Use the table for the question(s) below.
Consider the following information regarding the Fama French Carhart four factor
model:
Using the FFC four factor model and the historical average monthly returns, the
expected monthly return for GE is closest to:
A) 0.53%
B) 0.73%
C) 0.79%
D) 0.71%
Answer:
Which of the following statements is false?
A) Prices of bonds with lower durations are more sensitive to interest rate changes.
B) When a bond is trading at a discount, the price increase between coupons will
exceed the drop when a coupon is paid, so the bond’s price will rise and its discount will
decline as time passes.
C) Coupon bonds may trade at a discount, at a premium, or at par.
D) The sensitivity of a bond’s price changes in interest rates is the bond’s duration.
Answer:
Consider a bond that pays annually an 8% coupon with 20 years to maturity. The
amount that the price of the bond will change if its yield to maturity increases from 5%
to 7% is closest to:
A) -$270
B) -$225
C) -$310
D) -$250
Answer:
Suppose that Defenestration decides to pay a dividend of only $2 per share this year and
use the remaining $2 per share to repurchase stock. If Defenestration maintains this
dividend and total payout rate, then the rate at which Defenestration’s dividends and
earnings per share are expected to grow is closest to:
A) 7%
B) 13%
C) 9%
D) 5%
Answer:
The discount rate that sets the present value of the promised bond payments equal to the
current market price of the bond is called
A) the current yield.
B) the yield to maturity.
C) the zero coupon yield.
D) the discount yield.
Answer:
Which of the following statements is false?
A) When a firm fails to make a required payment to debt holders, it is in bankruptcy.
B) With perfect capital markets, the riskof bankruptcy is not a disadvantage of
debt bankruptcy simply shifts the ownership of the firm from equity holders to debt
holders without changing the total value available to all investors.
C) Bankruptcy is a long and complicated process that imposes both direct and indirect
costs on the firm and its investors that the assumption of perfect capital markets
ignores.
D) Bankruptcy is rarely simple and straightforward equity holders don”t just “hand the
keys” to debt holders the moment the firm defaults on a debt payment.
Answer:
If you want to value a firm but don’t want to explicitly forecast its dividends, share
repurchases, or its use of debt, what is the simplest model for you to use?
A) Discounted free cash flow model
B) Dividend discount model
C) Enterprise value model
D) Total payout model
Answer:
Use the following information to answer the question(s) below.
Nielson Motors is currently an all equity financed firm. It expects to generate EBIT of
$20 million over the next year. Currently Nielson has 8 million shares outstanding and
its stock is trading at $20.00 per share. Nielson is considering changing its capital
structure by borrowing $50 million at an interest rate of 8% and using the proceeds to
repurchase shares. Assume perfect capital markets.
Nielson’s EPS if they change their capital structure is closest to:
A) $2.00
B) $2.30
C) $2.50
D) $2.90
Answer:
Use the following information to answer the question(s) below.
Rearden Metal has earnings per share of $2. It has 10 million shares outstanding and is
trading at $20 per share. Rearden Metal is thinking of buying Associated Steel, which
has earnings per share of $1.25, 4 million shares outstanding, and a price per share of
$15. Rearden Metal will pay for Associated Steel by issuing new shares. There are no
expected synergies from the transaction.
If Rearden pays no premium to buy Associated Steel, then Rearden’s earnings per share
after the merger will be closest to:
A) $1.85
B) $1.90
C) $2.00
D) $2.25
Answer:
Use the following information to answer the question(s) below.
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 “Y” is closest to:
A) -1.00
B) -0.25
C) 0.00
D) 0.25
Answer:
Which of the following statements is false?
A) Absent market imperfections, leases represent another form of zero-NPV financing
available to a firm, and the Modigliani-Miller propositions apply: Leases neither
increase nor decrease firm value, but serve only to divide the firm’s cash flows and risks
in different ways.
B) In a perfect market, the cost of leasing is equivalent to the cost of purchasing and
reselling the asset.
C) Each lease agreement can be tailored to fit the precise nature of the asset and the
needs of the parties at hand.
D) Features of leases will be priced as part of the lease payment. Terms that give
valuable options to the lessee lower the amount of the lease payments, whereas terms
that restrict these options will raise them.
Answer:
Consider the following equation:
C = P + S – PV(K)– PV(Div)
In this equation the term C refers to
A) the value of the call option.
B) the stocks current price.
C) the payoff of a zero coupon bond.
D) the strike price of the option.
Answer:
Which of the following statements is false?
A) To determine the benefit of leverage for the value of the firm, we must compute the
present value of the stream of future interest tax shields the firm will receive.
B) Because the cash flows of the levered firm are equal to the sum of the cash flows
from the unlevered firm plus the interest tax shield, by the Law of One Price the same
must be true for the present values of these cash flows.
C) By increasing the amount paid to debt holders through interest payments, the amount
of the pre-tax cash flows that must be paid as taxes increases.
D) When a firm uses debt, the interest tax shield provides a corporate tax benefit each
year.
Answer:
If you buy shares of Coca-Cola on the primary market,
A) Coca-Cola receives the money because the company has issued new shares.
B) you buy the shares from another investor who decided to sell the shares.
C) you buy the shares from the New York Stock Exchange.
D) you buy the shares from the Federal Reserve.
Answer:
Which of the following statements is false?
A) With a discount loan, the borrower is required to pay the interest at the endof the
loan period.
B) Bridge loans are often quoted as discount loans with fixed interest rates.
C) A bridge loanis another type of short-term bank loan that is often used to “bridge the
gap” until a firm can arrange for long-term financing.
D) After a natural disaster, lenders may provide businesses with short-term loans to
serve as bridges until they receive insurance payments or long-term disaster relief.
Answer:
Use the table for the question(s) below.
Consider the following expected returns, volatilities, and correlations:
The volatility of a portfolio that is equally invested in Duke Energy and Microsoft is
closest to:
A) 8%
B) 9%
C) 11%
D) 6%
Answer:
If Moon Corporation’s gross margin declined, which of the following is true?
A) Its cost of goods sold increased.
B) Its cost of goods sold as a percent of sales increased.
C) Its sales increased.
D) Its net profit margin was unaffected by the decline.
Answer:
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 IRR for this project is closest to:
A) 18.9%
B) 22.7%
C) 34.1%
D) 39.1%
Answer:
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%.
The cost of capital for a project with the same beta as Exxon Mobil’s stock is closest to:
A) 11.6%
B) 11.2%
C) 12.8%
D) 7.6%
Answer:
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%.
The incremental cash flow that the Krusty Krab will incur in year 1 if they elect to
upgrade to the new grill is closest to:
A) 6,500
B) 7,800
C) 10,800
D) 11,500
Answer:
Use the information for the question(s) below.
You own your own firm and you need to raise $50 million to fund an expansion.
Following the expansion, your firm will be worth $75 million in its unlevered form.
You want to go ahead with the expansion, but you are concerned that you may not be
able to maintain ownership of over 50% of your firm’s equity. In other words, you are
concerned that if you use equity to finance the expansion, you may loose control of
your firm.
Assume that capital markets are perfect except for the existence of corporate taxes.
Your firm pays 40% of earnings in taxes and you decide to issue $25 million in new
debt and $25 million in new equity. You ownership stake in the firm following these
new issues of debt and equity is closest to:
A) 58%
B) 55%
C) 33%
D) 50%
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 required net working capital in the second year for the Sisyphean Corporation’s
project is closest to:
A) $3,960
B) $4,360
C) $3.190
D) $5,940
Answer:
If investors have relative wealth concerns, they care most about
A) the return on their portfolio relative to their overall current wealth.
B) the performance of their portfolio relative to that of their peers.
C) their current portfolio performance relative to their past portfolio performance.
D) the performance of their current wealth relative to their past wealth.
Answer:
Which of the following statements is false?
A) One advantage of quoting the yield to maturity rather than the price is that the yield
is independent of the face value of the bond.
B) Unlike the case of bonds that pay coupons, for zero-coupon bonds, there is no simple
formula to solve for the yield to maturity directly.
C) Because we can convert any bond price into a yield, and vice versa, bond prices and
yields are often used interchangeably.
D) The IRR of an investment in a bond is given a special name, the yield to maturity
(YTM).
Answer:
Use the information for the question(s) below.
Kinston Enterprises has no debt and a debt obligation of $47 million that is due now.
The market value of Kinston’s assets is $102 million, and the firm has no other
liabilities. Assume that capital markets are perfect and that Kinston has 5 million shares
outstanding.
Kinston’s current share price is closest to:
A) $20.40
B) $9.40
C) $11.00
D) $10.00
Answer:
Use the following information to answer the question(s) below.
Nielson Motors is considering an opportunity that requires an investment of $1,000,000
today and will provide $250,000 one year from now, $450,000 two years from now, and
$650,000 three years from now.
If the appropriate interest rate is 15%, then Nielson Motors should:
A) Invest in this opportunity since the NPV is positive.
B) Do Not Invest in this opportunity since the NPV is positive.
C) Invest in this opportunity since the NPV is negative.
D) Do Not Invest in this opportunity since the NPV is negative.
Answer:
Which of the following is not a way that a firm can increase its dividend?
A) By increasing its retention rate
B) By decreasing its shares outstanding
C) By increasing its earnings (net income)
D) By increasing its dividend payout rate
Answer:
Use the information for the question(s) below.
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 yield to maturity of MI’s debt is closest to:
A) 13.75%
B) 5.00%
C) 19.25%
D) 12.50%
Answer:
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.
Given Nielson’s current share price, if Nielson’s equity cost of capital is 13%, then
Nielson’s expected growth rate is closest to:
A) 5%
B) 6%
C) 7%
D) 8%
Answer:
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.
At the conclusion of this transaction, the value of a share of d’Anconia Copper will be
closest to:
A) $18.33
B) $20.00
C) $25.00
D) $27.50
Answer:
Luther Industries has outstanding tax loss carryforwards of $70 million from losses
over the past four years. If Luther earns $15 million per year in pre-tax income from
now on, Luther first pays taxes in:
A) 7 years
B) 2 years
C) 4 years
D) 5 years
Answer: