Luther Corporation
Consolidated Balance Sheet
December 31, 2009 and 2008 (in $ millions)
If in 2009 Luther has 10.2 million shares outstanding and these shares are trading at $16
per share, then using the market value of equity, the debt to equity ratio for Luther in
2009 is closest to:
A) 1.47
B) 1.78
C) 2.31
D) 4.07
Von Bora Corporation is expected pay a dividend of $1.40 per share at the end of this
year and a $1.50 per share at the end of the second year. You expect Von Bora’s stock
price to be $25.00 at the end of two years. Von Bora’s equity cost of capital is 10%.
Suppose you plan on purchasing Von Bora stock in one year, right after the $1.40
dividend is paid. You then plan on selling your stock at the end of year two, right after
the $1.50 dividend is paid. The capital gain rate that you will receive on your
investment is closest to:
A) 4.00%
B) 3.75%
C) 6.25%
D) 3.50%
Which of the following statements is FALSE?
A) The compounded geometric average return is most often used for comparative
purposes.
B) We should use the arithmetic average return when we are trying to estimate an
investment’s expected return over a future horizon based on its past performance.
C) The geometric average return will always be above the arithmetic average return and
the difference grows with the volatility of the annual returns.
D) The geometric average return is a better description of the long-run historical
performance of an investment.
A McDonald’s Big Mac value meal consists of a Big Mac Sandwich, Large Coke, and a
Large Fry. Assuming that there is a competitive market for McDonald’s food items, at
what price must a Big Mac value meal sell to insure the absence of an arbitrage
opportunity and uphold the law of one price?
A) $4.08
B) $4.38
C) $5.47
D) $5.77
Which of the following statements is FALSE?
A) A bond trades at par when its coupon rate is equal to its yield to maturity.
B) The clean price of a bond is adjusted for accrued interest.
C) The price of the bond will drop by the amount of the coupon immediately after the
coupon is paid.
D) If a coupon bond’s yield to maturity exceeds its coupon rate, the present value of its
cash flows at the yield to maturity will be greater than its face value.
Consider a project with the following cash flows:
If the appropriate discount rate for this project is 15%, then the NPV is closest to:
A) $6,000
B) -$867
C) $1,420
D) $867
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 $80,000 at the
risk free rate, then the cash flow that equity holders will receive in one year in a strong
economy is closest to:
A) $0
B) $6,000
C) $33,000
D) $10,000
Your firm is planning to invest in a new electrostatic power generation system.
Electrostat Inc is a firm that specializes in this business. Electrostat has a stock price of
$25 per share with 16 million shares outstanding. Electrostat’s equity beta is 1.18. It
also has $220 million in debt outstanding with a debt beta of 0.08. If the risk-free rate is
3%, and the market risk premium is 6%, then your estimate of your cost of capital for
electrostatic power generators is closest to:
A) 7.50%
B) 7.75%
C) 9.50%
D) 10.10%
Pro Forma Income Statement for Ideko, 2005-2010
With the proper changes it is believed that Ideko’s credit policies will allow for an
account receivables days of 60. The forecasted accounts receivable for Ideko in 2006 is
closest to:
A) $19,690
B) $16,970
C) 22,710
D) $14,525
Consider the following stock price and shares outstanding data:
The market capitalization for Wal-Mart is closest to:
A) $415 Billion
B) $276 Billion
C) $479 Billion
D) $200 Billion
Which of the following statements is FALSE?
A) In perfect capital markets, holding fixed the investment policy of a firm, the firm’s
choice of dividend policy is irrelevant and does not affect the initial share price.
B) In a perfect capital market, when a dividend is paid, the share price drops by the
amount of the dividend when the stock begins to trade ex-dividend.
C) In perfect capital markets, an open market share repurchase has no effect on the
stock price, and the stock price is the same as the ex-dividend price if a dividend were
paid instead.
D) In perfect capital markets, investors are indifferent between the firm distributing
funds via dividends or share repurchases. By reinvesting dividends or selling shares,
they can replicate either payout method on their own.
Luther Corporation
Consolidated Balance Sheet
December 31, 2009 and 2008 (in $ millions)
If in 2009 Luther has 10.2 million shares outstanding and these shares are trading at $16
per share, then what is Luther’s Enterprise Value?
A) -$63.3 million
B) $353.1 million
C) $389.7 million
D) $516.9 million
Consider the following graph of the security market line:
The market portfolio:
A) is underpriced.
B) has a positive alpha.
C) is overpriced.
D) falls on the SML.
Sovereign debt is:
A) debt issued by national governments.
B) debt denominated in sovereigns.
C) always riskless.
D) debt issued by Greece.
Defenestration Industries plans to pay a $4.00 dividend this year and you expect that the
firm’s earnings are on track to grow at 5% per year for the foreseeable future.
Defenestration’s equity cost of capital is 13%.
Assuming that Defenestration’s dividend payout rate and expected growth rate remain
constant, and Defenestration does not issue or repurchase shares, then Defenestration’s
stock price is closest to:
A) $50.00
B) $32.30
C) $22.25
D) $30.75
Consider the following probability distribution of returns for Alpha Corporation:
Suppose an investment is equally likely to have a 35% return or a – 20% return. The
variance on the return for this investment is closest to:
A) .151
B) .0378
C) 0
D) .075
Which of the following statements is FALSE?
A) The standard deviation is the square root of the variance.
B) Because investors dislike only negative resolutions of uncertainty, alternative
measures that focus solely on downside risk have been developed, such as the
semi-variance and the expected tail loss.
C) While the variance and the standard deviation are the most common measures of
risk, they do not differentiate between upside and downside risk.
D) While the variance and the standard deviation both measure the variability of the
returns, the variance is easier to interpret because it is in the same units as the returns
themselves.
Consider the following equation:
Pretain = Pcum ×
The term Ï„c in this equation represents:
A) the corporation’s tax rate on interest income.
B) the investor’s tax rate on interest income.
C) the investor’s tax rate on cumulative dividends.
D) the investor’s tax rate on capital gains.
Suppose that a young couple has just had their first baby and they wish to ensure that
enough money will be available to pay for their child’s college education. Currently,
college tuition, books, fees, and other costs, average $12,500 per year. On average,
tuition and other costs have historically increased at a rate of 4% per year.
Assuming that costs continue to increase an average of 4% per year, tuition and other
costs for one year for this student in 18 years when she enters college will be closest to:
A) $12,500
B) $21,500
C) $320,568
D) $25,323
Walgreen Company (NYSE: WAG) is currently trading at $48.75 on the NYSE.
Walgreen Company is also listed on NASDAQ and assume it is currently trading on
NASDAQ at $48.50. Does an arbitrage opportunity exists and if so how would you
exploit it and how much would you make on a block trade of 100 shares?
A) No, no arbitrage opportunity exists.
B) Yes, buy on NASDAQ and sell on NYSE, make $25.
C) Yes, buy on NYSE and sell on NASDAQ, make $25.
D) Yes, buy on NASDAQ and sell on NYSE, make $250.
Which of the following statements is FALSE?
A) The Law of One Price implies that leverage will affect the total value of the firm
under perfect capital market conditions.
B) In the absence of taxes or other transaction costs, the total cash flow paid out to all
of a firm’s security holders is equal to the total cash flow generated by the firm’s assets.
C) With perfect capital markets, leverage merely changes the allocation of cash flows
between debt and equity, without altering the total cash flows of the firm.
D) In a perfect capital market, the total value of a firm is equal to the market value of
the total cash flows generated by its assets and is not affected by its choice of capital
structure.
U.S. public companies are required to file their annual financial statements with the
U.S. Securities and Exchange Commission on which form?
A) 10-A
B) 10-K
C) 10-Q
D) 10-SEC
Which of the following equations would NOT be appropriate to use in a firm with risky
debt?
A) βE= βU+ (βU– βD)
B) βU= βE+ (βU– βD)
C) βE= βU+ βU
D) βU= βE+ βD
Luther Corporation
Consolidated Balance Sheet
December 31, 2009 and 2008 (in $ millions)
If on December 31, 2008 Luther has 8 million shares outstanding trading at $15 per
share, then what is Luther’s enterprise value?
What is sensitivity analysis?
Explain the main differences between the NYSE and NASDAQ stock markets.
Estimated 2005 Income Statement and Balance Sheet Data for Ideko Corporation
The following are financial ratios for three comparable companies:
What range for the market value of equity for Ideko is implied by the range of EV/Sales
multiples for the comparable firms if Ideko holds $6.5 million of cash in excess of its
working capital needs?
Epiphany Industries is considering a new capital budgeting project that will last for
three years. Epiphany plans on using a cost of capital of 12% to evaluate this project.
Based on extensive research, it has prepared the following incremental cash flow
projects:
Epiphany is worried about the reliability of the sales forecast. How sensitive is the
project’s NPV to a 10% change in sales.
