Professional Documents
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MBA 8622
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MBA 8622
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9. Elizabeth Carson has just won a lottery. She has two alternatives.
Alternative I is that she receives ten equal annual installments of $100,000
each, with the first installment being received today. Alternative II is for her to
receive a single lump sum today and nothing later. If her personal discount rate
is 12.3 percent, what should be the least amount paid by Alternative II for her
to choose that alternative?
a. $ 558,150.68
b. $ 100,000.00
c. $ 626,803.21
d. $1,000,000.00
e. $ 589,498.15
10. Which of the following is not true about bonds? In all of the statements,
assume other things are held constant.
a. Price sensitivity, that is, the change in price due to a given change in the
required rate of return, increases as a bond's maturity increases.
b. For a given bond of any maturity, a given percentage point increase in the
interest rate (kd) causes a larger dollar capital loss than the capital gain
stemming from an identical decrease in the interest rate.
c. When the yield to maturity on a bond is equal to the coupon rate, the price
of the bond will be equal to par value, regardless of whether the bond pays
coupon interest annually or semi-annually and regardless of the bond s
remaining term to maturity.
d. From a borrower's point of view, interest paid on bonds is tax-deductible.
e. A 20-year zero-coupon bond has less reinvestment rate risk than a 20-year
coupon bond.
11. Assuming g will remain constant, the dividend yield is a good measure of
the required return on a common stock under which of the following
circumstances?
a. g > 0.
b. g = 0.
c. g < 0.
d. Under no circumstances.
e. Answers a and b are both correct.
12. Renfroe Incorporated has 12 percent coupon bonds (coupon interest is
paid semi-annually) outstanding that have 24 years remaining to maturity.
These bonds have a par value of $1,000 and a current yield to maturity of 6.5
percent. Compute the current price of these Renfroe Incorporated bonds.
a. $1,804.98
b. $1,000.00
c. $1,659.91
d. $ 926.82
e. $1,663.88
MBA 8622
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14. Niven Rings Inc. just paid a regular dividend of $1.50 per share. The
regular dividend is expected to grow at a rate of 10 percent per year for the
next three years, at a rate of 7 percent per year for the next two years, and
after that at a rate of 4 percent per year forever. In addition to the regular
dividend, Niven Rings is expected to pay a special dividend of $5.00 at the
end of year 2. (NOTE: A special dividend is a one time only payment that will
not recur. It is not considered in calculating the amount of future dividends).
The appropriate discount rate is 14 percent per year. What is the price of the
stock?
a. $19.02
b. $21.67
c. $22.43
d. $22.86
e. $24.36
15. Hard Hat Construction's stock is currently selling at an equilibrium price of
$30 per share. The firm s long run growth rate is expected to remain equal to 6
percent per year, forever. Last year's earnings per share, E0, were $4.00, and
the dividend payout ratio is 40 percent. The risk-free rate is 8 percent, and the
market risk premium is 5 percent. If systematic risk (beta) increases by 50
percent, and all other factors remain constant, by how much will the stock
price change? (Hint: Use four decimal places in your calculations.)
a. ($ 7.31)
b. $ 7.14
c. ($15.00)
d. ($15.22)
e. $22.63
16. The Jackson Company wants to purchase an asset costing $6 million. The
firm just reported a net income (NI0) of $10 million; its payout ratio is 10
percent; and the firm has 1 million shares of stock outstanding. Jackson's
market value capital structure, shown below, is considered to be optimal
(assume that there is no short-term debt):
Long-term Debt $18,900,000
Equity 12,600,000
Total Capital $31,500,000
Jackson expects its earnings (and therefore its dividends) to continue to grow
at their historical rate of 4 percent per year for the indefinite future. The current
risk free rate is 5 percent and the expected return on the market portfolio is 16
percent. Jackson's cost of debt (kd) is 8 percent and the firm's tax rate is 40
percent. Calculate Jackson's weighted average cost of capital.
a. 7.78 percent.
b. 9.23 percent.
c. 12.15 percent.
d. 14.72 percent.
e. 18.99 percent.
MBA 8622
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17. Martin Corporation's common stock is currently selling for $50 per share.
The current dividend is $2.00 per share. If dividends are expected to grow at
6 percent per year, what is the firm's cost of retained earnings?
a. 10.71%
b. 11.38%
c. 10.24%
d. 9.31%
e. There is no cost because retained earnings are free.
19. Two projects being considered are mutually exclusive and have the
following projected cash flows:
Year Project A Project B
0 ($50,000) ($50,000)
1
15,625
0
2
15,625
0
3
15,625
0
4
15,625
0
5
15,625
99,500
If the required rate of return on these projects is 10 percent, which would be
chosen and why?
a. Project B because of higher NPV.
b. Project B because of higher IRR.
c. Project A because of higher NPV.
d. Project A because of higher IRR.
e. Neither, because both have IRRs less than the cost of capital.
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20. The present value of the expected net cash inflows for a project will most
likely exceed the present value of the expected net profit after tax for the same
project because:
a. Income is reduced by taxes paid, but cash flow is not.
b. There is a greater probability of realizing the projected cash flow than the
forecasted income.
c. Income is reduced by dividends paid, but cash flow is not.
d. Income is reduced by depreciation charges, but cash flow is not.
e. Cash flow reflects any change in net working capital, but sales do not.
21. Michigan Mattress Company is considering the purchase of land and the
construction
of a new plant. The land, which would be bought immediately (at t = 0), has a
cost of $100,000 and the building, which would be erected at the end of the
first year (t = 1), would cost $500,000. It is estimated that the firm's after-tax
cash flow will be increased by $90,000 starting at the end of the second year,
and that this incremental flow would increase at a 10 percent rate annually over
the next 10 years. What is the approximate payback period?
a. 2 years
b. 4 years
c. 6 years
d. 8 years
e. 10 years
22. Two of your classmates are evaluating a project with the following net cash
flows:
Year Cash Flow
0 ($ 10,000)
1 $100,000
2 ($100,000)
One classmate says that the project has an IRR of between 12 and 13%. The
other classmate calculates an IRR of just under 800%, but fears his calculator's
battery is low and may have caused an error. You agree to settle the dispute
by analyzing the project cash flows. Which statement best describes the IRR
for this project?
a. There is a single IRR of approximately 12.7 percent.
b. This project has no IRR, because the NPV profile does not cross the X
axis.
c. This project has two imaginary IRRs.
d. There are an infinite number of IRRs between 12.5 percent and 790 percent
that can define the IRR for this project.
e. There are multiple IRRs of approximately 12.7 percent and 787 percent.
MBA 8622
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MBA 8622
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7. B
8. C
9. C
10. B
11.B
12. E
14.D
15. A First solve for current k = D1/P0 + g = (4.00)(.40)(1.06)/30 + .06 =
.1165 or 11.65%.
Then find current beta from: 11.65 = 8% + b (5%); b = .73.
Next increase beta by 50% : .73(1.50) = 1.095.
Now solve for new k = 8% + (1.095)(5%) = 13.475%.
Finally, solve for new price = P0 = (1.60)(1.06)/ (.13475-.06) = 22.68.
Reduction in price = 30 - 22.68.
16. A Want to solve: K = (D/A)(kd)(1-T) + (S/A)(ks)
where, D/A = (18.9/31.5), S/A = (12.6/31.5), kd = 8%, and (1-T) = .6.
To get ks, must either solve the CAPM equation of the DCF equation. Since
we do not have a beta, we cannot solve the CAPM equation. The DCF
equation is:
k = D1/P0 + g. Here, D0 = (Net income x Dividend payout ratio) divided by
the number of shares outstanding = (10,000,000)(.1)/1,000,000 = 1.00 and
D1 = D0(1+g) = 1.00(1.04) = $1.04.
P0 can be found from the market value of equity and the number of shares
outstanding. Specifically, P0 = Market value of equity divided by the number
of shares outstanding = 12,600,000/1,000,000 = 12.60.
g = 4% = .04. Thus, ks = 1.04/12.60 + .04.
Plug this into the above equation to solve for WACC.
17. C Solve k = D0(1+g)/P0 + g; k = 2.00(1.06)/50 + .06 = .1024 =
10.24%.
19. A
20. D
21. C
22. E
23. C 24. E
25. E