Corp. Fin. 5160 Exam #1

If the risk-free rate of interest (r f ) is 6%, then you should be indifferent between receiving $250 in one year or

$235.85 today. $250.00/1.06 = $235.85

Taggart Transcontinental pays no dividends, but spent $4 billion on share repurchases last year. Taggart's equity cost of capital is 13% and the amount spent on repurchases is expected to grow by 5% per year. Taggart currently has 2 billion shares outstanding. Taggart's stock price is closest to:

$25.00. Market Capitalization = 4 billion/(0.13-0.05) = $50 billion and $50 billion/2 billion shares = $25.00 per share

Which of the following statements is FALSE?

The closer the correlation is to 0, the more the returns tend to move together as a result of common risk.

Which of the following statements is INCORRECT?

We refer to (1 - rf) as the interest rate factor for risk-free cash flows.

Which of the following statements is FALSE?

We say a portfolio is an efficient portfolio whenever it is possible to find another portfolio that is better in terms of both expected return and volatility.

Which of the following statements is FALSE?

We should use the general dividend discount model to value the stock of a firm with rapid or changing growth.

Which of the following statements is FALSE?

While the sign of the correlation is easy to interpret, its magnitude is not.

A ________ is when a rich individual or organization purchases a large fraction of the stock of a poorly performing firm and in doing so gets enough votes to replace the board of directors and the CEO.

hostile takeover

You own 100 shares of a "C" corporation. The corporation earns $5.00 per share before taxes. Once the corporation has paid any corporate taxes that are due, it will distribute the rest of its earnings to its shareholders in the form of a dividend. If the corporate tax rate is 21% and your personal tax rate on (both dividend and non-dividend) income is 30%, then how much money is left for you after all taxes have been paid?

$276.50 EPS × number of shares × (1 - Corporate Tax Rate) × (1 - Individual Tax Rate)$5.00 per share × 100 shares × (1 - .21) × (1 - .30) = $276.50

Wyatt Oil just reported that a major fire destroyed one of its oil production facilities in Colorado. While the facility was fully insured, the loss of oil production will decrease Wyatt's free cash flow by $120 million at the end of this year and by $80 million at the end of next year. Wyatt has 50 million shares outstanding and has a weighted average cost of capital of 9%. Assuming the value of Wyatt's debt is not affected by this event, the expected decrease in Wyatt's stock price is closest to:

$3.55.

Rearden Metals expects to have earnings this coming year of $2.50 per share. Rearden plans to retain all of its earnings for the next year. For the subsequent three years, the firm will retain 50% of its earnings. It will then retain 25% of its earnings from that point onward. Each year, retained earnings will be invested in new projects with an expected return of 20% per year. Any earnings that are not retained will be paid out as dividends. Assume Rearden's shares outstanding remains constant and all earnings growth comes from the investment of retained earnings. If Rearden's equity cost of capital is 10%, then Rearden's stock price is closest to:

$44.60.

Because of a catastrophic plane crash, the FAA announced that it is withdrawing its air worthiness certification for Fly by Night Aviation's (FBNA) new four-seat private plane. As a result, FBNA's future expected free cash flows will decline by $40 million a year for the next eight years. FBNA has 20 million shares outstanding, no debt, and an equity cost of capital of 12%. If this news is a complete surprise to investors, then the amount that FBNA's stock price should fall upon the announcement is closest to:

$9.90. FV = 0PMT = $40 millionI = 12N = 8Compute PV = $98.71 million and $198.71 million/20 million shares = $9.94 per share

Consider two banks. Bank A has 1000 loans outstanding each for $100,000, that it expects to be fully repaid today. Each of Bank A's loans have a 6% probability of default, in which case the bank will receive $0 for each of the defaulting loans. Bank B has 100 loans of $1 million outstanding, which it also expects to be fully repaid today. Each of Bank B's loans have a 5% probability of default, in which case the bank will receive $0 for each of the defaulting loans. The chance of default is independent across all the loans. The expected overall payoff to Bank A is:

$94,000,000. E[payoff] = (.06)(1000)($0) + (1 - .06)(1000)($100,000) = $94,000,000

If the risk-free rate of interest (r f) is 3.5%, then you should be indifferent between receiving $1,000 in one-year or:

$966.18 today. $1000/1.035 = $966.18

Rearden Metal needs to order a new blast furnace that will be delivered in one year. The $1,000,000 price for the blast furnace is due in one year when the new furnace is installed. The blast furnace manufacturer offers Rearden Metal a discount of $50,000 if they pay for the furnace now. If the interest rate is 7%, then the NPV of paying for the furnace now is closest to:

-$15,421. Solution: $1,000,000/1.07 - $950,000 = -$15,420.56

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 information arrives that does not change any of these numbers, but it does change the expected returns of the following stocks: The expected alpha for Taggart Transcontinental is closest to:

-1.00%.

Consider the following price and dividend data for General Electric Company: ​ Assume that you purchased General Electric Company stock at the closing price on December 31, 2008 and sold it after the dividend had been paid at the closing price on January 26, 2009. Your capital gains rate (yield) for this period is closest to:

-8.81%.

Consider the following realized annual returns: The variance of the returns on the Index from 2000 to 2009 is closest to:

.0375.

Consider the following price and dividend data for General Electric Company: Assume that you purchased General Electric Company stock at the closing price on December 31, 2008 and sold it after the dividend had been paid at the closing price on January 26, 2009. Your dividend yield for this period is closest to:

0.70%.

The volatility of the market portfolio is 10%, the expected return on the market is 12%, and the risk-free rate of interest is 4%. The beta for the portfolio of the three stocks is closest to:

0.92. βTT = SD(Ri)*Corr(R1,Rm)/SD(Rm) =14%*0.7/10% = 0.98βWO = SD(Ri)*Corr(Ri,Rm)/SD(Rm)=18%*0.6/10% = 1.08βRM = SD(Ri)*Corr(Ri,Rm)/SD(Rm)=15%*0.5/10%= 0.75βport = (.25)0.98 + (.35)1.08 + (.40)0.75 = .9230

You are presently invested in the Luther Fund, a broad-based mutual fund that invests in stocks and other securities. The Luther Fund has an expected return of 14% and a volatility of 20%. Risk-free Treasury bills are currently offering returns of 4%. You are considering adding a precious metals fund to your current portfolio. The metals fund has an expected return of 10%, a volatility of 30%, and a correlation of -.20 with the Luther Fund. The required return on the precious metals fund is closest to:

1%

Rearden Metals has a current stock price of $30 share, is expected to pay a dividend of $1.20 in one year, and its expected price right after paying that dividend is $33.Rearden's equity cost of capital is closest to:

14.0%. Equity cost of capital = $1.20/$30.00 + ($33 - $30)/$30 = .04 + .10 = .14

Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a 6% interest rate to invest in the stock market. You invest the entire $20,000 in an exchange traded fund (ETF) with a 12% expected return and a 20% volatility. The expected return on your investment is closest to:

18%

Consider a portfolio that consists of an equal investment in 20 firms. For each of these firms, there is a 70% probability that the firms will have a 16% return and a 30% probability that they will have a -8% return. Each of these firms' returns is independent of all others. The standard deviation of this portfolio is closest to:

2.5%. E[return] = (.70)(16%) + (.30)(-8%) = 8.8%SD(Rt) =sqrt[0.70(16%-8.8%)^2+0.30(-8%-8.8%)^2] = 10.9982%SD(Rportfolio) = 10.9982%/sqrt(20)= 2.459268%

Consider the following probability distribution of returns for Alpha Corporation: The standard deviation of the return on Alpha Corporation is closest to:

21.8%.

Nielson Motors has a share price of $25 today. If Nielson Motors is expected to pay a dividend of $0.75 this year, and its stock price is expected to grow to $26.75 at the end of the year, then Nielson's dividend yield and equity cost of capital are:

3.0% and 10.0% respectively. Dividend Yield = $0.75/$25 = .03 or 3%Equity cost of capital = $0.75/$25.00 + ($26.75 - $25.00)/$25.00 = .03 + .07 = .10 or 10%

Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes Companies, Inc. (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share. Suppose over the next year Ball Corporation has a return of 12.5%, Lowes Companies has a return of 20%, and Abbott Labs has a return of -10%. The return on your portfolio over the year is:

3.5%.

Consider the following returns: The Volatility on Stock X's returns is closest to:

35%

Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a 6% interest rate to invest in the stock market. You invest the entire $20,000 in an exchange traded fund (ETF) with a 12% expected return and a 20% volatility. The volatility of your investment is closest to:

40%

Consider the following probability distribution of returns for Alpha Corporation: The expected return for Alpha Corporation is closest to:

5.00%. E[R] = ΣR PR × R = .25(40%) + .50(0%) + .25(-20%) = 5%

Von Bora Corporation is expected to pay a dividend of $1.40 per share at the end of this year and a $1.50 per share at the end of the second year. You expect Von Bora's stock price to be $25.00 at the end of two years. Von Bora's equity cost of capital is 10%.Suppose you plan to hold Von Bora stock for only one year. Your dividend yield from holding Von Bora stock for the first year is closest to:

6.0%. P0 =Div1/(1+rE)+Div2/(1+rE)^2+P2/(1+rE)^2 =1.40/(1+0.10) + 1.5/(1+0.10)^2 + 25/(1+0.10)^2 = $23.17Dividend Yield = Div1/P0 = $1.40/$23.17 = .0604 or 6.0%

Taggart Transcontinental has a dividend yield of 2.5%. Taggart's equity cost of capital is 10%, and its dividends are expected to grow at a constant rate. Based on this information, Taggart's constant growth rate in dividends is closest to:

7.5%. Dividend yield=Div1/P0=rE-g → .10 - g = .025 → g = .075 or 7.5%

Nielson Motors has a share price of $50.00. Its dividend was $2.50, and you expect Nielson Motors to raise its dividend by approximately 6% per year in perpetuity. Given Nielson's current share price, if Nielson's equity cost of capital is 13%, then Nielson's expected growth rate is closest to:

8%. G = .13 - $2.50/$50.00 = .08 or 8%

Consider the following realized annual returns: The average annual return on the Index from 2000 to 2009 is closest to:

8.82%. Rannual = (R1+R2+...+RN)/N=0.882/10 = 8.82%

Consider the following expected returns, volatilities, and correlations: The volatility of a portfolio that is equally invested in Duke Energy and Microsoft is closest to:

9%

Which of the following is/are an advantage of incorporation?

All of these

The Principal-Agent Problem arises:

Both because managers have little incentive to work in the interest of shareholders when this means working against their own self-interest and because of the separation of ownership and control in a corporation

Which of the following is NOT a way that a firm can increase its dividend?

By increasing its retention rate

Which of the following statements is FALSE?

By repurchasing shares, the firm increases its share count, which decreases its earning and dividends on a per-share basis.

Which of the following are subject to double taxation?

Corporation

Which of the following statements is FALSE?

Correlation is the expected product of the deviations of two returns.

Which of the following statements regarding profitable and unprofitable growth is FALSE?

If a firm wants to increase its share price, it must cut its dividend and invest more.

Which of the following is NOT a diversifiable risk?

The risk that oil prices rise, increasing production costs

Which of the following statements is FALSE?

The variance of a portfolio depends only on the variance of the individual stocks.

Which of the following statements is FALSE?

To estimate a firm's enterprise value, we compute the present value of the free cash flows (FCF) that the firm has available to pay equity holders, but not debt holders.

The excess return is the difference between the average return on a security and the average return for:

Treasury Bills.

You overhear your manager saying that she plans to book an Ocean-view room on her upcoming trip to Miami for a meeting. You know that the interior rooms are much less expensive and that your manager is traveling at the Company's expense. This use of additional funds comes about as a result of:

an agency problem.