that the current interest rate in Great Britain is 5% and that you will
receive your first interest payment immediately upon purchasing the consol bond, then
the value of the consol bond is closest to:
A) ₤2000
B) ₤2100
C) ₤1000
D) ₤1100
The after tax interest expense in 2008 is closest to:
A) 2,380
B) 4,420
C) 6,800
D) 7,820
Wyatt Oil is considering an investment in a new project with an unlevered cost of
capital of 11%. Wyatt’s marginal corporate tax rate is 35% and its debt cost of capital is
6%. The project has free cash flows of $25 million per year which are expected to
decline by 3% per year.
If Wyatt adjusts its debt once per year to maintain a constant debt-equity ratio of 50%,
then the value of this new project is closest to:
A) $188 million
B) $188.5 million
C) $320 million
D) $340 million
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million,
and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff
has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35%
corporate tax bracket.
If Flagstaff maintains a .5 debt to equity ratio, then Flagstaff’s pre-tax WACC is closest
to:
A) 10.5%
B) 11.0%
C) 9.0%
D) 10.0%
When we express the value of a cash flow or series of cash flows in terms of dollars
today, we call it the ________ of the investment. If we express it in terms of dollars in
the future, we call it the ________.
A) present value; future value
B) future value; present value
C) ordinary annuity; annuity due
D) discount factor; discount rate
Your firm is preparing to open a new retail strip mall and you have multiple businesses
that would like lease space in it. Each business will pay a fixed amount of rent each
month plus a percentage of the gross sales generated each month. The cash flows from
each of the businesses has approximately the same amount of risk. The business names,
square footage requirements, and monthly expected cash flows for each of the
businesses that would like to lease space in your strip mall are provided below:
If your new strip mall will have 15,000 square feet of retail space available to be leased,
to which businesses should you lease and why?
If Luther’s accounts receivable were $55.5 million in 2009, then calculate Luther’s
accounts receivable days for 2009.
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 40% and that shareholders expects the
change in debt to be permanent. Assume that capital markets are perfect except for the
existence of corporate taxes and financial distress costs. If the price of BBB’s stock rises
to $10.80 per share following the announcement, then the present value of BBB’s
financial distress costs is closest to:
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 you borrow only $45,000 in financing the project. According to MM
proposition II, calculate the firm’s equity cost of capital.
Consider the following zero-coupon yields on default free securities:
What is the price today of a two-year, default-free security with a face value of $1000
and an annual coupon rate of 5.75%? Does this bond trade at a discount, premium, or at
par?
Consider two mutually exclusive projects with the following cash flows:
You are considering using the incremental IRR approach to decide between the two
mutually exclusive projects A & B. If the discount rate for project A is 16%, then what
is the NPV for project A?
Two separate firms are considering investing in this project. Firm unlevered plans to
fund the entire $80,000 investment using equity, while firm levered plans to borrow
$45,000 at the risk-free rate and use equity to finance the remainder of the initial
investment. Construct a table detailing the percentage returns to the equity holders of
both the levered and unlevered firms for both the weak and strong economy.
Draw a timeline detailing the cash flows from investment “B.”
