Which of the following statements is false?
A) Holding cash has the opposite effect of leverage on risk and return.
B) We use the market value of the firm’s net debt when computing its WACC and
unlevered beta to measure the cost of capital and market risk of the firm’s business
assets.
C) Since the WACC does not change with the use of leverage, the value of the firm’s
free cash flow evaluated using the WACC does not change, and so the enterprise value
of the firm does not depend on its financing choices.
D) Even if the firm’s capital structure is more complex, the WACC is calculated by
computing the weighted average cost of only the firm’s debt and equity.
Consider the following two quotes for XYZ stock:
How much would you have to pay to purchase 100 shares of XYZ stock on November
18th?
A) $2520
B) $2525
C) $2593
D) $2600
Which of the following statements is false?
A) U.S. tax policy requires U.S. corporations to pay taxes on their foreign income at the
same rate as profits earned in the United States.
B) The home government gets an opportunity to tax the income from a foreign project
to the domestic firm.
C) The general international arrangement prevailing with respect to taxation of
corporate profits is that the home country gets the first opportunity to tax income.
D) The home government must establish a tax policy specifying its treatment of foreign
income and foreign taxes paid on that income.
Which of the following statements is false?
A) The decision to lease is often driven by real-world market imperfections related to
leasing’s accounting, tax, and legal treatment.
B) When publicly traded firms disclose leasing transactions in their financial
statements, they must follow the recommendations of the Financial Accounting
Standards Board (FASB).
C) In its Statement of Financial Accounting Standards No. 13 (FAS13), the FASB
provides specific criteria that distinguish a true tax lease from a non-tax lease.
D) The categories used to report leases on the financial statements affect the values of
assets on the balance sheet, but they have no direct effect on the cash flows that result
from a leasing transaction.
In a ________ merger, the target and the acquirer operate in the same industry.
A) conglomerate
B) vertical
C) horizontal
D) diagonal
Taggart Transcontinental currently has no debt and an equity cost of capital of 16%.
Suppose that Taggart decides to increase its leverage and maintain a market
debt-to-value ratio of 1/3. Suppose Taggart’s debt cost of capital is 9% and its corporate
tax rate is 35%. Assuming that Taggart’s pre-tax WACC remains constant, then with the
addition of leverage its effective after-tax WACC will be closest to:
A) 12.9%
B) 13.0%
C) 15.0%
D) 16.0%
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.
The initial value of MI’s equity without leverage is closest to:
A) $133 million
B) $147 million
C) $140 million
D) $150 million
Which of the following statements is false?
A) In both the Binomial and Black-Scholes Pricing Models, we need to know the risk
neutral probability of each possible future stock price to calculate the option price.
B) In the real world, investors are risk averse. Thus, the expected return of a typical
stock includes a positive risk premium to compensate investors for risk.
C) Because no assumption on the risk preferences of investors is necessary to calculate
the option price using either the Binomial Model or the Black-Scholes formula, the
models must work for any set of preferences, includingrisk-neutral investors.
D) If all market participants were risk neutral, then allfinancial assets (including
options) would have the same cost of capital”the risk free rate of interest.
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 NPV of alternative #2 is closest to:
A) $350,000
B) $357,196
C) $370,561
D) $401,121
The Debt Capacity for Omicron’s new project in year 2 is closest to:
A) $55.25
B) $38.75
C) $22.00
D) $33.00
Use the information for the question(s) below.
The Sisyphean Company has a bond outstanding with a face value of $1000 that
reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate
for this bond is 8% and that the coupon payments are to be made semiannually.
Assuming the appropriate YTM on the Sisyphean bond is 7.5%, then the price that this
bond trades for will be closest to:
A) $1,045
B) $691
C) $1,000
D) $957
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%.
Suppose that Google Stock has a beta of 1.06 and Boeing stock has a beta of 1.31. If the
risk-free interest rate is 4% and the expected return from the market portfolio is 12%,
then the expected return on a portfolio that consists of 30% Google stock and 70%
Boeing stock is closest to:
A) 12.5%
B) 13.1%
C) 13.5%
D) 13.9%
Monsters’ required return is closest to:
A) 10.0%
B) 13.0%
C) 11.5%
D) 15.5%
Assume that investors hold Google stock in retirement accounts that are free from
personal taxes. Also assume that Google’s current pre-tax WACC is 12%. If Google
were to issue sufficient debt to give them a debt to value ratio of 0.5, then the Google’s
after-tax WACC would be closest to:
A) 10.4%
B) 12.8%
C) 13.0%
D) 15.0%
E) 16.0%
Which of the following statements is false?
A) No arbitrage opportunities will exist until the underlying prices diverge by more
than the amount of the transaction costs.
B) Because you will generally pay a slightly lower price when you buy a security (the
ask price) than you receive when you sell (the bid price) you will pay the bid-ask
spread.
C) The price of a security should equal the present value of its cash flows, up to the
transaction costs of trading the security and the cash flows.
D) In most markets, you must pay transactions costs to trade securities.
The dollar cost of debt for John Galt Industries is 8.0%. The firm faces a tax rate of
40% on all income, no matter where it is earned. Galt needs to know its Yen cost of
debt. The risk-free interest rates on dollars and yen are r% = 6% and r = 2%,
respectively. Galt is willing to assume that capital markets are internationally integrated
and that its free cash flows are uncorrelated with the yen-dollar spot rate. Galt’s
after-tax cost of debt in yen is closest to:
A) 0.9%
B) 2.0%
C) 3.9%
D) 4.8%
Use the information for the question(s) below.
Fly by Night Aviation (FBNA) expects to have net income next year of $24 million and
Free Cash Flow of $27 million. FBNA’s marginal corporate tax rate is 40%.
FBNA’s EBIT is closest to:
A) $43 million
B) $40 Million
C) $45 million
D) $60 million
Rearden Metal has borrowed $4 million for three months at a stated annual rate of 8%,
using inventory stored in a field warehouse as collateral. The warehouse charges a
$10,000 fee, payable at the end of the month. The effect annual rate on this loan is
closest to:
A) 9.3%
B) 11.3%
C) 15.2%
D) 17.1%
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.
Omicron’s enterprise value is closest to:
A) $500 million
B) $900 million
C) $450 million
D) $400 million
Use the following information to answer the question(s) below.
Using just the return data for 2009, your estimate of Wyatt Oil’s Beta is closest to:
A) 0.84
B) 0.87
C) 1.00
D) 1.16
Use the following timeline to answer the question(s) below.
0 1 2 3
$600 $1,200 $1,800
At an annual interest rate of 7%, the present value of this timeline in year 0 is closest to:
A) $3,080
B) $3,600
C) $3,770
D) $4,035
Consider a zero-coupon bond with a $1000 face value and 10 years left until maturity.
If the bond is currently trading for $459, then the yield to maturity on this bond is
closest to:
A) 7.5%
B) 10.4%
C) 9.7%
D) 8.1%
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 .5 debt to equity ratio, then the value of Flagstaff as an
all equity firm would be closest to:
A) $80 million
B) $100 million
C) $73 million
D) $115 million
Which of the following statements is false?
A) When bond yields have increased, by exercising the call on the callable bond and
then immediately refinancing, the issuer can lower its borrowing costs.
B) To understand how call provisions affect the price of a bond, we first need to
consider when an issuer will exercise its right to call the bond.
C) If the call provision offers a cheaper way to retire the bonds the issuer will forgo the
option of purchasing the bonds in the open market and call the bonds instead.
D) An issuer can always retire one of its bonds early by repurchasing the bond in the
open market.
The beta for the market portfolio is closest to:
A) 1
B) 0
C) Unable to answer this question without knowing the markets expected return
D) Unable to answer this question without knowing the markets volatility
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 expected return on the portfolio of the three stocks is closest to:
A) 10.0%
B) 11.4%
C) 11.8%
D) 12.0%
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.
Monsters’ beta with the market is closest to:
A) 1.3
B) 1.0
C) 0.6
D) 0.8
Which of the following statements is false?
A) Because insurance reduces the risk of financial distress, it can relax this tradeoff and
allow the firm to increase its use of debt financing.
B) By lowering the volatility of the stock, insurance discourage concentrated ownership
by an outside director or investor who will monitor the firm and its management.
C) When a firm is subject to graduated income tax rates, insurance can produce a tax
savings if the firm is in a higher tax bracket when it pays the premium than the tax
bracket it is in when it receives the insurance payment in the event of a loss.
D) In a perfect market without other frictions, insurance companies should compete
until they are just earning a fair return and the NPV from selling insurance is zero. The
NPV is zero if the price of insurance equals the present value of the expected payment;
in that case, we say the price is actuarially fair.
The British government has just issued a new consol bond that sells for 1000 and pays
interest of 8%. The annual interest payment on this bond must be:
A) 80
B) 8
C) 1000
D) 12,500
Which of the following statements is false?
A) When a bond is trading at a discount, the price drop when a coupon is paid will be
larger than the price increase between coupons, so the bond’s discount will tend to
decline as time passes.
B) When a bond trades at a price equal to its face value, it is said to trade at par.
C) As interest rates and bond yield rise, bond prices will fall.
D) Ultimately, the prices of all bonds approach the bond’s face value when the bonds
mature and their last coupon are paid.
Which of the following statements is false?
A) If the CAPM correctly computes the risk premium, investors would stop investing
only when they expected the alpha of an investment strategy to be negative.
B) If the CAPM correctly computes the risk premium, an investment opportunity with a
positive alpha is a positive NPV investment opportunity.
C) If the CAPM correctly computes the risk premium, investors should flock to invest
in positive alpha stocks.
D) Anyone can implement a momentum trading strategy and therefore generate a
positive investment opportunity.
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 highest 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
Assume that MM’s perfect capital markets conditions are met and that you can borrow
and lend at the same 5% rate as with. You have $5000 of your own money to invest and
you plan on buying Without stock. Using homemade leverage you borrow enough in
your margin account so that the payoff of your margined purchase of Without stock will
be the same as a $5000 investment in with stock. The number of shares of Without
stock you purchased is closest to:
A) 425
B) 1650
C) 2000
D) 825
Your firm purchases goods from its supplier on terms of 2/10, net 45. Calculate the
effective annual cost to your firm if it chooses not to take advantage of the trade
discount offered.
An exchange traded fund (ETF) is a security that represents a portfolio of individual
stocks. Consider an ETF for which each share represents a portfolio of two shares of
Apple Inc. (APPL), one share of Google (GOOG), and ten shares of Microsoft (MSFT).
Suppose the current stock prices of each individual stock are as shown below:
If the ETF is currently trading for $1,300, what arbitrage opportunity is available? What
trades would you make?
KT Enterprises would like to construct and operate a new ice skating rink. In addition to
the capital expenditures on the rink, management estimates that the project will require
an investment today of $220,000 in net working capital. The firm will recover the
investment in net working capital fifteen years from today, when management
anticipates closing the rink. The discount rate for this type of cash flow is 8% per year.
Calculate the present value of the cost of working capital for the ice skating rink.
Use the information for the question(s) below.
Suppose the purchase price of a bulldozer is $90,000, its residual value in four years is
certain to be $15,000, and there is no risk that the lessee will default on the lease.
Assume that capital markets are perfect and the risk-free interest rate is 6% APR with
monthly compounding.
Calculate the monthly lease payments for a four year fixed price lease that allows the
lessee to buy the Bulldozer at the end of the lease for $8,000.
What range for the market value of equity for Ideko is implied by the range of P/E
multiples for the comparable firms?
In December 2005, the spot exchange rate for the British Pound was $1.7188/ and the
one-year forward rate was $1.8675/. Suppose that at the same time Luther Industries
entered into a contract to purchase goods with a price of 375,000 to be delivered in one
year. Simultaneously Luther entered into a one-year forward contract to purchase
375,000. What is the amount of the payment in U.S. dollars that Luther Industries will
have to make in one year to pay for their goods?
Use the information for the question(s) below.
Luther Industries is in the process of selling shares of stock in an auction IPO. At the
end of the bidding period, Luther’s investment bank has received the following bids:
What will the proceeds from the IPO be if Luther is selling 1.1 million shares?
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.
Given that Rose issues new debt of $50 million initially to fund the acquisition, the total
value of this acquisition using the APV method is equal to?
What is the relationship between a bond’s price and its yield to maturity?
MJ Enterprises has 50 million shares outstanding with a market price of $25 per share
and no debt. MJ has had consistently stable earnings, and pays a 35% tax rate.
Management plans to borrow $500 million on a permanent basis through a leveraged
recapitalization in which they would use the borrowed funds to repurchase outstanding
shares. Calculate MJ’s share price following announcement of the recapitalization plan.
Use the table for the question(s) below.
Consider an ETF that is made up of one share each of IBM, MRK, and C. The current
quote for this ETF currently is $162.85 (bid) $163.00 (ask). What should you do?
Use the table for the question(s) below.
Consider the following Price and Dividend data for J. P. Morgan Chase:
Assume that you purchased J. P. Morgan Chase stock at the closing price on December
31, 2008 and sold it at the closing price on December 30, 2009. Calculate your realized
annual return is for the year 2005.
The Century 22 fund has invested in a portfolio of mortgaged backed securities that has
a current market value of $245 million. The duration of this portfolio of mortgaged
back securities is 14.7 years. The fund has borrowed to purchase these securities, and
the current value of its liabilities (i.e., the current value of the bonds Century 22 has
issued) is $160 million. The duration of these liabilities is 5.4 years. What is the initial
duration of the equity for the Century 22 fund?
What are some of the disadvantages of long-term supply contracts?
Describe the two factors that affect the value of an investment timing option?
What is the Yield to Call (YTC) on this bond?
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 $140 million face
value due next year. Calculate the value of levered equity, the value of debt, and the
total value of MI with leverage.