Consider the following information regarding corporate bonds:
Your estimate of the debt beta for Taggart Transcontinental would be:
A) 0.05
B) 0.10
C) 0.17
D) 1.00
If Firm A and Firm B are in the same industry and use the same production method, and
Firm A’s asset turnover is higher than that of Firm B, then all else equal we can
conclude:
A) Firm A is more efficient than Firm B.
B) Firm A has a lower dollar amount of assets than Firm B.
C) Firm A has higher sales than Firm B.
D) Firm A has a lower ROE than Firm B.
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 10%, then Nielson Motors should:
A) invest in this opportunity since the NPV is positive.
B) not invest in this opportunity since the NPV is positive.
C) invest in this opportunity since the NPV is negative.
D) not invest in this opportunity since the NPV is negative.
If the risk-free interest rate is 10%, then of the four projects listed, which project would
you never want to invest in?
A) Eenie
B) Meenie
C) Mighty
D) Moe
Consider the following two projects:
The profitability index for project A is closest to:
A) 0.12
B) 21.65
C) 0.17
D) 12.04
Consider the following formula:
rwacc= rE+ rD– rDÏ„c
The terms rE+ rD represent:
A) the after tax wacc.
B) the reduction due to equity financing.
C) the before tax wacc.
D) the reduction due to the interest tax shield.
Which of the following statements is FALSE?
A) An investor will be willing to pay up to the point at which the current price of a
share of stock equals the present value of the expected future dividends an expected
future sale price.
B) The expected total return of a stock should equal the expected return of other
investments available in the market with equivalent risk.
C) The total amount received in dividends and from selling the stock will depend on the
investor’s investment horizon.
D) If the current stock price were greater than P0= , it would be a positive
NPV investment, and we would expect investors to rush in and buy it, driving up the
stocks price.
Which of the following statements is FALSE?
A) The process of moving a value or cash flow backward in time is known as
discounting.
B) FV =
C) The process of moving a value or cash flow forward in time is known as
compounding.
D) The value of a cash flow that is moved forward in time is known as its future value.
How do you calculate (mathematically) the present value of a(n):
(a) perpetuity
(b) annuity
(c) growing perpetuity
(d) growing annuity
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.
If Nielson’s equity cost of capital is 13%, then Nielson’s expected share price is closest
to:
A) $19.23
B) $37.86
C) $35.71
D) $50.00
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 $40,000 at the
risk free rate and issues new equity to cover the remainder. In this situation, the cash
flow that equity holders will receive in one year in a strong economy is closest to:
A) $117,000
B) $75,000
C) $50,000
D) $0
Which of the following statements is FALSE?
A) The market portfolio contains more of the smallest stocks and less of the larger
stocks.
B) For the market portfolio, the investment in each security is proportional to its market
capitalization.
C) Because the market portfolio is defined as the total supply of securities, the
proportions should correspond exactly to the proportion of the total market that each
security represents.
D) Market capitalization is the total market value of the outstanding shares of a firm.
Which of the following equations is INCORRECT?
A) VL= VU+
B) VL= VU+ Ï„cD
C) rwacc= rE+ rD– rDÏ„c
D) rwacc= rE+ rD(1 + Ï„c)
If a project has a higher proportion of fixed to variable costs, holding the risk of its
revenues constant:
A) its beta will be lower, hence its cost of capital will be lower.
B) its beta will be higher, hence its cost of capital will be higher.
C) its beta will be unaffected, since beta does not measure the sensitivity of the project’s
cash flows to market risk.
D) its financial leverage will be higher.
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 14%. If Google
were to issue sufficient debt at a pre-tax cost of 7% 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) While the sign of the correlation is easy to interpret, its magnitude is not.
B) Independent risks are uncorrelated.
C) When the covariance equals 0, the returns are uncorrelated.
D) To find the risk of a portfolio, we need to know more than the risk and return of the
component stocks; we need to know the degree to which the stocks’ returns move
together.
Assume that you are 30 years old today, and that you are planning on retirement at age
65. Your current salary is $45,000 and you expect your salary to increase at a rate of 5%
per year as long as you work. To save for your retirement, you plan on making annual
contributions to a retirement account. Your first contribution will be made on your 31st
birthday and will be 8% of this year’s salary. Likewise, you expect to deposit 8% of
your salary each year until you reach age 65. Assume that the rate of interest is 7%.The
future value at retirement (age 65) of your savings is closest to:
A) $497,530
B) $928,895
C) $1,263,236
D) $108,000
If the risk-free interest rate is 10%, then of the four projects listed, if could only invest
in two of these projects, which two projects would you select?
A) Mighty & Eenie
B) Mighty & Meenie
C) Eenie & Moe
D) Eenie & Meenie
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. Suppose that at the start of the year, MI has no debt outstanding, but
has 5.6 million shares of stock outstanding. If MI does not issue debt, its share price is
closest to:
A) $5.15
B) $23.75
C) $23.90
D) $25.00
Which of the following questions is FALSE?
A) Net Working Capital = Current Assets – Current Liabilities.
B) Because depreciation is not a cash flow, we do not include it in the cash flow
forecast.
C) Tax loss carry backs allow corporations to take losses during the current year and
use them to offset income in future years.
D) Earnings are an accounting measure of firm performance.
Nielson Motors has a debt-equity ratio of 1.8, an equity beta of 1.6, and a debt beta of
0.20. It is currently evaluating the following projects, none of which would change
Nielson’s volatility.
(All amounts are in $millions.)
If Nielson Motors invests in only those projects which are beneficial to the
stockholders, then the total debt overhang associated with accepting these project(s) is
closest to:
A) $22.5 million
B) $36.0 million
C) $38.0 million
D) $57.5 million
The Aardvark Corporation is considering launching a new product and is trying to
determine an appropriate discount rate for evaluating this new product. Aardvark has
identified the following information for three single division firms that offer products
similar to the one Aardvark is interested in launching:
The unlevered cost of capital for Anteater Enterprises is closest to:
A) 10.1%
B) 9.5%
C) 9.9%
D) 10.3%
