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Question Description
- A smaller firm is more likely to value Profitability Index compared to a larger firm.
- The appropriate manner of adjusting for inflationary effects is to discount nominal cash flows with real interest rates.
- Project analysis methods such as NPV and IRR focus on cash flows as opposed to profits.
- By using the 5-part DuPont Equation, you could discover that a company’s low ROE may be caused by high interest payments.
- When deciding between mutually exclusive projects, the correct selection is the project with the higher IRR.
- You can use NPV to evaluate a loan as if it were a project.
- Zero-coupon bonds are issued at a premium, and the investor’s return comes from the difference between the purchase price and the payment of face value at maturity.
- Bonds and options are generally traded over-the-counter, whereas stocks are not.
- The dividend yield of a stock and current yield of a bond are similar in that they both ignore capital gains or losses.
- Values of put options would rise if volatility increases, interest rates increase, or the strike prices increase.
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Section 2: Multiple Choice – Exactly one answer choice is correct. 2pts each.
- Suppose McDonald’s has an ROE of 15%, ROC of 1.5%, an EPS of $1.25, and elects to plowback 25% of its earnings. Expected return (r) is 5%. What is the stock price?
- The PV of a perpetual tax shield increases as the firm’s tax rate _____ and the amount of principal _____.
- Increases; increases
- Increases; decreases
- Decreases; decreases
- Decreases; increases
- Which of the following financially benefit due to High Frequency Trading?
- Mutual funds
- Foreign investors
- The Federal Reserve
- NYSE
- Suppose the year 1 dividend yield for Chipotle is expected to be 5% based on a stock price of $25. What will the year 4 dividend be in dividends grow annually at a constant rate of 7%?
- $1.33
- $1.49
- $1.53
- $1.67
- Projects A and B are mutually exclusive projects. Project A has an IRR of 10% while Project B has an IRR of 15%. You would be most likely to select Project A if:
- What is the amount of the annual interest tax shield for a firm with $3m in debt that pays 12% interest if the firm is in the 21% tax bracket and bears a discount rate of 15%?
- $75,600
- $94,500
- $126,000
- $504,000
- What is the rate of return on a 3yr bond with a coupon of 6.5% if you bought it for $1,054.47 and sold it a year later for $1,037.19
- 2.33%
- 3.49%
- 3.58%
- 4.53%
- For a company with debt of $400,000, a total debt ratio of 0.4, and an asset turnover ratio of 3.0, what are annual sales?
- $333,333
- $1,200,000
- $1,800,000
- $3,000,000
- What is the market price of a stock for a company with 100,000 shares outstanding, a book value of equity of $3m, and a market-to-book of 3.0?
- $10
- $30
- $90
- $105
- If book value of equity is greater than market value of equity:
- The company is bankrupt
- Assets have been fully depreciated
- Profit margins are currently negative
- Investors anticipate low earning potential
- $50
- $75
- $100
- $125
- Project B has a longer life than Project A.
- Project A has more risk than Project B.
- Project A is twice the size of Project B.
- Project B has a larger cash inflow in Year 1 than Project A.
Section 3: Multiple Choice – Circle all correct answer choices. 4 pts each.
1. Which of the following could be considered bullish investments?
- A long call
- A short call
- A long put
- A short put
- A straddle
2. Which of the following are considered bearish economic events?
- Interest Coverage Ratios are decreasing
- Defined Contribution Funds are increasing
- The Fed buys $5m in t-bonds
- The VIX is decreasing
- Credit Default Swaps are becoming more expensive
3. Which of the following are designed to either lower or offset risk for a bondholder?
- TIPS
- Credit Default Swaps
- Premium bonds
- Convertible bonds
- Senior bonds
- A tax shield
- When the expected rate of return on a project is greater than its opportunity cost of capital, we would expect:
- The NPV to be positive.
- The profitability index to be greater than 1.0.
- The IRR to be greater than the opportunity cost of capital.
- The discount rate to be too low.
- Other projects to be generally less appealing.
- Angela has 100 shares of Merck (MRK). She believes that, in two months, Merck will lose a lawsuit against competitor Phizer (PFE) for patent infringement. Angela concludes that shares of MRK will fall and shares of PFE will be rise… and she is devising a strategy accordingly.
- Infers a suboptimal amount of debt for a firm
- Would apply to a zero coupon bond
- Would still be useful for a non-profit that pays no corporate taxes
- Is one side of the Trade Off Theory, with the other being society’s benefit of tax receipts
- Would benefit shareholders
Shares of MRK are currently at $50 and PFE is at $80.
Which of the following are true?
- Short MRK and long PFE could be considered a pair trade.
- Angela could execute this strategy by buying a MRK put for a $5 premium with a strike of $60
- Angela could execute this strategy with a short call on MRK for a $5 premium with a strike of $60.
- If Angela is right, values of MRK put options will rise and values of PFE call options will rise.
- Angela might consider buying (long) a butterfly spread just in case she’s wrong and MRK wins the lawsuit.
Section 4: Short Answer – 6pts each.
- Suppose the board of the Federal Reserve votes to raise interest rates in 2021.The Chairman then decides to execute this using the Fed’s most common policy tool.
- Calculate the NPV, Profitability Index, and Payback Period for the following mutually exclusive projects.
- How has high frequency trading evolved over time? Explain and provide details. (We discussed this in class, and with materials. You are welcome to use the internet to research this if you like, but list sources as needed.)
- Summarize what good corporate governance is. Then, describe ways in which “good” corporate governance could ultimately lead to “bad” results. (Use some critical thinking. You might ask yourself questions such as: “bad for whom?” This subject was hinted at several times in class.)
Explain what the Chairman plans to do. Show or describe the steps – cause and effect – between the Fed’s action and the ultimate rise of interest rates.
- 5-year project; a cost of $15,000; returns of $4,000 at the end of the first year; returns then increase by $1,000 annually.
- 5-year project; a cost of $15,000; returns of $13,000 at the end of the first year; returns of $2000 per year for each year after the first year.
The firm uses a 10% discount rate.
Which project would you choose on an NPV basis, a Profitability Index basis, and a Payback Period basis?
Section 4: Options – 6pts each. Make sure all charts are clear and writing is legible.
- You are selling a put option on Google stock. Here are the following circumstances:
- Ticker: GOOGL
- Strike: $100
- Premium: $15
- Today’s Date: 5.11.20
- Expiration Date: 6.1.20
- GOOGL share price today: $90
- You have a short call AND a long put on Amazon stock. Here are the circumstances:
- Ticker: AMZN
- Call:
- Strike: $150
- Premium: $15
- Put:
- Strike: $120
- Premium: $5
- Today’s Date: 5.11.20
- Expiration Date: 7.1.20
- AMZN share price today: $180
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