FIN Exam 2
Which of the following lists events in chronological order from earliest to latest?
Declaration date, ex-dividend date, record date
The effect of financial leverage depends on the company's _____________.
Earnings before interest and taxes.
The act of buying or selling the underlying asset via the option contract is called _______________ the option.
Exercising
Why does a discounted cash-flow approach to options valuation not work?
Finding the opportunity cost of capital is impossible as the risk of options changes every time the stock price moves. Correct
When financial distress is a possibility, the value of a levered firm is a function of: I) value of the firm if all-equity-financed; II) present value of tax shield; III) present value of costs of financial distress; IV) present value of omitted dividend payments
I + II − III
If a corporation cannot use its interest payments as a tax shield for a particular year because it has suffered a loss, it is still possible to use the tax shield because: I) the carry-back provision allows corporations to carry back the loss and receive a tax refund up to the amount of taxes paid in the previous two years; II) the carry-forward provision allows corporations to carry forward the loss and use it to shield income in subsequent years
I and II
The value of any option (both call and put options) is positively related to the I) volatility of the underlying stock price; II) time to expiration; III) risk-free rate;
I and II only
When a firm has no debt, then such a firm is known as I) an unlevered firm; II) a levered firm; III) an all-equity firm
I and III only
The value of a put option is negatively related to the: I) stock price; II) volatility of the underlying stock price; III) exercise price
I only
Firms can repurchase shares in the following ways: I) open market repurchase; II) tender offer; III) Dutch auction; IV) direct negotiation with a major shareholder
I, II, III, and IV
The following are examples of expansion options: I) A mining company acquires mineral rights to land that is not worth developing today but could be profitable if ore prices increase. II) A film studio acquires the rights to produce a film based on the novel. III) A real estate developer acquires a parcel of land that could be turned into a shopping mall. IV) A pharmaceutical company purchases a patent to market a new drug.
I, II, III, and IV
Which of the following are examples of applications of real options analysis? I) a strategic investment in the computer business; II) the valuation of an aircraft purchase option; III) the option to develop commercial real estate; IV) the decision to mothball an oil tanker
I, II, III, and IV
Which of the following are examples of real options? I) the option to expand if an investment project succeeds; II) the option to wait (and learn) before investing; III) the option to shrink or abandon a project; IV) the option to vary the mix of output or the firm's production methods
I, II, III, and IV
The following are indicators that the firm has a cash surplus:. I) Free cash flow is reliably positive. II) The firm has a low debt ratio compared to similar firms. III) The firm has sufficient debt capacity to cover unexpected opportunities or setbacks.
I, II, and III
The following statements are true of dividend reinvestment plans (DRIPs): I) They are offered by the companies to their shareholders. II) Generally, new shares are issued at a discount. III) The dividends are taxable as ordinary income.
I, II, and III
Which of the following features increase(s) the value of a call option? I) A high interest rate; II) A long time to maturity; III) A higher volatility of the underlying stock price
I, II, and III
Given are the following data for year 1: Profits after taxes = $20 million; Depreciation = $6 million; Interest expense = $4 million; Investment in fixed assets = $12 million; Investment in working capital = $4 million. The corporate tax rate is 25 percent. Calculate the free cash flow (FCF) for year 1.
$13 million
Given are the following data for year 1: Profit after taxes = $5 million; Depreciation = $2 million; Investment in fixed assets = $4 million; Investment net working capital = $1 million. Calculate the free cash flow (FCF) for year 1.
$2 million
Suppose VS's stock price is currently $20. In the next six months it will either fall to $10 or rise to $30. What is the current value of a put option with an exercise price of $15? The six-month risk-free interest rate is 5 percent per six-month period.
$2.14
Consider the following data: FCF1 = $20 million; FCF2 = $20 million; FCF3 = $20 million. Assume that free cash flow grows at a rate of 5 percent for year 4 and beyond. If the weighted average cost of capital is 12 percent, calculate the value of the firm.
$261.57 million
Suppose ABCD's stock price is currently $50. In the next six months it will either fall to $40 or rise to $60. What is the current value of a six-month call option with an exercise price of $50? The six-month risk-free interest rate is 2 percent (periodic rate).
$5.39
Given are the following data for Outsource Company: PV (of FCFs for years 1-3) = $35 million; PV (horizon value) = $65 million. Suppose that the market value of the debt = $30 million. Calculate the total market value of equity of the firm.
$70 million
Suppose ABCD's stock price is currently $50. In the next six months it will either fall to $40 or rise to $80. What is the current value of a six-month call option with an exercise price of $50? The six-month risk-free interest rate is 2 percent (periodic rate).
$8.09
Suppose ACC's stock price is currently $25. In the next six months it will either fall to $15 or rise to $40. What is the current value of a six-month call option with an exercise price of $20? The six-month risk-free interest rate is 5 percent per six-month period. (Use the replicating portfolio method.)
$8.57
Suppose Carol's stock price is currently $20. In the next six months it will either fall to $10 or rise to $40. What is the current value of a six-month call option with an exercise price of $15? The six-month risk-free interest rate is 5 percent per six-month period. (Use the replicating portfolio method.)
$8.73
Consider the following data: FCF1 = $7 million; FCF2 = $45 million; FCF3 = $55 million. Assume that free cash flow grows at a rate of 4 percent for year 4 and beyond. If the weighted average cost of capital is 10 percent, calculate the value of the firm.
$801.12 million
Samuel Corp. provides the following information: EBIT = $386.50 Tax (TC ) = 35% Debt = $810 RU = 15% What is the value of Samuel's equity?
$864.83
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?
0.600
A firm has debt beta of 0.2 and an asset beta of 1.9. If the debt-equity ratio is 75 percent, what is the levered equity beta?
3.18
Benson Company has 150,000 outstanding shares @ $20/share. The company has declared a two-for-one stock split. How many shares will be outstanding and at what value after the split?
300,000 shares @ $10/share Correct
Given are the following data for Golf Corporation: Market price/share = $12; Book value/share = $10; Number of shares outstanding = 100 million; Market price/bond = $800; Face value/bond = $1,000; Number of bonds outstanding = 1 million. Calculate the proportions of debt (D/V) and equity (E/V) for Golf Corporation that you should use for estimating its weighted average cost of capital (WACC).
40 percent debt and 60 percent equity
Mirion Tech, Inc., has rE of 12%, an rD of 6%, at a debt-equity ratio of 0.50. Mirion plans to raise enough preferred stock to retire half of their outstanding common stock, which currently has a market value of $7 million. If the preferred stock has an expected rate of return of 10%, what is the new WACC? (Assume a 21% marginal corporate tax rate and that rD remains at 6%.)
9.58%
Which of the following entities likely has the highest cost of financial distress?
A pharmaceuticals development company Correct
Free cash flow (FCF) and net income (NI) differ in the following ways: I) Net income accrues to shareholders, calculated after interest expense; free cash flow is calculated assuming all flows go to equity holders. II) Net income is calculated after various noncash expenses, including depreciation; FCF adds back depreciation. III) Capital expenditures and investments in working capital do not appear in net income calculations; they do reduce free cash flows. IV) Net income is never negative; free cash flows can be negative for rapidly growing firms, even if the firm is profitable, because investments can exceed cash flows from operations.
I, II, and III only
The value of a put option is positively related to the: I) exercise price; II) time to expiration; III) volatility of the underlying stock price; IV) risk-free rate
I, II, and III only
The MM theory with taxes implies that firms should issue maximum debt. In practice, this is not true because: I) debt is more risky than equity; II) bankruptcy and its attendant costs are a disadvantage to debt; III) the payment of personal taxes may offset the tax benefit of debt
II and III only
The capital structure of the firm can be defined as I) the firm's mix of different debt securities; II) the firm's mix of different securities used to finance assets; III) the market imperfection that the firm's managers can exploit
II only
The main advantage of debt financing for a firm is: I) no SEC registration is required for bond issues; II) interest expenses are tax deductible; III) unlevered firms have higher value than levered firms
II only
What are some of the possible consequences of financial distress? I) Bondholders, who face the prospect of getting only part of their money back, will likely want the company to take additional risks. II) Equity investors would like the company to cut its dividend payments to conserve cash. III) Equity investors would like the firm to shift toward riskier lines of business.
III only
Which of the following dividends are never in the form of cash? I) regular dividend; II) special dividend; III) stock dividend; IV) liquidating dividend
III only
Permanently rejecting an investment today might not be a good choice because I) the size of the firm will decline; II) there are always errors in the estimation of NPVs; III) the project's real option value is negative; IV) the company is forgoing the option to make the investment in the future if economic and industry conditions change for the better
IV only
The opportunity to defer investing to a later date may have value because I) the cost of capital may increase in the near future; II) uncertainty may be increased in the future; III) the project has positive, short-term cash flows; IV) market conditions may change and increase the NPV of the project
IV only
A call option has an exercise price of $100. At the exercise date, the stock price could be either $50 or $150. Which investment strategy provides the same payoff as the stock?
Lend PV of $50 and buy two calls. Correct
_________ tax rate is the amount of tax payable on the next dollar earned.
Marginal
While calculating the weighted average cost of capital, which values should one use for D, E, and V?
Market values
A stock split is characterized by all of the following, except:
Paid in cash to outstanding shareholders.
A stock split is characterized by all of the following, except:
Paid in cash to outstanding shareholders. Correct
Which of the following scenarios fails to describe a possible real option embedded in a project analysis?
The articles of incorporation amended to allow for stock splits and reverse stock splits
What does an equity option's delta reflect?
The number of shares needed to replicate one call option
Which of the following conditions might lead a financial manager to delay a positive-NPV project? (Assume that project NPV—if undertaken immediately—is held constant.)
Uncertainty about future project value increases.
The equation for M & M Proposition I, without taxes, is best shown as:
VL = VU
The equation for M & M Proposition I, with taxes, is best shown as:
VL = VU + Tc × D
Project M requires an initial investment of $25 million. The project is expected to generate $2.25 million in after-tax cash flow each year forever. If the weighted average cost of capital (WACC) is 9 percent, calculate the NPV of the project.
Zero
An example of a real option is
all of the options are correct.
For a levered firm,
as EBIT increases, EPS increases by a larger percentage. Correct
When one uses the after-tax weighted average cost of capital (WACC) to value a levered firm, the interest tax shield is
automatically considered because the after-tax cost of debt is included within the WACC formula
A put option gives the owner the right
but not the obligation to sell an asset at a given price.
The effect of financial leverage on the performance of the firm depends on the
firm's level of operating income. Correct
The writer (seller) of a regular exchange-listed put-option on a stock
has the obligation to buy 100 shares of the underlying stock at the exercise price.
The owner of a regular exchange-listed call-option on a stock
has the right to buy 100 shares of the underlying stock at the exercise price.
According to behavioral finance, investors prefer dividends because
investors prefer the discipline that comes from spending only the dividends.
An abandonment option, in effect,
limits the downside risk of an investment project.
If MM's Proposition I holds, minimizing the weighted average cost of capital (WACC) is the same as maximizing the
market value of the firm. Correct
To calculate the total value of the firm (V), one should rely on the
market values of debt and equity.
According to the trade-off theory of capital structure,
optimal capital structure occurs when the present value of tax savings on account of additional borrowing just offsets the increase in the present value of costs of distress.
Modigliani and Miller's Proposition I states that
the market value of any firm is independent of its capital structure.
A rational manager may be reluctant to commit to a positive net present value project when
the value of the option to wait is high.
If the volatility of the underlying asset decreases, then the
value of both the put and call option will decrease.
Samuel Corp. provides the following information: EBIT = $286.50 Tax (TC ) = 35% Debt = $810 RU = 15% What is the value of the firm?
$1,241.53
Given are the following data for Outsource Company: PV (of FCFs for years 1-3) = $35 million; PV (horizon value) = $65 million. Calculate the value of the firm.
$100 million
Dividend Reinvestment Plans have the option of:
Automatically reinvesting some or all of their cash dividends in shares of stock.