FOR ALL QUESTIONS, PICK THE CLOSEST ANSWER.
1. Which of the following properties will make a bond less like equity?
a. The bond has a sinking fund.
b. The bond has 100 years to maturity rather than 10.
c. The bond is junior rather than senior debt.
d. The bond is convertible.
e. The bond has no debentures.
2. As the CFO of BUAD Corp, you are considering two mutually exclusive bond issues that
will be used to finance a stock repurchase. Bank A would be able to issue $140 million
worth of Ballerina bonds at a 7% coupon rate whereas Bank B could issue $81 million
worth in Ballerina bonds at a 4% coupon rate. Thinking back to your finance training,
you realize that if M&M Proposition I with taxes holds, the following option would
maximize firm value?
a. Bank A
b. Bank B
c. Neither option will have any effect on firm value
d. Both options will have the same positive effect on firm value
e. None of the above
3. You plan to build a $1 million dollar portfolio consisting of Stock A, Stock B and risk
free T-bills. Your goal is to generate a portfolio with a beta that matches the beta of the
market. Stock A has beta of 2, stock B has a beta of 0.5. If you have already
(irreversibly) invested $200,000 in T-bills, how much did you invest in Stock A?
a. $200,000
b. $333,333
c. $400,000
d. $666,667
e. Cannot be determine with the information given
4. The current yield on a 10 year U.S. Treasury bond is 7%. Which of the following MUST
BE TRUE for any bond issued by BUAD Corp?
a. It will have a rate of return of more than 7%
a. It will have more interest rate risk than the 10 year U.S. Treasury
b. It will have more reinvestment risk than the 10 year U.S. Treasury
c. It will have more default risk than the 10 year U.S. Treasury
d. ALL OF THE ABOVE
5. Ballerina Industries wants to raise $20 million by selling additional equity. Currently
there are 5,000,000 shares of stock outstanding trading at $50 per share, and the
subscription price is set at $40. What is the value of a right?
a. $0.91
b. $1.00
c. $9.10
d. $10.00
e. $40.00
6. Consider the following information:
State Probability ABC, Inc. (%)
Boom .25 15
Normal .50 8
Slowdown .15 4
Recession .10 -3
What is the standard deviation of returns for ABC, Inc.?
a. 5.17%
b. 8.05%
c. 26.8%
d. 64.08%
e. Cannot calculate from the information given
7. An all-equity firm with a beta of 1.21 is considering the following projects
I. ?=1.1, Expected Return = 13%
II. ?=1.2, Expected Return = 14%
III. ?=1.3, Expected Return = 15%
The risk-free rate is 5% and the expected return on the market is 12%. Which projects
would be incorrectly accepted or incorrectly rejected if the firms overall cost of capital
were used as a hurdle rate?
a. I
b. I & II
c. I, II & III
d. II, III
e. None of the above
8. During the recent financial crisis, what was Treasury Secretary Henry Paulson most
worried about?
a. Wall Street vs. Main Street
b. Too big to fail
c. Systemic risk vs. Idiosyncratic risk
d. Systemic risk vs. Moral hazard
e. Democrats vs. Republicans
9. You are comparing the current income statement of a firm to the pro forma income
statement for next year. The pro forma is based on a four percent increase in sales. The
firm is currently operating at 95% capacity. Net working capital and all costs vary
directly with sales. The tax rate and the dividend payout ratio are fixed. Given this
information, which one of the following statements must be true?
1. The projected net income is equal to the current year’s net income
2. The tax rate will increase at the same rate as sales
3. Retained earnings will increase by four percent over its current level
4. Total assets will increase by less than four percent
5. Total liabilities and owners’ equity will increase by four percent
10. Mary’s Motors, which is currently operating at full capacity, has sales of $29,000, current
assets of $1,600, current liabilities of $1,200, net fixed assets of $27,500, and a 5% profit
margin. The firm has no long-term debt and does not plan on acquiring any. The firm
does not pay any dividends. Sales are expected to increase by 4.5 percent next year. If
all assets, short-term liabilities, and costs vary directly with sales, how much additional
equity financing is required for next year?
a. -$259.75* ($181)
b. -$967.30
c. $967.30
d. $1,099.08
e. $1,515.25
11. Bab’s Navigation Service is worth $250,000 as a whole. It has zero-coupon debt with a
face value of $100,000 and a market value of $92,593 due in one year. If corporate taxes
are 25% and the required return on the company’s equity is 18%, what is the firm’s
WACC?
a. 12.1%
b. 13.6%
c. 18%
d. 25%
e. Cannot be determined with the information provided
12. Carl’s Cabinets wants to maintain a growth rate of 5% without incurring any additional
equity financing. The firm maintains a constant debt-to-equity ratio of 0.55, a total asset
turnover ratio of 1.30, and a profit margin of 9.0%. What must the dividend payout ratio
be?
a. 2.50%
b. 26.26%
c. 38.87%
d. 61.13%
e. 73.74%
13. One commonly cited reason for the recent financial crisis is that traders on “Wall Street”
were not doing what was in the best interest of the firm’s owners. This misalignment of
incentives between owners and managers is best described by which of the following
terms?
a. Agency issues
b. Externalities
c. Capitalism
d. Paternalism
e. Protectionism
14. There is a 5-year (5 annual payments) regular annuity with the first payment occurring
five years from today. If each payment is $10,000 and the monthly discount rate is 1%,
compounded monthly, how much is the value of the annuity?
a. $19.223
b. $21,913
c. $22,908
d. $50,000
e. $117,100
15. You want to serve on the board of directors of BUAD Corp. Unfortunately you are
extremely unpopular and you will be only person voting for you. If BUAD Corp has
20,000 shares outstanding, and the stock currently sells for $306 per share, how much
will it cost you to buy a seat on the board if the company uses straight voting?
a. Trick question: You cannot get a seat if you are the only one willing to vote for
you.
b. Trick question: Depends on the number of seats on the board
c. $306
d. $3,060,306
e. $3,825,306
16. Consider the following simplified financial statements for ABC, Inc.
ABC Income Statement
Sales $900
Costs $700
Net Income $200
ABC Balance Sheet
Assets $300 Debt $200
Equity $100
Total $300 Total $300
ABC predicts sales and costs will increase by 50%. Assume ABC pays out half of net
income in the form of a cash dividend. Costs and assets vary with sales, but debt and
equity DO NOT. What is the external financing need?
a. -$100
b. $0
c. $100
d. $175
e. NONE OF THE ABOVE
17. In their initial public offering (IPO) BUAD Corp issues 20,000 shares at an initial price
of $11 a share. The stock generates a lot of interest and closes at $14 a share. Assuming
firm commitment underwriting, how much cash did the IPO generate for BUAD?
a. $155,000
b. $190,000
c. $200,000
d. $210,000
e. $280,000
18. As the CFO of BUAD Corp, you figure out how to decrease the NWC required for a
potential project. Previously the project required $150,000 in NWC for 10 years. Your
discovery now reduces the NWC required to $75,000 for the same 10 years. If the
discount factor is 10%, how much money (in today’s dollars) did your discovery
potentially save the firm?
a. $28,916
b. $43,193
c. $46,000
d. $75,000
e. $92,169
19. For a certain stock, you expect to receive a per-share dividend of $1 one year from today,
$2 in two years, $3 in three years, and $1 a year thereafter. If you require a return of 11%
for investments of this risk class, what is the most you are willing to pay for a share of
this stock?
a. $10.71
b. $11.36
c. $12.91
d. $13.81
e. $14.44
20. You are bidding on a project to supply bagel delivery services to GMI for one year. To
supply the services, you must buy and outfit a number of trucks at a total cost of
$500,000. The trucks will cost $250,000 a year to maintain and operate over the year
(note that this is an expenses NOT a capital investment), and can be sold at the end of the
year for $250,000. The trucks can be straight line-depreciated over the year to $250,000.
If your tax rate is 40% and you require a 10% return, what is the best bid price you can
offer for transportation services (assume that if you win, you get your bid price
IMMEDIATELY).
a. $466,940
b. $530,300
c. $1,123,000
d. $1,255,000
e. $1,374,000
21. You are considering a project that, starting in exactly one year, will pay $25,000 every
year (forever). The payback period for this project is 5 full years. What is the project’s
IRR?
a. 14.55%
b. 20.00%
c. 20.89%
d. 22.34%
e. Cannot determine the answer from the information given
22. An asset will return 20% if things go well, and 10% otherwise. The probability that
things go well is 40%. What is standard deviation of this asset’s return?
a. 3.87
b. 4.90
c. 5.29
d. 6.32
e. 28.00
23. Which of the following statements is always true?
I. Diversification reduces unsystematic risk
II. A portfolio of 2 stocks is diversified
III. A portfolio of 1000 stocks is diversified
a. Statement I
b. Statement II
c. Statement III
d. Statements I, III
e. NONE OF THE ABOVE
24. The market risk premium is currently 8%. CBS stock has a beta of .5, while ABC stock
has a beta of 1.1. What is the expected return of CBS stock if ABC stock has an expected
return of 11%?
a. 4.0%
b. 5.0%
c. 6.2%
d. 8.8%
e. 11.0%
25. As CFO of BUAD Corp, you are considering two different capital structures: an all
equity plan (Plan I) and a levered plan (Plan II). Under Plan I, GMI would have 200,000
share of stock outstanding. Under Plan II, there would be only 100,000 outstanding
shares of stock and $2 million in debt with an interest rate of 10%. If there are no taxes,
what is the break even EBIT?
a. $20,000
b. $180,000
c. $200,000
d. $400,000
e. $1,000,000*
26. BUAD Corp is currently worth $2,500,000. It as zero-coupon debt with a face value of
$1,000,000 and a market value of $900,000 due in exactly one year. BUAD faces a
corporate tax rate of 25%, and the required return on BUAD equity is 20%. What is the
firm’s WACC?
a. 5.0%
b. 11.1%
c. 15.8%
d. 20.0%
e. Cannot be determined with the information given
27. You are considering a project with a cost of $100, and a payback period of exactly 5
years. What is the highest possible IRR for this project?
a. -49.13%
b. 0.00%
c. 20.00%
d. 49.13%
e. Infinity
EXTRA CREDIT QUESTION:
28. Consider a situation where sellers are informed but buyers are not (i.e. the seller knows
exactly how much the thing is worth, but buyers do not). There is a 90% chance that an
investment is worth $100, and a 10% chance it is worth $50. If the seller does not have
to sell, what is the highest price the uninformed buyer should offer for the asset? (Hint:
How much would you personally offer?)
a. $0
b. $5
c. $50
d. $95
e. $100

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