Calculate Rockwood’s stock price following the market becoming aware of the new
information regarding Rockwood’s true value, if (1) Rockwood completed the
repurchase prior to the market becoming aware of the information and (2) Rockwood
completed the repurchase following the market becoming aware of the new
information.
Which of the following statements is false?
A) The size effect is the observation that small stocks have positive alphas.
B) When considering portfolios formed based on the market-to-book ratio, most of the
portfolios plot below the security market line.
C) The largest alphas occur in the smallest size deciles.
D) When considering portfolios formed based on size, although the portfolios with the
higher betas yield higher returns, most size portfolios plot above the security market
line.
Which of the following statements is false?
A) Unlike with capital structure, taxes are not an important market imperfection that
influence a firm’s decision to pay dividends or repurchase shares.
B) If dividends are taxed at a higher rate than capital gains, which has been true until
the most recent change to the tax code, shareholders will prefer share repurchases to
dividends.
C) Shareholders typically must pay taxes on the dividends they receive. They must also
pay capital gains taxes when they sell their shares.
D) But because long-term investors can defer the capital gains tax until they sell, there
is still a tax advantage for share repurchases over dividends.
In an agency problem known as debt overhang, if the company has risky debt
outstanding, equity holders will choose to invest only if
A) the NPV of the project exceeds a cutoff equal to the relative riskiness of the firm’s
debt times its debt-equity ratio.
B) the profitability index of the project exceeds a cutoff equal to the relative riskiness of
the firm’s debt times its debt-equity ratio.
C) the NPV of the project is negative.
D) the debt holders will lose all their money.
Which of the following formulas regarding NPV is incorrect?
A) NPV + PV(benefits) = PV(Cost)
B) NPV + PV(costs) = PV(benefits)
C) NPV = PV(All project cash flows)
D) All of the above
If we use future value rather than present value to decide whether to make an
investment,
A) we will make a bad decision, since the future value will always be higher if the
discount rate is positive.
B) we will make a bad decision, since the future value will always be lower if the
discount rate is positive.
C) we will make the same decision using either future value or present value.
D) There is not enough information given to answer the question.
You expect KT Industries (KTI) will have earnings per share of $3 this year and expect
that they will pay out $1.50 of these earnings to shareholders in the form of a dividend.
KTI’s return on new investments is 15% and their equity cost of capital is 12%. The
expected growth rate for KTI’s dividends is closest to:
A) 6.0%
B) 7.5%
C) 4.5%
D) 3.0%
Suppose the current exchange rate is $1.42/€, the interest rate in the United States is
4.0%, the interest rate in the EU is 6%, and the volatility of the $/€ exchange rate is
20%. Using the Black-Scholes formula, the price of a three-month European call option
on the Euro with a strike price of $1.45/€ will be closest to:
A) $0.040/€
B) $0.059/€
C) $0.078/€
D) $0.097/€
Which of the following statements is false?
A) Beta is the expected percent change in the excess return of the security for a 1%
change in the excess return of the market portfolio.
B) Beta represents the amount by which risks that affect the overall market are
amplified for a given stock or investment.
C) It is common practice to estimate beta based on the historical correlation and
volatilities.
D) Beta measures the diversifiable risk of a security, as opposed to its market risk, and
is the appropriate measure of the risk of a security for an investor holding the market
portfolio.
Which of the following statements is false?
A) In practice, most acquirers pay a substantial acquisition premium, which is the
percentage difference between the acquisition price and the premerger price of the
target firm.
B) When a bid is announced, the target shareholders enjoy a gain of 16% on average in
their stock price.
C) In most U.S. states, the law requires that when existing shareholders of a target firm
are forced to sell their shares, they receive the market price for their shares. In most
cases, this concept is interpreted as the value inclusive of any value that arises because
of the merger itself.
D) A bidder is unlikely to acquire a target company for less than its current market
value.
Use the information for the question(s) below.
Suppose that in the coming year, you expect Exxon-Mobil stick to have a volatility of
42% and a beta of 0.9, and Merck’s stock to have a volatility of 24% and a beta of 1.1.
The risk free interest rate is 4% and the markets expected return is 12%.
Which stock has the highest total risk?
A) Merck since it has a lower volatility
B) Merck since it has a higher Beta
C) Exxon-Mobil since it has a higher volatility
D) Exxon-Mobil since it has a lower beta
Rearden Metal currently has no debt and an equity cost of capital of 14%. Suppose that
Rearden decides to increase its leverage and maintain a market debt-to-value ratio of
1/2. Suppose Rearden’s debt cost of capital is 8% and its corporate tax rate is 40%.
Assuming that Rearden’s pre-tax WACC remains constant, then with the addition of
leverage its effective after-tax WACC will be closest to:
A) 10.8%
B) 12.4%
C) 12.8%
D) 13.4%
Use the information for the question(s) below.
As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one
barrel of Alaska North Slope (ANS) crude oil. Because of its lower sulfur content, you
can produce $77 worth of unleaded gasoline from one barrel of West Texas
Intermediate (WTI) crude.
Assuming you currently have 10,000 Bbls of WTI crude, the added benefit (cost) to you
if you were to sell the 10,000 Bbls of WTI crude and use the proceeds to purchase and
refine ANS crude is closest to:
A) ($1,400)
B) $1,400
C) ($3,908)
D) $3,908
At an annual interest rate of 7%, the future value of $5,000 in five years is closest to:
A) $3,565
B) $6,750
C) $7,015
D) $7,035
Use the following information for ECE incorporated:
Perrigo’s debt to equity ratio is closest to:
A) 0.24
B) 0.50
C) 0.75
D) 0.89
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 the following list of projects:
Assuming that your capital is constrained, what is the fifth project that you should
invest in?
A) Project H
B) Project I
C) Project B
D) Project A
The Sisyphean Company is planning on investing in a new project. This will involve
the purchase of some new machinery costing $450,000. The Sisyphean Company
expects cash inflows from this project as detailed below:
The appropriate discount rate for this project is 16%.
The payback period for this project is closest to:
A) 2.1 years
B) 3.0 years
C) 2 years
D) 2.2 years
Consider the following information regarding corporate bonds:
Your estimate of the asset beta for Taggart Transcontinental is closest to:
A) 0.42
B) 0.59
C) 0.66
D) 0.71
Which of the following statements is false?
A) The S&P 500 and the Wilshire 5000 indexes are both well-diversified indexes that
roughly correspond to the market of U.S. stocks.
B) Practitioners commonly use the S&P 500 as the market portfolio in the CAPM with
the belief that this index is the market portfolio.
C) Standard & Poor’s Depository Receipts (SPDR, nicknamed “spider”) trade on the
American Stock Exchange and represent ownership in the S&P 500.
D) The S&P 500 was the first widely publicized value weighted index and it has
become a benchmark for professional investors.
Use the information for the question(s) below.
Suppose that the risk-free rate is 5% and the market portfolio has an expected return of
13% with a volatility of 18%. Monsters Inc. has a 24% volatility and a correlation with
the market of .60, while California Gold Mining has a 32% volatility and a correlation
with the market of -.7. Assume the CAPM assumptions hold.
Suppose that Monsters’ expected return is 12%. Then Monsters’ alpha is closest to:
A) -2.0%
B) -1.0%
C) 1.0%
D) 0.5%
The difference between scenario analysis and sensitivity analysis is that
A) scenario analysis is based upon the IRR and sensitivity analysis is based upon NPV.
B) only sensitivity analysis allows us to change our estimated inputs of our NPV
analysis.
C) scenario analysis considers the effect on NPV of changing multiple project
parameters.
D) only scenario analysis breaks the NPV calculation into its component assumptions.
Use the following information to answer the question(s) below.
Suppose the current zero-coupon yield curve for risk-free bonds is as follows:
The price per $100 face value of a three-year, zero-coupon, risk-free bond is closest to:
A) $93.80
B) $90.06
C) $89.16
D) $86.39
Use the information for the question(s) below.
You expect CCM Corporation to generate the following free cash flows over the next
five years:
Following year five, you estimate that CCM’s free cash flows will grow at 5% per year
and that CCM’s weighted average cost of capital is 13%.
If CCM has $200 million of debt and 8 million shares of stock outstanding, then the
share price for CCM is closest to:
A) $49.50
B) $12.50
C) $19.35
D) $24.50
Consider the following two projects:
Which of the following statements is correct?
A) You should invest in project Beta since NPVBeta > 0.
B) You should invest in project Alpha since IRRAlpha > IRRBeta.
C) Your should invest i project Alpha since NPVAlpha < 0.
D) You should invest in project Beta since IRRBeta > 0.
Which of the following questions is false?
A) Any acquirer shares received in full or partial exchange for target shares triggers an
immediate tax liability for target shareholders.
B) In a friendly takeover, the target board of directors supports the merger, negotiates
with potential acquirers, and agrees on a price that is ultimately put to a shareholder
vote.
C) How the acquirer pays for the target affects the taxes of both the target shareholders
and the combined firm.
D) If the acquirer purchases the target assets directly (rather than the target stock), then
it can step upthe book value of the target’s assets to the purchase price.
Use the following information to answer the question(s) below.
Two years ago the Krusty Krab Restaurant purchased a grill for $50,000. The owner,
Eugene Krabs, has learned that a new grill is available that will cook Krabby Patties
twice as fast as the existing grill. This new grill can be purchased for $80,000 and
would be depreciated straight line over 8 years, after which it would have no salvage
value. Eugene Krab expects that the new grill will produce EBITDA of $50,000 per
year for the next eight years while the existing grill produces EBITDA of only $35,000
per year. The current grill is being depreciated straight line over its useful life of 10
years after which it will have no salvage value. All other operating expenses are
identical for both grills. The existing grill can be sold to another restaurant now for
$30,000. The Krusty Krab’s tax rate is 35%.
If the Krusty Krab’s opportunity cost of capital is 12%, what decision should the Krusty
Krab take regarding the new grill?
A) Do not install the new grill since NPV is approximately = – $10,630
B) Install the new grill since NPV is approximately = + $10,630
C) Install the new grill since IRR is approximately = 15%
D) Don’t install the new grill since IRR is less than 12%
Use the information for the question(s) below.
As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one
barrel of Alaska North Slope (ANS) crude oil. Because of its lower sulfur content, you
can produce $77 worth of unleaded gasoline from one barrel of West Texas
Intermediate (WTI) crude.
Assuming you just purchased 10,000 Bbls of WTI crude at the current market price, the
total benefit (cost) to you if you were to refine this crude oil and sell the unleaded
gasoline is closest to:
A) $730,600
B) $770,000
C) $771,400
D) $773,908
Using options to place a bet on the direction in which you believe the market is likely to
move is called
A) speculation.
B) hedging.
C) a covered position.
D) a naked position.
Which of the following statements is false?
A) Without trading, the portfolio weights will decrease for the stocks in the portfolio
whose returns are above the overall portfolio return.
B) The expected return of a portfolio is simply the weighted average of the expected
returns of the investments within the portfolio.
C) Portfolio weights add up to 1 so that they represent the way we have divided our
money between the different individual investments in the portfolio.
D) A portfolio weight is the fraction of the total investment in the portfolio held in an
individual investment in the portfolio.
Use the following information for the question(s) below.
Wyatt Oil has the following accounts on its books:
Rearden extends credit on terms of 1/15, net 30.
The percentage of Wyatt’s receivables that are more than 30 days past due is closest to:
A) 20.1%
B) 32.1%
C) 38.3%
D) 42.2%
Use the information for the question(s) below.
Luther Industries has no debt, a total equity capitalization of $20 billion, and a beta of
1.8. Included in Luther’s assets are $4 billion in cash and risk-free securities.
What is Luther’s enterprise value?
A) $16 billion
B) $10.5 billion
C) $24 billion
D) $20 billion
Use the information for the question(s) below.
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:
Use the information for the question(s) below.
Consider two firms: firm Without has no debt, and firm With has debt of $10,000 on
which it pays interest of 5% per year. Both companies have identical projects that
generate free cash flows of $1000 or $2000 each year. Suppose that there are no taxes,
and after paying any interest on debt, both companies use all remaining cash free cash
flows to pay dividends each year.
Fill in the table below showing the payments debt and equity holders of each firm will
receive given each of the two possible levels of free cash flows:
Use the information for the question(s) below.
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 $25.00 at the end of two years. Von Bora’s equity cost of capital is 10%
Suppose you plan to hold Von Bora stock for only one year. Calculate your total return
from holding Von Bora stock for the first year.
Use the information for the question(s) below.
Omicron Industries’ Market Value Balance Sheet ($ Millions) and Cost of Capital
Omicron Industries New Project Free Cash Flows
Assume that this new project is of average risk for Omicron and that the firm wants to
hold constant its debt to equity ratio.
Calculate the debt capacity of Omicron’s new project for years 0, 1, and 2.
Suppose you have the following Loans / Investments
What is the effective after-tax rate of each instrument, expressed as an EAR?
Use the information for the question(s) below.
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 currently maintains a .8 debt to equity ratio, then calculate the value of
Flagstaff’s interest tax shield.
With its current leverage, WELS Corporation will have net income net year of 2.6
million. If WELS corporate tax rate is 35% and it pays 8% interest on its debt, how
much additional debt can WELS issue this year and still receive the benefit of the
interest tax shield next year?
Consider the following income statement and other information:
If Luther’s accounts receivable were $55.5 million in 2009, then calculate Luther’s
accounts receivable days for 2009.
Use the information for the question(s) below.
The Sisyphean Corporation is considering investing in a new cane manufacturing
machine that has an estimated life of three years. The cost of the machine is $30,000
and the machine will be depreciated straight line over its three-year life to a residual
value of $0.
The cane manufacturing machine will result in sales of 2,000 canes in year 1. Sales are
estimated to grow by 10% per year each year through year three. The price per cane that
Sisyphean will charge its customers is $18 each and is to remain constant. The canes
have a cost per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will
require an increase in various net working capital accounts. It is estimated that the
Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual
sales in accounts receivable, 9% of its annual sales in inventory, and 6% of its annual
sales in accounts payable. The firm is in the 35% tax bracket, and has a cost of capital
of 10%.
Calculate the total Free Cash Flows for each of the three years for the Sisyphean
Corporation’s new project.
Luther Industries, a U.S. firm. has a subsidiary in the United Kingdom. This year, the
subsidiary reported and repatriated earnings before interest and taxes (EBIT) of 45
million. The current exchange rate is $1.86/. The tax rate in the U.K. for this activity is
28%. Under U.S. tax codes, Luther is facing a 35% corporate tax rate on their earnings.
What is Luther’s U.S. tax liability on its U.K. subsidiary?
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?
What is the Yield to Call (YTC) on this bond?
Use the information for the question(s) below.
The current price of Kinston Corporation stock is $10. In each of the next two years,
this stock price can wither go up by $3.00 or go down by $2.00. Kinston stock pays no
dividends. The one year risk-free interest rate is 5% and will remain constant.
Using the binomial pricing model, calculate the price of a two-year put option on
Kinston stock with a strike price of $9.
Consider the following financial information:
For the year ending December 31, 2009 Luther’s cash flow from financing activities is?
Luther Industries is considering launching a new toy just in time for the Christmas
season. They estimate that if Luther launches the new toy this year it will have an NPV
of $25 million. Luther has the option to wait one year until the next Christmas season to
launch the toy, however, the demand next year will depend upon what new toys Luther’s
competitors introduce and therefore greater uncertainty about next years demand.
Launching the new today will involve a total capital expenditure of $100 million. If the
risk-free rate is 5%, N(d1) is .62 and N(d2) is .65, then what is the value of the option to
wait until next year to launch the new toy?
Describe the “stakeholder” model of corporate governance.
Use the table for the question(s) below.
Consider the following four bonds that pay annual coupons:
Assume that the YTM increases by 1% for each of the four bonds listed. Rank the
bonds based upon the sensitivity of their prices from least to most sensitive.