Which of the following statements is false?
A) Depreciation is a method used for accounting and tax purposes to allocate the
original purchase cost of the asset over its life.
B) Sometimes the firm explicitly forecast free cash flow over a shorter horizon than the
full horizon of the project or investment.
C) Earnings include the cost of capital investments, but do not include non-cash
charges, such as depreciation.
D) Firms often report a different depreciation expense for accounting and for tax
purposes.
Answer:
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 past due is closest to:
A) 20.1%
B) 32.1%
C) 38.3%
D) 42.2%
Answer:
Which of the following statements is false?
A) As a practical matter, it is extremely difficult to identify portfolios that are efficient
because we cannot measure the expected return and the standard deviation of a portfolio
with great accuracy.
B) The portfolios in a multifactor model can be thought of as either risk factors
themselves or portfolios of stocks correlated with unobservable risk factors.
C) Each factor beta is the expected percent change in the excess return of a security for
a 1% change in the excess return of the factor portfolio.
D) Even if the market portfolio is not efficient, it still must capture all components of
systematic risk.
Answer:
Use the information for the question(s) below.
Temporary Housing Services Incorporated (THSI) is considering a project that involves
setting up a temporary housing facility in an area recently damaged by a hurricane.
THSI will lease space in this facility to various agencies and groups providing relief
services to the area. THSI estimates that this project will initially cost $5 million to
setup and will generate $20 million in revenues during its first and only year in
operation (paid in one year). Operating expenses are expected to total $12 million
during this year and depreciation expense will be another $3 million. THSI will require
no working capital for this investment. THSI’s marginal tax rate is 35%.
Ignoring the original investment of $5 million, what is THSI’s free cash flow for the
first and only year of operation?
A) $5.0 million
B) $3.75 million
C) $8.0 million
D) $6.25 million
Answer:
The quarterly working capital levels for Hasbeen Toys are presented in the following
table (in $ millions):
The temporary working capital needs for Hasbeen Toys in quarter 3 is closest to:
A) $845 million
B) $0 million
C) $770 million
D) $ 340 million
Answer:
Suppose a ten-year bond with semiannual coupons has a price of $1,071.06 and a yield
to maturity of 7%. This bond’s coupon rate is closest to:
A) 3.5%
B) 6.0%
C) 7.0%
D) 8.0%
Answer:
Use the information for the question(s) below.
Shepard Industries is evaluating a proposal to expand its current distribution facilities.
Management has projected the project will produce the following cash flows for the
first two years (in millions).
The depreciation tax shield for Shepard Industries project in year one is closest to:
A) $84
B) $168
C) $96
D) $72
Answer:
Consider the following investment alternatives:
Which alternative offers you the lowest effective rate of return?
A) Investment A
B) Investment B
C) Investment C
D) Investment D
Answer:
Which of the following statements is false?
A) The relationship between managerial ownership and firm value is unlikely to be the
same for every firm, or even for different executives of the same firm.
B) Even with the risk benefits of separating ownership and control, there are still
examples of corporations in which the top managers have substantial ownership
interests.
C) Academic studies do not support the notion that greater managerial ownership is
associated with fewer value-reducing actions by managers.
D) While increasing managerial ownership may reduce perquisite consumption, it also
makes managers harder to firethus reducing the incentive effect of the threat of
dismissal.
Answer:
Which of the following statements is false?
A) The yield to maturity of a coupon bond is a weighted average of the yields on the
zero-coupon bonds.
B) If the zero-coupon yield curve is downward sloping, the yield to maturity will
decrease with the coupon rate.
C) The information in the zero-coupon yield curve is sufficient to price all other
risk-free bonds.
D) When the yield curve is flat, all zero-coupon and coupon-paying bonds will have the
same yield, independent of their maturities and coupon rates.
Answer:
The statement of financial performance is also known as the
A) balance sheet.
B) income statement.
C) statement of cash flows.
D) statement of stockholder’s equity.
Answer:
Use the information for the question(s) below.
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 cost of capital for the firm’s levered equity is closest to:
A) 45%
B) 25%
C) 15%
D) 95%
Answer:
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%.
The incremental EBIT in the first year for the Sisyphean Corporation’s project is closest
to:
A) $18,000
B) $8,000
C) $11,700
D) $5,200
Answer:
Use the following information to answer the question(s) below.
The volatility of the market portfolio is 10%, the expected return on the market is 12%,
and the risk-free rate of interest is 4%.
The beta for Wyatt Oil is closest to:
A) 0.75
B) 0.80
C) 1.00
D) 1.10
Answer:
Rearden Metal can invest in a risk-free technology that requires an up-front investment
of $1 million. Rearden’s managers are hesitant to invest because of uncertainty over
future interest rates. Suppose that all interest rates will be either 8% or 4% in one year
and remain there forever. The risk-neutral probability that interest rates will drop to 4%
is 40%. The one-year risk-free interest rate is 5% and today’s rate on a risk-free
perpetual bond is 6%. The rate on an equivalent perpetual bond that is repayable at any
time (the callable annuity rate) is 7.65%.
Assuming that this project will provide Rearden with perpetual annual cash flows of
$80,000, the NPV of investing in using the hurdle rate is closest to:
A) -281,000
B) +46,000
C) +83,000
D) +143,000
E) +238,000
Answer:
Use the following information to answer the question(s) below.
Taggart Transcontinental pays no dividends, but spent $4 billion on share repurchases
last year. Taggart’s equity cost of capital is 13% and if the amount spent on repurchases
is expected to grow by 5% per year. Taggart currently has 2 billion shares outstanding.
Taggart’s market capitalization is closest to:
A) $25 billion
B) $31 billion
C) $40 billion
D) $50 billion
Answer:
Which of the following statements is false?
A) Although indirect costs of bankruptcy are difficult to measure accurately, they are
typically much smaller than the direct costs of bankruptcy.
B) Bankruptcy protection can be used by management to delay the liquidation of a firm
that should be shut down.
C) Because many aspects of the bankruptcy process are independent of the size of the
firm, the costs are typically higher, in percentage terms, for smaller firms.
D) Aside from the direct legal and administrative costs of bankruptcy, many other
indirect costs are associated with financial distress (whether or not the firm has formally
filed for bankruptcy).
Answer:
Use the information for the question(s) below.
Your firm needs to invest in a new delivery truck. The life expectancy of the delivery
truck is five years. You can purchase a new delivery truck for an upfront cost of
$200,000, or you can lease a truck from the manufacturer for five years for a monthly
lease payment of $4000 (paid at the end of each month). Your firm can borrow at 6%
APR with quarterly compounding.
The present value of the lease payments for the delivery truck is closest to:
A) $206,900
B) $207,050
C) $207,680
D) $198,420
Answer:
Use the table for the question(s) below.
Consider the following top federal tax rates in the United States:
Personal Tax Rates
In 2000, assuming an average dividend payout ratio of 50%, the effective tax advantage
for debt (t*) was closest to:
A) 40%
B) 24%
C) 30%
D) 18%
Answer:
Which of the following statements is false?
A) Traditionally, managers have used the equivalent annual benefit method to choose
between projects of different lives.
B) The equivalent annual benefit method ignores the value of any real options because
it assumes that the projects will always be replaced at their original terms.
C) If the future costs (or benefits) are certain with mutually exclusive projects, then we
must use a real options approach to determine the correct decision.
D) The equivalent annual benefit method accounts for the difference in project lengths
by calculating the constant payment over the life of the project that is equivalent to
receiving the NPV today and then selecting the project with the higher equivalent
annual benefit.
Answer:
Which of the following statements is false?
A) Margin investing is a risky investment strategy.
B) Because our return on the risk-free investments is fixed and does not move with (or
against) our portfolio, the correlation between the risk-free investment and the portfolio
is always equal to one.
C) Short selling the risk free investment is equivalent to borrowing money at the
risk-free interest rate through a standard loan.
D) Margin investing can provide higher expected returns than investing in the efficient
portfolio using only the funds we have available.
Answer:
Use the table for the question(s) below.
Consider the following top federal tax rates in the United States:
Personal Tax Rates
In 2005, the effective tax rate for debt holders was closest to:
A) 58%
B) 35%
C) 40%
D) 65%
Answer:
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 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 total return that you will receive on your investment is
closest to:
A) 9.50%
B) 10.75%
C) 10.25%
D) 10.00%
Answer:
Use the information for the question(s) below.
Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per
share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation
(BLL) at $40 per share.
Suppose over the next year Ball has a return of 12.5%, Lowes has a return of 20%, and
Abbott Labs has a return of -10%. The weight on Abbott Labs in your portfolio after
one year is closest to:
A) -10.0%
B) 43.5%
C) 45.0%
D) 50.0%
Answer:
Use the information for the question(s) below.
Omicron Technologies has $50 million in excess cash and no debt. The firm expects to
generate additional free cash flows of $40 million per year in subsequent years and will
pay out these future free cash flows as regular dividends. Omicrons unlevered cost of
capital is 10% and there are 10 million shares outstanding. Omicron’s board is meeting
to decide whether to pay out its $50 million in excess cash as a special dividend or to
use it to repurchase shares of the firm’s stock.
Assume that Omicron uses the entire $50 million in excess cash to pay a special
dividend. Omicron’s ex-dividend price is closest to:
A) $40.00
B) $5.00
C) $50.00
D) $45.00
Answer:
Use the information for the question(s) below.
Suppose that Rose Industries is considering the acquisition of another firm in its
industry for $100 million. The acquisition is expected to increase Rose’s free cash flow
by $5 million the first year, and this contribution us expected to grow at a rate of 3%
every year there after. Rose currently maintains a debt to equity ratio of 1, its marginal
tax rate is 40%, its cost of debt rD is 6%, and its cost of equity rE is 10%. Rose
Industries will maintain a constant debt-equity ratio for the acquisition.
The Free Cash Flow to Equity (FCFE) for the acquisition in year 0 is closest to:
A) $5 million
B) $100 million
C) -$100 million
D) -$50 million
Answer:
Which of the following statements is false?
A) The payback investment rule is based on the notion that an opportunity that pays
back its initial investments quickly is a good idea.
B) An IRR will always exist for an investment opportunity.
C) A NPV will always exist for an investment opportunity.
D) In general, there can be as many IRRs as the number of times the project’s cash
flows change sign over time.
Answer:
Use the following information to answer the question(s) below.
Assuming that Novartis AG (NVS) has an EPS of $3.35, based upon the average P/E
ratio for its competitors, Novartis’ stock price is closest to:
A) $13.00
B) $31.86
C) $43.47
D) $44.35
Answer:
Use the table for the question(s) below.
Consider the following information on options from the CBOE for Merck:
Assume you want to buy one option contract that with an exercise price closest to being
at-the-money and that expires January 2009. The current price that you would have to
pay for such a contract is:
A) $680
B) $380
C) $650
D) $420
Answer:
Use the information for the question(s) below.
KD Industries has 30 million shares outstanding with a market price of $20 per share
and no debt. KD has had consistently stable earnings, and pays a 35% tax rate.
Management plans to borrow $200 million on a permanent basis through a leveraged
recapitalization in which they would use the borrowed funds to repurchase outstanding
shares.
After the recapitalization, the value of a share of KD’s stock is closest to:
A) $22.35
B) $22.00
C) $22.65
D) $23.50
Answer: