Fight Finance

Question 114  WACC, capital structure, risk

A firm's WACC before tax would decrease due to:

(a) the firm's industry becoming more systematically risky, for example if it was a mining company and commodities prices varied more strongly and were more positively correlated with the market portfolio.

(b) the firm's industry becoming less systematically risky, for example if it was a child care centre and the government announced permanently higher subsidies for parents' child care expenses.

(c) the firm issuing more debt and using the proceeds to repurchase stock.

(d) the firm issuing more equity and using the proceeds to pay off debt holders.

(e) none of the above.

Question 367  CFFA, interest tax shield

There are many ways to calculate a firm's free cash flow (FFCF), also called cash flow from assets (CFFA). Some include the annual interest tax shield in the cash flow and some do not.

Which of the below FFCF formulas include the interest tax shield in the cash flow?

###(1) \quad FFCF=NI + Depr - CapEx -ΔNWC + IntExp### ###(2) \quad FFCF=NI + Depr - CapEx -ΔNWC + IntExp.(1-t_c)### ###(3) \quad FFCF=EBIT.(1-t_c )+ Depr- CapEx -ΔNWC+IntExp.t_c### ###(4) \quad FFCF=EBIT.(1-t_c) + Depr- CapEx -ΔNWC### ###(5) \quad FFCF=EBITDA.(1-t_c )+Depr.t_c- CapEx -ΔNWC+IntExp.t_c### ###(6) \quad FFCF=EBITDA.(1-t_c )+Depr.t_c- CapEx -ΔNWC### ###(7) \quad FFCF=EBIT-Tax + Depr - CapEx -ΔNWC### ###(8) \quad FFCF=EBIT-Tax + Depr - CapEx -ΔNWC-IntExp.t_c### ###(9) \quad FFCF=EBITDA-Tax - CapEx -ΔNWC### ###(10) \quad FFCF=EBITDA-Tax - CapEx -ΔNWC-IntExp.t_c###

The formulas for net income (NI also called earnings), EBIT and EBITDA are given below. Assume that depreciation and amortisation are both represented by 'Depr' and that 'FC' represents fixed costs such as rent.

###NI=(Rev - COGS - Depr - FC - IntExp).(1-t_c )### ###EBIT=Rev - COGS - FC-Depr### ###EBITDA=Rev - COGS - FC### ###Tax =(Rev - COGS - Depr - FC - IntExp).t_c= \dfrac{NI.t_c}{1-t_c}###

(a) 1, 3, 5, 7, 9.

(b) 2, 4, 6, 8, 10.

(c) 1, 4, 6, 8, 10.

(d) 2, 3, 5, 7, 9.

(e) 1, 3, 5, 8, 10.

Question 399  option, no explanation

A European call option will mature in ##T## years with a strike price of ##K## dollars. The underlying asset has a price of ##S## dollars.

What is an expression for the payoff at maturity ##(f_T)## in dollars from owning (being long) the call option?

(a) ##\max(S_T - K, 0)##.

(b) ##\max(S_T - K, K)##.

(c) ##\max(K-S_T, 0)##.

(d) ##\max(K-S_T, K)##.

(e) ##\min(K-S_T, 0)##.

Question 461  book and market values, ROE, ROA, market efficiency

One year ago a pharmaceutical firm floated by selling its 1 million shares for $100 each. Its book and market values of equity were both $100m. Its debt totalled $50m. The required return on the firm's assets was 15%, equity 20% and debt 5% pa.

In the year since then, the firm:

• Earned net income of $29m.
• Paid dividends totaling $10m.
• Discovered a valuable new drug that will lead to a massive 1,000 times increase in the firm's net income in 10 years after the research is commercialised. News of the discovery was publicly announced. The firm's systematic risk remains unchanged.

Which of the following statements is NOT correct? All statements are about current figures, not figures one year ago.

(a) The book value of equity would be larger than the market value of equity.

(b) The book ROA from accounting would be larger than the required return on assets from finance.

(c) The book ROE from accounting would be larger than the required return on equity from finance.

(d) The book ROE would be larger than the book ROA.

(e) The required return on equity would be larger than the required return on assets.

Hint: Book return on assets (ROA) and book return on equity (ROE) are ratios that accountants like to use to measure a business's past performance.

###\text{ROA}= \dfrac{\text{Net income}}{\text{Book value of assets}}###

###\text{ROE}= \dfrac{\text{Net income}}{\text{Book value of equity}}###

The required return on assets ##r_V## is a return that financiers like to use to estimate a business's future required performance which compensates them for the firm's assets' risks. If the business were to achieve realised historical returns equal to its required returns, then investment into the business's assets would have been a zero-NPV decision, which is neither good nor bad but fair.

###r_\text{V, 0 to 1}= \dfrac{\text{Cash flow from assets}_\text{1}}{\text{Market value of assets}_\text{0}} = \dfrac{CFFA_\text{1}}{V_\text{0}}###

Similarly for equity and debt.

Question 641  future, no explanation

Which of the below formulas gives the payoff at maturity ##(f_T)## from being long a future? Let the underlying asset price at maturity be ##S_T## and the locked-in futures price be ##K_T##.

(a) ##f_{LF,T}=S_T+K_T##

(b) ##f_{LF,T}=-S_T-K_T##

(c) ##f_{LF,T}=S_T-K_T##

(d) ##f_{LF,T}=K_T-S_T##

(e) ##f_{LF,T}=S_T##

Question 777  CAPM, beta

The market's expected total return is 10% pa and the risk free rate is 5% pa, both given as effective annual rates.

A stock has a beta of 0.5.

In the last 5 minutes, the federal government unexpectedly raised taxes. Over this time the share market fell by 3%. The risk free rate was unchanged.

What do you think was the stock's historical return over the last 5 minutes, given as an effective 5 minute rate?

(a) -1%

(b) -1.5%

(c) -2.5%

(d) -3%

(e) -7.5%

Question 782  portfolio return, portfolio weights

An investor owns a portfolio with:

• 80% invested in stock A; and
• 20% invested in stock B.

Today there was a:

• 10% rise in stock A's price; and
• No change in stock B's price.

No dividends were paid on either stock. What was the total historical portfolio return on this day? All returns above and answer options below are given as effective daily rates.

(a) 2%

(b) 4%

(c) 8%

(d) 10%

(e) 80%

Question 942  dividend date, ex dividend date

To receive the dividend you must own the stock when the market closes on which date?

(a) Announcement date

(b) Last cum-dividend date

(c) Ex-dividend date

(d) Record date

(e) Payment date

Question 949  future, contango

If futures prices are in contango, then futures prices (##F_{0,T}##) are than, than or to spot prices (##S_0##)?

Question 969  foreign exchange rate, no explanation

RBA analyst Adam Hamilton wrote in the December 2018 Bulletin article ‘Understanding Exchange Rates and Why They Are Important’ the following passage about bilateral exchange rates:

A bilateral exchange rate refers to the value of one currency relative to another. It is the most commonly referenced type of exchange rate. Most bilateral exchange rates are quoted against the US dollar (USD), as it is the most traded currency globally. Looking at the Australian dollar (AUD), the AUD/USD exchange rate gives you the amount of US dollars that you will receive for each Australian dollar that you convert (or sell). For example, an AUD/USD exchange rate of 0.75 means that you will get US75 cents for every 1 AUD.

An appreciation of the Australian dollar is an increase in its value compared with a foreign currency. This means that each Australian dollar buys you more foreign currency than before. Equivalently, if you are buying an item that is priced in foreign currency it will now cost you less in Australian dollars than before. If there is a depreciation of the Australian dollar, the opposite is true.

Based on this information, which of the following statements is NOT correct?

(a) 'US75 cents for every 1 AUD’ is an American terms quote of the AUD.

(b) 'US75 cents for every 1 AUD’ is equivalent to 0.75AUD per USD.

(c) The AUD would have appreciated against the USD if the quote moved from US75 to US80 cents for every 1 AUD.

(d) Importers of US goods into Australia would pay less in AUD and be happy if the exchange rate moved from US75 to US80 cents for every 1 AUD, all other things remaining equal.

(e) Exporters of Australian goods into the USA would receive less in AUD and be unhappy if the exchange rate moved from US75 to US80 cents for every 1 AUD, all other things remaining equal.