Set of flashcards FENG2016CMEEXAMOLDTUD2013till2016 (Page 3 of 12)

Flashcards	462
Language	English
Category	Finance
Level	University
Created / Updated	11.09.2016 / 28.10.2016
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Which of the following statements is true?
I) The spot interest rate is a weighted average of yields to maturity
II) Yield to maturity is the weighted average of spot interest rates and estimated forward rates
III) The yield to maturity is always higher than the spot rates

I only

II only

III only

I and III only

Assume General Electric (GE) has about 10.3 billion shares outstanding and the stock price is
$37.10. Also assume the P/E ratio is about 18.3. Calculate the market capitalization for GE.
(Approximately)

A. $679 billion
B. $188 billion
C. $382 billion
D. None of the above

C. $382 billion

market capitalization = (10.3)(37.10) = $382.13 billion

Super Computer Company's stock is selling for $100 per share today. It is expected that this
stock will pay a dividend of 6 dollars per share, and then be sold for $114 per share at the end of
one year. Calculate the expected rate of return for the shareholders.
A. 20%
B. 15%
C. 10%
D. 25%

A. 20%

r = (114 + 6 - 100)/100 = 20%

World-Tour Co. has just now paid a dividend of $2.83 per share (D0); the dividends are expected
to grow at a constant rate of 6% per year forever. If the required rate of return on the stock is 16%,
what is the current value on stock, after paying the dividend?
A. $30
B. $56
C. $70
D. $48

A. $30

P0 = (2.83 * 1.06)/(0.16 - 0.06) = 30

The following are measures used by firms when making capital budgeting decisions except

Payback period

Internal rate of return

P/E ratio

Net present value

Story Company is investing in a giant crane. It is expected to cost 6.0 million in initial investment
and it is expected to generate an end of year cash flow of 3.0 million each year for three years.
Calculate the NPV at 12% (approximately).
A. 2.4 million
B. 1.2. million
C. 0.80 million
D. 0.20 million

B. 1.2. million

NPV = -6.0 + 3/1.12 + 3/(1.12^2) + 3/(1.12^3) = 1. 2

Investment in net working capital is not depreciated because

It is not a cash flow

It is recovered during or at the end of the project and is not a depreciating asset

It is a sunk cost

All of the above

Working capital is one of the most common causes of misunderstanding in estimating project
cash flows. The following are the most common errors:
I) forgetting about working capital entirely
II) forgetting that working capital may change during the life of the project
III) forgetting that working capital is recovered at the end of the project
IV) forgetting to depreciate the working capital

I and II only

I, II, and III only

II,III and IV only

I,II and IV only

If the depreciable investment is $1,000,000 and the MACRS 5-Year class schedule is:
Year-1: 20%; Year-2: 32%; Year-3: 19.2%; Year-4: 11.5%; Year-5: 11.5% and Year-6: 5.8%
Calculate the depreciation tax shield for Year-2 using a tax rate of 30%:

A. $224,000
B. $60,000
C. $96,000
D. $300,000

C. $96,000

Depreciation = (1,000,000)(0.32)(0.3) = 96,000

Standard error measures:

Nominal annual rate of return on a portfolio

Risk of a portfolio Reliability of an estimate

Reliability of an estimate

Real annual rate of return on a portfolio

If the standard deviation of returns of the market is 20% and the beta of a well-diversified
portfolio is 1.5, calculate the standard deviation of the portfolio:

A. 30%
B. 20%
C. 10%
D. none of the above

A. 30%

Standard deviation of the portfolio = (1.5) * (20) = 30%

Florida Company (FC) and Minnesota Company (MC) are both service companies. Their historical
return for the past three years are: FC: - 5%, 15%, 20%; MC: 8%, 8%, 20%.
Calculate the covariance between the returns of FC and MC

A. 60
B. 80
C. 40
D. None of the above

A. 60

[( -5 - 10)(8 - 12) + (15 - 10)(8 - 12) + (20 - 10)(20 - 12)]/(3 - 1) = 60
Yearly deviations of both companies. Divided by N-1.

The efficient portfolios:
I) have only unique risk
II) provide highest returns for a given level of risk
III) provide the least risk for a given level of returns
IV) have no risk at all

I only

II and III only

IV only

II only

If a stock is overpriced it would plot

Above the security market line

Below the security market line

On the security market line

On the Y-axis

Given the following data for a stock: beta = 0.5; risk-free rate = 4%; market rate of return =
12%; and Expected rate of return on the stock = 10%. Then the stock is:

A. overpriced
B. under priced
C. correctly priced
D. cannot be determined

B. under priced

r = 4 + (0.5) * (12 - 4) = 8%; the expected rate of return is more than the required rate of return.
The stock is under priced.

The market value of Charcoal Corporation's common stock is $20 million, and the market value
of its risk-free debt is $5 million. The beta of the company's common stock is 1.25, and the market
risk premium is 8%. If the Treasury bill rate is 5%, what is the company's cost of capital? (Assume
no taxes.)
A. 15%
B. 14.6%
C. 13%
D. None of the above

C. 13%

rE = 5 + 1.25(8) = 15 ; rD = 5%
Company Cost of capital = 5 (5/25) + 15(20/25) = 1 + 12 = 13%

The historical returns data for the past three years for Stock B and the stock market portfolio
are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%. Calculate the variance of the
market portfolio returns.
A. 192
B. 128
C. 28
D. None of the above

C. 28

Variance = [(10 - 14)^2 + (12 - 14)^2 + (20 - 14)^2]/2 = 28

14 = (10 + 12 + 20)/3

Hammer Company proposes to invest $6 million in a new type of hammer-making equipment.
The fixed costs are $1.0 million per year. The equipment is expected to last for five years. The
manufacturing cost per hammer is $1 and the selling price per hammer is $6. Calculate the breakeven
(i.e. NPV = 0) volume per year, if the cost of capital is 20%. (Ignore taxes.)
A. 500,000 units
B. 600,000 units
C. 100,000 units
D. None of the above

B. 600,000 units

EAC = 6/2.9906 = 2 million
X (6 - 1) - 1,000,000 = 2,000,000
X = 3,000,000/5 = 600,000 units
r=20% . formula see annuity Table 3 , t=5 en r=20% the factor is 2,9906 almost 3

Which of the following is not true?

Firms have long-run target dividend payout ratios

Dividend changes follows shifts in long-term, sustainable earnings

Managers are reluctant to make dividend changes that might have to be reversed

All of the above

One possible reason that shareholders often insist on higher dividends is:

They agree with Miller and Modigliani

Tax consideration

The stock market is efficient

They do not trust managers to spend retained earnings wisely

The law of conservation of value implies that:
I) the mix of senior and subordinated debt does not affect the value of the firm
II) the mix of convertible and non-convertible debt does not affect the value of the firm
III) the mix of common stock and preferred stock does not affect the value of the firm

I only

II only

III only

I, II, and III

Wealth and Health Company is financed entirely by common stock that is priced to offer a 15%
expected return. The common stock price is $40/share. The earnings per share (EPS) is expected to
be $6. If the company repurchases 25% of the common stock and substitutes an equal value of debt
yielding 6%, what is the expected value of earnings per share after refinancing? (Ignore taxes.)
A. $6.00
B. $7.52
C. $7.20
D. None of the above

C. $7.20

I = (10)(0.06) = 0.60; new EPS = (6 - 0.60)/0.75 = $7.20/share

25% van Stock price = 10

Remark from Chris:

Interest per share = (0.25)40$(0.06) = 0.6$ ; EPS = (6$-0.6$)/(1-0.25) = 7.20$

If a firm permanently borrows $50 million at an interest rate of 10%, what is the present value
of the interest tax shield? Assume a 30% tax rate.
A. $50.0 million
B. $25.0 million
C. $15.0 million
D. $1.5 million

C. $15.0 million

PV of interest tax shield = (0.30)(50) = $15.0 million
(0,3*0,1*50) = 1,5 divided by rent (10%) = 15 mio
“permanently” means eternal I/r is sum

Assume the corporate tax rate is 30%. The firm has no debt in its capital structure. It is valued
at $100 million. What would be the value of the firm if it issued $50 in perpetual debt and
repurchased the equity?
A. $65
B. $115
C. $100
D. None of the above

B. $115

VU = 100; (TC)(B) = 0.3(50) = 15; VL = VU + TCB = 100 + 15 = $115

Given the following information, leverage will add how much value to the unlevered firm per
dollar of debt?
(Approximately) Corporate tax rate: 34% Personal tax rate on income from bonds: 30% Personal
tax rate on income from stocks: 20%
A. $0.66
B. $0.25
C. -$0.66
D. -$0.34

B. $0.25

[1 - ((1 - TC)(1 - TpE)/(1 - Tp))]D = [1 - ((0.66)(1 - 0.2)/(1 - 0.3)]D = 0.25D;
That is $0.25 per dollar

A firm has a total market value of $10 million and debt has a market value of $4 million. What is
the after-tax weighted average cost of capital if the before - tax cost of debt is 10%, the cost of
equity is 15% and the tax rate is 35%?
A. 13%
B. 11.6%
C. 8.75%
D. None of the given answers

B. 11.6%

WACC = 0.4(0.10)(1 - 0.35) + 0.6(0.15) = 11.6%

Suppose an investor sells (writes) a put option. What will happen if the stock price on the
exercise date exceeds the exercise price?

The seller will need to deliver stock to the owner of the option

The seller will be obliged to buy stock from the owner of the option

The owner will not exercise his option

None of the above

Suppose Ralph's stock price is currently $50. In the next six months it will either fall to $30 or
rise to $80. What is the option delta of a call option with an exercise price of $50?
A. 0.375
B. 0.500
C. 0.600
D. 0.75

C. 0.600

Option delta = (30 - 0)/(80 - 30) = 30/50 = 0.6
P554: If the stock price falls to 30 the option will be worthless, if the stock prices rises to 80 the
price will be 30. So, spread of option prices = 30 – 0 = 30. Spread of stock prices = 80 – 30 = 50

If the strike price increases then the: [Assume everything else remaining the same

Value of the put option increases and that of the call option decreases

Value of the put option decreases and that of the call option increases

Value of both the put option and the call option increases

Value of both the put option and the call option decreases

Which of the following statements regarding American puts is/are true?
A. An American put can be exercised any time before expiration
B. An American put is always more valuable than an equivalent European put
C. Multi-period binomial model can be used to value an American put
D. All of the above

All of the above

American option can be exercised any time before the final exercise date

Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction of a
deep-sea oil rig at a cost of $50 million (C0) and is expected to remain constant. The price of oil P is
$40/bbl and the extraction costs are $25/bbl. The quantity of oil Q = 300,000 bbl per year forever.
The risk-free rate is 6% per year and that is also the cost of capital (Ignore taxes).
Bbl is short for barrel.
Calculate the NPV to invest today.
A. +40 million
B. +75 million
C. +25 million
D. None of the above

C. +25 million

NPV today = [(40 - 25)(300,000)]/(0.06) - 50,000,000 = + 25,000,000 = 25 million

Which of the following statements about the option to build flexibility into production facilities is
(are) true?

Typically is more expensive

Must consider the NPV of alternative uses

May be valuable by allowing reconfiguration to produce of goods or service with higher profit.

All of the above are true

A corporate bond has one-year maturity. The bond pays an interest of $50 and principal of
$1,000 at the time of maturity.
If the bond has 10% probability of default and payment under default is $400, and an investor buys
the bond for $938.10. Calculate the promised yield on the bond. (assume no default)
A. 6.6%
B. 11.93%
C. 5.0%
D. None of the given values

B. 11.93%

Promised yield = 1050/938.10 = 11.93%

The three main bond rating agencies in the USA are:
I) Moody's
II) Standard and Poor's
III) A.M. Best
IV) Dominion Bond
V) Fitch

I, II and III

I, II and IV

I, II and V

I, II, III, IV and V

An analyst predicts that at the 95% confidence level a bank could lose 7% of its asset value.
Given assets of $30 million, what is the value at risk?

A. $2.1 mil
B. $7.0 mil
C. $28.5 mil
D. $30 mil

A. $2.1 mil

30 mil x 07 = 2.1 mil

The following are various types of secured debt:
I) Mortgage bonds
II) Collateral trust bonds
III) Equipment trust certificate
IV) Debentures

I only

I and II only

I, II and III only

I, II, III and IV

The call policy that maximizes shareholder wealth is to call a bond issue when

The bond's price is above par

The bond's price is above par, but below the call price

The bond's price exceeds the call premium

The bond's price equals or exceeds the call price

The following are examples of tangible assets except:

Machinery

Factories

Trademarks

Offices

The following are important functions of financial markets:

I) Source of financing;

II) Provide liquidity;

III) Reduce risk;

IV) Source of information

I only

I and II only

I, II, III, and IV

IV only

The following statements regarding the NPV rule and the rate of return rule are true except

Accept a project if its NPV > 0

Reject a project if the NPV < 0

Accept a project if its rate of return > 0

Accept a project if its rate of return > opportunity cost of capital

FENG2016CMEEXAMOLDTUD2013till2016

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