Corporate finance quiz compilation
Denote TC= Corporate tax rate; TPE= Personal tax rate on equity income; and TP= Personal tax rate on interest income. For every dollar of operating income paid out as equity income, the shareholder realizes:
(1 - TPE) (1 - TC)
The after-tax weighted average cost of capital is calculated using the formula:
(rD) (D/V) + (rE) (E/V) where: V = D + E
The Sharpe ratio of a portofolio P is defined as:
(rp- rf) / omegap
What does MM Proposition II state? Select all that apply.
- The risk to equity increases with leverage - shareholders are indifferent to increased leverage bc their higher risk is exactly offset by higher expected returns - the expected return on equity is positively related to leverage - the required return on equity is a linear function of the firms debt to equity ratio
Steps in the adjusted present value method
- assessing the risk of the project - calculating the unlevered value of the project - calculating the value of the interest tax shield - deducting costs arising from market imperfections or other side-effects of financing
Which statements regarding the general approach of valuing investment projects using WACC to capture the tax benefit of debt financing are CORRECT?
- cash flows are forecasted after-tax, as if the fir was 100% equity financed - in calculating PV, the mistake in forecasting after-tax cashflows assuming 100% equity financing in the nominator is corrected by adjusted the discount rate for tax benefits in the denominator - the tax benefit of debt financing is captured solely by adjusting the discount rate
In the APV framework, how would you treat side effects of financing
- issue costs for equity required for a project decrease APV - Interest tax shields increase APV - the PV of financial distress costs, even if hard to estimate decreases APV - advantageous financing conditions offered by suppliers, such as 0 interest credit for limited time, increase APV
FIrms can pay out earnings to their shareholder in the following ways
- repurchasing shares in the open market - repurchasing shared in a tender offer to shareholders - special cash dividends - regular cash dividends
If we take an MM-assumptions firm, and add taxes. Then, lowering the debt-equity ratio of a firm can change:
- the cost of debt - the cost of equity - the ffective tax rate -the relative proportions of financing used by the firm
Firms can repurchase shares in several ways. Which ones? Select all that apply.
- through a tender offer - through direct negotiation with a major shareholder - through open market repurchase
If you buy shares of Coca-Cola on the primary market...
...Coca-Cola receives the money because the company has issued new shares.
If you buy shares of Coca-Cola on the secondary market...
...you buy the shares from another investor who decided to sell the shares.
The correlation between an efficient portfolio, say the S&P500 index, and the risk-free asset is:
0
Stock A and stock B have had annual observed returns of -0.1, 0.12, 0.28 and 0.18, 0.13, 0.24 respectively. Calculate the covariance between the securities, in decimal form.
0.0049
The market value of AAA's common stock is 80 million and the market value of the risk-free debt is 20 million. The beta of the company's common stock is 1.5, and the expected market risk premium is 0.069. If the Treasury bill rate is 2%, what is the firm's cost of capital, in decimal form? (Assume no taxes)
0.0988
You purchased a share of stock for $68. One year later you received $3.00 as a dividend and sold the share for $74.50. What was your holding-period return? Specify your answer in decimal form.
0.14
The cost of a building today is EUR 3.9 million and you expect to sell it in one year at EUR 4.5 million. Equally risky investments in the capital market offer a return of 4 percent. What is the NPV of buying the building, in million EUR?
0.43
Stock A and Stock B have had the following observed returns for the past three years: -12%, 11%, 32%; and 15%, 6%, 24% respectively. Calculate the correlation between the two securities, in decimal form.
0.477
If the present value of 480 to be paid at the end of one year is 300, what is the one-year discount factor?
0.625
Dividend payment events
1. declaration date 2. ex-dividend date 3.record date 4.payment date
Suppose TC= (Corporate tax rate) = 35%; TPE= Personal tax rate on equity income = 30%; and TP= Personal tax rate on interest income = 20%. What is the relative tax advantage of debt with personal and corporate taxes?
1.76
the route of cash flows financial markets and firms is typically:
1.Cash raised from investors 2. Cash invested in the firm 3. cash generated by operations 4. cash reinvested or returned to investors
If the present value of a cash flow generated by an initial investment of $200,000 is $210,000, what is the NPV of the project?
10,000
A government bond issued in Germany has a coupon rate of 5.9 %, face value of EUR 100 and is maturing in five years. The interest payments are made annually. Calculate the price of the bond (in EUR) if the yield to maturity is 3.5%.
110.84
Nogrowth Inc. 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 Nogrowths' stock is closest to
12.50%
If the present value of $6000 expected to be received one year from today is $400, what is the one-year discount rate?
1400%
If the interest rate is r=0.03, what is the present value annuity factor for an annuity of 23 years?
16.44
Given the following data: Sales = 3963; Cost of good sold = 1584; Average receivables = 192, calculate the average collection period (in number of days):
17.68
If the one-year discount factor is 0.844, what is the discount rate/interest rate per year?
18.48%
If the present value of $350 expected to be received one year from today is $340, what is the discount rate?
2.9%
If a firm permanently borrows $12 million at an interest rate of i=3.3%, what is the present value of the interest tax shield (in millions)? Assume that the tax rate is 30%.
3.6
Given the following data for Project AAA: Initial investment = 200 Real cash flow year 1 = 150 Real cash flow year 2 = 100 Real discount rate = 5% Nominal discount rate = 10% Calculate the NPV of the project
33.560
The beta of AAA stock is 1.5. On the day of AAA earnings' announcement, the return of stock AAA is 18% whereas the return on the market portfolio is 8% and the return on the risk-free asset is 0%. What is the associated abnormal return of stock AAA on the announcement date according to the market model?
6%
Given the following data: Sales = 3193; Cost of goods sold = 1504; Average total assets = 1693; Average inventory = 268, calculate the days in inventory:
65.03
AAA Inc has a dividend yield of 4.5% and a cost of equity capital of 12%. AAA's dividends are expected to grow at a constant rate indefinitely. The growth rate of AAA's dividends is closest to:
7.5%
You would like to have enough money saved to receive a per year perpetuity of 63449 after retirement so that you and your family can lead a good life. How much would you need to save in your retirement fund to achieve this goal if you retire today? Assume that the perpetuity payments start one year after the day of retirement. The interest rate is 8%.
793112.5
Which statements about beta as a measure of risk are correct? Select all that apply.
Beta measures the sensitivity of the security returns to changes in market returns Beta is a measure of market risk and is useful in the context of a well-diversified portfolio the market portfoliio has a beta of 1
How can one invest today at the forward rate that applies to the period that starts one year from today to two years from today? That is, the forward rate from year t=1 to t=2?
By buying a 2-year bond and selling a 1-year bond with the same coupon. AND By providing a loan that starts in one year and is repaid in two years
The following are known as current assets (select all that apply)
Cash, Inventories, Receivables, marketable securities
What does inventory consist of? Select all that apply.
Finished goods Work in prgress raw material
When financial distress is a possibility, the value of a levered firm consists 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
Subsidized loans have the effect of
Increasing the NPV of the loan, thereby increasing the APV
The following assets are intangible assets except:
Machinery
Although the use of debt provides tax benefits to the firm, debt also puts pressure on the firm to:
Meet interest and principal payments which if not met can put the company into financial distress
According to the trade-off theory of capital structure:
Optimal capital structure is reached when the present value of tax savings on account of additional borrowing is just offset by increases in the present value of costs of distress
Investments A and B both offer an expected rate of return of 2.5%. If the standard deviation of A is 12% and that of B is 10%, then investors would:
Prefer B to A
The appropriate discount rate for a given project is given by:
Rf + Bproject * (E(Rm) -Rf)
What is MM's Proposition 2?
The expected rate of return on the common stock of a levered firm increases in proportion to the debt-equity ratio (D/E), expressed in market values; the rate of increase depends on the spread between rA and rD.
Modigliani and Miller's Proposition I states that:
The market value of any firm is independent of its capital structure
Assume MM assumptions of perfect capital markets hold, and consider two identical firms (except for their capital structure). If firm U is unlevered and firm L is levered, then which of the following is true? Select all that apply.
The market value of the assets of firm U is equal to the market value of the assets of firm L
Your total wealth is currently 1000EUR. You invest 1500EUR in the market portfolio. Assume the CAPM holds.
You are borrowing at a risk free rate
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, but that your manager is traveling at the Company's expense. This use of additional funds comes about as a result of:
an agency problem
A US treasury bond can be valued as a combination of:
an annuity and one single payment
The company cost of capital is the appropriate discount rate for a firm's:
average risk projects
On a graph with stock returns on the Y-axis and market returns on the X-axis, the slope of the regression line represents
beta
Which portfolio had the highest standard deviation during the past 100+ year period?
common stocks
A statistical measure of the degree to which securities' returns move together is called:
correlation coefficient
If both dividends and capital gains are taxed at the same ordinary income tax rate, the economic effect of tax may still be different because:
dividends are taxed when distributed while capital gains are deferred until the stock is sold
Cost of capital is the same as cost of equity for firms that are (select all that apply):
financed entirely by equity; financed entirely by common stock
If the market risk premium is 8%, then according to the CAPM, the risk premium of a stock with beta value of 1.7 must be:
greater than 12%
Assets are listed on the balance sheet in order of (select all that apply):
how quickly and easily they can be converted to cash
A stock with a beta of 1.25 would be expected to:
increase in value 25% more than the market in up markets
Assume a tax system where there is a corporate tax rate of 35%,no personal taxes on capital gains, but personal taxes on interest income (with a tax rate to be specified). In this tax system,a company can direct $1 to either debt interest or capital gains for equity investors. Which of the following investors would not care how the money was channeled?
investors paying personal tax of 35%
Current assets minus current liabilities is called
net working capital
If the one-year discount factor is 0.90, and interest rates are not stable from year to year, what is the present value of $120 to be received two years from today?
not enough info
Sole Proprietorship is owned by
one person
Given the following data for a stock: beta = 1.9; risk-free rate = 4%; market rate of return = 14%; and Expected rate of return on the stock = 13%. Then the stock is:
overpriced according to the CAPM as its expected return is lower than the one given by the CAPM
The European Central Bank (ECB) announces bad news for the European economy on day t. As a result, the Italian stock market falls by 5% on day t. The CAPM-implied abnormal returns (AR) of Pirelli on day t is +5% for Pirelli. Assume the risk-free rate is unaffected, and that the FTSE MIB is the relevant market return. Which statement(s) are correct?
the ECB announcement contains relatively good news for Pirelli
In which of the following situations would you get the largest reduction in risk by spreading your investment across two stocks?
the two stocks returns are negatively correlated
tax systems
under an imputation tax system, shareholders may pay a higher effective tax return than the corporate tax rate ; Under an imputation tax system, shareholders receive a tax credit for the corporate tax the firm pays
Assume you increase the number of stocks in a portfolio, by adding securities randomly. By doing this you also achieve the following:
unique risk decreases and approaches 0
types os risk that can be eliminated by diversification:
unsystematic risk, idiosyncratic risk & diversifiable risk