The benefit-cost ratio is equal to profitability index plus one.
The market value of debt is very close to the book value of debt for healthy firms.
Depreciation acts as a tax shield in reducing the taxes.
All securities in an equivalent risk class are priced to offer the same expected return.
Firms with high operating leverage tend to have higher asset betas.
Explain why growth mutual funds are worse investments than taking out a second
mortgage on a home and investing in the market index.
The MM formula for adjusted cost of capital takes into consideration only the effect of
interest tax shield on debt.
Forward rates are always higher than spot rates.
In large firms, there is usually a Chief Financial Officer (CFO) who oversees both the
treasurer and controller’s work.
The value of a call option increases with higher volatility of the stock prices.
Value additivity does not hold good when assets are split up.
The existing tax code encourages a preference for equity over debt in corporate
financing.
Since the expected rate of return on debt is less than the expected rate of return on
equity, the weighted average cost of capital declines as more debt is issued.
The standard statistical measures of spread are beta and covariance.
In 2005, ExxonMobil was the largest repurchaser of its own shares with $18.2 billion
worth of repurchases.
It is not possible to earn a return that is outside the efficient frontier without the
existence of a risk free asset or some other asset that is uncorrelated with your portfolio
assets.
PVH = (FCFH + 1)/(WACC – g)
The value of a firm is the present value of free cash flows minus the present value of
horizon value.
Always use the average corporate tax rate to calculate the tax shields for firms.
Australia follows the imputation tax system.
Firms can pay out cash to their shareholders in two ways: cash dividends and stock
dividends.
The relative accuracy of a beta estimate for risk can be determined by the standard
error.
Sales forecasts are the starting point for financial planning.
Equivalent annual cash flows are used whenever the lives of projects are the same.
All large U.S. corporations keep two separate sets of books, one for the stockholders
and one for the Internal Revenue Service.
When calculating cash flows, it is important to consider them on an incremental basis.
According to Modigliani and Miller Proposition II, the rate of return required by the
debt holders increases as the firm’s debt-equity ratio increases.
The rate of return, discount rate, hurdle rate or opportunity cost of capital all means the
same.
According to the CAPM, market portfolio is a risky portfolio.
The weak form of efficient market theory implies that technical analysis is valuable.
The calculation of market value added for a firm requires the use of the book value per
share.
Suppose VS’s stock price is currently $20. In the next six months it will either fall by
50% or rise by 50%. What is the current value of a put option with an exercise price of
$15 and expiration of one year? The six-month risk-free interest rate is 5% (periodic
rate). Use the two stage binomial method.
A. $5.00
B. $2.14
C. $7.86
D. $8.23
Mr. X invests $1000 at 10% nominal rate for one year. If the inflation rate is 4%, what
is the real value of the investment at the end of one year?
A. $1100
B. $1000
C. $1058
D. None of the above
The Miles-Ezzell formula for the adjusted cost of capital assumes that:
A. the firm rebalances once a year and not rebalance continuously
B. the project cash flow is a perpetuity
C. the project is a carbon copy of the firm
D. MM’s Proposition I corrected for taxes holds (i.e., T* = TC = 0.35)
The financial goal of a corporation is to:
A. Maximize profits
B. Maximize sales
C. Maximize the value of the firm for the shareholders
D. Maximize managers’ benefits
Which of the following countries had the lowest risk premium?
A. U.S.A
B. Denmark
C. Italy
D. none of the above
If the 4-year spot rate is 7% and the 3-year spot rate is 6%, what is the one-year forward
rate of interest three years from now?
A. 10.0%
B. 6.5%
C. 9.6%
D. None of the above
The distribution of returns, measured over a short interval of time, like daily returns,
can be approximated by:
A. Normal distribution
B. Lognormal distribution
C. Binomial distribution
D. none of the above
The market value of XYZ Corporation’s common stock is 40 million and the market
value of the risk-free debt is 60 million. The beta of the company’s common stock is
0.8, and the expected market risk premium is 10%. If the Treasury bill rate is 6%, what
is the firm’s cost of capital? (Assume no taxes.)
A. 9.2%
B. 14%
C. 8.1%
D. None of the above
RainMan Inc. is in the business of producing rain upon request. They must decide
between two investment projects; a new airplane for seeding rain clouds or a new
weather control machine built by Dr. Nutzbaum. The discount rate for the new airplane
is 9%, while the discount rate for the weather machine is 39% (it happens to be higher
risk). Which investment should the company select and why?
A. Airplane because is has a higher NPV
B. Weather machine because is has a higher NPV
C. Airplane because is has a higher annuity
D. Weather machine because is has a higher annuity
The par value of the outstanding shares is defined as:
A. Retained earnings
B. Legal capital
C. Book value of equity
D. None of the above
According to financial executives’ views about dividend policy, the following statement
is the most frequently cited one:
I) we try to avoid reducing the dividend
II) we try to maintain a smooth dividend stream
III) we look at the current dividend level
IV) we are reluctant to make a change that may have to be reversed
A. I only
B. II only
C. III only
D. IV only
For every dollar of operating income paid out as interest, the bondholder realizes:
A. (1 – Tp)
B. (1 – TpE) (1 – TC)
C. (1 – TC)
D. None of the above
Cost of equity can be estimated using:
A. The Fama-French three-factor model
B. Capital Asset Pricing Model (CAPM)
C. Arbitrage Pricing theory (APT)
D. All of the above
Which theory offers an explanation for the crash of a stock market one day and its
rebound the next?
A. Market efficiency theory
B. Random walk theory
C. Convergence trading
D. Prospect theory
A 5-year treasury bond with a coupon rate of 8% has a face value of $1000. What is the
semi-annual interest payment?
A. $80
B. $40
C. $100
D. None of the above
Taj Mahal Tour Company proposes to invest $3 million in a new tour package project.
Fixed costs are $1 million per year. The tour package costs $500 and can be sold at
$1500 per package to tourists. This tour package is expected to be attractive for the next
five years. If the cost of capital is 20%, what is the NPV break-even number of tourists
per year? (Ignore taxes, give an approximate answer)
A. 1000
B. 2000
C. 15000
D. None of the above
Which of the following statements is true?
I) The spot interest rate is a weighted average of yields to maturity
II) Yield to maturity is the weighted average of spot interest rates and estimated forward
rates
III) The yield to maturity is always higher than the spot rates
A. I only
B. II only
C. III only
D. I and III only
A call option has an exercise price of $100. At the final exercise date, the stock price
could be either $50 or $150. Which investment would combine to give the same payoff
as the stock?
A. Lend PV of $50 and buy two calls
B. Lend PV of $50 and sell two calls
C. Borrow $50 and buy two calls
D. Borrow $50 and sell two calls
What is the present value of the following cash flow at a discount rate of 9%?
A. $372,431.81
B. $450,000
C. $405,950.68
D. None of the above
Generally, a bond can be valued as a package of:
I) Annuity, II) Perpetuity, III) Single payment
A. I and II only
B. II and III only
C. I and III only
D. none of the above
Stock X has a standard deviation of return of 10%. Stock Y has a standard deviation of
return of 20%. The correlation coefficient between stocks is 0.5. If you invest 60% of
the funds in stock X and 40% in stock Y, what is the standard deviation of a portfolio?
A. 10%
B. 20%
C. 12.2%
D. None of the above
Otobai Motor Company is currently paying a dividend of $1.40 per year. The dividends
are expected to grow at a rate of 18% for the next three years and then a constant rate of
5% thereafter. What is the expected dividend per share in year 5?
A. $2.35
B. $2.54
C. $2.91
D. $1.50
Cost of equity can be estimated using:
A. Discounted cash flow (DCF) approach
B. Capital Asset Pricing Model (CAPM)
C. Arbitrage Pricing theory (APT)
D. All of the above
Which of the following statements regarding American puts is/are true?
A. An American put can be exercised any time before expiration
B. An American put is always more valuable than an equivalent European put
C. Multi-period binomial model can be used to value an American put
D. All of the above
If “u” equals the quantity (1 + upside change), then the quantity (1 + downside change)
is equal to:
A. -u
B. -1/u
C. 1/u
D. none of the above.
What signal is sent to the market when a firm decides to issue new stock to raise
capital?
A. Bond markets are overpriced
B. Bond markets are underpriced
C. Stock price is too low
D. Stock price is too high
An example of diversifiable risk that should be ignored when analyzing project risk
would include
A. Commodity price changes
B. Labor costs
C. Stock price fluctuations
D. Risk of government non-approval
Suppose a firm has a $100 million in excess cash. It could:
A. Invest the funds in projects with positive NPVs
B. Pay high dividends to the shareholders
C. Buy another firm
D. All of the above
The total market value (V) of the securities of a firm with both debt (D) and equity (E)
is:
A. V = D – E
B. V = E – D
C. V = D * E
D. V = D + E
The capital asset pricing model (CAPM) states that:
A. The expected risk premium on an investment is proportional to its beta
B. The expected rate of return on an investment is proportional to its beta
C. The expected rate of return on an investment depends on the risk-free rate and the
market rate of return
D. The expected rate of return on an investment is dependent on the risk-free rate
Which of the following lists events in the chronological order from earliest to latest?
A. Record date, declaration date, ex-dividend date
B. Declaration date, record date, ex-dividend date
C. Declaration date, ex-dividend date, record date
D. None of the above
What are TIPs? Briefly explain.
Describe how you would go about finding the present value of any annuity given the
formula for
the present value of a perpetuity.
Briefly explain the term “risk-free rate of interest”
What are the three basic financial statements?
Briefly explain how shareholders’ returns are taxed twice in the United States?
Explain the term market risk.
Briefly discuss different ways in which a firm can pay dividends to its shareholders.
Explain the pecking order theory of capital structure.
Discuss the process of preparing a financial plan?
Why do firms with large cash flow betas also have high asset betas?
Briefly explain the term “discount rate.”
Briefly explain put-call parity.
What is SEC Rule 10b-18? Briefly explain.
Why is liquidity relevant?
What are some of the additional factors that have to be considered when analyzing an
international project? Briefly explain.
Define the term risk premium.
Briefly discuss the concept of volatility.
How can individual investors diversify?
Briefly explain the term ‘security market line.”