Use the table for the question(s) below.
Consider the following returns:
The covariance between Stock X’s and Stock Z’s returns is closest to:
A) 0.05
B) 0.06
C) 0.10
D) 0.71
Use the table for the question(s) below.
If the risk-free interest rate is 10%, then of the four projects listed, if could only invest
in two of these projects, which two projects would you select?
A) Mighty & Eenie
B) Mighty & Meenie
C) Eenie & Moe
D) Eenie & Meenie
In addition to the balance sheet, income statement, and the statement of cash flows, a
firm’s complete financial statements will include all of the following except:
A) Management discussion and Analysis
B) Notes to the financial statements
C) Securities and Exchange Commission’s (SEC) commentary
D) Statement of stockholders’ equity
Use the table for the question(s) below.
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 an equally weighted portfolio that contains five stocks. If the average
volatility of these stocks is 40% and the average correlation between the stocks is .5,
then the volatility of this equally weighted portfolio is closest to:
A) .17
B) .44
C) .41
D) .19
2Var(R
2Var(R
Which of the following statements is false?
A) If the profit opportunities from having private information are large, other
individuals will attempt to gain the expertise and devote the resources needed to acquire
it.
B) When private information is relegated to the hands of a relatively small number of
investors, these investors may be able to profit by trading on their information.
C) When a buyer seeks to buy a stock, the willingness of other parties to sell the same
stock suggests that they value the stock differently.
D) Since stock markets aggregate the information and view of many different investors,
we expect the stock price to react slowly to new publicly available information as the
investors continue to trade until a consensus is reached as to the new value of the stock.
You are considering purchasing a new truck that will cost you $34,000. The dealer
offers you 1.9% APR financing for 48 months (with payments made at the end of the
month). Assuming you finance the entire $34,000 and finance through the dealer, your
monthly payments will be closest to:
A) $708
B) $725
C) $736
D) $1,086
Which of the following statements is false?
A) An investor’s preferences will determine only how much to invest in the tangent or
efficient portfolio versus the risk-free investment.
B) Conservative investors will invest a small amount in the tangent or efficient
portfolio, choosing a portfolio on the line near the risk-free investment
C) Only aggressive investors will choose to hold the portfolio of risky assets, the
tangent or efficient portfolio.
D) Aggressive investors will invest more in the tangent portfolio choosing a portfolio
that is near the tangent portfolio or even beyond it by buying stocks on margin.
Use the table for the question(s) below.
Consider the information for the following four firms:
The weighted average cost of capital for “Eenie” is closest to:
A) 6.0%
B) 6.5%
C) 7.5%
D) 5.5%
Which of the following is not a systematic risk?
A) The risk that oil prices rise, increasing production costs
B) The risk that the Federal Reserve raises interest rates
C) The risk that the economy slows, reducing demand for your firm’s products
D) The risk that your new product will not receive regulatory approval
Which of the following statements is false?
A) In the event of default, the assets not pledged as collateral for outstanding bonds
cannot be used to pay off the holders of subordinated debentures until all more senior
debt has been paid off.
B) Because more than one debenture might be outstanding, the bondholder’s priority in
claiming assets in the event of default, known as the bond’s seniority, is important.
C) When a firm conducts a subsequent debenture issue that has lower priority than its
outstanding debt, the new debt is known as a subordinated debenture.
D) Most debenture issues contain clauses restricting the company from issuing new
debt with equal or lower priority than existing debt.
Use the following information to answer the question(s) below.
Suppose that you have received two job offers. Rearden Metal offers you a contract for
$75,000 per year for the next two years while Wyatt Oil offers you a contract for
$90,000 per year for the next two years. Both jobs are equivalent. Suppose that Rearden
Metal’s contract is certain, but Wyatt Oil has a 60% chance of going bankrupt at the end
of the year. In the event that Wyatt Oil files for bankruptcy, it will cancel your contract
and pay you the lowest amount possible for you to not quit. If you do quit, you expect
you could find an new job paying $75,000 per year, but you would be unemployed for
four months while searching for this new job.
If you take the job with Wyatt Oil, then, in the event of bankruptcy, the least amount
that Wyatt Oil would pay you next year is closest to:
A) $45,000
B) $50,000
C) $54,000
D) $75,000
Use the following information to answer the question(s) below.
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.
Suppose you are a shareholder in d’Anconia Copper holding 500 shares, and you
disagree with the decision to lever the firm. You can undo the effect of this decision by
A) borrowing $2,000 and buying 100 shares of stock.
B) selling 100 shares of stock and lending $2,000.
C) borrowing $1,200 and buying 60 shares of stock.
D) selling 60 shares of stock and lending $1,200.
Use the following information to answer the question(s) below.
The risk-free rate of interest is 3% and the market risk premium is 5%.
The value of the oil exploration division is closest to:
A) $4,500
B) $7,500
C) $8,750
D) $10,000
You have an investment opportunity in Germany that requires an investment of
$250,100 today and will produce a cash flow of €208,650 in one year with no risk.
Suppose the risk-free rate of interest in Germany is 7% and the current competitive
exchange rate is €0.78 to $1.00. What is the NPV of this project? Would you take the
project?
A) NPV = -$100; No
B) NPV = $100; Yes
C) NPV = $2,358; Yes
D) NPV = $3,650; Yes
A corporate bond which receives a BBB rating from Standard and Poor’s is considered
A) a junk bond.
B) an investment grade bond.
C) a defaulted bond.
D) a high-yield bond.
If shareholders are unhappy with a CEO’s performance, they are most likely to
A) buy more shares in an effort to gain control of the firm.
B) file a shareholder resolution.
C) replace the CEO through a grassroots shareholder uprising.
D) sell their shares.
Use the following information to answer the question(s) below.
(Please use a copy of the Cumulative Probabilities for the standard normal distribution
for these problems.)
Taggart Transcontinental’s stock has a volatility of 25% and a current stock price of $40
per share. Taggart pays no dividends. The risk-free interest rate is 4%.
Assuming the beta on Taggart stock is 0.75, then the beta for a one-year, at-the-money
call option on Taggart stock is closest to:
A) 0.60
B) 0.75
C) 2.84
D) 3.89
Use the following information to answer the question(s) below.
Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%.
Wyatt will pay interest only on this debt. Wyatt’s marginal tax rate is expected to be
40% for the foreseeable future.
Assume that five years have passed since Wyatt issued this debt. While tax rates have
remained at 40%, interest rates have dropped so that Wyatt’s current cost of debt capital
is now only 4%. The present value of Wyatt’s annual interest tax shield is now closest
to:
A) $2.8 million
B) $40.0 million
C) $60.0 million
D) $70.0 million
Which of the following statements is false?
A) The registered bond system also facilitates tax collection because the government
can easily keep track of all interest payments made.
B) Asset backed bonds and mortgage bonds are secured debt: Specific assets are
pledged as collateral that bondholders have a direct claim to in the event of bankruptcy.
C) Notes typically have longer maturities (more than ten years) than debentures.
D) Although the word “bond” is commonly used to mean any kind of debt security,
technically a corporate bond must be secured.
A lease where the lessee has the option to purchase the asset at the end of the lease for a
set price that is set upfront in the lease contract is called a
A) fixed price lease.
B) $1.00 out lease.
C) fair market value lease.
D) fair market value cap lease.
Wyatt Oil has 8 million shares outstanding and is about to issue 10 million new shares
in an IPO. The IPO price has been set at $15 per share, and the underwriting spread is
6%. The IPO is a big success with investors, and the share price rises to $35 the first
day of trading.
The amount that Wyatt Oil raised during the IPO is closest to:
A) $113 million
B) $141 million
C) $150 million
D) $329 million
E) $350 million
Firms should adjust for execution risk by
A) assigning a higher cost of capital to new projects.
B) ignoring execution risk since it is diversifiable.
C) capturing this risk in the expected cash flows generated by the project.
D) noticing missteps in the firm’s execution of new projects.
Which of the following statements is false?
A) Lease payments are a fixed obligation of the firm.
B) The risk of the lease payments is no greater than the risk of secured debt, so it is
reasonable to discount the lease payments at the firm’s secured borrowing rate.
C) If a firm purchases a piece of equipment, the expense is a capital expenditure.
Therefore, the purchase price can be depreciated over time, generating a depreciation
tax shield.
D) If the equipment is leased and the lease is a non-tax lease, there is no capital
expenditure, but the lease payments are an operating expense.
Suppose the interest rate is 9% APR with monthly compounding. Then the present
value of an annuity that pays $250 every three months for the next five years is closest
to:
A) $2,280
B) $3,985
C) $3,990
D) $3,995
Consider the following equation:
= (1 + ) – 1
the term r$ in this equation refers to
A) the cost of capital for the firm in terms of yen.
B) the cost of capital in terms of dollars.
C) the risk-free rate of interest on the dollar.
D) the risk-free rate of interest on the yen.
Use the following information to answer the question(s) below.
Nielson Motors has a share price of $50.00. Its dividend was $2.50, and you expect
Nielson Motors to raise its dividend by approximately 6% per year in perpetuity.
If Nielson’s equity cost of capital is 13%, then Nielson’s expected share price is closest
to:
A) $19.23
B) $35.71
C) $41.67
D) $50.00
The geometric average annual return on the Index from 2000 to 2009 is closest to:
A) 9.75%
B) 8.75%
C) 7.10%
D) 8.35%
Use the information below to answer the following question(s):
The owner of the Krusty Krab is considering selling his restaurant and retiring. An
investor has offered to buy the Krusty Krab for $350,000 whenever the owner is ready
for retirement. The owner is considering the following three alternatives:
1. Sell the restaurant now and retire.
2. Hire someone to manage the restaurant for the next year and retire. This will require
the owner to spend $50,000 now, but will generate $100,000 in profit next year. In one
year the owner will sell the restaurant.
3. Scale back the restaurant’s hours and ease into retirement over the next year. This will
require the owner to spend $40,000 on expenses now, but will generate $75,000 in
profit at the end of the year. In one year the owner will sell the restaurant.
If the interest rate is 7%, the alternative with the lowest NPV is:
A) Alternative #1 with an NPV of approximately $350,000
B) Alternative #2 with an NPV of approximately $370,561
C) Alternative #3 with an NPV of approximately $357,196
D) Alternative #2 with an NPV of approximately $380,561
Which of the following statements is false?
A) If a bond trades at a premium, its yield to maturity will exceed its coupon rate.
B) A bond that trades at a premium is said to trade above par.
C) When a coupon-paying bond is trading at a premium, an investor’s return from the
coupons is diminished by receiving a face value less than the price paid for the bond.
D) Holding fixed the bond’s yield to maturity, for a bond not trading at par, the present
value of the bond’s remaining cash flows changes as the time to maturity decreases.
Which of the following statements is false?
A) Beta measures the sensitivity of a security to market wide risk factors.
B) Volatility measures total risk, while beta measures only systematic risk.
C) The beta is the expected percentage change in the excess return of the market
portfolio for a 1% change in the excess return of a security.
D) Utilities tend to be stable and highly regulated, and thus are insensitive to
fluctuations in the overall market.
Consider the following two projects:
The payback period for project beta is closest to:
A) 2.9 years
B) 3.1 years
C) 2.6 years
D) 3.2 years
Which of the following statements is false?
A) The volatility declines as the number of stocks in a portfolio grows.
B) An equally weighted portfolio is a portfolio in which the same amount is invested in
each stock.
C) As the number of stocks in a portfolio grows large, the variance of the portfolio is
determined primarily by the average covariance among the stocks.
D) When combining stocks into a portfolio that puts positive weight on each stock,
unless all of the stocks are uncorrelated with the portfolio, the risk of the portfolio will
be lower than the weighted average volatility of the individual stocks.
Which of the following statements is false?
A) When the investment cannot be delayed, the optimal rule is to invest whenever the
profitability index is greater than zero.
B) It is often better to wait too long (use a profitability index criterion that is too high)
than to invest too soon (use a profitability index criterion that is too low).
C) When the source of uncertainty that creates a motive to wait is interest rate
uncertainty, the hurdle rate is relatively easy to calculate.
D) When there is an option to delay, a good rule of thumb is to invest only when the
profitability index is at least 1.
Which of the following statements is false?
A) Because an American option cannot be worth less than its intrinsic value, it cannot
have a negative time value.
B) An American option with a later exercise date cannot be worth less than an otherwise
identical American option with an earlier exercise date.
C) The value of an option generally decreases with the volatility of the stock.
D) The intrinsic value is the amount by which the option is currently in-the money or 0
if the option is out-of-the-money.
Use the information for the question(s) below.
Luther Industries has just issued a callable (at 102) ten-year, 8% coupon bond with
semiannual coupon payments. The bond can be called at 102 in three years or anytime
thereafter on a coupon payment date. It has a current price of 99.
What is the Yield to Maturity (YTM) on this bond?
Consider the following balance sheet:
If on December 31, 2008 Luther has 8 million shares outstanding trading at $15 per
share., then what is Luther’s market-to-book ratio?
Consider two mutually exclusive projects with the following cash flows:
If the discount rate for project B is 15%, then what is the NPV for project B?
Use the table for the question(s) below.
Consider the following expected returns, volatilities, and correlations:
Consider a portfolio consisting of only Microsoft and Wal-Mart stock. Calculate the
expected return on such a portfolio when the weight on Microsoft stock is 0%, 25%,
50%, 75%, and 100%
Use the information for the question(s) below.
Rockwood Enterprises is currently an all equity firm and has just announced plans to
expand their current business. In order to fund this expansion, Rockwood will need to
raise $100 million in new capital. After the expansion, Rockwood is expected to
produce earnings before interest and taxes of $50 million per year in perpetuity.
Rockwood has already announced the planned expansion, but has not yet determined
how best to fund the expansion. Rockwood currently has 16 million shares outstanding
and following the expansion announcement these shares are trading at $25 per share.
Rockwood has the ability to borrow at a rate of 5% or to issue new equity at $25 per
share.
Show mathematically that the stock price of Rockwood does not depend on whether
they issue new stock or borrow to fund their expansion.
What is the role of an auditor in financial statement analysis?
Use the information for the question(s) below.
Kinston Industries has come up with a new mountain bike prototype and is ready to go
ahead with pilot production and test marketing. The pilot production and test marketing
phase will last for one year and cost $500,000. Your management team believes that
there is a 50% chance that the test marketing will be successful and that there will be
sufficient demand for the new mountain bike. If the test-marketing phase is successful,
then Kinston Industries will invest $3 million in year one to build a plant that will
generate expected annual after tax cash flows of $400,000 in perpetuity beginning in
year two. If the test marketing is not successful, Kinston can still go ahead and build the
new plant, but the expected annual after tax cash flows would be only $200,000 in
perpetuity beginning in year two. Kinston has the option to stop the project at any time
and sell the prototype mountain bike to an overseas competitor for $300,000. Kinston’s
cost of capital is 10%.
Assume that Kinston has the ability to ignore the pilot production and test marketing
and to go ahead and build their manufacturing plant immediately and that the
probability of high or low demand would still be 50%. What is the value of the the
option to do pilot production and test marketing?
You are in the process of purchasing a new automobile that will cost you $25,000. The
dealership is offering you either a $1,000 rebate (applied toward the purchase price) or
3.9% financing for 60 months (with payments made at the end of the month). You have
been pre-approved for an auto loan through your local credit union at an interest rate of
7.5% for 60 months. Should you take the $2000 rebate and finance through your credit
union or forgo the rebate and finance through the dealership at the lower 3.9% APR?
Rose Industries is currently trading for $47 per share. The stock pays no dividends. A
one-year European call option on Luther with a strike price of $45 is currently trading
for $7.45. If the risk-free interest rate is 6% per year, then calculate the price of a
one-year European put option on Luther with a strike price of $45.
Suppose that in January 2001, the U.S. Treasury issued a ten-year inflation-indexed
note with a coupon of 3 1/2%. On the date of issue the consumer price index (CPI) was
175.1. In January 2006, the CPI had increased to 198.3. What coupon payment was
made on this bond in January 2006?
You currently own $100,000 worth of Wal-Mart stock. Suppose that Wal-Mart has an
expected return of 14% and a volatility of 23%. The market portfolio has an expected
return of 12% and a volatility of 16%. The risk-free rate is 5%. Assuming the CAPM
assumptions hold, what alternative investment has the lowest possible volatility while
having the same expected return as Wal-Mart? What is the volatility of this portfolio?
Delta Products has decided to spin-off one of its subsidiaries, Gamma Technologies.
Each Delta shareholder will receive 0.125 shares of Gamma for each share of Delta
they own. Delta’s price is $35.00 cum-dividend and immediately after the spin-off
Gamma Technologies was trading for $24.00 per share. In a perfect capital market,
what would Delta Product’s ex-dividend share price be after this transaction?
Assume that you have $250,000 to invest and you are interested in creating a
value-weighted portfolio of these four stocks. How many shares of each of the four
stocks will you hold? What percentage of the shares outstanding of each stock will you
hold?
Use the information for the question(s) below.
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:
What is the NPV of the Epiphany’s project?
Describe the main requirements of the Sarbanes-Oxley Act of 2002.