# Concordia University Department of Finance John Molson School of Business GDBA 505 Homework No 2 Wint by wqv15485

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```									                                          Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                              Dr. Thomas Walker

GDBA 505 - HOMEWORK NO. 2

Instructions: The homework is comprised of 82 multiple choice questions. Each question counts 1 mark for a total
of 82 marks. For each question choose the best answer and mark it on the response sheet provided in class. If you
have any questions about this homework, please ask me during class or see me during my office hours so we can
clarify them before the due date. Do not e-mail your answers to me. Only answers submitted on the response sheet
will be graded. Finally, please mark all your answers with pencil only. Response sheets marked with pen will not be
accepted.

Chapter 14:
1.   By using the tax shield approach for computing operating cash flows we can:
A)   Obtain more accurate results than with the customary methods.
B)   More readily verify what cash flows would be without interest expenses.
C)   More readily identify the tax benefits of depreciation.
D)   More readily identify the tax benefits of debt financing.
E)   Start with the bottom line, net income, and work backwards.

2. Given the following information and assuming straight-line depreciation to zero, what is the NPV of this
project? Initial investment = \$400,000; life = 5 years; cost savings = \$150,000 per year; salvage value =
\$30,000 in year 5; tax rate = 34%; discount rate = 14%.
A) -\$149,841
B) -\$33,117
C) \$43,538
D) \$19,800
E) \$0

3. Given the following information and assuming straight-line depreciation to zero, what is the IRR of this
project? Initial investment = \$400,000; life = 4 years; cost savings = \$125,000 per year; salvage value =
\$20,000 in year 4; tax rate = 34%; discount rate = 12%.
A) 6.25%
B) 10.24%
C) 8.15%
D) 9.43%
E) 7.50%

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Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                               Dr. Thomas Walker

4. Given the following information and assuming straight-line depreciation to zero, what is the profitability
index for this project? Initial investment = \$500,000; life = 5 years; cost savings = \$160,000 per year;
salvage value = \$20,000 in year 5; tax rate = 34%; discount rate = 13%.
A) 0.74
B) 0.45
C) 1.65
D) 0.99
E) 1.98

5.   Which of the following is NOT considered a relevant, incremental cash flow in capital budgeting analysis?
A)   Opportunity costs
B)   Sunk costs
C)   Additions to net working capital
D)   Erosion costs
E)   Fixed asset salvage values

6. Given the following information and assuming straight-line depreciation to zero, what is the payback
period for this project? Initial investment = \$500,000; life = 5 years; cost savings = \$160,000 per year;
salvage value = \$30,000 in year 5; tax rate = 34%; discount rate = 13%.
A) 4.4 years
B) 3.9 years
C) 3.6 years
D) 2.5 years
E) The payback period is greater than the project's life.

7. You discover the engine-oil additive your scientists developed three years ago makes a great men's after-
shave once diluted properly using certain chemicals. How should you treat the original \$125,000 of R&D
expenditures that went into developing the engine-oil additive for your present decision regarding whether
or not to begin production of the after-shave?
A) Treat it as a cash outflow three years ago for the current project; that is, find the future value today of the
\$125,000 spent three years ago.
B) The full \$125,000 should be treated as an initial investment today.
C) As a cash inflow since the formula has obviously increased in value over the years.
D) As an opportunity cost if the formula cannot presently be sold to another manufacturer.
E) As a sunk cost since the R&D expenditure has no bearing on today's decision.

8. When considering mutually exclusive investment projects with different lives that will be replaced once
they terminate, it is best to evaluate them using _________________________.
A) the discounted payback rule
B) the profitability index rule
C) the equivalent annual cost rule
D) the internal rate of return rule
E) the net present value rule

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Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                               Dr. Thomas Walker

9. The EAC method for evaluating projects applies when which of the following project characteristics exist?
I. The projects are mutually exclusive.
II. The projects have different economic lives.
III. The projects will be replaced more or less indefinitely.
A) III only
B) I and II only
C) I and III only
D) II and III only
E) I, II, and III

10. A firm purchases Class 8 equipment for \$1,000,000 (CCA Rate 20%) for a 10 year project. What will be
the CCA tax shield in year 3? The tax rate is 35%.
A) \$144,000
B) \$50,400
C) \$201,600
D) \$63,000
E) \$35,000

11. Your company may introduce a new line of tennis shoes. You have been given the following projections:
sales = 35,000 units @ \$40 per unit; variable costs = \$25 per unit; fixed costs = \$125,000 per year; initial
investment = \$1,000,000; interest expense = \$50,000 per year; project life = 10 years. What is the net
income for this project if the corporate tax rate is 34%? You may assume straight-line depreciation and a
discount rate of 12%. (Note: Construct the income statement including interest expenses. Remember,
tough, that you should exclude interest expenses when calculating the incremental cash flows associated
with a project).
A) \$119,000
B) \$264,000
C) \$198,000
D) \$165,000
E) \$297,000

12. A machine costs \$60 and requires \$35 in maintenance for each year of its three year life. After three years,
this machine will be replaced. If the machine is straight-line depreciable to zero and has no salvage value,
what is the EAC? Assume a tax rate of 34% and a discount rate of 14%.
A) -\$39.48
B) -\$42.14
C) -\$48.33
D) -\$59.13
E) -\$97.84

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Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                                  Dr. Thomas Walker

Use the following to answer questions 13-16:

Your firm needs a computerized line-boring machine which costs \$80,000, and requires \$20,000 in maintenance for
each year of its three year life. After three years, the salvage value will be zero. The machine falls into the Class 10
equipment category (CCA rate 30%). Assume a tax rate of 34% and a discount rate of 10%.

13.   Compute the depreciation tax shield for year 3.
A)    \$2,016
B)    \$4,855
C)    \$4,031
D)    \$5,222
E)   \$5,719

14.   Compute the annual after-tax maintenance cost.
A)    \$10,000
B)    \$12,250
C)    \$13,200
D)    \$15,250
E)   \$27,200

15. Assume the machine can be sold for \$10,000 at the end of year 3. Compute the present value of the salvage
value at the end of year 3.
A) \$10,000
B) \$7,513
C) \$6,600
D) \$8,616
E) \$9,678

Chapters 8-10 (Part 1):
16.   The hypothesis that market prices reflect all historical information is called efficiency in the:
A)    Open form.
B)    Stable form.
C)    Weak form.
D)    Strong form.
E)   Semi-strong form.

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Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                                 Dr. Thomas Walker

17.   If capital markets are efficient, then ________________________.
A)    there is no reason to believe that prices are too high or too low
B)    it is not possible to make money by playing the stock market
C)    historical price trends will give you a good idea of where prices are headed in the future
D)    prices will adjust slowly when reacting to new information
E)   it is possible to profit regularly from publicly available information

18. You discover you can make above normal returns if you buy oil-company stocks just before noon on any
given trading day and then sell them immediately before the market closes that same day. Which of the
following describes this event?
A) This would be a violation of weak form efficiency.
B) This would be a violation of all forms of market efficiency.
C) This would be a violation of strong form efficiency.
D) This would not be a violation of market efficiency.
E) This would be a violation of semi-strong form efficiency.

19. If we assume that the annual return on common stocks are normally distributed, then approximately 95% of
the returns will fall within the range ___________% if the average historical return is 13.2% with a
standard deviation of 20.3%.
A) –7.1 to 33.5
B) –27.4 to 53.8
C) 7.1 to 33.5
D) –27.4 to 33.5
E) –5.1 to 45.7

20. You purchased 200 shares of preferred stock on January 1, 1998 for \$42.27 per share. The stock pays an
annual dividend of \$7 per share. On December 31, 1998 the market price is \$46.88 per share. What is your
total dollar return for the year?
A) \$2,322
B) \$2,678
C) \$1,400
D) \$ 478
E) \$ 922

21. An investment earned the following returns for the years 1995 through 1998: –20%, 50%, 30%, and 10%.
What is the variance of returns for this investment?
A) 0.2987
B) 0.1747
C) 0.0892
D) 0.1121
E) 0.1541

PAGE 5
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                              Dr. Thomas Walker

22. You purchased a bond on January 1, 1998 for \$839.67. The bond has a \$1,000 face value, an 8% annual
coupon, and can be sold for \$822.33 on December 31, 1998. What is your percentage return on investment
for the year?
A) 7.5%
B) 11.6%
C) 11.8%
D) –2.1%
E) 8.6%

23. Given the following historical returns, what is the standard deviation? Year 1 = 20%; year 2 = –12%; year 3
= 16%; year 4 = 3%; year 5 = –15%.
A) 14.18%
B) 12.48%
C) 16.87%
D) 15.85%
E) 11.89%

24. Which of the following two stocks is more volatile based on their historical returns?
Year              1            2            3              4            5
Return A          .04          .06          .08            .10          .12
Return B          .08          .09          .10            .11          .12
A) A because it has a lower mean
B) B because it has a lower standard deviation
C) B because it has a higher variance
D) B because it has a higher mean
E) A because it has a higher standard deviation

Use the following to answer questions 25-26:

Use the following historical data over the 1926–1998 period

Asset                              Average Return    Standard Deviation
Large-company stocks                                   13.2%                20.3%
Small-company stocks                                   17.4%                33.8%
Long-term government bonds                              5.7%                  9.2%
US Treasury bills                                      3.8%                  3.2%

25.   What is the historical risk premium on large-company stocks?
A)    7.5%
B)    13.6%
C)    1.9%
D)    0.0%
E)   9.4%

PAGE 6
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                                      Dr. Thomas Walker

26. Assume the return on T-bills is normally distributed. With 68% confidence, what is the highest return you
would expect to earn on T-bills?
A) 13.4%
B) 7.0%
C) 3.2%
D) 3.8%
E) 10.2%

Chapters 8-10 (Part 2):
27.   Risk that affects a large number of assets, each to a greater or lesser degree, is called:
A)    Diversifiable risk.
B)    Total risk.
C)    Asset-specific risk.
D)    Idiosyncratic risk.
E)   Systematic risk.

28.   A particular risky asset's risk premium, measured relative to its beta coefficient, is its:
A)    Systematic risk.
B)    Reward to risk ratio.
C)    Market risk premium.
D)    Security market line.
E)   Diversifiable risk.

29. If portfolio weights are positive: 1) Can the return on a portfolio ever be less than the smallest return on an
individual security in the portfolio? 2) Can the variance of a portfolio ever be less than the smallest
variance of an individual security in the portfolio?
A) 1) no; 2) yes
B) 1) yes; 2) no
C) 1) no; 2) no
D) 1) maybe;          2) no
E) 1) yes; 2) yes

30. You have a portfolio consisting of equal amounts of IBM stock and Treasury bills. If you replace half of
the Treasury bills with more IBM stock, the portfolio expected return will likely ___________ , all else the
same.
A) remain unchanged
B) decrease if IBM is considered a small-cap stock
C) either increase or decrease
D) increase
E) decrease

PAGE 7
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                               Dr. Thomas Walker

31. Given the following information: The risk-free rate is 7%, the beta of stock A is 1.2, the beta of stock B is
0.8, the expected return on stock A is 13.5%, and the expected return on stock B is 11.0%. Further, we
know that stock A is fairly priced and that the betas of stocks A and B are correct. Which of the following
regarding stock B must be true?
A) The expected return on stock A is too high.
B) The price of stock A is too high.
C) The price of stock B is too high.
D) Stock B is also fairly priced.
E) The expected return on stock B is too high.

32. Asset A, which has an expected return of 12% and a beta of 0.8, plots on the security market line. Which of
the following is false about Asset B, another risky asset with a beta of 1.4?
A) If Asset B plots on the SML, then Asset B and Asset A have the same reward to risk ratio.
B) Asset B has more systematic risk than both Asset A and the market portfolio.
C) If Asset B plots on the SML with an expected return = 18%, the expected return on the market must be
15%.
D) If the market is in equilibrium, Asset B also plots on the SML.
E) If Asset B plots on the SML with an expected return = 18%, then the risk-free rate must be 4%.

33. What is the expected return for the following stock?
State                       Probability        Return
Average                     .55                .20
Recession                   .20                .10
Depression                  .25                –.20
A) 0.110
B) 0.095
C) 0.055
D) 0.105
E) 0.080

34. What is the variance of the following returns?
State                      Probability         Return
Boom                       .15                 .60
Good                       .50                 .20
Recession                  .25                 –.10
Depression                 .10                 –.30
A) 0.4156
B) 0.0673
C) 0.1324
D) 0.0523
E) 0.0835

PAGE 8
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                                Dr. Thomas Walker

35. What is the expected portfolio return given the following information:
Asset              Portfolio weight          Return
A                  .25                       15%
B                  .25                       20%
C                  .30                       10%
D                  .20                       35%
A) 9.23%
B) 21.15%
C) 7.71%
D) 19.25%
E) 18.75%

36. What is the expected market return if the expected return on asset A is 16% and the risk-free rate is 7%?
Asset A has a beta of 1.2.
A) 17.5%
B) 14.5%
C) 16.5%
D) 20.5%
E) 9.5%

37. What is the portfolio beta if 25% of your funds are invested in the market portfolio, 25% in an asset with
twice as much risk as the market portfolio, and the remainder in a risk-free asset?
A) 0.25
B) 1.00
C) 1.25
D) 0.75
E) 0.50

38. You hold three stocks in your portfolio: A, B, and C. The portfolio beta is 1.50. Stock A comprises 20% of
the dollar value of your holdings and has a beta of 1.0. If you sell all of your investment in A and invest the
proceeds in the risk-free asset, your new portfolio beta will be:
A) 1.625
B) 0.850
C) 1.200
D) 1.300
E) 1.025

PAGE 9
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                              Dr. Thomas Walker

Use the following to answer questions 39-42:

State             Probability        Return on A      Return on B
Boom              .6                 0.15             0.08
Bust              .4                 0.05             0.20

39.   What is the expected return on security B?
A)    0.128
B)    0.138
C)    0.100
D)    0.080
E)   0.110

40.   What is the expected return on a portfolio that is 40% invested in A and 60% invested in B?
A)    0.100
B)    0.138
C)    0.128
D)    0.110
E)   0.121

41. What is the expected return on a portfolio that equally-weighted amongst A, B, and the risk-free asset? The
expected return on the risk free asset is 4%.
A) 0.138
B) 0.089
C) 0.118
D) 0.093
E) 0.101

42.   What is the standard deviation of security A?
A)    0.0002
B)    0.0006
C)    0.0490
D)    0.0600
E)   0.0545

PAGE 10
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                             Dr. Thomas Walker

Chapter 20:
43. When firms develop a WACC for individual projects based on the cost of capital for other firms in similar
lines of business as the project, the firm is utilizing a ____________________.
A) security market line approach
B) subjective risk approach
C) pure play approach
D) capital adjustment approach
E) divisional cost of capital approach

44. Which of the following is NOT a legitimate reason it is generally considered easier to estimate the cost of
preferred stock than it is to estimate the cost of common stock?
A) Calculation of the cost of preferred stock does not require any information about future preferred dividends.
B) The cost of preferred stock is simply equal to its dividend yield.
C) The cost of preferred stock can be calculated as a perpetuity based on the fixed dividend payment and the
present stock price.
D) Preferred stock is often rated for default risk.
E) Preferred stock generally carries with it a fixed dividend payment.

45. Suppose a firm uses a constant WACC in determining the value of capital budgeting projects rather than
using the security market line. The firm will tend to _____________________.
A) accept profitable, low risk projects
B) become more risky over time
C) accept profitable, low risk projects and reject unprofitable, high risk projects
D) accept profitable, low risk projects and accept unprofitable, high risk projects
E) reject unprofitable, high risk projects

46. Ignoring taxes, if a firm issues debt at par, then _____________________.
I. the cost of debt is equal to its coupon rate
II. the cost of debt is equal to its yield to maturity
III. the cost of debt differs from its current yield
A) I and III only
B) I, II and III
C) I and II only
D) I only
E) II only

PAGE 11
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                              Dr. Thomas Walker

47. Which of the following is/are true: The cost of capital _______________________.
I. is an opportunity cost that depends on the use of the funds, not the source
II. is the same thing as the required rate of return
III. is the same as the WACC for projects with equal risk to the firm as a whole
IV. is also known as the appropriate discount rate
A) I, III, and IV only
B) II, III, and IV only
C) I, II, III, and IV
D) I, II, and IV only
E) II and III only

48. Suppose that two firms, A and B, are considering the same project which has the same risk as firm B's
overall operations. The project has an IRR of 14.0%. Firm A has a beta of 1.4, while firm B's beta is 1.1. If
the risk-free rate is 5.25% and the market risk premium is 7.0%, which firm(s) should take the project?
A) A only
B) B only
C) Both A and B
D) Neither A nor B
E) Cannot be determined without additional information

49. Given the following: the risk-free rate is 8% and the market risk premium is 8.5%. Which projects should
be accepted if the firm's beta is 1.2?
Project             Beta            Expected return
I                   0.65            12%
II                  0.90            17%
III                 1.40            19%
A) I and II only
B) None of the projects are acceptable
C) II only
D) III only
E) I only

50. The long-term debt of Topstone Industries is currently selling for 104.50% of its face value. The issue
matures in 10 years and pays an annual coupon of 8%. What is the cost of debt?
A) 7.84%
B) 9.45%
C) 6.75%
D) 8.60%
E) 7.35%

PAGE 12
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                                Dr. Thomas Walker

51. Topstone Industries' preferred stock pays an annual dividend of \$4.00 per share. When issued, the shares
sold for their par value of \$100 per share. What is the cost of preferred stock if the current price is \$125 per
share?
A) 4.7%
B) 31.3%
C) 3.2%
D) 3.7%
E) 4.0%

52. Topstone Industries is expected to pay a dividend of \$2.10 per share in one year. This dividend, along with
the firm's earnings, is expected to grow at a rate of 5% forever. If the current market price for a share of
Topstone is \$38.62, what is the cost of equity?
A) 6.00%
B) 10.44%
C) 11.22%
D) 11.00%
E) 10.71%

53. Suppose that Topstone Industries has a cost of equity of 14% and a cost of debt of 9%. If the target
debt/equity ratio is 75%, and the tax rate is 34%, what is Topstone's weighted average cost of capital
(WACC)?
A) 8.4%
B) 10.9%
C) 10.5%
D) 7.9%
E) 6.6%

54. Suppose a firm has 10.4 million shares of common stock outstanding with a par value of \$1.00 per share.
The current market price per share is \$12.00. The firm has outstanding debt with a par value of \$56.0
million selling at 102% of par. What capital structure weight would you use for debt when calculating the
firm's WACC?
A) 0.843
B) 0.739
C) 0.314
D) 0.686
E) 0.157

PAGE 13
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                                 Dr. Thomas Walker

55. A firm has a WACC of 12%. It is financed with 40% debt and 60% equity. The firm's cost of debt is 10%
and its tax rate is 40%. If the firm's dividend growth rate is 8% and its current stock price is \$40, what is the
value of the next dividend the firm is expected to pay?
A) Greater than \$4.25
B) Cannot be determined without additional information
C) Less than \$3.00
D) Between \$3.51 and \$4.25, inclusive
E) Between \$3.01 and \$3.50, inclusive

56. Given the following information, what is WBM Corporation's WACC?
Common Stock:1 million shares outstanding, \$40 per share, \$1 par value, beta = 1.3
Bonds:10,000 bonds outstanding, \$1,000 face value each, 8% annual coupon, 22 years to maturity, market
price = \$1,101.23 per bond
Market risk premium = 8.6%, risk-free rate = 4.5%, marginal tax rate = 34%
A) 7.89%
B) 13.30%
C) 9.90%
D) 15.78%
E) 12.19%

57. A proposed project lasts 3 years and has an initial investment of \$200,000. The aftertax cash flows are
estimated at \$60,000 for year 1, \$120,000 for year 2, and \$135,000 for year 3. The firm has a target
debt/equity ratio of 1.2. The firm's cost of equity is 14% and its cost of debt is 9%. The tax rate is 34%.
What is the NPV of this project?
A) \$ 37,723
B) \$ 46,120
C) \$ 57,185
D) –\$12,370
E) \$ 13,687

Chapter 21:
58.   The implicit costs associated with corporate default, such as lost sales, are the __________ of the firm.
A)    flotation costs
B)    indirect bankruptcy costs
C)    default beta coefficients
D)    default risk premia
E)   direct bankruptcy costs

PAGE 14
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                                    Dr. Thomas Walker

59.   The proposition that the cost of equity is a positive linear function of capital structure is called:
A)    The Efficient Markets Hypothesis.
B)    M&M Proposition II.
C)    The Law of One Price.
D)    M&M Proposition I.
E)   The Capital Asset Pricing Model.

60. Which of the following is NOT accurate regarding financial leverage?
A) The level of financial leverage that produces the highest firm value is the one most beneficial to
stockholders.
B) Whenever a firm's debt increases faster than its equity, financial leverage increases.
C) Investors can undo the effects of the firm's capital structure by using homemade leverage.
D) Leverage is most beneficial when EBIT is relatively high.
E) Increasing financial leverage will always increase the EPS for stockholders.

61.Of the following, all are conclusions that can be drawn from the capital structure puzzle EXCEPT:
A) All else the same, firms with tangible, liquid assets will have an incentive to borrow more.
B) The financial structure that minimizes WACC is the one that will maximize the value of the firm.
C) In the framework of the static theory of capital structure, a firm can precisely identify its optimal capital
structure.
D) Firms in lower tax brackets will tend to benefit less from increases in financial leverage.
E) Firms with tax shields from other sources such as depreciation will benefit less from leverage.

62. Below the breakeven EBIT, increased financial leverage will _______ EPS, all else the same. Assume there
are no taxes.
A) increase
B) increase EBIT but decrease
C) not affect
D) decrease
E) either increase or decrease

63. The Brassy Co. has expected EBIT = \$910, an unlevered cost of capital of 12%, and debt with a face and
market value of \$2,000 paying an 8.5% annual coupon. If the tax rate is 34%, what is the WACC of Brassy
Co.?
A) 10.56%
B) 11.12%
C) 13.25%
D) 13.64%
E) 14.45%

PAGE 15
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                             Dr. Thomas Walker

64. An unlevered firm with a market value of \$1 million has 50,000 shares outstanding. The firm restructures
itself by issuing 200 new par bonds with face value \$1,000 and an 8% coupon. The firm uses the proceeds
to repurchase outstanding stock. In considering the newly levered versus formerly unlevered firm, what is
the breakeven EBIT? Ignore taxes.
A) \$50,000
B) \$95,000
C) \$75,000
D) \$80,000
E) \$25,000

65. The unlevered cost of capital for Red Ryder, Inc. is 12%. Pretax debt costs are 8%. Assuming a debt equity
ratio of 0.33, what is the cost of equity? The tax rate is 34%.
A) 13.8%
B) 13.4%
C) 12.6%
D) 11.0%
E) 12.9%

66. A firm with no debt has 200,000 shares outstanding valued at \$20 each. Its cost of equity is 12%. The firm
is considering adding \$1 million in debt to its capital structure. The coupon rate would be 8% and the bonds
would sell for par value. The firm's tax rate is 34%. How much will the firm be worth after adding the debt?
A) \$4.033 million
B) \$4.340 million
C) \$4.180 million
D) \$5.000 million
E) \$4.660 million

67. An unlevered firm has aftertax net income = \$125,000. The unlevered cost of capital is 13% and the
corporate tax rate is 34%. What is the value of this firm?
A) \$ 729,654
B) \$ 961,538
C) \$1,051,591
D) \$ 594,102
E) \$ 634,615

68. The Wrangler Co. has expected EBIT = \$9,250, debt with a face and market value of \$14,000 paying a 9%
annual coupon, and an unlevered cost of capital of 12%. If the tax rate is 39%, what is the value of
Wrangler's equity?
A) \$55,635
B) \$65,600
C) \$52,481
D) \$38,481
E) \$58,525

PAGE 16
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                              Dr. Thomas Walker

69. An unlevered firm has an EBIT = \$250,000, aftertax net income = \$165,000, and a cost of capital of 12%.
A levered firm with the same assets and operations has \$1.25 million in face value debt paying an 8%
annual coupon; the debt sells for par value in the marketplace. What is the value of the levered firm? The
tax rate is 34%.
A) \$1,250,000
B) \$2,625,000
C) \$1,800,000
D) \$1,666,667
E) \$1,375,000

70. The Wrangler Co. has expected EBIT = \$9,250, and debt with a face and market value of \$14,000 paying a
9% annual coupon. The market value of the firm is \$58,525. If the tax rate is 34%, what is Wranger's
unlevered cost of capital?
A) 11.35%
B) 12.76%
C) 12.99%
D) 9.00%
E) 12.12%

71. Given the following, what is the WACC? EBIT = \$2 million; tax rate = 34%; market value and book value
of debt = \$4 million; unlevered cost of capital = 14%; cost of debt = 9%.
A) 11.9%
B) 13.1%
C) 12.2%
D) 11.4%
E) 12.6%

Chapter 22:
72. The date before which a new purchaser of stock is entitled to receive a declared dividend, but on or after
which she does not receive the dividend, is called the ____________ date.
A) ex-dividend
B) payment
C) declaration
D) ex-rights
E) record

PAGE 17
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                               Dr. Thomas Walker

73. Which of the following is NOT accurate regarding share repurchases?
A) Investors will not prefer share repurchases to extra cash dividends if the capital gains tax rate is lower than
the tax rate on dividends.
B) Repurchasing shares is a useful method of stabilizing cash dividends.
C) Share repurchases cannot be undertaken with the sole purpose of avoiding taxes.
D) Share repurchases result in an increase in earnings per share.
E) In a perfect world, there would be essentially no difference between a share repurchase and a cash
dividend.

74. Suppose a firm wishes to have its stock listed on an exchange but its share price is not high enough to meet
the exchange's specified minimum price level. How might the firm remedy this situation and reduce the
number of shares outstanding at the same time?
A) Pay a liquidating dividend.
B) Pay a stock dividend.
C) Pay a regular cash dividend.
D) Execute a stock split.
E) Execute a reverse stock split.

75.   A firm plans to split its stock 2-for-1. Which of the following most likely will NOT occur?
A)    Price per share will fall by half.
B)    The number of shares outstanding will double.
C)    The number of shares owned by each individual investor will double.
D)    Total shareholders' equity will be reduced by half.
E)   Par value per share will be reduced by half.

76. You own stock in a firm that has 1.25 million shares outstanding. The current stock price is \$13.50 per
share. If the company issues a 10% stock dividend, what would you expect the stock price to be after the
dividend is paid?
A) \$12.27
B) \$13.30
C) \$12.82
D) \$13.71
E) \$13.49

77. DRK, Inc. currently has 400,000 shares of stock outstanding, with a market price of \$20 and a par value of
\$2. The firm would prefer to have its stock trade at a value between \$30 and \$35 per share. Of the
following choices, which would allow the firm to achieve its objective?
A) A 1-for-2 reverse stock split
B) A \$2 per share cash dividend
C) A 2-for-3 reverse stock split
D) A 2-for-1 stock split
E) A 50% stock dividend

PAGE 18
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                                                Dr. Thomas Walker

Chapter 12:
78. The value of an option if it were to immediately expire, that is, it's lower pricing bound, is called an
option's _________________.
A) market value
B) intrinsic value
C) time value
D) strike value
E) volatility value

79. In July, you purchase a September 75 put option on Keebler, Inc. common stock. You:
A) Will have a negative cash flow at the time you initiate the contract and a positive cash flow when the option
expires if the stock price is less than \$75 at that time.
B) Have given the seller the right to buy a share of Keebler stock at \$75 sometime prior to the September
expiration.
C) Will have a worthless option in August if the stock price is \$80 at that time.
D) Have the right to buy a share of Keebler stock at \$75 sometime prior to the September expiration.
E) Should exercise the option at expiration if the price of Keebler stock is \$80.

80. A put option you own is going to expire in one second. The current stock price is \$25 and the strike price of
your option is \$30. Which of the following statements is NOT true?
A) Your option is in-the-money.
B) You have the right to sell the stock for \$30.
C) Someone other than you stands to gain \$5 per share when the option is exercised.
D) Your option should be exercised or sold.
E) Your option has intrinsic value.

81. A local retail store allows you to return the merchandise you purchase and get your money back for up to
30 days after the purchase date. The store has, in effect, provided each shopper with _______________
options.
A) American call
B) convertible bond
C) American put
D) European call
E) European put

PAGE 19
Concordia University
Department of Finance, John Molson School of Business
GDBA 505 - Homework No. 2 (Winter 2010)
Due Date: Tuesday, March 30, 2010                                             Dr. Thomas Walker

82. Which of the following would decrease the value of a call option?
I. The exercise price is decreased
II. The value of the underlying asset decreases
III. The expiration date is extended
IV. The variance of the underlying asset decreases
A) I and III only
B) II and III only
C) II and IV only
D) I and II only
E) I and IV only

PAGE 20

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