Use the information for the question(s) below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million,
and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff
has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35%
corporate tax bracket.
If Flagstaff maintains a debt to equity ratio of 1, then Flagstaff’s pre-tax WACC is
closest to:
A) 11.0%
B) 10.5%
C) 10.0%
D) 9.0%
Which of the following statements is false?
A) Portfolios with high market capitalizations will have positive alphas if the market
portfolio is not efficient.
B) The book-to-market is the observation that firms with high book-to-market ratios
have positive alphas.
C) If the market portfolio is not efficient, then a portfolio of high book-to-market stocks
will likely have positive alphas.
D) Portfolios with low book-to-market rations will have negative alphas if the market
portfolio is not efficient.
Which of the following statements is false?
A) After we have constructed the tree and calculated the probabilities in the risk-neutral
world, we can use them to price the derivative by simply discounting its expected
payoff (using the risk neutral probabilities) at the risk-free rate.
B) By using the probabilities in the risk-neutral world we can price any derivative
security”that is, any security whose payoff depends solely on the prices of other
marketed assets.
C) To ensure that all assets in the risk-neutral world have an expected return equal to
the risk-free rate, relative to the true probabilities, the risk-neutral probabilities
underweight the bad states and overweight the good states.
D) In Monte Carlo simulation, the expected payoff of the derivative security is
estimated by calculating its average payoff after simulating many random paths for the
underlying stock price.
Which of the following statements is false?
A) SEO rights offers have lower costs than cash offers.
B) The decision to raise financing externally usually implies that a firm plans to pursue
an investment opportunity.
C) Although not as costly as IPOs, seasoned offerings are still expensive.
D) Researchers have found that, on average, the market greets the news of an SEO with
a price increase.
Which of the following statements is false?
A) The difference between an annuity and a perpetuity is that an annuity ends after
some fixed number of payments.
B) Most car loans, mortgages, and some bonds are annuities.
C) A growing perpetuity is a cash flow stream that occurs at regular intervals and grows
at a constant rate forever.
D) An annuity is a stream of N equal cash flows paid at irregular intervals.
Consider the following income statement and other information:
Assuming that Luther has no convertible bonds outstanding, then for the year ending
December 31, 2009 Luther’s diluted earnings per share are closest to:
A) $1.01
B) $1.04
C) $1.28
D) $1.33
NoGrowth industries presently pays an annual dividend of $1.50 per share and it is
expected that these dividend payments will continue indefinitely. If NoGrowth’s equity
cost of capital is 12%, then the value of a share of NoGrowth’s stock is closest to:
A) $10.00
B) $15.00
C) $14.00
D) $12.50
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 on your firm’s borrowings is closest to:
A) 6.00%
B) 6.14%
C) 6.25%
D) 6.30%
Use the table for the question(s) below.
Consider the following probability distribution of returns for Alpha Corporation:
The standard deviation of the return on Alpha Corporation is closest to:
A) 22.4%
B) 19.0%
C) 21.8%
D) 19.4%
Wyatt Oil has a net profit margin of 4.0%, a total asset turnover of 2.2, total assets of
$525 million, and a book value of equity of $220 million. Wyatt Oil’s current
return-on-equity (ROE) is closest to:
A) 8.8%
B) 9.5%
C) 21.0%
D) 22.8%
Wyatt oil is contemplating issuing a 20-year bond with semiannual coupons, a coupon
rate of 8%, and a face value of $1000. Wyatt Oil believes it can get a AAA rating from
Standard and Poor’s for this bond issue. If Wyatt Oil is successful in getting a AAA
rating, then the issue price for these bonds would be closest to:
A) $891
B) $901
C) $1,000
D) $1,107
Suppose you invest $15,000 in Merck stock and $25,000 in Home Depot stock. You
expect a return of 16% for Merck and 12% for Home Depot. What is the expected
return on your portfolio?
A) 13.50%
B) 14.00%
C) 13.75%
D) 14.50%
Which of the following statements is false?
A) The ultimate goal in capital budgeting is to determine the effect of the decision to
take a particular project on the firm’s cash flows.
B) To the extent that overhead costs are fixed and will be incurred in any case, they are
incremental to the project and should be included in the capital budgeting analysis.
C) Unlevered Net Income = (Revenue – Costs – Depreciation) x (1 – τc).
D) Earnings are not cash flows.
Which of the following statements is false?
A) On Nasdaq, stocks can and do have multiple market makers who compete with each
other. Each market maker must post bid and ask prices in the Nasdaq network where
they can be viewed by all participants.
B) Bid prices exceed ask prices.
C) Because customers always buy at the ask and sell at the bid, the bid-ask spread is a
transaction costinvestors have to pay in order to trade.
D) On the floor of the NYSE, market makers(known on the NYSE as specialists) match
buyers and sellers.
Use the information for the question(s) below.
The current price of KD Industries stock is $20. In the next year the stock price will
either go up by 20% or go down by 20%. KD pays no dividends. The one year risk-free
rate is 5% and will remain constant.
Assuming the Beta on KD stock is 1.1, The calculated beta for a one-year call option on
KD stock with a strike price of $20 is closest to:
A) -1.8
B) 2.4
C) -7.7
D) 4.6
Use the following information to answer the question(s) below.
Your great aunt Matilda put some money in an account for you on the day you were
born. This account pays 8% interest per year. On your 21st birthday the account balance
was $5,033.83.
The amount of money that would be in the account is you left the money there until
your 65th birthday is closest to:
A) $29,556
B) $148,780
C) $168,824
D) $748,932
The Sisyphean Company’s common stock is currently trading for $25.00 per share. The
stock is expected to pay a $2.50 dividend at the end of the year and the Sisyphean
Company’s equity cost of capital is 14%. If the dividend payout rate is expected to
remain constant, then the expected growth rate in the Sisyphean Company’s earnings is
closest to:
A) 8%
B) 6%
C) 4%
D) 2%
Use the following information to answer the question(s) below.
Using the average historical excess returns for both Wyatt Oil and the Market portfolio
estimate of Wyatt Oil’s Beta. When using this beta, the alpha for Wyatt oil in 2007 is
closest to:
A) -0.5000%
B) -0.0250%
C) -0.0125%
D) +0.0250%
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 not to use the $200 million to expand and hold the
cash instead is closest to:
A) $16.50
B) $16.80
C) $19.00
D) $13.75
Which of the following statements is false?
A) Investors pay less for bonds with credit risk than they would for an otherwise
identical default-free bond.
B) The yield to maturity of a defaultable bond is equal to the expected return of
investing in the bond.
C) The risk of default, which is known as the credit risk of the bond, means that the
bond’s cash flows are not known with certainty.
D) For corporate bonds, the issuer may defaultthat is, it might not pay back the full
amount promised in the bond certificate.
Use the table for the question(s) below.
Capital Structure and Unlevered Beta Estimates for Comparable Firms
If the risk-free rate of interest is 6% and the market risk premium has historically
averaged 5%, then the cost of capital for Nike is closest to:
A) 14.7%
B) 10.2%
C) 9.1%
D) 13.5%
Use the table for the question(s) below.
Consider the following average annual returns:
What is the excess return for Treasury Bills?
A) 0%
B) -8.4%
C) -2.7%
D) -1.4%
A stock’s ________ measures the stock’s return relative to that predicted based on its
beta, at the time of some event.
A) excessive abnormal return
B) cumulative average return
C) excessive predicted return
D) cumulative abnormal return
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 equity value
of Ideko in 2010 is closest to:
A) $152.8 million
B) $181.7 million
C) $301.7 million
D) $272.8 million
Which of the following are subject to double taxation?
A) Corporation
B) Partnership
C) Sole proprietorship
D) A and B
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 certificate of deposit that pays 3.9% APR compounded
monthly is closest to:
A) 3.83%
B) 3.90%
C) 3.97%
D) 4.04%
Use the following information to answer the question(s) below.
If the expected return on the market is 11% and the expected return of investing in
Merck is 10.35%, then the risk-free rate must be:
A) 3.0%
B) 4.0%
C) 4.5%
D) 5.0%
You have an investment opportunity that will cost you $10,000 today, but return
$12,500 to you in one year. The IRR of this investment opportunity is closest to:
A) 80%
B) 125%
C) 20%
D) 25%
Which of the following statements is false?
A) The firm’s unlevered cost of capital is equal to its pre-tax weighted average cost of
capital”that is, using the pre-tax cost of debt, rd , rather than its after-tax cost, rd (1 –
τc ).
B) A firm’s levered cost of capital is a weighted average of its equity and debt costs of
capital.
C) When the firm maintains a target leverage ratio, its future interest tax shields have
similar risk to the project’s cash flows, so they should be discounted at the project’s
unlevered cost of capital.
D) The first step in the APV method is to calculate the value of free cash flows using
the project’s cost of capital if it were financed without leverage.
Which of the following statements is false?
A) The preferred stock issued by young companies typically does not pay regular cash
dividends.
B) The preferred stock issued by young companies usually gives the owner an option to
convert it into common stock on some future date, so it is often called callable preferred
stock.
C) If the company runs into financial difficulties, the preferred stockholders have a
senior claim on the assets of the firm relative to any common stockholders.
D) Preferred stockissued by mature companies such as banks usually has a preferential
dividend and seniority in any liquidation and sometimes special voting rights.
Use the table for the question(s) below.
Suppose the term structure of interest rates is shown below:
What is the shape of the yield curve and what expectations are investors likely to have
about future interest rates?
A) Inverted; Higher
B) Normal; Higher
C) Inverted; Lower
D) Normal; Lower
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 volatility of his portfolio, then the
amount that Tom should invest in the market portfolio to maximize his expected return
is closest to:
A) 72%
B) 92%
C) 110%
D) 140%
Which of the following statements is false?
A) An inverted yield curve generally signals an expected decline in future interest rates.
B) An inverted yield curve is often interpreted as a positive forecast for economic
growth.
C) All the formulas for computing present values of annuities and perpetuities are based
upon discounting all of the cash flows at the same rate.
D) The rate of growth of your purchasing power is determined by the real interest rate.
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 weight on Ball Corporation in your portfolio
after one year is closest to:
A) 20.0%
B) 12.5%
C) 20.7%
D) 21.7%
What is the role of takeovers in corporate governance?
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:
What range for the market value of equity for Ideko is implied by the range of EV/Sales
multiples for the comparable firms if Ideko holds $6.5 million of cash in excess of its
working capital needs?
Use the information for the question(s) below.
Coloma Cooper Incorporated is able to produce $640 worth of copper from one ton of
low-grade copper ore. Because of its higher copper content, Coloma can produce $940
worth of copper from one ton of high-grade copper ore.
A mining company is offering to trade you 7,250 tons of low-grade copper ore for 5,000
tons of high-grade copper ore. Assuming you currently have 5,000 tons of high-grade
ore, what should you do?
Use the information for the question(s) below.
Martin Manufacturing has earnings per share (EPS) of $3.00, 5 million shares
outstanding, and a share price of $32. Martin is considering buying Luther Industries,
which has earnings per share of $2.50, 2 million shares outstanding, and a share price of
$20. Marin will pay for Luther by issuing new shares. There are no expected synergies
from the transaction.
Assume that Martin pays no premium to acquire Luther. Calculate Martin’s
price-earnings (P/E) ratio both pre and post merger.
List five general categories of indirect costs associated with bankruptcy.
Explain why the market portfolio proxy may not be efficient.
Use the table for the question(s) below.
Consider the following information on options from the CBOE for Merck:
You have decided to buy 10 January 2009 call options on Merck with an exercise price
of $45 per share. How much will this transaction cost you and are these contracts in or
out of the money?
Using the income statement above and the following information:
Calculate Ideko’s Free Cash Flow to the Firm and Free Cash Flow to Equity in 2009.
Assuming that the discount rate for project A is 16% and the discount rate for B is 15%,
then given that these are mutually exclusive projects, which project would you take and
why?
Use the table for the question(s) below.
Luther Industries currently has the following balance sheet (in Thousands of dollars):
Luther is about to add a new fleet of delivery trucks. The price of the fleet is $1.5
million.
What will Luther’s balance sheet look like if they acquire the new fleet of delivery
trucks using a capital lease?
Use the information for the question(s) below.
Consider two firms: firm Without has no debt, and firm With has debt of $10,000 on
which it pays interest of 5% per year. Both companies have identical projects that
generate free cash flows of $1000 or $2000 each year. Suppose that there are no taxes,
and after paying any interest on debt, both companies use all remaining cash free cash
flows to pay dividends each year.
Suppose you own 10% of the equity of Without. What is another portfolio you could
hold that would provide you with the same exact cash flows?
Use the information for the question(s) below.
KD Industries has 30 million shares outstanding with a market price of $20 per share
and no debt. KD has had consistently stable earnings, and pays a 35% tax rate.
Management plans to borrow $200 million on a permanent basis through a leveraged
recapitalization in which they would use the borrowed funds to repurchase outstanding
shares.
Assume the following tax schedule:
Personal Tax Rates
Considering the effect of personal taxes, calculate the PV of the interest tax shield
provided by KD’s recapitalization in 2005.
Use the information for the question(s) below.
The Sisyphean Company has a bond outstanding with a face value of $1000 that
reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate
for this bond is 8% and that the coupon payments are to be made semiannually.
Assuming that this bond trades for $1,035.44, then the YTM for this bond is equal to:
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 current
quote for this ETF currently is $162.75 (bid) $162.80 (ask). What should you do?
Use the table for the question(s) below.
Assume that the risk-free interest rate is 10%. Rank each of the four projects from most
desirable to least desirable based upon NPV. Which project would you invest in first?
Are there any projects that you wouldn’t invest in?
Use the information for the question(s) below.
Suppose that you currently have $250,000 invested in a portfolio with an expected
return of 12% and a volatility of 10%. The efficient (tangent) portfolio has an expected
return of 17% and a volatility of 12%. The risk-free rate of interest is 5%.
Suppose that you want to maximize your expected return without increasing your risk.
How can you achieve this goal? Without increasing your risk, what is the maximum
expected return you can expect?
Use the information for the question(s) below.
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.
