Sample Questions for Final Exam

1. A building is appraised at $1 million. This estimate is based on a forecast of net

rent of $80,000 per year discounted at 8% [PV = 80,000/0.08= 1,000,000]. The rent is
the net of repair and maintenance costs and taxes. Suppose the building is currently in
disrepair and it takes one year and $200,000 to bring it into rentable condition. How
much would you be willing to pay for the building today?
A) $1,000,000
B) $925,926
C) $740,740
D) None of the above
PV of $800,000 in one year at 8% = $740,740.75

2. Suppose the current price of gold is $300 per ounce. The price of gold is expected
to grow at 4% per year for the foreseeable future. If the approximate discount rate is
10%, then the present value of gold is:
A) Less than $300 per ounce
B) $300 per ounce
C) Greater than $300 per ounce
D) Not enough information
Market price already reflects this information

3. A large firm is receiving a loan guarantee from the government. Because of the
guarantee, the firm is able to borrow $50 million for five years at 10% interest rate per
year instead of 14% per year. Calculate the value of the guarantee to the
firm. (Ignore taxes.)
A) 0
B) +6.87 million
C) –6.87 million
D) None of the above
PV of $2M per year for five years at 14% (opportunity cost for the firm) = $6,866,161.94

4. Which of the following statement(s) is/are true if the efficient market hypothesis
holds?
A) It implies perfect forecasting ability
B) It implies market is irrational
C) It implies that prices follow a particular pattern
D) It implies that prices reflect all available information

5. Suppose you own 500 shares of common stock of a firm and there are five
directors being elected, what is the maximum number of votes you can cast for a
particular director under cumulative voting?
A) 500
B) 2,500
C) 100
D) None of the above

6. A new public equity issue from a company with equity previously outstanding is
called:
A) An initial public offering (IPO)
B) American depositing receipts (ADRs)
C) A seasoned equity offering (SEO)
D) A private placement

7. Mirage Corporation has 1,000,000 shares outstanding. It wishes to issue 250,000

new shares using rights issue. If the current stock price is $50 and the subscription
price is $45/share, calculate the value of a right.
A) $0.25/right
B) $5.00/right
C) $2.50/right
D) $1.00/right
$5/(n+1) = $1.00

8. One key assumption of the Miller and Modigliani dividend irrelevance argument is
that:
A) Future stock prices are certain
B) There are no capital gains taxes
C) New shares are sold at a fair price
D) All investments are risk-free

9. If investors have a marginal tax rate of 30% and a firm has announced a dividend
of $10;
A) The price of stock should decrease by $7 on the ex-dividend date
B) The price of the stock should decrease by $10 on the ex-dividend date
C) The price of the stock should increase by $10 on the ex-dividend date
D) The price of the stock should increase by $7 on the ex-dividend date

10. The law of conservation of value implies that:

A) The mix of senior and subordinated debt does not affect the value of the firm
B) The mix of convertible and non-convertible debt does not affect the value of the
firm
C) The mix of common stock and preferred stock does not affect the value of the
firm
D) All of the above

11. Health and Wealth Company is financed entirely by common stock which is
priced to offer a 15% expected return. The common stock price is
$40/share. The earnings per share is expected to be $6. If the company
repurchases 25% of the common stock and substitutes an equal value of debt
yielding 6%, what is the expected value of earnings per share after
refinancing? (Ignore taxes.)

A) $6.00
B) $7.20
C) $7.52
D) None of the above

I = (10)(0.06) = 0.60; new EPS = (6-0.60)/0.75 = $7.20/share

12. A firm has a debt-to-equity ratio of 1.0. If it had no debt, its cost of equity would
be 13%. Its cost of debt is 10%. What is its cost of equity if there are no taxes?
A) 21%
B) 18%
C) 15%
D) 16%
E) None of the above

( .50*.10) + (.5* x) = .13

x = 16%

13. If a firm borrows $25 million for one year at an interest rate of 8%, what is the
present value of the interest tax shield? Assume a 35% tax rate. (Approximately.)
A) $648,150
B) $700,000
C) $1,000,000
D) $25,000,000
E) None of the above

The present value of $700,000 (2M interest times tax rate) at 8% is $648,148.15

14. MM Proposition I with corporate taxes states that:

A) Capital structure can affect firm value by an amount which is equal to the present
value of the interest tax shield
B) By raising the debt-to-equity ratio, the firm can lower its taxes and thereby
increase its total value
C) Firm value is maximized at an all debt capital structure
D) All of the above

15. A project costs $15.4 million and is expected to produce cash flows of $3 million
a year for 10 years. The opportunity cost of capital is 14%. If the firm has to issue
stock to undertake the project and issue costs are $100,000, what is the project's APV
(approximately)?
A) -$352,000
B) $148,350
C) $648,350
D) $952,000

Present value of $3M per year, 10 yrs. 14% = $15,648,346.94 less 15.4M outlflow = $248,346.91 less
$100,000 issue costs = $148.346.91

16. A firm has zero debt in its capital structure. Its overall cost of capital is 8%. The
firm is considering a new capital structure with 50% debt. The interest rate on the
debt would be 5%. Assuming that the corporate tax rate is 40%, its cost of equity
capital with the new capital structure would be?
A) 9.2%
B) 13.0%
C) 11%
D) None of the above

(.50 * 3%) + (.50 * x) = 8

x = 13%

17. Suppose an investor buys one share of stock and a put option on the stock. What
will be the value of her investment on the final exercise date if the stock price is
below the exercise price?
A) The value of two shares of stock
B) The value of one share of stock plus the exercise price
C) The exercise price
D) The value of one share of stock minus the exercise price

18. Suppose an investor buys one share of stock and a put option on the stock and
simultaneously sells a call option on the stock with the same exercise price. What will
be the value of his investment on the final exercise date?
A) Above the exercise price if the stock price rises and below the exercise price if it
falls
B) Equal to the exercise price regardless of the stock price
C) Equal to zero regardless of the stock price
D) Below the exercise price if the stock price rises and above if it falls

19. A project is worth $12 million today without an abandonment options. Suppose
the value of the project is $18 million one year from today with high demand and $8
million with low demand. It is possible to sell off the project for $10 million if the
demand is low. Calculate the value of the abandonment option if the discount rate is
5% per year.
A) $1.03 million
B) $2 million
C) $1.9 million
D) None of the above

1.8A +1.05B=0
0.8A+1.05B=2
A= -0.2 or B=3.43
P=-0.2(12)+3.43=1.03.

20. SM Company has 200,000 shares outstanding and 50,000 warrants. Each warrant
entitles its owner to buy one share anytime in the next two years at a price of
$20. Undiluted earnings per share are $2.40. What are diluted earnings per share?
A) $1.92
B) $1.80
C) $1.20
D) $2.40

$2.40 * 200,000 = $480,000 / 250,000 = $1.92

21. SOO Company has 500,000 shares outstanding and has just issued 200,000
warrants. Each warrant entitles its owner to buy one share anytime in the next year at
a price of $30. The common stock price is currently $40; the warrant sale price was
$15. The value of each warrant is equal to 1/(1+q) = 0.714 call options on an
alternative firm. What would the share price of that alternative firm be?
A) $25.00
B) $28.00
C) $32.00
D) $46.00

call option price = 15/0.714 = $21 call option price warrant price = 21 - 15 = $6.

Share price of an alternative firm = 40+6 = 46

22. Consider a bond with a face value of $1,000, a coupon rate of 0%, a yield to
maturity of 9%, and ten years to maturity. This bond's duration is:
A) 6.7 years
B) 7.5 years
C) 9.6 years
D) 10.0 years

23. If the 5-year spot rate is 10% and the 4-year spot rate is 9%, what is the forward
rate of interest?
A) 14.1%
B) 0.9%
C) 1.0%
D) 11.0%

(1.10)5 / (1.09)4 = 1.140926 = 14.0926%

24. Bonds which are unsecured obligations of a company are called:

A) Indentures
B) Debentures
C) Mortgage bonds
D) Bearer bonds

25. If the after-tax present value of buying an equipment and using it for 6 years is
$100,000, calculate the break-even after tax lease payment each year (7 payments)
using 7% discount rate. (Assume that the lease payments are made at the beginning of
the year.)
A) $14,286
B) $17,341
C) $18,555
D) None of the above

PV = -100,000; N = 7, I = 7%; Use BGN mode, Compute PMT on a financial calculator PMT = 17,341

26. The current level of Standard & Poor's index is 250. The prospective dividend
yield is 3.2%, and the interest rate is 7%. What is the value of a one-year future on
the index? (Assume all dividend payments occur at the end of the year.)
A) 230.7
B) 250.0
C) 259.5
D) 267.5

Futures price = [250 ((250(0.032))/1.07](1.07) = 259.50

27. Firm A is paying $750,000 in interest payments while Firm B is paying LIBOR
plus 75 basis points on $10,000,000 loans. The current LIBOR rate is 6.5%. Firm A
and B have a greed to swap interest payments, how much will be paid to which Firm
this year?
A) $750,000 to Firm B
B) 725,000 to Firm A
C) $25,000 to Firm A
D) $25,000 to Firm B

A is paying $750K while B is paying $725K so the difference is $25K

28. If the direct quotation for the euro is $1.16/euro, what is the indirect quotation?
A) 1.16
B) –1.16
C) 0.862
D) None of the above

1/1.16 = .862069

29. The direct rate exchange for D-marks is $0.56. The indirect exchange rate for
British pounds is BP0.60. If there is no triangle arbitrage, how many British pounds
does it take to buy a D-mark?
A) 0.336
B) 3.400
C) 0.920
D) 1.090
 1/.60 = $1.66667 .56/1.666667 = .336

30. If a Big Mac costs 300 Yen in Japan and $2.40 in the USA, according to
purchasing power parity, what is the implied exchange rate in Yen/US$?
A) 125
B) 720
C) 0.008
D) None of the above

300/2.40 = 1.25