30 – Multiple Choice Questions (calculations not required)

Please simply highlight the best answer for each of the following multiple choice questions;

QUESTION 1. Which of the following is/are an advantage(s) of incorporation?

A) Access to capital markets

B) Limited liability

C) Unlimited life

D) All of the above

QUESTION 2. Which of the following statements is false?

A) In bankruptcy, management is given the opportunity to reorganize the firm and renegotiate with debt holders.

B) Because a corporation is a separate legal entity, when it fails to repay its debts, the people who lent to the firm (the debt holders) are entitled to seize the assets of the corporation in compensation for the default.

C) As long as the corporation can satisfy the claims of the debt holders, ownership remains in the hands of the equity holders.

D) If the corporation fails to satisfy debt holders’ claims, equity holders may take control of the firm.

QUESTION 3. Which of the following is NOT a financial statement that every public company is required by IFRS to produce?

A) Income Statement

B) Statement of Comprehensive Income

C) Balance Sheet

D) Statement of Changes in Equity

QUESTION 4. The P/E ratio is not useful when the firm’s ________ are negative. In this case, it is common to look at the firm’s ________ relative to sales.

A) operating earnings; enterprise value

B) net earnings; enterprise value

C) operating earnings; market value

D) net earnings; market value

QUESTION 5. Consider the following oil prices:

ExxonMobil Oil (XOM)

$71.75/Bbl

Marathon Petroleum (MPC)

$73.06/Bbl

As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one barrel of ExxonMobil Oil (XOM) crude oil.  Because of its lower sulfur content, you can produce $77 worth of unleaded gasoline from one barrel of Marathon Petroleum (MPC) crude.

Another oil refiner is offering to trade you 10,150 Bbls of ExxonMobil Oil (XOM) crude oil for 10,000 Bbls of Marathon Petroleum (MPC) crude oil. Assuming you currently have 10,000 Bbls of MPC crude, the added benefit (cost) to you if you take the trade is closest to:

A) ($1,400)

B) $1,400

C) ($3,908)

D) $3,908

QUESTION 6. You have an investment opportunity in France that requires an investment of $250,000 today and will produce a cash flow of €208,650 in one year with no risk. Suppose the risk-free rate of interest in France is 6% and the current competitive exchange rate is €0.78 to $1.00. What is the NPV of this project? Would you take the project?

A) NPV = 0; No

B) NPV = 2,358; No

C) NPV = 2,358; Yes

D) NPV = 13,650; Yes

QUESTION 7. Consider the following timeline detailing a stream of cash flows:

If the current market rate of interest is 6%, then the future value of this stream of cash flows is closest to:

A) $1,723

B) $1,500

C) $1,626

D) $1,288

QUESTION 8. After many years teaching finance at Georgetown University, Johnathan wants to establish a scholarship to offer 4 $1,000 awards each year to students whose performance is excellent in finance courses. If the university can negotiate a 12.75% effective interest rate, at least how much does Johnathan need to endorse over to the scholarship (closest estimate)?

A) $32,000

B) $31,000

C) $31,500

D) $32,500

QUESTION 9. Consider the following investment alternatives:

Investment

Rate

Compounding

A

6.25%

Annual

B

6.10%

Daily

C

6.125

Quarterly

D

6.120

Monthly

The highest effective rate of return you could earn on any of these investments is closest to:

A) 6.250%

B) 6.267%

C) 6.300%

D) 6.320%

QUESTION 10. Which of the following statements is false?

A) The yield curve changes over time.

B) The formulas for computing present values of annuities and perpetuities cannot be used in situations in which cash flows need to be discounted at different rates.

C) We can use the term structure to compute the present and future values of a risk-free cash flow over different investment horizons.

D) The yield curve tends to be inverted as the economy comes out of a recession.

QUESTION 11. The Millennium Company has a bond outstanding with a face value of $1,000 that reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate for this bond is 8% and that the coupon payments are to be made semi-annually.

Assuming that this bond trades for $903, then the YTM for this bond is closest to:

A) 8.0%

B) 6.8%

C) 9.9%

D) 9.2%

QUESTION 12. Consider the following four bonds that pay annual coupons:

Bond

Years to maturity

Coupon

YTM

A

1

0%

5%

B

5

6%

7%

C

10

10%

9%

D

20

0%

8%

The percentage change in the price of the bond “A” if its yield to maturity increases from 5% to 6% is closest to:

A) -4%

B) -6%

C) -1%

D) 4%

QUESTION 13. You expect that Westonian Enterprises will have earnings per share of $2 for the coming year. Westonian plans to retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 20% per year. If Westonian’s equity cost of capital is 12%, then the price of a share of Westonian’s stock is closest to:

A) $17.00

B) $10.75

C) $27.75

D) $43.50

QUESTION 14. McCormick Industries plans to pay a $4.00 dividend this year and you expect that the firm’s earnings are on track to grow at 5% per year for the foreseeable future. McCormick’s equity cost of capital is 13%.

Suppose that McCormick decides to pay a dividend of only $2 per share this year and use the remaining $2 per share to repurchase stock. If Defenestration maintains this dividend and total payout rate, then the rate at which McCormick’s dividends and earnings per share are expected to grow is closest to:

A) 7%

B) 13%

C) 9%

D) 5%

QUESTION 15. Edward the Magician has been offered $14 million to star in the lead role of the next three Magical movie series. If Edward takes this offer, he will have to forgo acting in other Magician movies that would pay him $5 million at the end of each of the next three years. Assume Edward’s personal cost of capital is 10% per year.

The NPV of Edward’s three-movie Magical movie series, offer is closest to:

A) 3.5 million

B) -1.6 million

C) 1.6 million

D) -1.0 million

QUESTION 16. Techno-Corp has come up with a new medical instrument. Development will take Techno-Corp four years and cost $250,000 per year, with the first of the four equal investments payable today upon acceptance of the project.  Once in production the medical instrument is expected to produce annual cash flows of $200,000 each year for 10 years. Techno-Corp’s discount rate is 10%.

The IRR for Techno-Corp’s’ project is closest to:

A) 10.4%

B) 10.0%

C) 11.0%

D) 15.1%

QUESTION 17. The Giant Corporation is considering investing in a new metal-shelving manufacturing machine that has an estimated life of three years.  The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0. 

The metal-shelving manufacturing machine will result in sales of 2,000 metal-shelves in year 1.  Sales are estimated to grow by 10% per year each year through year three.  The price per metal-shelve that Giant will charge its customers is $18 each and is to remain constant.  The metal-shelves have a cost per unit to manufacture of $9 each.

Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts.  It is estimated that the Giant Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable.  The firm is in the 35% tax bracket, and has a cost of capital of 10%.

The depreciation tax shield (assuming the half-year rule is not applied for straight-line depreciation) for the Giant Corporation’s project in the first year is closest to:

A) $8,000

B) $3,500

C) $2,800

D) $5,200

QUESTION 18. You are considering adding a carbonated water-dispenser onto one of your firm’s existing outlets. This will entail an increase in inventory of $8,000, an increase in accounts payable of $2,500, and an increase in property, plant, and equipment of $40,000. All other accounts will remain unchanged. The change in net working capital resulting from the addition of the carbonated water-dispenser, is:

A) $45,500

B) $10,500

C) $6,500

D) $5,500

QUESTION 19. Suppose an investment is equally likely to have a 35% return or a -20% return. The standard deviation on the return for this investment is closest to:

A) 38.9%

B) 0%

C) 19.4%

D) 27.5%

QUESTION 20. Suppose that in the coming year, you expect Chevron Corporation stock to have a volatility of 42% and a beta of 0.9, and BP’s stock to have a volatility of 24% and a beta of 1.1. The risk free interest rate is 4% and the market’s expected return is 12%.

The cost of capital for a project with the same beta as Chevron Corporation’s stock is closest to:

A) 11.6%

B) 11.2%

C) 12.8%

D) 7.6%

QUESTION 21. Suppose you invest $20,000 by purchasing 200 shares of ConocoPhillips (COP) at $50 per share, 200 shares of Enterprise Products (EPD) at $30 per share, and 100 shares of Valero Energy (VLO) at $40 per share.

Suppose over the next year Valero Energy has a return of 12.5%, Lowes has a return of 20%, and ConocoPhillips has a return of -10%. The weight of Enterprise Products in your portfolio after one year is closest to:

A) 20.0%

B) 34.8%

C) 30.0%

D) 36.0%

QUESTION 22. Consider an equally weighted portfolio that contains 100 stocks. If the average volatility of these stocks is 50% and the average correlation between the stocks is .7, then the volatility of this equally weighted portfolio is closest to:

A) .72

B) .59

C) .40

D) .50

QUESTION 23. Which of the following statements is false?

A) Investors may have different information regarding expected returns, correlations, and volatilities, but they correctly interpret that information and the information contained in market prices and they adjust their estimates of expected returns in a rational way.

B) Investors may learn different information through their own research and observations, but as long as they understand the differences in information and learn from other investors by observing prices, the CAPM conclusions still stand.

C) Every investor, regardless of how much information he has access to, can guarantee himself an alpha of zero by holding the market portfolio.

D) The CAPM requires making the strong assumptions of homogeneous expectations.

QUESTION 24. The only way it can be possible to earn a positive alpha and beat the market is if some investors are holding portfolios with ________ alphas.

A) positive

B) zero

C) negative

D) none of the above

QUESTION 25. Consider the following graph of the security market line:

Which of the following statements regarding portfolio “X” is/are correct?

1.   Portfolio “X” has a negative alpha.

2.   Portfolio “X” is overpriced.

3.   Portfolio “X” is less risky than the market portfolio.

4.   Portfolio “X” should not exist if the market portfolio is efficient.

A) 1 and 3

B) 2 and 4

C) 1, 3, and 4

D) 3 only

QUESTION 26. Uninformed individuals tend to ________ the precision of their knowledge. In finance, we call this presumptuousness the ________ hypothesis.

A) underestimate; underconfidence

B) overestimate; overconfidence

C) underestimate; overconfidence

D) overestimate; underconfidence

QUESTION 27. Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project’s cost of capital is 15%. The risk-free interest rate is 5%.

Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free rate and issues new equity to cover the remainder. In this situation, the cash flow that equity holders will receive in one year in a strong economy is closest to:

A) $117,000

B) $75,000

C) $50,000

D) $0

QUESTION 28. You are evaluating a new project and need an estimate for your project’s beta. You have identified the following information about three firms with comparable projects:

Firm Name

Equity Beta

Debt Beta

Debt to Equity Ratio

Franklin

1.25

0

0.25

TXR

1.6

0.2

1

Sempcor

2.3

0.3

1.5

20) The unlevered beta for Sempcor is closest to:

A) 1.00

B) 0.90

C) 0.95

D) 1.10

QUESTION 29. Consider the following income statement for Smith Corp. (all figures in $ millions):

Year

2006

2005

2004

Total Sales

60,553

56,434

53,791

Cost of goods sold

45,565

42,140

39,637

Selling, general & admin expenses

11,688

12,191

11,575

Depreciation

1,265

1,256

1,209

Operating Income

2,035

847

1,370

Other Income

0

0

0

EBIT

2,035

847

1,370

Interest expense

510

557

604

Earnings before tax

1,525

290

766

Taxes (35%)

534

102

268

Net Income

991

189

498

The interest rate tax shield for Smith Corp. in 2006 is closest to:

A) $187 million

B) $332 million

C) $534 million

D) $179 million

QUESTION 30. The total amount available to pay out to all the investors in Smith Corp. in 2006 is closest to:

A) $990 million

B) $1,525 million

C) $1,500 million

D) $2,035 million