EXERCISES FOR BEFORE THE EXAM

1. You own 100 shares of a Sub Chapter "S" corporation. The corporation earns $5.00 per share
before taxes. Once the corporation has paid any corporate taxes that are due, it will distribute
the rest of its earnings to its shareholders in the form of a dividend. If the corporate tax rate is
40% and your personal tax rate on (both dividend and non-dividend) income is 30%, then how
much money is left for you after all taxes have been paid?
A) $210
B) $300
C) $350
D) $500

2. You are a shareholder in a "C" corporation. This corporation earns $4 per share before taxes.
After it has paid taxes, it will distribute the remainder of its earnings to you as a dividend. The
dividend is income to you, so you will then pay taxes on these earnings. The corporate tax rate
is 35% and your tax rate on dividend income is 15%. The effective tax rate on your share of the
corporations earnings is closest to:
A) 15%
B) 35%
C) 45%
D) 50%

3. Consider the following two quotes for XYZ stock:

November 11th November 18th

Ask: 25.25 Ask: 26.00
Bid: 25.20 Bid: 25.93

a) How much would you have to pay to purchase 100 shares of XYZ stock on November 18th?
A) $2520
B) $2525
C) $2593
D) $2600

b) How much would you receive if you sold 200 shares of XYZ stock on November 11th?
A) $5050
B) $5040
C) $5186
D) $5200

c) What are your net proceeds if you purchased 2500 shares of XYZ stock on November 11th
and then sold them a week later on November 18th?

4. At an annual interest rate of 7%, the future value of $5000 in five years is closest to:
A) $3565
B) $6750
 C) $7015
D) $7035

5. Your great aunt Matilda put some money in an account for you on the day you were born. This
account pays 8% interest per year. On your 21st birthday the account balance was $5033.83.
a) The amount of money that your great aunt Matilda originally put in the account is closest to:
A) $600
B) $800
C) $1000
D) $1200

b) The amount of money that would be in the account if you left the money there until your
65th birthday is closest to:
A) $29,556
B) $148,780
C) $168,824
D) $748,932

6. Taggart Transcontinental currently has a bank loan outstanding that requires it to make three
annual payments at the end of the next three years of $1,000,000 each. The bank has offered to
allow Taggart Transcontinental to skip making the next two payments in lieu of making one
large payment at the end of the loan's term in three years. If the interest rate on the loan is 6%,
then the final payment that the bank will require to make Taggart Transcontinental indifferent
between the two forms of payments is closest to:
A) $2,673,000
B) $3,000,000
C) $3,184,000
D) $3,375,000

7. Nielson Motors is considering an opportunity that requires an investment of $1,000,000 today

and will provide $250,000 one year from now, $450,000 two years from now, and $650,000 three
years from now.
If the appropriate interest rate is 10%, then the NPV of this opportunity is closest to:
A) ($88,000)
B) $88,000
C) $300,000
D) $1,300,000

8. Wyatt oil is considering drilling a new self sustaining oil well at a cost of $1,000,000. This well
will produce $100,000 worth of oil during the first year, but as oil is removed from the well the
amount of oil produced will decline by 2%, per year forever. If the Wyatt oil's appropriate
interest rate is 8%, then the NPV of this oil well is closest to:
A) -$250,000
B) $0
C) $250,000
D) $1,000,000

9. Suppose that a young couple has just had their first baby and they wish to ensure that enough
 money will be available to pay for their child's college education. Currently, college tuition,
books, fees, and other costs, average $12,500 per year. On average, tuition and other costs have
historically increased at a rate of 4% per year.
Assuming that costs continue to increase an average of 4% per year, tuition and other costs for
one year for this student in 18 years when she enters college will be closest to:
A) $12,500
B) $21,500
C) $320,568
D) $25,323

10. Assuming that college costs continue to increase an average of 4% per year and that all her
college savings are invested in an account paying 7% interest, then the amount of money she
will need to have available at age 18 to pay for all four years of her undergraduate education is
closest to:
A) $97,110
B) $107,532
C) $101,291
D) $50,000

11. The British government has a consol bond outstanding that pays ₤100 in interest each year.
Assuming that the current interest rate in Great Britain is 5% and that you will receive your first
interest payment one year from now, then the value of the consol bond is closest to:
A) ₤1000
B) ₤1100
C) ₤2100
D) ₤2000

12. If the current rate of interest is 8%, then the future value 20 years from now of an investment
that pays $1000 per year and lasts 20 years is closest to:
A) $45,762
B) $36,725
C) $9818
D) $93,219

13. Suppose that a young couple has just had their first baby and they wish to insure that enough
money will be available to pay for their child's college education. They decide to make deposits
into an educational savings account on each of their daughter's birthdays, starting with her first
birthday. Assume that the educational savings account will return a constant 7%. The parents
deposit $2000 on their daughter's first birthday and plan to increase the size of their deposits by
5% each year. Assuming that the parents have already made the deposit for their daughter's
18th birthday, then the amount available for the daughter's college expenses on her 18th
birthday is closest to:
A) $42,825
B) $97,331
C) $67,998
D) $103,063

14. Suppose that a young couple has just had their first baby and they wish to ensure that enough
 money will be available to pay for their child's college education. Currently, college tuition,
books, fees, and other costs, average $12,500 per year. On average, tuition and other costs have
historically increased at a rate of 4% per year.
Assuming that college costs continue to increase an average of 4% per year and that all her
college savings are invested in an account paying 7% interest, then what is the amount of
money she will need to have available at age 18 to pay for all four years of her undergraduate
education?

15. Assume that you are 30 years old today, and that you are planning on retirement at age 65.
Your current salary is $45,000 and you expect your salary to increase at a rate of 5% per year as
long as you work. To save for your retirement, you plan on making annual contributions to a
retirement account. Your first contribution will be made on your 31st birthday and will be 8%
of this year's salary. Likewise, you expect to deposit 8% of your salary each year until you
reach age 65. Assume that the rate of interest is 7%.
What is the future value at retirement (age 65) of your savings?

16. You are interested in purchasing a new automobile that costs $35,000. The dealership offers
you a special financing rate of 6% APR (0.5%) per month for 48 months. Assuming that you do
not make a down payment on the auto and you take the dealer's financing deal, then your
monthly car payments would be closest to:
A) $729
B) $822
C) $842
D) $647

17. If the current rate of interest is 8% APR, then the future value of an investment that pays $250
per quarter and lasts 20 years is closest to:
A) $18,519
B) $48,443
C) $9936
D) $20,000

18. You are saving for retirement. To live comfortably, you decide that you will need $2.5 million
dollars by the time you are 65. If today is your 30th birthday, and you decide, starting today,
and on every birthday up to and including your 65th birthday, that you will deposit the same
amount into your savings account. Assuming the interest rate is 5%, the amount that you must
set aside each year on your birthday is closest to:
A) $71,430
B) $27,680
C) $26,100
D) $26,260

19. You have an investment opportunity that will cost you $10,000 today, but return $12,500 to you
in one year. The IRR of this investment opportunity is closest to:
A) 80%
B) 125%
C) 20%
D) 25%
20. You are considering investing in a zero coupon bond that will pay you its face value of $1000 in
ten years. If the bond is currently selling for $485.20, then the IRR for investing in this bond is
closest to:
A) 12%
B) 8.0%
C) 7.5%
D) 10%

21. The effective annual rate (EAR) for a loan with a stated APR of 8% compounded monthly is
closest to:
A) 7.72%
B) 8.00%
C) 8.30%
D) 8.66%

22. The effective annual rate (EAR) for a savings account with a stated APR of 4% compounded
daily (use 365 day year) is closest to:
A) 3.92%
B) 4.00%
C) 4.08%
D) 14.60%

23. Consider the following investment alternatives:

Investment Rate Compounding

A 6.25% Annual
B 6.10% Daily
C 6.125 Quarterly
D 6.120 Monthly

Which alternative offers you the highest effective rate of return?

A) Investment A
B) Investment B
C) Investment C
D) Investment D

24. Your firm needs to invest in a new delivery truck. The life expectancy of the delivery truck is
five years. You can purchase a new delivery truck for an upfront cost of $200,000, or you can
lease a truck from the manufacturer for five years for a monthly lease payment of $4000 (paid at
the end of each month). Your firm can borrow at 6% APR with quarterly compounding.
The effective annual rate on your firm's borrowings is closest to:
A) 6.00%
B) 6.14%
C) 6.25%
D) 6.30%
25. Your firm needs to invest in a new delivery truck. The life expectancy of the delivery truck is
five years. You can purchase a new delivery truck for an upfront cost of $200,000, or you can
lease a truck from the manufacturer for five years for a monthly lease payment of $4000 (paid at
the end of each month). Your firm can borrow at 6% APR with quarterly compounding.
The present value of the lease payments for the delivery truck is closest to:
A) $206,900
B) $207,050
C) $207,680
D) $198,420

26. You are considering purchasing a new automobile that will cost you $28,000. The dealer offers
you 4.9% APR financing for 60 months (with payments made at the end of the month).
Assuming you finance the entire $28,000 and finance through the dealer, your monthly
payments will be closest to:
A) $1454
B) $527
C) $467
D) $457

27. You are purchasing a new home and need to borrow $250,000 from a mortgage lender. The
mortgage lender quotes you a rate of 6.25% APR for a 30-year fixed rate mortgage. The
mortgage lender also tells you that if you are willing to pay 2 points, they can offer you a lower
rate of 6.0% APR for a 30-year fixed rate mortgage. One point is equal to 1% of the loan value.
So if you take the lower rate and pay the points you will need to borrow an additional $5000 to
cover points you are paying the lender.
Assuming you don't pay the points and borrow from the mortgage lender at 6.25%, then your
monthly mortgage payment (with payments made at the end of the month) will be closest to:
A) $694
B) $708
C) $1540
D) $1600

28. Assume that you presently have a monthly home mortgage with a stated interest rate of 7%
APR. If your income tax rate is 20%, then the after tax EAR for your home mortgage is closest
to:
A) 5.6%
B) 7.2%
C) 5.8%
D) 7.0%

29. The Sisyphean Company has a bond outstanding with a face value of $1000 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 semiannually.
a) How much will each semiannual coupon payment be?
A) $60
B) $40
C) $120
D) $80
 b) Assuming the appropriate YTM on the Sisyphean bond is 7.5%, then the price that this bond
trades for will be closest to:
A) $1045
B) $691
C) $1000
D) $957

c) Assuming the appropriate YTM on the Sisyphean bond is 7.5%, then this bond will trade at
A) par.
B) a discount.
C) a premium.
D) None of the above

30. Consider a zero coupon bond with 20 years to maturity.

a) The amount that the price of the bond will change if its yield to maturity decreases from 7%
to 5% is closest to:
A) $120
B) -$53
C) $53
D) $673

b) The percentage change in the price of the bond if its yield to maturity decreases from 7% to
5% is closest to:
A) 46%
B) 17%
C) 22%
D) 38%

31. Sarah Palin reportedly was paid a $11 million advance to write her book Going Rogue. The book
took one year to write. In the time she spent writing, Palin could have been paid to give
speeches and appear on TV news as a political commentator. Given her popularity, assume that
she could have earned $8 million over the year (paid at the end of the year) she spent writing
the book.
Assume that once her book is finished, it is expected to generate royalties of $5 million in the
first year (paid at the end of the year) and these royalties are expected to decrease by 40% per
year in perpetuity. Assuming that Palin's cost of capital is 10% and given these royalties
payments, the NPV of Palin's book deal is closest to:
A) $3.75 million
B) $12.20 million
C) $13.00 million
D) $13.75 million

32. You are considering investing in a start up project at a cost of $100,000. You expect the project to
return $500,000 to you in seven years. Given the risk of this project, your cost of capital is 20%.
a) The NPV for this project is closest to:
A) $29,200
B) $39,500
C) $129,200
 D) $139,500

b) The IRR for this project is closest to:

A) 15.60%
B) 18.95%
C) 20.00%
D) 25.85%

33. Sarah Palin reportedly was paid a $11 million advance to write her book Going Rogue. The book
took one year to write. In the time she spent writing, Palin could have been paid to give
speeches and appear on TV news as a political commentator. Given her popularity, assume that
she could have earned $8 million over the year (paid at the end of the year) she spent writing
the book.
a) Assuming that Palin's cost of capital is 10%, then the NPV of her book deal is closest to:
A) $2.00 million
B) $2.20 million
C) $3.00 million
D) $3.75 million

b) The IRR of Palin's book deal is closest to:

A) -27.25%
B) -37.50%
C) 27.25%
D) 37.50%

34. Frank Dewey Esquire from the firm of Dewey, Cheatum, and Howe, has been offered an
upfront retainer of $30,000 to provide legal services over the next 12 months to Taggart
Transcontinental. In return for this upfront payment, Taggart Transcontinental would have
access to 8 hours of legal services from Frank for each of the next 12 months. Frank's normal
billable rate is $250 per hour for legal services.
a) Assuming that Dewey's cost of capital is 12% EAR, then the NPV of his retainer offer is
closest to:
A) -$7500
B) -$7400
C) $6000
D) $7400

b) Assuming that Dewey's cost of capital is 12% EAR, then the IRR of his retainer offer is closest
to:
A) -39.3%
B) -3.3%
C) 20.0%
D) 39.3%

35. Rearden Metals is considering opening a strip mining operation to provide some of the raw
materials needed in producing Rearden metal. The initial purchase of the land and the
associated costs of opening up mining operations will cost $100 million today. The mine is
expected to generate $16 million worth of ore per year for the next 12 years. At the end of the
 12th year Rearden will need to spend $20 million to restore the land to its original pristine
nature appearance.
The payback period for Rearden's mining operation is closest to:
A) 5.00 years
B) 6.00 years
C) 6.25 years
D) 6.50 years

36. Ford Motor Company is considering launching a new line of Plug-in Electric SUVs. The heavy
advertising expenses associated with the new SUV launch would generate operating losses of
$35 million next year. Without the new SUV, Ford expects to earn pre-tax income of $80 million
from operations next year. Ford pays a 30% tax rate on its pre-tax income.
a) The amount that Ford Motor Company will owe in taxes next year without the launch of the
new SUV is closest to:
A) $24.0 million
B) $56.0 million
C) $31.5 million
D) $13.5 million

b) The amount that Ford Motor Company will owe in taxes next year with the launch of the
new SUV is closest to:
A) $13.5 million
B) $31.5 million
C) $56.0 million
D) $24.0 million

37. Temporary Housing Services Incorporated (THSI) is considering a project that involves setting
up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease
space in this facility to various agencies and groups providing relief services to the area. THSI
estimates that this project will initially cost $5 million to set up and will generate $20 million in
revenues during its first and only year in operation (paid in one year). Operating expenses are
expected to total $12 million during this year and depreciation expense will be another $3
million. THSI will require no working capital for this investment. THSI's marginal tax rate is
35%.
a) Ignoring the original investment of $5 million, what is THSI's free cash flow for the first and
only year of operation?
A) $5.0 million
B) $3.75 million
C) $8.0 million
D) $6.25 million

b) Assume that THSI's cost of capital for this project is 15%. The NPV of this temporary
housing project is closest to:
A) $435,000
B) -$650,000
C) $1,960,000
D) -$435,000
38. Rearden Metals has a current stock price of $30 share, is expected to pay a dividend of $1.20 in
one year, and its expected price right after paying that dividend is $33.
a) Rearden's expected dividend yield is closest to:
A) 3.40%
B) 3.65%
C) 4.00%
D) 4.20%

b) Rearden's expected capital gains yield is closest to:

A) 4.0%
B) 6.4%
C) 8.2%
D) 10.0%

c) Rearden's equity cost of capital is closest to:

A) 4.0%
B) 6.4%
C) 8.2%
D) 14.0%

39. Nielson Motors has a share price of $25 today. If Nielson Motors is expected to pay a dividend
of $0.75 this year, and its stock price is expected to grow to $26.75 at the end of the year, then
Nielson's dividend yield and equity cost of capital are:
A) 3.0% and 7.0% respectively.
B) 3.0% and 10.0% respectively.
C) 4.0% and 6.0% respectively.
D) 4.0% and 10.0% respectively.

40. Von Bora Corporation (VBC) is expected to pay a $2.00 dividend at the end of this year. If you
expect VBC's dividend to grow by 5% per year forever and VBC's equity cost of capital is 13%,
then the value of a share of VBS stock is closest to:
A) $25.00
B) $40.00
C) $15.40
D) $11.10

41. Luther Industries has a dividend yield of 4.5% and and a cost of equity capital of 12%. Luther
Industries dividends are expected to grow at a constant rate indefinitely. The grow rate of
Luther's dividends are closest to:
A) 7.5%
B) 5.5%
C) 16.5%
D) 12%
Answer: A

42. You expect KT Industries (KTI) will have earnings per share of $3 this year and expect that they
will pay out $1.50 of these earnings to shareholders in the form of a dividend. KTI's return on
new investments is 15% and their equity cost of capital is 12%. The value of a share of KTI's
 stock is closest to:
A) $39.25
B) $20.00
C) $33.35
D) $12.50

43. JRN Enterprises just announced that it plans to cut its dividend from $2.50 to $1.50 per share
and use the extra funds to expand its operations. Prior to this announcement, JRN's dividends
were expected to grow at 4% per year and JRN's stock was trading at $25.00 per share. With the
new expansion, JRN's dividends are expected to grow at 8% per year indefinitely. Assuming
that JRN's risk is unchanged by the expansion, the value of a share of JRN after the
announcement is closest to:
A) $25.00
B) $15.00
C) $31.25
D) $27.50

44. Von Bora Corporation is expected pay a dividend of $1.40 per share at the end of this year and a
$1.50 per share at the end of the second year. You expect Von Bora's stock price to be $25.00 at
the end of two years. Von Bora's equity cost of capital is 10%.
a) The price you would be willing to pay today for a share of Von Bora stock, if you plan to hold
the stock for two years is closest to:
A) $23.15
B) $20.65
C) $21.95
D) $21.90

b) Suppose you plan to hold Von Bora stock for one year. The price one would expect to be able
to sell a share of Von Bora stock for in one year is closest to:
A) $26.50
B) $22.70
C) $23.15
D) $24.10

c) Suppose you plan to hold Von Bora stock for only one year. Your capital gain from holding
Von Bora stock for the first year is closest to:
A) $0.95
B) $1.40
C) $1.85
D) $1.25

d) Suppose you plan to hold Von Bora stock for only one year. Your capital gain rate from
holding Von Bora stock for the first year is closest to:
A) 3.5%
B) 4.0%
C) 6.0%
D) 4.5%
 e) Suppose you plan to hold Von Bora stock for only one year. Your dividend yield from
holding Von Bora stock for the first year is closest to:
A) 6.0%
B) 4.0%
C) 6.5%
D) 5.5%

f) Suppose you plan on purchasing Von Bora stock in one year, right after the $1.40 dividend is
paid. You then plan on selling your stock at the end of year two, right after the $1.50 dividend
is paid. The capital gain rate that you will receive on your investment is closest to:
A) 4.00%
B) 3.75%
C) 6.25%
D) 3.50%

45. Taggart Transcontinental has a divided yield of 2.5%. Taggart's equity cost of capital is 10%,
and its dividends are expected to grow at a constant rate. Based on this information, Taggart's
constant growth rate in dividends is closest to:
A) 2.5%
B) 5.0%
C) 10.0%
D) 7.5%

46. Kinston Industries just announced that it will cut its dividend from $3.00 to $2.00 per share and
use the extra funds to expand its operations. Kinston's dividends were expected to grow at a 2%
rate, and its share price was $37.50. With the new expansion, Kinston dividends are expected to
grow at a 5% rate. Kinston's share price following this announcement should be:
A) $20.00
B) $30.00
C) $37.50
D) $40.00

47. Taggart Transcontinental pays no dividends, but spent $4 billion on share repurchases last year.
Taggart's equity cost of capital is 13% and the amount spent on repurchases is expected to grow
by 5% per year. Taggart currently has 2 billion shares outstanding.
Taggart's stock price is closest to:
A) $12.50
B) $15.40
C) $20.00
D) $25.00

48. A corporation will pay an annual dividend of $0.65 one year from now. Analysts expect this
dividend to grow at 12% per year thereafter until the fifth year- after then, growth will level off
at 2% per year. According to the dividend-discount model, what is the value of a share of the
corporation stock if the firm’s equity cost of capital is 8%?

49. Colgate-Palmolive Company has just paid an annual dividend of $0.96. Analysts are
predicting an 11% per year growth rate in earnings over the next five years. After then,
 Colgate’s earnings are expected to grow at the current industry average of 5.2% per year. If
Colgate’s equity cost of capital is 8.5% per year and its dividend payout ratio remains
constant, what price does the dividend-discount model predict Colgate stock should sell for?

50. The Rufus Corporation has 125 million shares outstanding and analysts expect Rufus to have
earnings of $500 million this year. Rufus plans to pay out 40% of its earnings in dividends and
they expect to use another 20% of their earnings to repurchase shares. If Rufus' equity cost of
capital is 15% and Rufus' earnings are expected to grow at a rate of 3% per year, then the value
of a share of Rufus stock is closest to:
A) $13.35
B) $33.50
C) $20.00
D) $16.00

51. Defenestration 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. Defenestration's equity
cost of capital is 13%.
Assuming that Defenestration's dividend payout rate and expected growth rate remain
constant, and Defenestration does not issue or repurchase shares, then Defenestration's stock
price is closest to:
A) $50.00
B) $32.30
C) $22.25
D) $30.75

52. Consider the following probability distribution of returns for Alpha Corporation:

Current
Stock Price Stock Price in Probability
($) One Year ($) Return R PR
$35 40% 25%
$25 $25 0% 50%
$20 -20% 25%

a) The expected return for Alpha Corporation is closest to:

A) 6.67%
B) 5.00%
C) 10%
D) 0.00%

b) The variance of the return on Alpha Corporation is closest to:

A) 5.00%
B) 4.75%
C) 3.625%
D) 3.75%

c) The standard deviation of the return on Alpha Corporation is closest to:

 A) 22.4%
B) 19.0%
C) 21.8%
D) 19.4%

53. Bank A has 1000 loans outstanding each for $100,000, that it expects to be fully repaid today.
Each of Bank A's loans have a 6% probability of default, in which case the bank will receive $0
for each of the defaulting loans. The chance of default is independent across all the loans.
a) The expected overall payoff to Bank A is:
A) $5,000,000
B) $6,000,000
C) $94,000,000
D) $95,000,000

b) The standard deviation of the overall payoff to Bank A is closest to:

A) $689,000
B) $751,000
C) $2,179,000
D) $2,375,000

54. Consider a portfolio that consists of an equal investment in 20 firms. For each of these firms,
there is a 70% probability that the firms will have a 16% return and a 30% that they will have a -
8% return. Each of these firms' returns is independent of all others. The standard deviation of
this portfolio is closest to:
A) 2.5%
B) 4.2%
C) 8.8%
D) 11.0%

55. Consider an economy with two types of firms, S and I. S firms always move together, but I
firms move independently of each other. For both types of firm there is a 70% probability that
the firm will have a 20% return and a 30% probability that the firm will have a -30% return.
a) What is the expected return for an individual firm?
A) 14%
B) 3%
C) 5%
D) -5%

b) The standard deviation for the return on an individual firm is closest to:
A) 23.0%
B) 5.25%
C) 15.0%
D) 10.0%

56. Suppose that the market portfolio is equally likely to increase by 24% or decrease by 8%.
Security "X" goes up on average by 29% when the market goes up and goes down by 11% when
the market goes down.
The beta for security "X" is closest to:
 A) 0
B) 0.80
C) 1.00
D) 1.25

57. If the market risk premium is 6%, beta is 2.77 and the risk-free rate is 4%, then the expected
return of investing in Ford Motor Company is closest to:
A) 10.0%
B) 16.2%
C) 17.1%
D) 20.6%

58. Suppose that Luther's beta is 0.9. If the market risk premium is 8% and the risk-free interest
rate is 4%, then then expected return for Luther stock is?
A) 7.6%
B) 11.6%
C) 11.2%
D) 12.9%

59. Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200
shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per
share. Suppose over the next year Ball has a return of 12.5%, Lowes has a return of 20%, and
Abbott Labs has a return of -10%. The return on your portfolio over the year is:
A) 0%
B) 7.5%
C) 3.5%
D) 5.0%

60. Consider an equally weighted portfolio that contains five stocks. If the average volatility of
these stocks is 40% and the average correlation between the stocks is .5, then the volatility of
this equally weighted portfolio is closest to:
A) .17
B) .03
C) .41
D) .19

61. Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a 6% interest
rate to invest in the stock market. You invest the entire $20,000 in an exchange traded fund
(ETF) with a 12% expected return and a 20% volatility.
a) The expected return on your investment is closest to:
A) 18%
B) 20%
C) 12%
D) 24%

b) The volatility of your investment is closest to:

A) 40%
B) 20%
 C) 30%
D) 24%

c) Assume that the EFT you invested in returns -10%, then the realized return on your
investment is closest to:
A) -20%
B) -10%
C) -24%
D) -26%

62. Suppose that you currently have $250,000 invested in a portfolio with an expected return of 12%
and a volatility of 10%. The efficient (tangent) portfolio has an expected return of 17% and a
volatility of 12%. The risk-free rate of interest is 5%.
a) The Sharpe ratio for your portfolio is closest to:
A) 1.2
B) 0.6
C) 1.0
D) 0.7

b) The Sharpe ratio for the efficient portfolio is closest to:

A) 0.7
B) 1.0
C) 1.4
D) 1.2

63. The volatility of the market portfolio is 10%, the expected return on the market is 12%, and the
risk-free rate of interest is 4%.
Portfolio Correlation w/
Firm Weight Volatility Market Portfolio
Taggart Transcontinental 0.25 14% 0.7
Wyatt Oil 0.35 18% 0.6
Rearden Metal 0.40 15% 0.5

a) The beta for Taggart Transcontinental is closest to:

A) 0.75
B) 0.80
C) 1.00
D) 1.10

b) The expected return for Wyatt Oil is closest to:

A) 11.4%
B) 11.8%
C) 12.0%
D) 12.6%

c) The beta for the market is closest to:

A) 0.80
 B) 1.00
C) 1.10
D) 1.25
64. Merck stock is trading for $36.70 per share with 2.11 billion shares outstanding. Merck's market
capitalization is closest to:
A) $38.2 billion
B) $77.4 billion
C) $89.4 billion
D) $115.6 billion

65. Your firm is planning to invest in a new electrostatic power generation system. Electrostat Inc
is a firm that specializes in this business. Electrostat has a stock price of $25 per share with 16
million shares outstanding. Electrostat's equity beta is 1.18. It also has $220 million in debt
outstanding with a debt beta of 0.08. Your estimate of the asset beta for electrostatic power
generators is closest to:
A) 0.76
B) 0.79
C) 0.93
D) 1.10

66. The risk-free rate of interest is 3% and the market risk premium is 5%. Beta is 1.4, Cash flow is
450 and growth rate is 4%. The value is closest to:
A) $4500
B) $7500
C) $8750
D) $10,000

67. Luther Industries has 25 million shares outstanding trading at $18 per share. In addition, Luther
has $150 million in outstanding debt. Suppose Luther's equity cost of capital is 13%, its debt cost
of capital is 7%, and the corporate tax rate is 40%.
a) Luther's unlevered cost of capital before tax is closest to:
A) 7.0%
B) 9.8%
C) 10.8%
D) 11.5%

b) Luther's weighted average cost of capital after tax is closest to:

A) 9.8%
B) 10.8%
C) 11.5%
D) 13.0%

68. Nielson Motors (NM) has no debt. Its assets will be worth $600 million in one year if the
economy is strong, but only $300 million if the economy is weak. Both events are equally likely.
The market value today of Nielson's assets is $400 million.
a) The expected return for Nielson Motors stock without leverage is closest to:
A) -25.0%
B) -17.5%
 C) -12.5%
D) 12.5%

b) Suppose the risk-free interest rate is 4%. If Nielson borrows $150 million today at this rate
and uses the proceeds to pay an immediate cash dividend, then according to MM, the market
value of its equity just after the dividend is paid would be closest to:
A) $0 million
B) $150 million
C) $250 million
D) $400 million

c) Suppose the risk-free interest rate is 4%. If Nielson borrows $150 million today at this rate
and uses the proceeds to pay an immediate cash dividend, then according to MM, the expected
return of Nielson's stock just after the dividend is paid would be closest to:
A) -17.5%
B) -12.5%
C) 12.5%
D) 17.5%

69. 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%.

a) The NPV for this project is closest to:

A) $6250
B) $14,100
C) $10,000
D) $18,600

b) Suppose that to raise the funds for the initial investment, the project is sold to investors as an
all-equity firm. The equity holders will receive the cash flows of the project in one year. The
market value of the unlevered equity for this project is closest to:
A) $94,100
B) $90,000
C) $86,250
D) $98,600

70. Galt Industries has 50 million shares outstanding and a market capitalization of $1.25 billion. It
also has $750 million in debt outstanding. Galt Industries has decided to delever the firm by
issuing new equity and completely repaying all the outstanding debt. Assume perfect capital
markets.
Suppose you are a shareholder in Galt industries holding 100 shares, and you disagree with this
decision to delever the firm. You can undo the effect of this decision by
A) borrowing $1500 and buying 60 shares of stock.
B) selling 32 shares of stock and lending $800.
C) borrowing $1000 and buying 40 shares of stock.
D) selling 40 shares of stock and lending $1000.
71. d'Anconia Copper is an all-equity firm with 60 million shares outstanding, which are currently
trading at $20 per share. Last month, d'Anconia announced that it will change its capital
structure by issuing $300 million in debt. The $200 million raised by this issue, plus another
$200 million in cash that d'Anconia already has, will be used to repurchase existing shares of
stock. Assume that capital markets are perfect.
a) The market capitalization of d'Anconia Copper after this transaction takes place is closest to:
A) $800 million
B) $900 million
C) $1100 million
D) $1200 million

b) At the conclusion of this transaction, the number of shares that d'Anconia Copper will
repurchase is closest to:
A) 5 million
B) 15 million
C) 20 million
D) 40 million

72. Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has
decided to use this cash to repurchase shares from its investors, and has already announced the
stock repurchase plan. Currently Luther is an all equity firm with 1.25 billion shares
outstanding. Luther's shares are currently trading at $20 per share.
After the repurchase how many shares will Luther have outstanding?
A) 0.75 billion
B) 1.0 billion
C) 1.1 billion
D) 1.2 billion

73. Suppose that Taggart Transcontinental currently has no debt and has an equity cost of capital of
10%. Taggart is considering borrowing funds at a cost of 6% and using these funds to
repurchase existing shares of stock. Assume perfect capital markets. If Taggart borrows until
they achieved a debt-to-value ratio of 20%, then Taggart's levered cost of equity would be
closest to:
A) 8.0%
B) 9.2%
C) 10.0%
D) 11.0%

74. 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 you borrow $30,000 in financing the project. According to MM proposition II, the
firm's equity cost of capital will be closest to:
A) 21%
B) 15%
C) 20%
D) 25%
75. Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate
tax rate of 35%. The amount of Rosewood's interest tax shield is closest to:
A) $115 million
B) $290 million
C) $175 million
D) $60 million

76. Assume that investors hold Google stock in retirement accounts that are free from personal
taxes. Also assume that Google's current pre-tax WACC is 14%. If Google were to issue
sufficient debt at a pre-tax cost of 7% to give them a debt to value ratio of 0.5, then the Google's
after-tax WACC would be closest to:
A) 10.4%
B) 12.8%
C) 13.0%
D) 15.0%
E) 16.0%

77. Wyatt Oil issued $100 million in perpetual debt (at par) with an annual coupon of 7%. Wyatt
will pay interest only on this debt. Wyatt's marginal tax rate is expected to be 40% for the
foreseeable future.
a) Wyatt's annual interest tax shield is closest to:
A) $2.8 million
B) $4.2 million
C) $7.0 million
D) $40 million

b) The present value of Wyatt's annual interest tax shield is closest to:
A) $4.2 million
B) $7.0 million
C) $40 million
D) $60 million

78. Rearden Metal currently has no debt and an equity cost of capital of 14%. Suppose that Rearden
decides to increase its leverage and maintain a market debt-to-value ratio of 1/2. Suppose
Rearden's debt cost of capital is 8% and its corporate tax rate is 40%. Assuming that Rearden's
pre-tax WACC remains constant, then with the addition of leverage its effective after-tax
WACC will be closest to:
A) 10.8%
B) 12.4%
C) 12.8%
D) 13.4%

79. Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this
free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity
cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket. If
Flagstaff currently maintains a .5 debt to equity ratio, then the value of Flagstaff's interest tax
shield is closest to:
A) $11 million
 B) $18 million
C) $10 million
D) $24 million

80. Kinston Enterprises has no debt and a debt obligation of $47 million that is due now. The
market value of Kinston's assets is $102 million, and the firm has no other liabilities. Assume
that capital markets are perfect and that Kinston has 5 million shares outstanding.
a) Kinston's current share price is closest to:
A) $20.40
B) $9.40
C) $11.00
D) $10.00

b) The number of new shares that Kinston must issue to raise the capital needed to pay its debt
obligation is closest to:
A) 4.3 million
B) 4.7 million
C) 5.0 million
D) 4.0 million

81. Big Blue Banana (BBB) is a clothing retailer with a current share price of $10.00 and with 25
million shares outstanding. Suppose that Big Blue Banana announces plans to lower its
corporate taxes by borrowing $100 million and using the proceeds to repurchase shares.
Suppose that BBB pays corporate taxes of 35% and that shareholders expects the change in debt
to be permanent.
a) Assuming that capital markets are perfect except for the existence of corporate taxes, the
share price for BBB after this announcement is closest to:
A) $10.00
B) $10.85
C) $8.60
D) $11.40

b) If the price of BBB's stock rises to $10.85 per share following the announcement, then the
present value of BBB's financial distress costs is closest to:
A) $21.25 million
B) $35.00 million
C) $11.40 million
D) $13.75 million

82. Luther Industries has no debt and expects to generate free cash flows of $48 million each year.
Luther believes that if it permanently increases its level of debt to $100 million, the risk of
financial distress may cause it to lose some customers and receive less favorable terms from its
suppliers. As a result, Luther's expected free cash flows with debt will be only $44 million per
year. Suppose Luther's tax rate is 40%, the risk-free rate is 6%, the expected return of the
market is 14%, and the beta of Luther's free cash flows is 1.25 (with or without leverage).
The value of Luther with leverage is closest to:
A) $315 million
B) $340 million
 C) $205 million
D) $300 million
SOLUTIONS

1. Answer: C
Explanation: C) EPS × number of shares × (1 - Individual Tax Rate)
$5.00 per share × 100 shares × (1 - .30) = $350
2. Answer: C
Explanation: C) First the corporation pays taxes. It earned $4 per share, but must pay $4 × .35 =
$1.40 to the government in corporate taxes. That leaves $4.00 - $1.40 = $2.60 to distribute to the
shareholders. However, the shareholder must pay $2.60 × .15 = $0.39 in income taxes on this
amount, leaving only $2.21 to the shareholder after all taxes are paid. The total amount paid in
taxes is $1.40 + 0.39 = $1.79. The effective tax rate is then $1.79 ÷ $4 = .4475 or 44.75% which is
closest to 45%.
3. a) Answer: D
Explanation: D) 100 shares × $26.00 (ask price) = $2600
b) Answer: B
Explanation: B) 200 shares × $25.20 (bid price) = $5040
c) Answer: buy at ask price 11/11 = 2500 × $25.25 = $63,125
sell at bid price 11/18 = 2500 × $25.93 = $64,825
now subtract the price paid for the shares
so net proceeds = 64,825 - 63,125 = $1700
4. Answer: C
Explanation: C) FV = PV(1 + i)N = 5000(1.07)5 = 7012.76
5. a) Answer: C
Explanation: C) PV = FV/(1 + i)N = 5033.83(/1.08)21 = 1000
b) Answer: B
Explanation: B) FV = PV(1 + i)N = 5033.83(1.08)(65 - 21) = $148,779.85
6. Answer: C
Explanation: C) FV = PV(1 + i)N = $1,000,000(1.06)2 + 1,000,000(1.06)1 + 1,000,000 = 3,183,600
7. Answer: B
Explanation: B) NPV = -1,000,000 + 250,000/(1.10)1 + 450,000/(1.10)2 + 650,000/(1.10)3 = 87,528.17
8. Answer: B
Explanation: B) NPV = -1,000,000 + $100,000/(.08 - (-.02)) = $0
9. Answer: D
Explanation: D) FV = PV(1 + i)N = $12,500(1.04)18 = $25,322.71
10. Answer: A
Explanation: A) This is a two step problem.
Step #1 determine the cost of the first year of college.

FV = PV(1 + i)N = $12,500(1.04)18 = $25,322.71

Step #2 figure out the value for four years of college.

 PV of a growing annuity due = C × (1 + r)

= $25,322.71 × (1 + .07) = $97,110.01

11. Answer: D
Explanation: D) PVP = C/r = 100/.05 = 2000
12. Answer: A
Explanation: A) FV = C/r((1 + r)N - 1) = 1000/0.08((1 + 0.08)20 - 1)
FV = $45,762
13. Answer: B
Explanation: B) FV of a growing annuity

$2000 × (1.07)18 = $97,331

14. Answer: This is a two step problem.
Step #1 determine the cost of the first year of college.

FV = PV(1 + i)N = $12,500(1.04)18 = $25,322.71

Step #2 figure out the value for four years of college.

PV of a growing annuity due = C × (1 + r)

= $25,322.71 × (1 + .07) = $97,110.01

15. Answer: First deposit = .08 × $45,000 = $3600

$3600 × (1.07)35 = $928,895

16. Answer: B
Explanation: B) PV = 35,000
I = .5
N = 48
FV = 0
Compute Payment = $821.98
17. Answer: B
Explanation: B) FV = C/r ((1 + r)N-1) = 250/.02 ((1 + 0.02)80 - 1)
FV = $48,443
18. Answer: C
Explanation: C) PV (age 29) = 2,500,000/(1.05)36 = 431,643.54

PV = 431,643.54
FV = 0
 I=5
N = 36
Compute PMT = $26,086
19. Answer: D

Explanation: D) IRR = - 1 = 0.25 or 25%

20. Answer: C
Explanation: C) PV = -485.20
FV = 1000
PMT = 0
N = 10
Compute I = 7.5%
21. Answer: C
Explanation: C) EAR = (1 + APR/k)k - 1 = (1 + .08/12)12 - 1 = .083 or 8.3%
22. Answer: C
Explanation: C) EAR = (1 + APR/k)k - 1 = (1 + .04/365)365 - 1 = .04088 or 4 .08%
23. Answer: D
Explanation: D) EAR (A) = (1 + APR/k)k - 1 = (1 + .0625/1)1 - 1 = .0625 or 6.250%
EAR (B) = (1 + APR/k)k - 1 = (1 + .0610/365)365 - 1 = .06289 or 6.289%
EAR (C) = (1 + APR/k)k - 1 = (1 + .06125/4)4 - 1 = .06267 or 6.267%
EAR (D) = (1 + APR/k)k - 1 = (1 + .0612/12)12 - 1 = .06295 or 6.300%
24. Answer: B
Explanation: B) EAR = (1 + APR/k)k - 1 = (1 + .06/4)4 - 1 = .06136 or 6.14%
25. Answer: B
Explanation: B) First we need to calculate the monthly discount rate for the lease arrangement.
EAR = (1 + APR/k)k - 1 = (1 + .06/4)4 - 1 = .06136 or 6.14%
Monthly rate = (1 + EAR)(1/12) - 1 = (1.06136)(1/12) - 1 = .004975 = 0.4975%
PV = 4000 × (1/0.004975) × (1 - 1/(1.00497560)) = 207,051.61
26. Answer: B
Explanation: B) First we need the monthly interest rate = APR/k = .049/12 = .004083 or .4083%.
28,000 = PMT × (1/0.004083) × (1 - 1/(1.00408360))
PMT = $527.11
27. Answer: C
Explanation: C) First we need the monthly interest rate = APR/k = .0625/12 = .005208 or .5208%.
250,000 = PMT × (1/0.005208) × (1 - 1/(1.005208360))
PMT = $1539.29
28. Answer: C
Explanation: C) Step #1 find the EAR

EAR = (1 + .07/12)12 - 1 = 7.2%

Step #2 find the after tax cost

aftertax = before tax (1 - T) = .072 (1 - .2) = .0578 or approximately 5.8%

29. a) Answer: B
 Explanation: B) Coupon = (coupon rate × face value)/number of coupons per year
= (.08 × 1000)/2 = $40
b) Answer: A
c) Answer: C
30. a) Answer: A
chg = (376.89 - 258.42) = 118.47
b) Answer: A
%chg = (376.89 - 258.42)/258.42 = .4584 or 45.8%
31. Answer: D
Explanation: D) NPV = $11 - $8/(1.10)1 + $5/(.10 - -0.40) = $ 13.72727
32. a) Answer: B
Explanation: B) NPV = -100,000 + 500,000/(1.020)7 = 39,540.82
b) Answer: D

Explanation: D) IRR = - 1 = .25849895

33. a) Answer: D
Explanation: D) NPV = $11 - $8/(1.10)1 = $ 3.72727
b) Answer: A

Explanation: A) IRR = - 1 = -0.27272727

34. a) Answer: D

Explanation: D) Step #1 Monthly Interest Rate - 1 = .009488793

Step #2 Monthly Opportunity Cost = 8 × $250 = $2000
Step #3

NPV = $30,000 - 2000 - = $7416.97

b) Answer: A
Explanation: A) Step #1 Monthly Opportunity Cost = 8 × $250 = $2000
Step #2 PV = 30,000, N = 12, PMT = -2000, FV = 0,
Compute I = -3.276502% × 12 = -39.3180%
35. Answer: C
Explanation: C) Payback = 100/16 = 6.25 years
36. a) Answer: A
Explanation: A) = $80 × .30 = $24 million
b) Answer: A
Explanation: A) = (80 - 35) × .30 = 13.5 million
37. a) Answer: D
Explanation: D) FCF = (revenues - expenses - depreciation) × (1 - tax rate) + depreciation
FCF = (20 - 12 - 3) × (1 - .35) + 3 = 6.25
b) Answer: A
Explanation: A) FCF = (20 - 12 - 3) × (1 - .35) + 3 = 6.25
So, NPV = -5.0 + 6.25/1.15 = .434782 or $434,782
38. a) Answer: C
Explanation: C) Div yield = 1.20/30 = .04 or 4%
b) Answer: D
 Explanation: D) Div yield = (33 - 30)/30 = .10 or 10%
c) Answer: D
Explanation: D) Equity cost of capital = 1.20/30.00 + (33 - 30)/30 = .04 + .10 = .14
39. Answer: B
Explanation: B) Dividend Yield = $0.75/$25 = .03 or 3%
Equity cost of capital = 0.75/25.00 + (26.75 - 25.00)/25.00 = .03 + .07 = .10 or 10%
40. Answer: A
Explanation: A) P0 = Div1/(rE - g) = 2.00/(.13 - .05) = $25.00
41. Explanation: A) rE = Div1/P0 + g
.12 = .045 + g so g = .075
42. Answer: C
Explanation: C) g = retention rate × return on new investment
= (3.00 - 1.50)/3.00 × .15 = .075 or 7.5%
P0 = Div1/(rE - g) = 1.50/(.12 - .075) = 33.33
43. Answer: A
Explanation: A) Two steps.
Step #1 solve for rE,
rE = Div1/P0 + g = 2.50/25.00 + .04 = .14 or 14%
Step #2
solve for new stock price:
P0 = Div1/(rE - g) = 1.50/(.14 - .08) = 25.00
44. a) Answer: A

Explanation: A) P0 = + = + = $23.17
b) Answer: D

Explanation: D) P1 = = = $24.10
c) Answer: A

Explanation: A) P1 = = = $24.10

P0 = + = + = $23.17
Capital Gain = P1 - P0 = 24.10 - 23.17 = $0.93
d) Answer: B

Explanation: B) P1 = = = $24.10

P0 = + = + = $23.17
Capital Gain = P1 - P0 = 24.10 - 23.17 = $0.93
Capital Gain rate = capital gain/P0 = 0.93/23.17 = .0401 or 4.0%
 e) Answer: A

Explanation: A) P0 = + = + = $23.17
Dividend yield = Div1/P0 = $1.40/23.17 = .0604 or 6.0%
f) Answer: B

Explanation: B) P1 = = = $24.10
So capital gain rate = (P2 - P1)/P1 = ($25.00 - $24.10)/$24.10 = .03734 or 3.73%
45. Answer: D

Explanation: D) P0 = → re - g = = .10 - g = .025 = g = .075 or 7.5%

46. Answer: D

Explanation: D) Step #1 re = + .02 = .10

Step #2 P0 = = 40.00
47. Answer: D

Explanation: D) Market Capitalization = = $50 billion/2 billion shares = $25.00 per

share
48. Explanation:
Vlaue of first five dividends: .65*(.08-.12) * (1- (1.12/1.08)^5) = $3.24
Value on date 5 of the rest of the dividend payments: (.65*(1.12^4)*1.02) / (.08-.02) = $17.39
Discount value on date 5: 17.39/(1.08 ^5) = $11.83
PV = 3.24 + 11.83 = $15.07
49. Explanation:
Compounded dividend (it was just paid): .96*1.11 = 1.0656
Value of first five dividends: 1.0656/(.085 - .011) * (1- (1.11/1.085)^5) = 5.14217
Value on date 5 of the rest of dividend payments: (1.0656*(1.11^5)*1.052) / (.085-.052) = 51.5689
Discount value on date 5: 51.5689/(1.085^5) = 34.2957
PV = 5.14217 + 34.2957 = 39.4378
50. Answer: C
Explanation: C) Dividends = $500 × .40 = $200 million
Repurchases = $500 × .20 = $100 million
PV(Future Total Dividends and Repurchases) = ($200 + $100)/(.15 - .03) = $2500 million
P0 = $2500 million/125 million shares = $20 per share
51. Answer: A

Explanation: A) P0 = = = $50
52. a) Answer: B

Explanation: B) E[R] = PR × R = .25(40%) + .50(0%) + .25(-20%) = 5%

 b) Answer: B
Explanation: B) E[R] = PR × R = .25(40%) + .50(0%) + .25(-20%) = 5%

Var(R) = PR × (R - E[R])2 = .25(.40 - .05)2 + .50(.00 - .05)2 + .25(-20 - .05)2 = .0475 or 4.75%
c) Answer: C
Explanation: C) E[R] = PR × R = .25(40%) + .50(0%) + .25(-20%) = 5%

Var(R) = PR × (R - E[R])2 = .25(.40 - .05)2 + .50(.00 - .05)2 + .25(-20 - .05)2 = .0475 or 4.75%

SD(R) = = = .2179 or 21.79%

53. a) Answer: C
Explanation: C) E[payoff] = (.06)(1000)($0) + (1 - .06)(1000)($100,000) = $94,000,000
b) Answer: B
Explanation: B) E[payoff] = (.06)(1000)($0) + (1 - .06)(1000)($100,000) = $94,000,000
SD(Payoff) = = 23.748684 million

SD(Overall Payoff) = = $750,999.33

54. Answer: A
Explanation: A) E[return] = (.70)(16%) + (.30)(-8%) = 8.8%
SD(Rt) = = 10.9982%

SD(Rportfolio) = = 2.459268%
55. a) Answer: C
Explanation: C) expected return = .7(20%) + .3(-30%) = 5%
b) Answer: A
Explanation: A) expected return = .7(20%) + .3(-30%) = 5%
standard deviation = = .2291
56. Answer: D
Explanation: D) Change in Market = 24% - (-8%) = 32%, change in security = 29% - (-11%) = 40%,
Beta = 40%/32% = 1.25
57. Answer: D
Explanation: D) Return = .04 + 2.77(.06) = .2062
58. Answer: C
Explanation: C) E[R] = Rf + Beta × Risk Premium = .04 + .9 × .08 = .112
59. Answer: C
Explanation: C)
Stock Weight Return W×R
ABT 0.5 -0.1 -0.05
LOW 0.3 0.2 0.06
BLL 0.2 0.125 0.025
Rp = 0.035
60. Answer: B

Explanation: B) Variance of an equally Weighted Portfolio = (Average Variance of Individual

 Stocks) + (1 - )(Average covariance between the stocks)
Var(Rp) = x12Var(R1) + x22Var(R2) + 2X1X2Cov(R1,R2)
Var = (1/5)(.40)2 + (1 - 1/5)(.5)(.40)(.40)
Var = 0.032 + .064 = .096
stdev = = .0309
61. a) Answer: A
Explanation: A) E[Rxp] = rf + x(E[Rp] - rf)
= .06 + 2(.12 - .06) = .18 or 18%
b) Answer: A
Explanation: A) SD( Rxp) = xSD(Rp)
= 2(.20) = .40
c) Answer: D
Explanation: D) Value of portfolio = $20,000( 1 + -.10) = $18,000 - $10,600 loan & interest = 7400
So, return = (7400 - 10,000)/10,000 = -26%
62. a) Answer: D

Explanation: D) Sharpe ratio = = = .7

b) Answer: B

Explanation: B) Sharpe ratio = = = 1.0

63. a) Answer: C

Explanation: C) βTT = = = 0.98

b) Answer: D

Explanation: D) βWO = = = 1.08

ri = rf + βi(Rm - rf) = .04 + 1.08(.12 - .04) = .1264 or 12.64%
c) Answer: B

Explanation: B) βWO = = = 1.00

64. Answer: B
Explanation: B) Market Cap = Price × shares outstanding = $36.70 × 2110 = $77,437 million
65. Answer: B

Explanation: B) βU = βE + βD = × 1.18 + × 0.08 =

0.789677
66. Answer: B
Explanation: B) ri = rrf + β(rm - rrf) = .03 + 1.4(.05) = .10 or 10.0%

V= = = $7500
67. a) Answer: D
 Explanation: D) rU = rE + rD = (13%) + (7%) = 11.5%
b) Answer: B

Explanation: B) rU = rE + (1 - Tc)

= (13%) + (7%)(1 - .4) = 10.8%

68. a) Answer: D

Explanation: D) E[rNM] = =
b) Answer: C
Explanation: C) Value of equity = Total value - value of debt = $400 - 150 = $250
c) Answer: D
Explanation: D) Value of equity = Total value - value of debt = $400 - 150 = $250

E[rNM] = = = 17.6%
69. a) Answer: C

Explanation: C) NPV = - $80,000 = $10,000

b) Answer: B

Explanation: B) PV(equity cash flows) = = $90,000

70. Answer: A

Explanation: A) share price = = $25 → value of equity = 25 × 100 =

$2500

Galt's pre-delevered Debt/Equity = = .60 → for every $1 equity need $0.60 debt, so you
need to borrow $0.60 × $2500 = $1500 and then buy $1500/$25 = 60 more shares of stock.
71. a) Answer: A
Explanation: A) Market Cap = 60 million shares × $20 share - $200 Debt - $200 Cash = $800
million
b) Answer: C

Explanation: C) Number of shares repurchased = =

20 mil
72. Answer: B
Explanation: B) $5 billion/$20 Share = .250 billion shares repurchased.
Shares outstanding = 1.25 - .25 = 1.0 billion
73. Answer: D

Explanation: D) re = ru + (ru - rd) = 10% + (10% - 6%) = 11%

74. Answer: C

Explanation: C) PV(equity cash flows - unlevered) = = $90,000

Given rE = rU + (rU - rD)

rE = .15 + (.15 - .05) = .20 or 20%

75. Answer: D
Explanation: D) Interest expense(τC) = 175(.35) = $61.25
76. Answer: B

Explanation: B) rWACC = re + rd - rdTc = 14% - (7%)(35%) = 12.775%

Note that = re + rd is the pre-tax WACC.

77. a) Answer: A
Explanation: A) Annual interest tax shield = Debt × Interest × Tax rate = $100 million × 7% ×
40% = $2.8 million
b) Answer: C
Explanation: C) Annual interest tax shield = Debt × Interest × Tax rate = $100 million × 7% × 40%
= $2.8 million

PV Tax shield = = = $40 million

78. Answer: B

Explanation: B) rWACC = re + rd - rdTe = 14% - (8%)(40%) = 12.40%

Note that = re + rd is the pre-tax WACC.

79. Answer: A

Explanation: A) rwacc = rE + rD (Pre tax)

rwacc = .13 + .07 = .11

VU = = = $100 million

rwacc = rE + rD (1 - τc) (after tax)

rwacc = .13 + .07 (1 - .35) = .101833

VL = = = $111.37 million
 PV of tax shield = VL - VU = $111.37 - $100 = $11.37
80. a) Answer: C

Explanation: C) Price = = $11.00 per share

b) Answer: A

Explanation: A) Price = = $11.00 per share

81. a) Answer: D
Explanation: D) VU = $10.00 × 25 million shares = $250 million
VL = VU + τcB = $250 + .35($100) = $285 million/25 million shares = $11.40
b) Answer: D
Explanation: D) VU = $10.00 × 25 million shares = $250 million
VL = VU + τcB = $250 + .35($100) = $285 million/25 million shares = $11.40
PV of financial distress costs = ($11.40 - $10.85) × 25 million shares = $13.75 million
82. Answer: A
Explanation: A) RE = rf - β(rM - rf) = .06 + 1.25(.14 - .06) = .16

VU = = = $275 million (using lower cash flow from leverage)

V L = VU + τcD = $275 + .4($100) = $315