Usethetableforthequestions18and19below.

Thefollowingtablesummarizespricesofvariousdefault-freezero-couponbonds(expressedasapercentageofface
value):
Maturity(years)
1
2
3
4
5
Price(per$100facevalue)
94.52
89.68
85.40
81.65
78.35

18)Theyieldtomaturityforthetwoyearzero-couponbondisclosestto:
A)6.0%
B)5.8%
C)5.6%
D)5.5%
Answer:C
yield=(100/price)(1/n)-1
=(100/89.68).5-1=.056or5.6%

19)Basedupontheinformationprovidedinthetableabove,youcanconclude
A)thattheyieldcurveisflat.
B)nothingabouttheshapeoftheyieldcurve.
C)thattheyieldcurveisdownwardsloping.
D)thattheyieldcurveisupwardsloping.
Answer:C

20)YouexpectthatBeanEnterpriseswillhaveearningspershareof$2forthecomingyear.Beanplanstoretain
allofitsearningsforthenextthreeyears.Forthesubsequenttwoyears,thefirmplansonretaining50%of
itsearnings.Itwillthenretainonly25%ofitsearningsfromthatpointforward.Retainedearningswillbe
investedinprojectswithanexpectedreturnof20%peryear.IfBeansequitycostofcapitalis12%,thenthe
priceofashareofBeansstockisclosestto:
A)$17.00
B)$10.75
C)$27.75
D)$43.50
Answer:C
Explanation: A)
B)
C)Year
Earnings Dividends
g
1
$2.00
$0.00
20%
2
$2.40
$0.00
20%
3
$2.88
$0.00
20%
4
$3.46
$1.73
10%
5
$3.80
$1.90
10%
6
$4.18
$3.14
5%
P0=1.73/(1.12)4+1.90/1.125+(3.14/(.12-.05))/1.125=27.63
Eachgiscalculatedasthe20%returnontheprojectstheretentionratio.
D)

Usetheinformationforthequestion21below.

YouexpectCCMCorporationtogeneratethefollowingfreecashflowsoverthenextfiveyears:
Year
FCF($millions)

1
25

2
28

3
32

4
37

5
40

Followingyearfive,youestimatethatCCMsfreecashflowswillgrowat5%peryearandthatCCMsweightedaverage
costofcapitalis13%.

21)TheenterprisevalueofCCMcorporationisclosestto:
A)$396million
B)$290million
C)$382million
D)$350million
Answer:A
FCFN
VN
FCF1
FCF2
Explanation: A)
V0=
+
+...+
+
N
2
1 + rwacc
(1 + rwacc )
(1 + rwacc )
(1 + rwacc ) N
40
25
28
32
37
+
+
+
+ .13 .05 =395.58million
V0=
1 + .13
(1 + .13) 2
(1 + .13)3
(1 + .13) 4
(1 + .13) 4

Usethetableforthequestion22below.

ConsiderthefollowingPriceandDividenddataforGeneralMotors:
Date
December31,2004
February9,2005
May7,2005
August10,2005
November8,2005
December30,2005

Price($)
$40.06
$36.80
$30.41
$34.86
$25.86
$18.86

Dividend($)
$0.50
$0.50
$0.50
$0.50

22)AssumethatyoupurchasedGeneralMotorsstockattheclosingpriceonDecember31,2004andsolditatthe
closingpriceonDecember30,2005.Yourrealizedannualreturnisfortheyear2005isclosestto:
A) 30.04%
B) 23.79%
C) 49.85%
D) 18.97%
Answer:C
Answer:Date
Price($) Dividend($)
Return
(1+return)
December31,2004
$40.06
0.00%
1
1
January26,2005
$36.80
$0.50
-6.89%
0.931103
0.931103
April28,2005
$30.41
$0.50
-16.01%
0.839946
0.782076
July29,2005
$34.86
$0.50
16.28%
1.162775
0.909379
October28,2005
$25.86
$0.50
-24.38%
0.756168
0.687643
December30,2005
$18.86
-27.07%
0.729312
0.501506
TheProductof(1+returns)-1=-0.49849
Thelastcolumninthetablecontainsthecummulativeproductof(1+returns)

23)Whichofthefollowingstatementsisfalse?
A)Firmspecificnewisgoodorbadnewsaboutthecompanyitself.
B)Firmsareaffectedbybothsystematicandfirm-specificrisk.
C)Whenfirmscarrybothtypesofrisk,onlythefirm-specificriskwillbediversifiedwhenwecombine
manyfirmsstocksintoaportfolio.
D)Theriskpremiumforastockisaffectedbyitsidiosyncraticrisk.
Answer:D
Explanation: A)
B)
C)
D)
Theriskpremiumforastockisaffectedbyitssystematicrisk.

Usethetableforthequestion24below.

Considerthefollowingcovariancesbetweensecurities:

Duke
Microsoft
Wal-Mart

Duke
0.0568
-0.0193
0.0037

Microsoft
-0.0193
0.2420
0.1277

Wal-Mart
0.0037
0.1277
0.1413

24)ThevarianceonaportfoliothatismadeupofequalinvestmentsinDukeEnergyandMicrosoftstockis
closestto:
A)0.065
B)0.090
C)0.149
D)-0.020
Answer:A
Explanation: A)Var(Rp)=x12Var(R1)+x22Var(R2)+2X1X2Cov(R1,R2)
=(.50)2(0.0568)+(.50)2(0.2420)+2(.5)(.5)(-0.0193)=0.0651
B)
C)
D)

25)Whichofthefollowingstatementsisfalse?
A)Thevolatilitydeclinesasthenumberofstocksinaportfoliogrows.
B)Anequallyweightedportfolioisaportfolioinwhichthesameamountisinvestedineachstock.
C)Asthenumberofstocksinaportfoliogrowslarge,thevarianceoftheportfolioisdeterminedprimarily
bytheaveragecovarianceamongthestocks.
D)Whencombiningstocksintoaportfoliothatputspositiveweightoneachstock,unlessallofthestocks
areuncorrelatedwiththeportfolio,theriskoftheportfoliowillbelowerthantheweightedaverage
volatilityoftheindividualstocks.
Answer:D

26)Whichofthefollowingstatementsisfalse?
A)Becauseallinvestorsshouldholdtheriskysecuritiesinthesameproportionsastheefficientportfolio,
theircombinedportfoliowillalsoreflectthesameproportionsastheefficientportfolio.
B)WhentheCAPMassumptionshold,choosinganoptimalportfolioisrelativelystraightforward:itis
thecombinationoftherisk-freeinvestmentandthemarketportfolio.
C)Graphically,whenthetangentlinegoesthroughthemarketportfolio,itiscalledthesecuritymarket
line(SML).
D)Aportfoliosriskpremiumandvolatilityaredeterminedbythefractionthatisinvestedinthemarket.
Answer:C
Explanation: A)
B)
C)Graphically,whenthetangentlinegoesthroughthemarketportfolio,itiscalledthecapital
marketline(CML).

27)Whichofthefollowingstatementsisfalse?
A)Securitiesthattendtomovemorethanthemarkethavebetashigherthan0.
B)Securitieswhosereturnstendtomoveintandemwiththemarketonaveragehaveabetaof1.
C)Betacorrespondstotheslopeofthebestfittinglineintheplotofthesecuritiesexcessreturnsversusthe
marketexcessreturn.
D)Thestatisticaltechniquethatidentifiesthebets-fittinglinethroughasetofpointsiscalledlinear
regression.
Answer:A

Usetheinformationforthequestion28below.
Consideraprojectwithfreecashflowsinoneyearof$90,000inaweakeconomyor$117,000inastrongeconomy,with
eachoutcomebeingequallylikely.Theinitialinvestmentrequiredfortheprojectis$80,000,andtheprojectscostof
capitalis15%.Therisk-freeinterestrateis5%.

28)Supposethattoraisethefundsfortheinitialinvestment,theprojectissoldtoinvestorsasanall-equityfirm.
Theequityholderswillreceivethecashflowsoftheprojectinoneyear.Themarketvalueoftheunlevered
equityforthisprojectisclosestto:
A)$10,000
B)$90,000
C)$86,250
D)$98,600
Answer:B
Explanation: A)
B)
(.5)$90, 000 + (.5)$117, 000
PV(equitycashflows)=
=$90,000
1.15
C)
D)
29)WhichofthefollowingisnotoneofModiglianiandMillerssetofconditionsreferredtoasperfectcapital
markets?
A)Allinvestorsholdtheefficientportfolioofassets.
B)Therearenotaxes,transactioncosts,orissuancecostsassociatedwithsecuritytrading.
C)Afirmsfinancingdecisionsdonotchangethecashflowsgeneratedbyitsinvestments,nordothey
revealnewinformationaboutthem.
D)Investorsandfirmscantradethesamesetofsecuritiesatcompetitivemarketpricesequaltothe
presentvalueoftheirfuturecashflows.
Answer:A

Usetheinformationforthequestion30below.

LCMSIndustrieshas$70millionindebtoutstanding.Thefirmwillpayonlyinterestonthisdebt(thedebtisperpetual).
LCMSmarginaltaxrateis35%andthefirmpaysarateof8%interestonitsdebt.

30)Assumingthattheriskofthetaxshieldisonly6%eventhoughtheloanpays8%,thenthepresentvalueof
LCMSinteresttaxshieldisclosestto:
A)$24.5million
B)$18.0million
C)$33.0million
D)$20.0million
Answer:C
Explanation: PVofTaxshield=debtCrD/RD2=$70M.35.08/.06=32.67

Usetheinformationforthequestion31below.

FlagstaffEnterprisesexpectedtohavefreecashflowinthecomingyearof$8million,andthisfreecashflowisexpected
togrowatarateof3%peryearthereafter.Flagstaffhasanequitycostofcapitalof13%,adebtcostofcapitalof7%,andit
isinthe35%corporatetaxbracket.

31)IfFlagstaffcurrentlymaintainsa.5debttoequityratio,thenthevalueofFlagstaffasanallequityfirm
wouldbeclosestto:
A)$80million
B)$100million
C)$73million
D)$115million
Answer:B
Explanation: A)
B)
E
D
rwacc=
rE+
rD(Pretax)
E+D
E+D
rwacc=
VU=

1
.5
.13+
.07=.11
1 + .5
1 + .5

$80
FCF
=
=$100million
rE g .11 .03

C)
D)

Usetheinformationforthequestion32below.

MonstersIncorporated(MI)inreadytolaunchanewproduct.Dependinguponthesuccessofthisproduct,MIwillhave
avalueofeither$100million,$150million,or$191million,witheachoutcomebeingequallylikely.Thecashflowsare
unrelatedtothestateoftheeconomy(i.e.riskfromtheprojectisdiversifiable)sothattheprojecthasabetaof0andacost
ofcapitalequaltotherisk-freerate,whichiscurrently5%.Assumethatthecapitalmarketsareperfect.

32) SupposethatMIhaszero-coupondebtwitha$140millionfacevalueduenextyear.Assumethatinthe
eventofdefault,20%ofthevalueofMIsassetswillbelostinbankruptcycostsCalculatethevalue
ofleveredequity,thevalueofdebt,andthetotalvalueofMIwithleverageisclosestto:
A)$120.53million
B)$172.49million
C)$133.65million
D)$157.38million
Answer:C
1/ 3(0) + 1/ 3(10) + 1/ 3(51)
Explanation:VL=
=$19.37million
1.05
1/ 3(100(1 .20)) + 1/ 3(140) + 1/ 3(140)
Vdebt=
=$114.29million
1.05
TotalValue=VL+Vdebt=$19.37+$114.29=$133.66million

Usetheinformationforthequestion33below.

BigBlueBanana(BBB)isaclothingretailerwithacurrentsharepriceof$10.00andwith25millionsharesoutstanding.
SupposethatBigBlueBananaannouncesplanstoloweritscorporatetaxesbyborrowing$100millionandusingthe
proceedstorepurchaseshares.

33)SupposethatBBBpayscorporatetaxesof35%andthatshareholdersexpectsthechangeindebttobe
permanent.Assumethatcapitalmarketsareperfectexceptfortheexistenceofcorporatetaxesand
financialdistresscosts.IfthepriceofBBBsstockrisesto$10.85persharefollowingtheannouncement,
thenthepresentvalueofBBBsfinancialdistresscostsisclosestto:
A)$21.25million
B)$35.00million
C)$11.40million
D)$13.75million
Answer:D
Explanation:VU=$10.0025millionshares=$250million
VL=VU+cB=$250+.35($100)=$285million/25millionshares=$11.40
PVoffinancialdistresscosts=($11.40-$10.85)25millionshares=$13.75million

Usetheinformationforthequestion34below.
OmicronIndustriesMarketValueBalanceSheet($Millions)andCostofCapital
Assets
Liabilities
CostofCapital
Cash
20
Debt
220
Debt
6%
OtherAssets
500
Equity
300
Equity 12%
c 35%
OmicronIndustriesNewProjectFreeCashFlows
Year
0
1
2
FreeCashFlows
($100)
$40
$50

3
$60

AssumethatthisnewprojectisofaverageriskforOmicronandthatthefirmwantstoholdconstantitsdebttoequity
ratio.

34) TheNPVforOmicronsnewprojectisclosestto:
A)$23.75
B)$27.50

C)$28.75
D)$25.75
Answer:D
Explanation: A)
B)
C)
D)
rwacc=

E
D
rE+
rD(1-c),whereD=netdebt=Debt-Cash
E+D
E+D
300
200
rwacc=
(.12)+
(.06)(1-.35)=.0876
300 + 200
300 + 200
40
50
60
NPV=-100+
+
+
=$25.69
1
2
(1.0876)
(1.0876)
(1.0876)3

35)35)

35) TheDebtCapacityforOmicronsnewprojectinyear0isclosestto:
A)$38.75
B)$75.50
C)$50.25
D)$10.25
Answer:C
Explanation: A)
B)
C)
E
D
rwacc=
rE+
rD(1-c),whereD=netdebt=Debt-Cash
E+D
E+D
300
200
rwacc=
(.12)+
(.06)(1-.35)=.0876
300 + 200
300 + 200
40
50
60
V0L =
+
+
=$125.69
1
2
(1.0876)
(1.0876)
(1.0876)3
D0=d V0L
D0=

200
($125.69)=$50.28
300 + 200