The excess return if the difference between the average return on a security and the
average return for
A) Treasury Bonds.
B) a portfolio of securities with similar risk.
C) a broad based market portfolio like the S&P 500 index.
D) Treasury Bills.
If you want to value a firm that has consistent earnings grow, but varies how it pays out
these earnings to shareholders between dividends and repurchases, the simplest model
for you to use is the
A) enterprise value model.
B) dividend discount model.
C) total payout model.
D) discounted free cash flow model.
The British government has a consol bond outstanding that pays ₤100 in interest each
year. Assuming that the current interest rate in Great Britain is 5% and that you will
receive your first interest payment one year from now, then the value of the consol bond
is closest to:
A) ₤1000
B) ₤1100
C) ₤2100
D) ₤2000
Consider the following information regarding corporate bonds:
Nielson Motors plans to issue 10-year bonds that it believes will have an BBB rating.
Suppose AAA bonds with the same maturity have a 3.5% yield. Assume that the market
risk premium is 5% and the expected loss rate in the event of default on the bonds is
60%. The yield that these bonds will have to pay during average economic times is
closest to:
A) 3.50%
B) 3.75%
C) 4.00%
D) 5.50%
Use the table for the question(s) below.
Consider the following mutually exclusive projects:
ProjectYear 0
C/FYear 1
C/FYear 2
C/FYear 3
C/FYear 4
C/FYear 5
C/FYear 6
C/FYear 7
C/FDiscount
RateA-792025303540N/AN/A15%B-802525252525252515%
The NPV of project A is closest to:
A) $21.70
B) $24.00
C) $18.10
D) $16.90
Which of the following statements is false?
A) Future dividend payments and stock prices are not known with certainty; rather
these values are based on the investor’s expectations at the time the stock is purchased.
B) The capital gain is the difference between the expected sale price and the purchase
price of the stock.
C) The sum of the dividend yield and the capital gain rate is called the total return of the
stock.
D) We divide the capital gain by the expected future stock price to calculate the capital
gain rate.
Which of the following statements is false?
A) The equivalent after-tax interest rate is r – (τ r).
B) Interest rates vary based on the identity of the borrower.
C) The ability to deduct the interest expense increases the effective after-tax interest
rate paid on the loan.
D) For loans to borrowers other than the U.S. Treasury, the stated interest rate is the
maximum amount that investors will receive.
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.
Rose’s unlevered cost of capital is closest to:
A) 8.0%
B) 7.5%
C) 7.0%
D) 9.0%
When discounting dividends you should use
A) the weighted average cost of capital.
B) the after tax weighted average cost of capital.
C) the equity cost of capital.
D) the before tax cost of debt.
Consider two securities, A & B. Suppose a third security, C, has the same cash flows as
A and B combined. Given this information about securities A,B, & C, which of the
following statements is incorrect?
A) If the total price of A and B is cheaper than the price of C, then we could make a
profit selling A and B and buying C.
B) Price(C) = Price(A) + Price(B)
C) Because security C is equivalent to the portfolio of A and B, by the law of one price
they must have the same price.
D) The relationship known as value additivity says that the value of a portfolio is equal
to the sum of the values of its parts.
Taggart Transcontinental needs a $100,000 loan for the next 30 days. Taggart has three
alternatives available:
Alternative #1: Forgo the discount on its trade credit agreement that offers terms of 2/5
net 35.
Alternative #2: Borrow the money from Bank A, which has offered to lead the firm
$100,000 for one month at
an APR of 9%. The bank will require a (no-interest) compensating balance of 10% of
the face-value of the loan and will charge a $200 loan origination fee, which means that
Taggart must morrow even more than the $100,000 they need.
Alternative #3: Borrow the money from Bank B, which has offered to lend the firm
$100,000 for one month at an APR of 12%. The loan has a 1% origination fee.
The effective annual rate for Taggart if they choose alternative #1 is closest to:
A) 13.9%
B) 18.8%
C) 27.0%
D) 27.9%
The share of any positive return generated by venture capital firms that is taken by the
firm’s partners is known as
A) carried interest.
B) partner return.
C) carried capital.
D) angel interest.
Which of the following statements is false?
A) A biotech firm might be developing drugs with tremendous potential, but it has yet
to receive any revenue from these drugs. Such a firm will not have taxable earnings. In
that case, a tax-optimal capital structure does not include debt.
B) No corporate tax benefit arises from incurring interest payments that regularly
exceed EBIT.
C) The optimal level of leverage from a tax saving perspective is the level such that
interest equals EBIT.
D) In general, as a firm’s interest expense approaches its expected taxable earnings, the
marginal tax advantage of debt increases, limiting the amount of equity the firm should
use.
Consider the following information regarding corporate bonds:
Your estimate of the asset beta for Rearden Metal is closest to:
A) 0.42
B) 0.59
C) 0.66
D) 0.71
Which of the following statements is false?
A) Global bondscombine the features of domestic, foreign, and Eurobonds, and are
offered for sale in several different markets simultaneously.
B) In a leveraged buyout (LBO), a group of private investors purchases all the equity of
a public corporation.
C) A term loan is a bank loan that lasts for a specific term.
D) Eurobondsare international bonds that are denominated in the local European
currency of the country in which they are issued.
Which of the following statements regarding private placements is false?
A) A private placement is a bond issue that does not trade on a public market but rather
is sold to a small group of investors.
B) Privately placed debt need not conform to the same standards as public debt; as a
consequence, it can be tailored to the particular situation.
C) In 1990, the U.S. Securities and Exchange Commission (SEC) issued Rule 144A,
which significantly decreased the liquidity of certain privately placed debt.
D) Because a private placement does not need to be registered, it is less costly to issue.
Consider the following two projects:
The payback period for project B is closest to:
A) 2.5 years
B) 2.0 years
C) 2.2 years
D) 2.4 years
Use the following information to answer the question(s) below.
Nielson Motors sold 10 million shares of stock in an SEO. The market price of
Nielson’s stock at the time was $37.50. Of the 10 million shares sold, 4 million shares
were primary shares sold by the company, and the remaining 6 million shares were
being sold by the venture capital investors. Assume the underwriter charges 4% of the
gross proceeds as an underwriting fee which is shared proportionately between the
primary and secondary shares.
The amount of money the underwriter will earn on this transaction is closest to:
A) $4 million
B) $6 million
C) $9 million
D) $15 million
Which of the following statements is false?
A) Sensitivity analysis allows us to explore the effects of errors in our estimated inputs
in our NPV analysis for the project.
B) To compute the NPV for a project, you need to estimate the incremental cash flows
and choose a discount rate.
C) Estimates of the cash flows and cost of capital are often subject to significant
uncertainty.
D) When we are certain regarding the input to a capital budgeting decision, it is often
useful to determine the break-even level of that input.
Use the information for the question(s) below.
Consider two firms, ChihuahuaCorporation 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 a cost of capital of 15%. Bernard Industries is
not as shaky as Chihuahua, so Bernard has a 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 market value for Bernard is closest to:
A) $12.0 million
B) $10 million
C) $15.0 million
D) $12.5 million
Use the information for the question(s) below.
Big Blue Banana (BBB) is a clothing retailer with a current share price of $10.00 and
with 25 million shares outstanding. Suppose that Big Blue Banana announces plans to
lower its corporate taxes by borrowing $100 million and using the proceeds to
repurchase shares.
Suppose that BBB pays corporate taxes of 35% and that shareholders expects the
change in debt to be permanent. Assume that capital markets are perfect except for the
existence of corporate taxes and financial distress costs. If the price of BBB’s stock rises
to $10.85 per share following the announcement, then the present value of BBB’s
financial distress costs is closest to:
A) $21.25 million
B) $35.00 million
C) $11.40 million
D) $13.75 million
Frank Dewey Esquire from the firm of Dewey, Cheatum, and Howe, has been offered
an upfront retainer of $30,000 to provide legal services over the next 12 months to
Taggart Transcontinental . In return for this upfront payment, Taggart Transcontinental
would have access to 8 hours of legal services from Frank for each of the next 12
months. Frank’s normal billable rate is $250 per hour for legal services.
Assuming that Dewey’s cost of capital is 12% EAR, then the NPV of his retainer offer
is closest to:
A) -$7,500
B) -$7,400
C) $6,000
D) $7,400
Which of the following statements is false?
A) When stocks are perfectly positively correlated, the set of portfolios is identified
graphically by a straight line between them.
B) An investor seeking high returns and low volatility should only invest in an efficient
portfolio.
C) When the correlation between securities is less than 1, the volatility of the portfolio
is reduced due to diversification.
D) Efficient portfolios can be easily ranked, because investors will choose from among
them those with the highest expected returns.
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.
The IRR for Larry’s three movie deal offer is closest to:
A) 3.5%
B) 1.6%
C) -3.5%
D) -1.6%
Which of the following statements is false?
A) By convention, practitioners always plot the yield of the most senior issued bonds,
termed the on-the-run-bonds.
B) We can determine the no-arbitrage price of a coupon bond by discounting its cash
flows using the zero-coupon yields.
C) If the zero coupon yield curve is upward sloping, the resulting yield to maturity
decreases with the coupon rate of the bond.
D) The yield to maturity of a coupon bond is a weighted average of the yields on the
zero-coupon bonds.
Use the following information to answer the question(s) below.
Rearden Metal imports ore from South America. Rearden Metal is worried that the
South American mines may enter into a long-term contract with the Chinese to sell all
of their ore output to China, hence cutting off Rearden Metal’s supply. In the event of
such a contract with the Chinese, Rearden Metal will face much higher costs for its raw
materials causing its operating profits to decline substantially and its marginal tax rate
to fall from its current level of 35% down to 10%. An insurance firm has agreed to
write a trade insurance policy that will pay Rearden Metal $2,500,000 in the event of
the South American supply of ore being cut off. The chance of the South American
supply being cut off is estimated to be 20%, with a beta of -2.0. The risk-free rate of
interest is 4% and the return on the market is estimated to be 12%.
The actuarially fair premium for this insurance policy is closest to:
A) $417,000
B) $446,000
C) $500,000
D) $568,000
The lease is treated as a capital lease (financial lease) for the lessee and must be listed
on the firm’s balance sheet if it satisfies any of the following conditions except:
A) The lease contains an option to purchase the asset at its fair market value.
B) The present value of the minimum lease payments at the start of the lease is 90% or
more of the asset’s fair market value.
C) The title to the property transfers to the lessee at the end of the lease term.
D) The lease term is 75% or more of the estimated economic life of the asset.
Which of the following statements is false?
A) Debt holders are not foolishthey recognize that when the firm defaults, they will not
be able to get the full value of the assets. As a result, they will pay less for the debt
initially.
B) The costs of financial distress represent an important departure from Modigliani and
Miller’s assumption of perfect capital markets.
C) Levered firms risk incurring financial distress costs that reduce the cash flows
available to investors.
D) When securities are fairly priced, the original shareholders of a firm pay the future
value of the costs associated with bankruptcy and financial distress.
The term 2/10 net 30 means:
A) If the invoice is paid within 10 days a 2% discount can be taken. If the invoice is
paid between 11 and 29 days a 1% discount can be taken. After 30 days the full invoice
is due.
B) If the invoice is paid within 2 days a 10% discount can be taken, otherwise the full
invoice is due in 30 days.
C) If the invoice is paid within 2 days a 10% discount can be taken, otherwise a 2%
discount can be taken if the invoice is paid in 30 days.
D) If the invoice is paid within 10 days a 2% discount can be taken, otherwise the full
invoice is due in 30 days.
You are opening up a brand new retail strip mall. You presently have more potential
retail outlets wanting to locate in your mall than you have space available. What is the
most appropriate tool to use if you are trying to determine the optimal allocation of your
retail space?
A) IRR
B) Payback period
C) NPV
D) Profitability index
Use the information for the question(s) below.
You own a small manufacturing plant that currently generates revenues of $2 million
per year. Next year, based upon a decision on a long-term government contract, your
revenues will either increase by 20% or decrease by 25%, with equal probability, and
stay at that level as long as you operate the plant. Other costs run $1.6 million dollars
per year. You can sell the plant at any time to a large conglomerate for $5 million and
your cost of capital is 10%.
Assume that you are not able to sell the plant, but you are able to shut down the plant at
no cost at any time. The value of the option to abandon production will be closest to:
A) $1.0 million
B) $0.5 million
C) -$1.0 million
D) $3.0 million
A a written, legally binding agreement that obligates the bank to lend a firm any amount
up to a stated maximum, regardless of the financial condition of the firm (unless the
firm is bankrupt) as long as the firm satisfies any restrictions in the agreement is called
A) a bridge loan.
B) a single, end-of-period-payment loan.
C) a short-term mortgage loan.
D) a committed line of credit.