Use the following information to answer the question(s) below.
Galt Industries has 50 million shares outstanding and a market capitalization of $1.25
billion. It also has $750 million in debt outstanding. Galt Industries has decided to
delever the firm by issuing new equity and completely repaying all the outstanding
debt. Assume perfect capital markets.
Suppose you are a shareholder in Galt industries holding 600 shares, and you disagree
with this decision to delever the firm. You can undo the effect of this decision by:
A) Borrow $6,000 and buy 240 shares of stock
B) Sell 240 shares of stock and lend $6,000
C) Borrow $9,000 and buy 360 shares of stock
D) Sell 360 shares of stock and lend $9,000
Consider the following information regarding corporate bonds:
Your estimate of the debt beta for Nielson Motors would be:
A) 0.10
B) 0.17
C) 1.00
D) 1.68
Use the information for the question(s) below.
Iota Industries is an all-equity firm with 50 million shares outstanding. Iota has $200
million in cash and expects future free cash flows of $75 million per year. Management
plans to use the cash to expand the firm’s operations, which in turn will increase future
free cash flows by 12%. Iota’s cost of capital is 10% and assume that capital markets are
perfect.
The price per share of Iota if they use the $200 million to expand is closest to:
A) $13.75
B) $16.50
C) $19.00
D) $16.80
Use the following information to answer the question(s) below.
Suppose that all stocks can be grouped into two mutually exclusive portfolios (with
each stock appearing in only one portfolio): growth stocks and value stocks. Assume
that these two portfolios are equal in size (market value), the correlation of their returns
is equal to 0.6, and the portfolios have the following characteristics:
The risk free rate is 3.5%.
The expected return on the market portfolio (which is a 50-50 combination of the value
and growth portfolios) is closest to:
A) 12.0%
B) 13.5%
C) 15.0%
D) 19.0%
Use the table for the question(s) below.
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.
Use the tables for the question(s) below.
Estimated 2005 Income Statement and Balance Sheet Data for Ideko Corporation
The following are financial ratios for three comparable companies:
Based upon the average EV/EBITDA ratio of the comparable firms, Ideko’s target
economic value is closest to:
A) $191 million
B) $155 million
C) $157 million
D) $193 million
E) $165 million
Use the information for the question(s) below.
Iota Industries is an all-equity firm with 50 million shares outstanding. Iota has $200
million in cash and expects future free cash flows of $75 million per year. Management
plans to use the cash to expand the firm’s operations, which in turn will increase future
free cash flows by 12%. Iota’s cost of capital is 10% and assume that capital markets are
perfect.
The NPV of Iota’s expansion project is closest to:
A) -$110 million
B) -$137.5 million
C) $0
D) $75 million
Galt Industries has issued four-month commercial paper with a $8 million face value.
The firm netted $7,831,000 on the sale. The effect annual rate for this financing is
closest to:
A) 5.6%
B) 6.6%
C) 7.2%
D) 8.4%
Which of the following statements is false?
A) Bond traders typically quote bond prices rather than bond yields .
B) Treasury bills are zero-coupon bonds.
C) Zero-coupon bonds always trade at a discount.
D) The yield to maturity is typically stated as an annual rate by multiplying the
calculated YTM by the number of coupon payment per year, thereby converting it to an
APR.
Use the table for the question(s) below.
Consider the following zero-coupon yields on default free securities:
The price today of a 3 year default free security with a face value of $1000 and an
annual coupon rate of 6% is closest to:
A) $1000
B) $1021
C) $1013
D) $1005
Use the following information to answer the question(s) below.
Suppose you purchase a 20-year treasury bond with a 6% annual coupon ten years ago
at par. Today the bond’s yield to maturity has risen to 8% (EAR).
If you sell this bond now, the internal rate of return you will earn on your investment
will be closest to:
A) 5.0%
B) 5.6%
C) 6.0%
D) 8.0%
Use the information for the question(s) below.
KT Enterprises, a U.S. import-export trading, is considering its international tax
situation. Currently KT is U.S. tax rate is 35%. KT has significant operations in both
Japan and Ireland. In Japan the current exchange rate is 118.4/$ and earnings in Japan
are taxed at 41%. In Ireland the current exchange rate is $1.27/€ and earnings in Ireland
are taxed at 12.5%. KT’s profits, which are fully and immediately repatriated, and
foreign taxes paid for the current year are shown here (in millions):
The amount of the taxes paid in dollars for the Irish operations is closest to:
A) $20.5 million
B) $5.1 million
C) $29.5 million
D) $50.0 million
Which of the following statements is false?
A) A momentum strategy is one where you buy stocks that have had low past returns
and (short) sell stocks that have had high past returns.
B) Over the years since the discovery of the CAPM, it has become increasing clear to
researchers and practitioners alike that forming portfolios based on market
capitalization, book-to-market ratios, and past returns, one can construct trading
strategies that have a positive alpha.
C) Portfolios containing firms with the highest realized returns over the previous six
months have positive alphas over the next six months.
D) If the market portfolio is not efficient, then a portfolio of small stocks will likely
have positive alphas.
Use the following information for the question(s) below.
Wyatt Oil has the following accounts on its books:
Rearden extends credit on terms of 1/15, net 30.
The percentage of Wyatt’s receivables that are still eligible to take the discount is closest
to:
A) 20.1%
B) 32.1%
C) 38.3%
D) 42.2%
Use the following information to answer the question(s) below.
Suppose that Merck (MRK) stock is trading for $36.70 per share with 2.11 billion
shares outstanding while Boeing (BA) has 697.5 million shares outstanding and a
market capitalization of $38.223 billion. Assume that you hold the market portfolio.
Boeing’s stock price is closest to:
A) $18.25
B) $36.70
C) $54.80
D) $63.40
Which of the following statements is false?
A) If indeed alphas are positive, it is possible that the positive alpha trading strategies
contain risk that investors are unwilling to bear but the CAPM does not capture.
B) If indeed alphas are positive, it is possible that the costs of implementing investment
strategies are larger than the NPVs of undertaking them.
C) If indeed alphas are positive, then investors have to be systematically ignoring
positive-NPV investments opportunities.
D) The only way a positive NPV investment opportunity can exist in a market is if
some barrier to entry restricts competition.
Use the tables for the question(s) below.
Pro Forma Income Statement for Ideko, 2005-2010
Pro Forma Balance Sheet for Ideko, 2005-2010
Assuming that Ideko has a EBITDA multiple of 9.4, then the continuation unlevered
P/E ratio of Ideko in 2010 is closest to:
A) 17.2
B) 16.4
C) 14.5
D) 19.4
Which of the following statements is false?
A) Sales will ultimately decline as the product nears obsolescence or faces increased
competition.
B) Managers sometimes continue to invest in a project that has a negative NPV because
they have already invested a large amount in the project and feel that by not continuing
it, the prior investment will wasted.
C) With straight-line depreciation the asset’s cost is divided equally over its life.
D) A projects unlevered net income is equal to its incremental revenues less costs and
depreciation, evaluated on an pre-tax basis.
Which of the following statements is false?
A) There are two potential sources of cash flows from owning a stock.
B) An investor will be willing to pay a price today for a share of stock up to the point
that this transaction has a zero NPV.
C) An investor might generate cash by choosing to sell the shares at some future date.
D) Because the cash flows from stock are known with certainty, we can discount them
using the risk-free interest rate.
The quarterly working capital levels for Hasbeen Toys are presented in the following
table (in $ millions):
The temporary working capital needs for Hasbeen Toys in quarter 1 is closest to:
A) $0 million
B) $340 million
C) $770 million
D) $845 million
Which of the following statements is false?
A) Modigliani and Miller’s conclusion verified the common view, which stated that
even with perfect capital markets, leverage would affect a firm’s value.
B) We can evaluate the relationship between risk and return more formally by
computing the sensitivity of each security’s return to the systematic risk of the economy.
C) Investors in levered equity require a higher expected return to compensate for its
increased risk.
D) Leverage increases the risk of equity even when there is no risk that the firm will
default.
Which of the following statements is false?
A) When a firm faces financial distress, creditors can gain by making sufficiently risky
investments, even if they have negative NPV.
B) When a firm has leverage, a conflict of interest exists if investment decisions have
different consequences for the value of equity and the value of debt.
C) In some circumstances, managers may take actions that benefit shareholders but
harm the firm’s creditors and lower the total value of the firm.
D) Agency costs are costs that arise when there are conflicts of interest between
stakeholders.
In a ________ merger, the target’s industry buys or sells to the acquirer’s industry.
A) conglomerate
B) vertical
C) horizontal
D) diagonal
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.
Suppose you are a shareholder in d’Anconia Copper holding 300 shares, and you
disagree with the decision to lever the firm. You can undo the effect of this decision by
A) borrowing $2,000 and buying 100 shares of stock.
B) selling 100 shares of stock and lending $2,000.
C) borrowing $1,200 and buying 60 shares of stock.
D) selling 60 shares of stock and lending $1,200.
Suppose that Nielson Motors stock is trading for $50 per share and that Nielson pays no
dividends. What is the maximum possible price for a call option on Nielson Motors?
A) $0
B) $20
C) $50
D) infinite
Use the information for the question(s) below.
Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per
share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation
(BLL) at $40 per share.
Suppose over the next year Ball has a return of 12.5%, Lowes has a return of 20%, and
Abbott Labs has a return of -10%. The return on your portfolio over the year is:
A) 0%
B) 7.5%
C) 3.5%
D) 5.0%
The third party who checks annual financial statements to ensure that they are prepared
according to GAAP and verifies that the information reported is reliable is the
A) NYSE Enforcement Board.
B) Accounting Standards Board.
C) Securities and Exchange Commission (SEC).
D) auditor.
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 #1 is closest to:
A) $350,000
B) $357,000
C) $375,500
D) $400,000
Use the figure for the question(s) below.
An option strategy in which you hold a long position in both a put and a call option
with the same strike price is called
A) a strangle.
B) portfolio insurance.
C) a butterfly spread.
D) a straddle.
Which of the following equations is incorrect?
A) E[RxCML] = rf + x(E[RMkt] +rf)
B) ri = rf + b(E[RMkt] – rf)
C) SD(RxCML)= xSD(RMkt)
D) E[RxCML] = (1 – x)rf + xE[RMkt]
Which of the following statements regarding arbitrage and security prices is incorrect?
A) We call the price of a security in a normal market the no-arbitrage price for the
security.
B) In financial markets it is possible to sell a security you do not own by doing a short
sale.
C) When a bond is underpriced, the arbitrage strategy involves selling the bond and
investing some of the proceeds.
D) The general formula for the no-arbitrage price of a security is Price(security) =
PV(All cash flows paid by the security).