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%.
To insure their assets against hazards such as fire, storm damage, vandalism,
earthquakes, and other natural and environmental risks firms commonly purchase
A) key personnel insurance.
B) business liability insurance.
C) business interruption insurance.
D) property insurance.
Which of the following statements is incorrect?
A) In general, money today is worth more than money in one year.
B) We define the risk-free interest rate, rf for a given period as the interest rate at which
money can be borrowed or lent without risk over that period.
C) We refer to (1 – rf) as the interest rate factor for risk-free cash flows.
D) For most financial decisions, costs and benefits occur at different points in time.
Use the following information to answer the question(s) below.
Your investment portfolio consists of $10,000 worth of Google stock. Suppose that the
risk-free rate is 4%, Google stock has an expected return of 14% and a volatility of
35%, and the market portfolio has an expected return of 10% and a volatility of 18%.
Assume that the CAPM assumptions hold.
The volatility of the alternative investment that has the lowest possible volatility while
having the same expected return as Google is closest to:
A) 18.0%
B) 22.5%
C) 23.4%
D) 35.0%
Which of the following statements is false?
A) Bonds are a securities sold by governments and corporations to raise money from
investors today in exchange for promised future payments.
B) By convention the coupon rate is expressed as an effective annual rate.
C) Bonds typically make two types of payments to their holders.
D) The time remaining until the repayment date is known as the term of the bond.
Which of the following statements is false?
A) SEC rules make it difficult for investors to buy much more than about 10% of a firm
in secret. After an acquirer acquires such an initial stake in the target, called a toehold,
they would have to make their intentions public by informing investors of his large
stake.
B) With the availability of both the freezeout merger and the leveraged buyout as
acquisition strategies, most of the value added accrues to the acquiring shareholders.
C) The laws on tender offers allow the acquiring company to freeze existing
shareholders out of the gains from merging by forcing non-tendering shareholders to
sell their shares for the tender offer price.
D) Premiums in LBO transactions are often quite substantialwhile they can avoid the
free-rider problem acquirers must still get board approval to overcome other defenses
such as poison pills, as well as outbid other potential acquirers.
Which of the following money market investments is a short-term, unsecured debt
obligation issued by a large corporation. The minimum denomination is $25,000, but
most have a face value of $100,000 or more?
A) Banker’s Acceptance
B) Commercial Paper
C) Repurchase Agreement
D) Certificates of Deposit (CD)
E) Treasury Bill
Consider the following information regarding corporate bonds:
Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to
maturity of 8.6%, and a B rating. The bondholders expected loss rate in the event of
default is 50%. Assuming the economy is in recession, then the expected return on
Rearden Metal’s debt is closest to:
A) 0.6%
B) 1.6%
C) 4.6%
D) 6.0%
Which of the following is not considered to be an important choice when estimating
beta?
A) The choice of the time horizon to use for estimation
B) The choice of method used to extrapolate beta
C) The choice between weekly and monthly returns
D) The choice of index used as the market portfolio
Which of the following statements is false?
A) The creditors must vote to accept the Chapter 11 reorganization plan, and the
bankruptcy court must approve it. If an acceptable plan is not put forth, the court may
ultimately force a Chapter 7 liquidation of the firm.
B) In Chapter 13 liquidation, a trustee is appointed to oversee the liquidation of the
firm’s assets through an auction. The proceeds from the liquidation are used to pay the
firm’s creditors, and the firm ceases to exist.
C) When a corporation becomes financially distressed, outside professionals, such as
legal and accounting experts, consultants, appraisers, auctioneers, and others with
experience selling distressed assets, are generally hired.
D) In the case of Chapter 11 reorganization, creditors must often wait several years for
a reorganization plan to be approved and to receive payment.
The geometric average annual return on Stock A from 2000 to 2009 is closest to:
A) 12.4%
B) 16.7%
C) 13.2%
D) 17.8%
The callable annuity rate can be calculated as:
A) x Hurdle Rate
B) x Hurdle Rate
C) x Cost of Capital
D)
Consider the following income statement and other information:
Luther’s EBITDA coverage ratio for the year ending December 31, 2009 is closest to:
A) 1.64
B) 1.78
C) 1.98
D) 2.19
Which of the following statements is false?
A) The bond certificate typically specifies that the coupons will be paid periodically
until the maturity date of the bond.
B) The bond certificate indicates the amounts and dates of all payments to be made.
C) The only cash payments the investor will receive from a zero coupon bond are the
interest payments that are paid up until the maturity date.
D) Usually the face value of a bond is repaid at maturity.
Use the information for the question(s) below.
Your firm needs to invest in a new delivery truck. The life expectancy of the delivery
truck is five years. You can purchase a new delivery truck for an upfront cost of
$200,000, or you can lease a truck from the manufacturer for five years for a monthly
lease payment of $4000 (paid at the end of each month). Your firm can borrow at 6%
APR with quarterly compounding.
The effective annual rate for a credit card that charges a 19.9% APR compounded daily
is closest to:
A) 18.15%
B) 19.9%
C) 22.0%
D) 24.2%
Use the following information to answer the question(s) below.
In which years were dividends not tax disadvantaged?
A) 1987 – 2002
B) 1987, 1993 – 2002
C) 1987, 1991 – 2002
D) 1988 – 1990, 2003 – 2009
Use the table for the question(s) below.
Consider an ETF that is made up of one share each of IBM, MRK, and C. The
minimum ask price for this ETF in a normal market is closest to:
A) $162.85
B) $163.00
C) $168.00
D) $168.10
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.
If Alex Corporation takes out a bank loan to purchase a machine used in production and
everything else stays the same, its equity multiplier will ________, and its ROE will
________.
A) increase; increase
B) decrease; decrease
C) increase; decrease
D) decrease; increase
Hugh Akston took out a 30-year mortgage with an EAR of 5.9%. If Hugh borrowed
$300,000 to buy his home, then his monthly payment will be closest to:
A) $835
B) $1,750
C) $1,780
D) $10,240
Use the information for the question(s) below.
Electronic Gaming Incorporated (EGI) is a firm with no debt and its 20 million shares
are currently trading for $16 per share. Based on the prospects for EGI’s new hand held
video game, management feels the true value of the firm is $20 per share. Management
believes that the share price will reflect this higher value after the video game is
released next fall. EGI has already announced plans to raise $100 million from
investors to build a new factory.
Assume that EGI decides to wait until after the release of the new video game before
they raise the $100 million through the issuance of new shares. The number of new
shares that EGI will issue is closest to:
A) 1.6 million
B) 5.0 million
C) 10 million
D) 6.25 million
Consider the following equation:
the term d in this equation is
A) the firms target debt to value ratio.
B) the dollar amount of debt outstanding at time t.
C) the firms target debt to equity ratio.
D) the investment’s debt capacity.
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.
At the conclusion of this transaction, the number of shares that d’Anconia Copper will
repurchase is closest to:
A) 5 million
B) 15 million
C) 20 million
D) 40 million
Use the following information to answer the question(s) below.
Assume that the CAPM is a good description of stock price returns. The market
expected return is 8% with 12% volatility and the risk-free rate is 3%. New news
arrives that does not change any of these numbers, but it does change the expected
returns of the following stocks:
Which of the following stocks represent selling opportunities?
1. Taggart Transcontinental
2. Rearden Metal
3. Wyatt Oil
4. Nielson Motors
A) 1 only
B) 1 & 2 only
C) 2 & 3 only
D) 2 & 4 only
Use the information for the question(s) below.
Suppose that the risk-free rate is 5% and the market portfolio has an expected return of
13% with a volatility of 18%. Monsters Inc. has a 24% volatility and a correlation with
the market of .60, while California Gold Mining has a 32% volatility and a correlation
with the market of -.7. Assume the CAPM assumptions hold.
Suppose that California Gold Mining’s expected return is 2%. Then California Gold
Mining’s alpha is closest to:
A) -3%
B) -13%
C) 7%
D) -11%
Consider the following two projects:
Assume that projects Alpha and Beta are mutually exclusive. Which of the following
statements is true regarding the investment decision tools’ suitability for deciding
between projects Alpha & Beta.
A) The incremental IRR should not be used since the projects have different lives.
B) The incremental IRR should not be used since the projects have different discount
rates
C) The incremental IRR should not be used since the projects have different cash flow
patterns.
D) Both the NPV and incremental IRR approaches are appropriate to solve this
problem.
Use the information for the question(s) below.
Tom’s portfolio consists solely of an investment in Merck stock. Merck has an expected
return of 13% and a volatility of 25%. The market portfolio has an expected return of
12% and a volatility of 18%. The risk-free rate is 4%. Assume that the CAPM
assumptions hold in the market.
Assuming that Tom wants to maintain the current expected return on his portfolio, then
the amount that Tom should invest in the market portfolio to minimize his volatility is
closest to:
A) 100%
B) 90%
C) 125%
D) 110%
Use the information for the question(s) below.
The current spot exchange rate, S, is $1.8862/. Suppose that the yield curve in both
countries is flat. The risk-free rate on dollars, r$, is 5.35% and the risk-free interest rat
on pounds, r, is 4.80%.
Using the covered interest parity condition, the calculated one-year forward rate F1 is
closest to:
A) $1.8568/
B) $1.8764/
C) $1.9161/
D) $1.8961/
Use the information for the question(s) below.
Rockwood Enterprises is currently an all equity firm and has just announced plans to
expand their current business. In order to fund this expansion, Rockwood will need to
raise $100 million in new capital. After the expansion, Rockwood is expected to
produce earnings before interest and taxes of $50 million per year in perpetuity.
Rockwood has already announced the planned expansion, but has not yet determined
how best to fund the expansion. Rockwood currently has 16 million shares outstanding
and following the expansion announcement these shares are trading at $25 per share.
Rockwood has the ability to borrow at a rate of 5% or to issue new equity at $25 per
share.
If Rockwood finances their expansion by issuing $100 million in debt at 5%, what will
Rockwood’s cost of equity capital be?
A) 11.25%
B) 10.70%
C) 12.50%
D) 12.00%
Wesley Mouch’s auto loan requires monthly payments and has an effect annual rate of
6.43%. The APR on this auto loan is closest to:
A) 6.00%
B) 6.25%
C) 6.50%
D) 6.62%
Suppose that you want to use the 10 year historical average return on the Index to
forecast the expected future return on the Index. The 95% confidence interval for your
estimate of the expect return is closest to:
A) -10.6% to 28.2%
B) 6.8% to 10.7%
C) -37.0% to 47.6%
D) 4.9% to 12.7%
Kinston Industries issued $4,000,000 in commercial paper which matures in six months
and received $3,876,000. Calculate the effective annual rate that Kinston is paying.
What is a compensating balance?
You currently own $100,000 worth of Wal-Mart stock. Suppose that Wal-Mart has an
expected return of 14% and a volatility of 23%. The market portfolio has an expected
return of 12% and a volatility of 16%. The risk-free rate is 5%. Assuming the CAPM
assumptions hold, what alternative investment has the highest possible expected return
while having the same volatility as Wal-Mart? What is the expected return of this
portfolio?
When referring to IPOs, what is book building?
What does the existence of a positive alpha investment strategy imply?
What is the market portfolio?
Using the data provided in the table, calculate the average annual return, the variance of
the annual returns, and the standard deviation of the average returns for Stock B from
2000 to 2009.
Use the information for the question(s) below.
Luther Industries, a U.S. Corporation, is considering a new project located in Great
Britain. The expected free cash flows from the project are detailed below:
You know that the spot exchange rate is S = 1.8862/. In addition, the risk-free interest
rate on dollars and pounds is 5.4% and 4.6% respectively. Assume that these markets
are internationally integrated and the uncertainty in the free cash flow is not correlated
with uncertainty in the exchange rate. You have determined that the dollar WACC for
these cash flows is 10.2%.
Calculate the pound denominated cost of capital for Luther’s project.
Use the information for the question(s) below.
Epiphany Industries is considering a new capital budgeting project that will last for
three years. Epiphany plans on using a cost of capital of 12% to evaluate this project.
Based on extensive research, it has prepared the following incremental cash flow
projects:
Epiphany is worried about the reliability of the sales forecast. How sensitive is the
project’s NPV to a 10% change in sales.
Use the information for the question(s) below.
Epiphany Industries is considering a new capital budgeting project that will last for
three years. Epiphany plans on using a cost of capital of 12% to evaluate this project.
Based on extensive research, it has prepared the following incremental cash flow
projects:
Epiphany would like to know how sensitive the project’s NPV is to changes in the
discount rate. How much can the discount rate vary before the NPV reaches zero?
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.
Farmville Industries is a major agricultural firm and is concerned about the possibility
of drought impacting corn production. In the event of a drought, Farmville Industries
anticipates a loss of $75 million. Suppose the likelihood of a drought is 10% per year,
and the beta associated with such a loss is 0.4. If the risk-free interest rate is 5% and the
expected return on the market is 10%, then what is the actuarially fair insurance
premium?
Use the information for the question(s) below.
Kinston Industries is considering investing in a machine that will cost $125,000 and
will last for three years. The machine will generate revenues of $120,000 each year and
the cost of goods sold will be 50% of sales. At the end of year three the machine will be
sold for $15,000. The appropriate cost of capital is 10% and Kinston is in the 35% tax
bracket.
Assume that Kinston’s new machine will be depreciated straight line to a salvage value
of $5,000 at the end of year three. What is the after-tax salvage value of this project?
A company that manufactures copper piping is offering to trade you 5,925 tons of
low-grade copper ore for 4,000 tons of high-grade copper ore. Assuming you currently
have 4,000 tons of high-grade ore, what are the total benefits and added benefits of
taking the trade?
Use the information for the question(s) below.
Kinston Industries is considering investing in a machine that will cost $125,000 and
will last for three years. The machine will generate revenues of $120,000 each year and
the cost of goods sold will be 50% of sales. At the end of year three the machine will be
sold for $15,000. The appropriate cost of capital is 10% and Kinston is in the 35% tax
bracket.
Assume that Kinston’s new machine will be depreciated straight line to a salvage value
of $5,000 at the end of year three. What is the NPV for this project?
