Consider the following timeline detailing a stream of cash flows:
If the current market rate of interest is 10%, then the present value of this stream of
cash flows is closest to:
A) $674
B) $600
C) $460
D) $287
As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one
barrel of Alaska North Slope (ANS) crude oil. Because of its lower sulfur content, you
can produce $77 worth of unleaded gasoline from one barrel of West Texas
Intermediate (WTI) crude.
Another oil refiner is offering to trade you 10,150 Bbls of Alaska North Slope (ANS)
crude oil for 10,000 Bbls of West Texas Intermediate (WTI) crude oil. Assuming you
just purchased 10,000 Bbls of WTI crude at the current market price, the added benefit
(cost) to you if you were to refine this crude oil and sell the unleaded gasoline is closest
to:
A) $730,600
B) $39,400
C) $770,000
D) -$39,400
Which one of the following statements is FALSE?
A) When we compute the return of a security based on the average payoff we expect to
receive, we call it the expected return.
B) The notion that investors prefer to have a safe income rather than a risky one of the
same average amount is call risk aversion.
C) Because investors are risk averse, the risk-free interest rate is not the right rate to use
when converting risky cash flows across time.
D) The more risk averse investors are, the higher the current price of a risky asset will
be compared to a risk-free bond.
Which of the following statements is FALSE?
A) Calculating the precise present value of financial distress costs is a relatively
straightforward process.
B) Two key qualitative factors determine the present value of financial distress costs:
(1) the probability of financial distress and (2) the magnitude of the costs after a firm is
in distress.
C) Technology firms are likely to incur high costs when they are in financial distress,
due to the potential for loss of customers and key personnel, as well as a lack of
tangible assets that can be easily liquidated.
D) The magnitude of the financial distress costs will depend on the relative importance
of the sources of these costs and is likely to vary by industry.
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
Luther Corporation
Consolidated Balance Sheet
December 31, 2009 and 2008 (in $ millions)
The change in Luther’s quick ratio from 2008 to 2009 is closest to:
A) a decrease of .10
B) an increase of .10
C) a decrease of .15
D) an increase of .15
Which of the following statements is FALSE?
A) The actual return kept by an investor will depend on how the interest is taxed.
B) The equivalent after-tax interest rate is r(1 – Ï„).
C) The highest interest rate, for a given horizon, is the rate paid on U.S. Treasury
securities.
D) It is important to use a discount rate that matches both the horizon and the risk of the
cash flows.
If managed effectively, Rearden Metal will have assets with a market value of $200
million, $300 million, or $400 million next year, with each outcome being equally
likely. Managers, however, may decided to engage in wasteful empire building, which
will reduce Rearden’s market value by $20 million in all cases. Managers may also
increase the risk of the firm, changing the probability of each outcome to 50%, 5%, and
45% respectively.
Suppose that the managers at Rearden Metal will increase risk to maximize the
expected payoff to equity holders. If Rearden has $180 million in debt due in one year,
then the expected value of Rearden’s assets is closest to:
A) $280 million
B) $295 million
C) $300 million
D) $900 million
Common risk is also called:
A) diversifiable risk.
B) correlated risk.
C) uncorrelated risk.
D) independent risk.
Pro Forma Income Statement for Ideko, 2005-2010
Pro Forma Balance Sheet for Ideko, 2005-2010
Assuming that Ideko has a EBITDA multiple of 8.5, then the continuation equity value
of Ideko in 2010 is closest to:
A) $181.7 million
B) $272.8 million
C) $152.8 million
D) $301.7 million
Consider two firms, Chihuahua Corporation and Bernard Industries that are each
expected to pay the same $1.5 million dollar dividend every year in perpetuity.
Chihuahua Corporation is riskier and has an equity cost of capital of 15%. Bernard
Industries is not as shaky as Chihuahua, so Bernard has an equity cost of capital of only
10%. Assume that the market portfolio is not efficient. Both stocks have the same beta
and the CAPM would assign them both an expected return of 12% to both.
The alpha for Chihuahua is closest to:
A) +2%
B) -5%
C) -3%
D) +3%
You own 100 shares of a Sub Chapter “S” corporation. The corporation earns $5.00 per
share before taxes. Once the corporation has paid any corporate taxes that are due, it
will distribute the rest of its earnings to its shareholders in the form of a dividend. If the
corporate tax rate is 40% and your personal tax rate on (both dividend and
non-dividend) income is 30%, then how much money is left for you after all taxes have
been paid?
A) $210
B) $300
C) $350
D) $500
Consider the following equation:
βU= βE+ βD
The term βUin the equation is:
A) the same as the beta of the firm’s assets.
B) the required return on the firm’s equity.
C) the proportion of the firm financed with equity.
D) equal to zero if the firm’s debt is riskless.
The cost of ________ is highest for firms that are likely to have profitable future
growth opportunities requiring large investments.
A) asset substitution
B) debt overhang
C) debt covenants
D) debt maturity
Consider the following four bonds that pay annual coupons:
Which of the four bonds is the least sensitive to a one percent increase in the YTM?
A) Bond A
B) Bond B
C) Bond C
D) Bond D
Taggart Transcontinental has a value of $500 million if it continues to operate, but has
outstanding debt of $600 million. If Taggart declares bankruptcy, bankruptcy costs will
equal $50 million, and the remaining $450 million will go to creditors. Instead of
declaring bankruptcy, Taggart proposes to exchange the firm’s debt for a fraction of its
equity in a workout. The minimum fraction of the firm’s equity that Taggart would need
to offer to its creditors for the workout to be successful is closest to:
A) 50%
B) 75%
C) 83%
D) 90%
Consider the following zero-coupon yields on default free securities:
A 3 year default free security with a face value of $1000 and an annual coupon rate of
6% will trade
A) at a discount.
B) at a premium.
C) at par.
D) There is insufficient information provided to answer this question.
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.
Growing Real Fast Company (GRF) is expected to have a 25 percent growth rate for the
next four years (effecting D1, D2, D3, and D4). Beginning in year five, the growth rate
is expected to drop to 7 percent per year and last indefinitely. If GRF just paid a $2.00
dividend and the appropriate discount rate is 15 percent, then what is the value of a
share of GRE?
(-(chg IE)(.6) = chg NI
-1,000,000(.6) = -600,000
Or, -$1 million(1 – .6) = -$600,000
You have been offered the following investment opportunity, if you pay $2500 today,
you will receive $1000 at the end of each of the next three years. Draw a timeline
detailing this investment opportunity.
Larry the Cucumber has been offered $14 million to star in the lead role of the next
three Larry Boy adventure movies. If Larry takes this offer, he will have to forgo acting
in other Veggie movies that would pay him $5 million at the end of each of the next
three years. Assume Larry’s personal cost of capital is 10% per year.
Explain why the NPV decision rule might provide Larry with a different decision
outcome than the IRR rule when evaluating Larry’s three movie deal offer.
In a normal market with transactions costs, is it possible for different investors to place
different values on an investment opportunity? Are there any limits on the amount that
their values can differ?
How does scenario analysis differ from sensitivity analysis?
What are some implicit assumptions that are made when valuing a firm using multiples
based on comparable firms?
Joe just inherited the family business, and having no desire to run the family business,
he has decided to sell it to an entrepreneur. In exchange for the family business, Joe has
been offered an immediate payment of $100,000. Joe will also receive payments of
$50,000 in one year, $50,000 in two years, and $75,000 in three years. The current
market rate of interest for Joe is 6%.
In terms of present value, how much will Joe receive for selling the family business?
Suppose that a young couple has just had their first baby and they wish to ensure that
enough money will be available to pay for their child’s college education. Currently,
college tuition, books, fees, and other costs, average $12,500 per year. On average,
tuition and other costs have historically increased at a rate of 4% per year.
Assume that college costs continue to increase an average of 4% per year and that all
her college savings are invested in an account paying 7% interest. Draw a timeline that
details the amount of money she will need to have in the future four each of her four
years of her undergraduate education.
What is a sunk cost? Should it be included in the incremental cash flows for a project?
Why or why not?