Fight Finance

Question 128  debt terminology, needs refinement

An 'interest payment' is the same thing as a 'coupon payment'. or ?

Question 129  debt terminology

An 'interest rate' is the same thing as a 'coupon rate'. or ?

Question 130  debt terminology

An 'interest rate' is the same thing as a 'yield'. or ?

Question 374  debt terminology

Which of the following statements is NOT equivalent to the yield on debt?

Assume that the debt being referred to is fairly priced, but do not assume that it's priced at par.

(a) Debt coupon rate.

(b) Required return on debt.

(c) Total return on debt.

(d) Opportunity cost of debt.

(e) Cost of debt capital.

Question 373  debt terminology

Which of the following statements is NOT correct? Lenders:

(a) Are long debt.

(b) Invest in debt.

(c) Are owed money.

(d) Provide debt funding.

(e) Have debt liabilities.

Question 290  APR, effective rate, debt terminology

Which of the below statements about effective rates and annualised percentage rates (APR's) is NOT correct?

(a) An effective annual rate could be called: "a yearly rate compounding per year".

(b) An APR compounding monthly could be called: "a yearly rate compounding per month".

(c) An effective monthly rate could be called: "a yearly rate compounding per month".

(d) An APR compounding daily could be called: "a yearly rate compounding per day".

(e) An effective 2-year rate could be called: "a 2-year rate compounding every 2 years".

Question 330  APR, effective rate, debt terminology

Which of the following statements about effective rates and annualised percentage rates (APR's) is NOT correct?

(a) Effective rates compound once over their time period. So an effective monthly rate compounds once per month.

(b) APR's compound more than once per year. So an APR compounding monthly compounds 12 times per year. The exception is an APR that compounds annually (once per year) which is the same thing as an effective annual rate.

(c) To convert an effective rate to an APR, multiply the effective rate by the number of time periods in one year. So an effective monthly rate multiplied by 12 is equal to an APR compounding monthly.

(d) To convert an APR compounding monthly to an effective monthly rate, divide the APR by the number of months in one year (12).

(e) To convert an APR compounding monthly to an effective weekly rate, divide the APR by the number of weeks in one year (approximately 52).

Question 16  credit card, APR, effective rate

A credit card offers an interest rate of 18% pa, compounding monthly.

Find the effective monthly rate, effective annual rate and the effective daily rate. Assume that there are 365 days in a year.

All answers are given in the same order:

### r_\text{eff monthly} , r_\text{eff yearly} , r_\text{eff daily} ###

(a) 0.0072, 0.09, 0.0002.

(b) 0.0139, 0.18, 0.0005.

(c) 0.0139, 6.2876, 0.0055.

(d) 0.015, 0.1956, 0.0005.

(e) 0.015, 0.1956, 0.006.

Question 26  APR, effective rate

A European bond paying annual coupons of 6% offers a yield of 10% pa.

Convert the yield into an effective monthly rate, an effective annual rate and an effective daily rate. Assume that there are 365 days in a year.

All answers are given in the same order:

### r_\text{eff, monthly} , r_\text{eff, yearly} , r_\text{eff, daily} ###

(a) 0.0041, 0.05, 0.0001.

(b) 0.0080, 0.1, 0.0003.

(c) 0.0083, 0.1, 0.0003.

(d) 0.0083, 2.1384, 0.0031.

(e) 0.0083, 0.1047, 0.0033.

Question 49  inflation, real and nominal returns and cash flows, APR, effective rate

In Australia, nominal yields on semi-annual coupon paying Government Bonds with 2 years until maturity are currently 2.83% pa.

The inflation rate is currently 2.2% pa, given as an APR compounding per quarter. The inflation rate is not expected to change over the next 2 years.

What is the real yield on these bonds, given as an APR compounding every 6 months?

(a) 0.3086%

(b) 0.6171%

(c) 0.6181%

(d) 0.6239%

(e) 0.6300%

Question 265  APR, Annuity

On his 20th birthday, a man makes a resolution. He will deposit $30 into a bank account at the end of every month starting from now, which is the start of the month. So the first payment will be in one month. He will write in his will that when he dies the money in the account should be given to charity.

The bank account pays interest at 6% pa compounding monthly, which is not expected to change.

If the man lives for another 60 years, how much money will be in the bank account if he dies just after making his last (720th) payment?

(a) $712,534.12

(b) $211,628.47

(c) $21,600.00

(d) $15,993.85

(e) $5,834.58

Question 348  PE ratio, Multiples valuation

Estimate the US bank JP Morgan's share price using a price earnings (PE) multiples approach with the following assumptions and figures only:

• The major US banks JP Morgan Chase (JPM), Citi Group (C) and Wells Fargo (WFC) are comparable companies;
• JP Morgan Chase's historical earnings per share (EPS) is $4.37;
• Citi Group's share price is $50.05 and historical EPS is $4.26;
• Wells Fargo's share price is $48.98 and historical EPS is $3.89.

Note: Figures sourced from Google Finance on 24 March 2014.

(a) $53.2353

(b) $53.1831

(c) $53.0995

(d) $26.5498

(e) $2.7849

Question 341  Multiples valuation, PE ratio

Estimate Microsoft's (MSFT) share price using a price earnings (PE) multiples approach with the following assumptions and figures only:

• Apple, Google and Microsoft are comparable companies,
• Apple's (AAPL) share price is $526.24 and historical EPS is $40.32.
• Google's (GOOG) share price is $1,215.65 and historical EPS is $36.23.
• Micrsoft's (MSFT) historical earnings per share (EPS) is $2.71.

Source: Google Finance 28 Feb 2014.

(a) $63.15

(b) $61.67

(c) $30.83

(d) $28.25

(e) $8.60

Question 347  PE ratio, Multiples valuation

Which of the following investable assets are NOT suitable for valuation using PE multiples techniques?

(a) Common equity in small private companies.

(b) Common equity in large private companies.

(c) Common equity in listed public companies.

(d) Fixed term bonds of listed public companies.

(e) Real estate.

Question 354  PE ratio, Multiples valuation

Which firms tend to have low forward-looking price-earnings (PE) ratios?

Only consider firms with positive earnings, disregard firms with negative earnings and therefore negative PE ratios.

(a) Illiquid small private companies.

(b) High growth technology firms.

(c) Firms expected to have temporarily low earnings over the next year, but with higher earnings later.

(d) Firms with a very low level of systematic risk.

(e) Firms whose assets include a very large proportion of cash.

Question 357  PE ratio, Multiples valuation

Which of the following investable assets are NOT suitable for valuation using PE multiples techniques?

(a) Common equity in a listed public mining extraction company that will cease operations, wind up, and return all capital to shareholders in one year when its sole gold mine becomes depleted.

(b) Common equity in a small private owner-operated mining services company whose main asset is its sole tanker truck which delivers fuel to mines. The firm's shares are 100% owned by Bob, the driver of the tanker truck.

(c) Common equity in a large listed public company in the banking industry.

(d) Residential apartment real estate.

(e) Commercial warehouse real estate.

Question 364  PE ratio, Multiples valuation

Which firms tend to have high forward-looking price-earnings (PE) ratios?

(a) Illiquid small private companies.

(b) Exchange-listed companies operating in stagnant industries with negative growth prospects.

(c) Exchange-listed companies expected to have temporarily high earnings over the next year, but with lower earnings later.

(d) Exchange-listed companies operating in high-risk industries with very high required returns on equity.

(e) Exchange-listed companies whose assets include a very large proportion of cash.

Question 173  CFFA

Find Candys Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Candys Corp
Income Statement for
year ending 30th June 2013
	$m
Sales	200
COGS	50
Operating expense	10
Depreciation	20
Interest expense	10
Income before tax	110
Tax at 30%	33
Net income	77

Candys Corp
Balance Sheet
as at 30th June	2013	2012
	$m	$m
Assets
Current assets	220	180
PPE
Cost	300	340
Accumul. depr.	60	40
Carrying amount	240	300
Total assets	460	480
Liabilities
Current liabilities	175	190
Non-current liabilities	135	130
Owners' equity
Retained earnings	50	60
Contributed equity	100	100
Total L and OE	460	480

 

Note: all figures are given in millions of dollars ($m).

(a) 242

(b) 182

(c) 112

(d) 92

(e) 52

Question 224  CFFA

Cash Flow From Assets (CFFA) can be defined as:

(a) Cash available to distribute to creditors and stockholders.

(b) Cash flow to creditors minus cash flow to stockholders.

(c) Net income (or earnings) plus depreciation plus interest expense.

(d) Net income minus the increase in net working capital.

(e) Net income minus net capital spending minus the increase in net working capital.

Question 225  CFFA

A firm has forecast its Cash Flow From Assets (CFFA) for this year and management is worried that it is too low. Which one of the following actions will lead to a higher CFFA for this year (t=0 to 1)? Only consider cash flows this year. Do not consider cash flows after one year, or the change in the NPV of the firm. Consider each action in isolation.

(a) Buy less land, buildings and trucks than what was planned. Assume that this has no impact on revenue.

(b) Pay off more debt than was planned, to reduce the firm’s interest expense.

(c) Change the depreciation method used for tax purposes from diminishing value to straight line, so less depreciation occurs this year and more occurs in later years. Assume that the government’s tax department allow this.

(d) Buying more inventory than was planned, so there is an increase in net working capital. Assume that there is no increase in sales.

(e) Raising new equity through a rights issue. Assume that all of the money raised is spent on new capital assets such as land and trucks, but they will be fitted out and delivered in one year so no new cash will be earned from them.

Question 359  CFFA

Which one of the following will have no effect on net income (NI) but decrease cash flow from assets (CFFA or FFCF) in this year for a tax-paying firm, all else remaining constant?

Remember:

###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c )### ###CFFA=NI+Depr-CapEx - ΔNWC+IntExp###

(a) An increase in revenue (Rev).

(b) An increase in rent expense (a type of recurring fixed cost, FC).

(c) An increase in depreciation expense (Depr).

(d) An increase in inventories (a current asset).

(e) An decrease in interest expense (IntExp).

Question 360  CFFA

Find Ching-A-Lings Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Ching-A-Lings Corp
Income Statement for
year ending 30th June 2013
	$m
Sales	100
COGS	20
Depreciation	20
Rent expense	11
Interest expense	19
Taxable Income	30
Taxes at 30%	9
Net income	21

Ching-A-Lings Corp
Balance Sheet
as at 30th June	2013	2012
	$m	$m
Inventory	49	38
Trade debtors	14	2
Rent paid in advance	5	5
PPE	400	400
Total assets	468	445
Trade creditors	4	10
Bond liabilities	200	190
Contributed equity	145	145
Retained profits	119	100
Total L and OE	468	445

 

Note: All figures are given in millions of dollars ($m).

The cash flow from assets was:

(a) $43m

(b) $31m

(c) $23m

(d) $11m

(e) $1m

Question 361  CFFA

Over the next year, the management of an unlevered company plans to:

• Make $5m in sales, $1.9m in net income and $2m in equity free cash flow (EFCF).
• Pay dividends of $1m.
• Complete a $1.3m share buy-back.

Assume that:

• All amounts are received and paid at the end of the year so you can ignore the time value of money.
• The firm has sufficient retained profits to legally pay the dividend and complete the buy back.
• The firm plans to run a very tight ship, with no excess cash above operating requirements currently or over the next year.

How much new equity financing will the company need? In other words, what is the value of new shares that will need to be issued?

(a) $2m

(b) $1m

(c) $0.4m

(d) $0.3m

(e) No new shares need to be issued, the firm will be sufficiently financed.

Question 504  CFFA

Read the following financial statements and calculate the firm's free cash flow over the 2014 financial year.

UBar Corp
Income Statement for
year ending 30th June 2014
	$m
Sales	293
COGS	200
Rent expense	15
Gas expense	8
Depreciation	10
EBIT	60
Interest expense	0
Taxable income	60
Taxes	18
Net income	42

UBar Corp
Balance Sheet
as at 30th June	2014	2013
	$m	$m
Assets
Cash	30	29
Accounts receivable	5	7
Pre-paid rent expense	1	0
Inventory	50	46
PPE	290	300
Total assets	376	382
Liabilities
Trade payables	20	18
Accrued gas expense	3	2
Non-current liabilities	0	0
Contributed equity	212	212
Retained profits	136	150
Asset revaluation reserve	5	0
Total L and OE	376	382

 

Note: all figures are given in millions of dollars ($m).

The firm's free cash flow over the 2014 financial year was:

(a) $51

(b) $52

(c) $58

(d) $61

(e) $62

Question 485  capital budgeting, opportunity cost, sunk cost

A young lady is trying to decide if she should attend university or not.

The young lady's parents say that she must attend university because otherwise all of her hard work studying and attending school during her childhood was a waste.

What's the correct way to classify this item from a capital budgeting perspective when trying to decide whether to attend university?

The hard work studying at school in her childhood should be classified as:

(a) A sunk cost.

(b) An opportunity cost.

(c) A negative side effect.

(d) A positive side effect.

(e) A depreciation expense.

Question 486  capital budgeting, opportunity cost, sunk cost

A young lady is trying to decide if she should attend university. Her friends say that she should go to university because she is more likely to meet a clever young man than if she begins full time work straight away.

What's the correct way to classify this item from a capital budgeting perspective when trying to find the Net Present Value of going to university rather than working?

The opportunity to meet a desirable future spouse should be classified as:

(a) A sunk cost.

(b) An opportunity cost.

(c) A negative side effect.

(d) A positive side effect.

(e) A depreciation expense.

Question 491  capital budgeting, opportunity cost, sunk cost

A man is thinking about taking a day off from his casual painting job to relax.

He just woke up early in the morning and he's about to call his boss to say that he won't be coming in to work.

But he's thinking about the hours that he could work today (in the future) which are:

(a) A sunk cost.

(b) An opportunity cost.

(c) A negative side effect.

(d) A capital expense.

(e) A depreciation expense.

Question 492  capital budgeting, opportunity cost, sunk cost

A man has taken a day off from his casual painting job to relax.

It's the end of the day and he's thinking about the hours that he could have spent working (in the past) which are now:

(a) A sunk cost.

(b) An opportunity cost.

(c) A negative side effect.

(d) A capital expense.

(e) A depreciation expense.

Question 377  leverage, capital structure

Issuing debt doesn't give away control of the firm because debt holders can't cast votes to determine the company's affairs, such as at the annual general meeting (AGM), and can't appoint directors to the board. or ?

Question 379  leverage, capital structure, payout policy

Companies must pay interest and principal payments to debt-holders. They're compulsory. But companies are not forced to pay dividends to share holders. or ?

Question 94  leverage, capital structure, real estate

Your friend just bought a house for $400,000. He financed it using a $320,000 mortgage loan and a deposit of $80,000.

In the context of residential housing and mortgages, the 'equity' tied up in the value of a person's house is the value of the house less the value of the mortgage. So the initial equity your friend has in his house is $80,000. Let this amount be E, let the value of the mortgage be D and the value of the house be V. So ##V=D+E##.

If house prices suddenly fall by 10%, what would be your friend's percentage change in equity (E)? Assume that the value of the mortgage is unchanged and that no income (rent) was received from the house during the short time over which house prices fell.

Remember:

### r_{0\rightarrow1}=\frac{p_1-p_0+c_1}{p_0} ###

where ##r_{0-1}## is the return (percentage change) of an asset with price ##p_0## initially, ##p_1## one period later, and paying a cash flow of ##c_1## at time ##t=1##.

(a) -100%

(b) -50%

(c) -12.5%

(d) -10%

(e) -8%

Question 301  leverage, capital structure, real estate

Your friend just bought a house for $1,000,000. He financed it using a $900,000 mortgage loan and a deposit of $100,000.

In the context of residential housing and mortgages, the 'equity' or 'net wealth' tied up in a house is the value of the house less the value of the mortgage loan. Assuming that your friend's only asset is his house, his net wealth is $100,000.

If house prices suddenly fall by 15%, what would be your friend's percentage change in net wealth?

Assume that:

• No income (rent) was received from the house during the short time over which house prices fell.
• Your friend will not declare bankruptcy, he will always pay off his debts.

(a) -1,000%

(b) -150%

(c) -100%

(d) -15%

(e) -10%

Question 511  capital budgeting, CFFA

Find the cash flow from assets (CFFA) of the following project.

One Year Mining Project Data
Project life	1 year
Initial investment in building mine and equipment	$9m
Depreciation of mine and equipment over the year	$8m
Kilograms of gold mined at end of year	1,000
Sale price per kilogram	$0.05m
Variable cost per kilogram	$0.03m
Before-tax cost of closing mine at end of year	$4m
Tax rate	30%

Note 1: Due to the project, the firm also anticipates finding some rare diamonds which will give before-tax revenues of $1m at the end of the year.

Note 2: The land that will be mined actually has thermal springs and a family of koalas that could be sold to an eco-tourist resort for an after-tax amount of $3m right now. However, if the mine goes ahead then this natural beauty will be destroyed.

Note 3: The mining equipment will have a book value of $1m at the end of the year for tax purposes. However, the equipment is expected to fetch $2.5m when it is sold.

Find the project's CFFA at time zero and one. Answers are given in millions of dollars ($m), with the first cash flow at time zero, and the second at time one.

(a) -9,   15.65

(b) -9,   14.3

(c) -12,   16.8

(d) -12,   16.35

(e) -12,   14.3

Question 512  capital budgeting, CFFA

Find the cash flow from assets (CFFA) of the following project.

Project Data
Project life	2 years
Initial investment in equipment	$6m
Depreciation of equipment per year for tax purposes	$1m
Unit sales per year	4m
Sale price per unit	$8
Variable cost per unit	$3
Fixed costs per year, paid at the end of each year	$1.5m
Tax rate	30%

Note 1: The equipment will have a book value of $4m at the end of the project for tax purposes. However, the equipment is expected to fetch $0.9 million when it is sold at t=2.

Note 2: Due to the project, the firm will have to purchase $0.8m of inventory initially, which it will sell at t=1. The firm will buy another $0.8m at t=1 and sell it all again at t=2 with zero inventory left. The project will have no effect on the firm's current liabilities.

Find the project's CFFA at time zero, one and two. Answers are given in millions of dollars ($m).

(a) -6,   12.25,   16.68

(b) -6.8,   13.25,   14.05

(c) -6.8,   13.25,   15.88

(d) -6.8,   13.25,   18.51

(e) -6.8,   13.25,   17.71

Question 67  CFFA, interest tax shield

Here are the Net Income (NI) and Cash Flow From Assets (CFFA) equations:

###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c)###

###CFFA=NI+Depr-CapEx - \varDelta NWC+IntExp###

What is the formula for calculating annual interest expense (IntExp) which is used in the equations above?

Select one of the following answers. Note that D is the value of debt which is constant through time, and ##r_D## is the cost of debt.

(a) ##D(1+r_D)##

(b) ##D/(1+r_D) ##

(c) ##D.r_D ##

(d) ##D / r_D##

(e) ##NI.r_D##

Question 223  CFFA, interest tax shield

Which one of the following will increase the Cash Flow From Assets in this year for a tax-paying firm, all else remaining constant?

(a) An increase in net capital spending.

(b) A decrease in the cash flow to creditors.

(c) An increase in interest expense.

(d) An increase in net working capital.

(e) A decrease in dividends paid.

Question 296  CFFA, interest tax shield

Which one of the following will decrease net income (NI) but increase cash flow from assets (CFFA) in this year for a tax-paying firm, all else remaining constant?

Remember:

###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c )### ###CFFA=NI+Depr-CapEx - ΔNWC+IntExp###

(a) An increase in revenue (##Rev##).

(b) An decrease in revenue (##Rev##).

(c) An increase in rent expense (part of fixed costs, ##FC##).

(d) An increase in interest expense (##IntExp##).

(e) An increase in dividends.

Question 89  WACC, CFFA, interest tax shield

A retail furniture company buys furniture wholesale and distributes it through its retail stores. The owner believes that she has some good ideas for making stylish new furniture. She is considering a project to buy a factory and employ workers to manufacture the new furniture she's designed. Furniture manufacturing has more systematic risk than furniture retailing.

Her furniture retailing firm's after-tax WACC is 20%. Furniture manufacturing firms have an after-tax WACC of 30%. Both firms are optimally geared. Assume a classical tax system.

Which method(s) will give the correct valuation of the new furniture-making project? Select the most correct answer.

(a) Discount the project's unlevered CFFA by the furniture manufacturing firms' 30% WACC after tax.

(b) Discount the project's unlevered CFFA by the company's 20% WACC after tax.

(c) Discount the project's levered CFFA by the company's 20% WACC after tax.

(d) Discount the project's levered CFFA by the furniture manufacturing firms' 30% WACC after tax.

(e) The methods outlined in answers (a) and (c) will give the same valuations, both are correct.

Question 368  interest tax shield, CFFA

A method commonly seen in textbooks for calculating a levered firm's free cash flow (FFCF, or CFFA) is the following:

###\begin{aligned} FFCF &= (Rev - COGS - Depr - FC - IntExp)(1-t_c) + \\ &\space\space\space+ Depr - CapEx -\Delta NWC + IntExp(1-t_c) \\ \end{aligned}###

Does this annual FFCF or the annual interest tax shield?

Question 369  interest tax shield, CFFA

One formula for calculating a levered firm's free cash flow (FFCF, or CFFA) is to use earnings before interest and tax (EBIT).

###\begin{aligned} FFCF &= (EBIT)(1-t_c) + Depr - CapEx -\Delta NWC + IntExp.t_c \\ &= (Rev - COGS - Depr - FC)(1-t_c) + Depr - CapEx -\Delta NWC + IntExp.t_c \\ \end{aligned} \\###

Does this annual FFCF or the annual interest tax shield?

Question 371  interest tax shield, CFFA

One method for calculating a firm's free cash flow (FFCF, or CFFA) is to ignore interest expense. That is, pretend that interest expense ##(IntExp)## is zero:

###\begin{aligned} FFCF &= (Rev - COGS - Depr - FC - IntExp)(1-t_c) + Depr - CapEx -\Delta NWC + IntExp \\ &= (Rev - COGS - Depr - FC - 0)(1-t_c) + Depr - CapEx -\Delta NWC - 0\\ \end{aligned}###

Does this annual FFCF with zero interest expense or the annual interest tax shield?

Question 375  interest tax shield, CFFA

One formula for calculating a levered firm's free cash flow (FFCF, or CFFA) is to use net operating profit after tax (NOPAT).

###\begin{aligned} FFCF &= NOPAT + Depr - CapEx -\Delta NWC \\ &= (Rev - COGS - Depr - FC)(1-t_c) + Depr - CapEx -\Delta NWC \\ \end{aligned} \\###

Does this annual FFCF or the annual interest tax shield?

Question 84  WACC, capital structure, capital budgeting

A firm is considering a new project of similar risk to the current risk of the firm. This project will expand its existing business. The cash flows of the project have been calculated assuming that there is no interest expense. In other words, the cash flows assume that the project is all-equity financed.

In fact the firm has a target debt-to-equity ratio of 1, so the project will be financed with 50% debt and 50% equity. To find the levered value of the firm's assets, what discount rate should be applied to the project's unlevered cash flows? Assume a classical tax system.

(a) The required return on equity, ##r_E##

(b) The required return on debt, ##r_D##

(c) The after-tax required return on debt, ##r_D.(1-t_c)##

(d) The after-tax WACC, ##\text{WACC after tax}=\frac{D}{V_L}.r_D.(1-t_c )+\frac{E_L}{V_L}.r_E##

(e) The pre-tax WACC, ##\text{WACC before tax}=\frac{D}{V_L}.r_D+\frac{E_L}{V_L}.r_E##

Question 99  capital structure, interest tax shield, Miller and Modigliani, trade off theory of capital structure

A firm changes its capital structure by issuing a large amount of debt and using the funds to repurchase shares. Its assets are unchanged.

Assume that:

• The firm and individual investors can borrow at the same rate and have the same tax rates.
• The firm's debt and shares are fairly priced and the shares are repurchased at the market price, not at a premium.
• There are no market frictions relating to debt such as asymmetric information or transaction costs.
• Shareholders wealth is measured in terms of utiliity. Shareholders are wealth-maximising and risk-averse. They have a preferred level of overall leverage. Before the firm's capital restructure all shareholders were optimally levered.

According to Miller and Modigliani's theory, which statement is correct?

(a) The firm's share price and shareholder wealth will both decrease. This is because the firm will have more debt and therefore more risk so the discount rate applied to its cash flows will be higher, decreasing the value of the firm and therefore the value of the firm's equity and share price.

(b) The firm's share price and shareholder wealth will both increase. This is because the firm will have more debt which will amplify the returns of equity investors. This will mean that returns on equity can be much higher and investors will pay a premium for this, leading to an increase in the stock price.

(c) The firm's share price and shareholder wealth will both increase since it has more debt and therefore more tax shields.

(d) The firm's share price will increase due to the higher value of tax shields. But shareholder wealth will remain unchanged because capital structure is irrelevant when investors can use home-made leverage to create tax-shields themselves.

(e) The firm's share price and shareholder wealth will both increase. This is because the cost of debt is cheaper than equity, leading to a lower (before and after tax) WACC. This lower WACC will lead to a higher value of the firm and a higher share price.

Question 115  capital structure, leverage, WACC

A firm has a debt-to-assets ratio of 50%. The firm then issues a large amount of debt to raise money for new projects of similar market risk to the company's existing projects. Assume a classical tax system. Which statement is correct?

(a) The debt-to-assets (D/V) ratio will decrease.

(b) The debt-to-equity ratio (D/E) will decrease.

(c) The firm's cost of equity will decrease.

(d) The company's after-tax WACC will decrease.

(e) The company's before-tax WACC will decrease.

Question 121  capital structure, leverage, financial distress, interest tax shield

Fill in the missing words in the following sentence:

All things remaining equal, as a firm's amount of debt funding falls, benefits of interest tax shields __________ and the costs of financial distress __________.

(a) Fall, fall.

(b) Fall, rises.

(c) Rise, fall.

(d) Rise, rise.

(e) Remain unchanged, remain unchanged.

Question 337  capital structure, interest tax shield, leverage, real and nominal returns and cash flows, multi stage growth model

A fast-growing firm is suitable for valuation using a multi-stage growth model.

It's nominal unlevered cash flow from assets (##CFFA_U##) at the end of this year (t=1) is expected to be $1 million. After that it is expected to grow at a rate of:

• 12% pa for the next two years (from t=1 to 3),
• 5% over the fourth year (from t=3 to 4), and
• -1% forever after that (from t=4 onwards). Note that this is a negative one percent growth rate.

Assume that:

• The nominal WACC after tax is 9.5% pa and is not expected to change.
• The nominal WACC before tax is 10% pa and is not expected to change.
• The firm has a target debt-to-equity ratio that it plans to maintain.
• The inflation rate is 3% pa.
• All rates are given as nominal effective annual rates.

What is the levered value of this fast growing firm's assets?

(a) $13.19m

(b) $12.36m

(c) $11.77m

(d) $11.53m

(e) $11.20m

Question 411  WACC, capital structure

A firm plans to issue equity and use the cash raised to pay off its debt. No assets will be bought or sold. Ignore the costs of financial distress.

Which of the following statements is NOT correct, all things remaining equal?

(a) The firm's WACC before tax will rise.

(b) The firm's WACC after tax will rise.

(c) The firm's required return on equity will be lower.

(d) The firm's net income will be higher.

(e) The firm's free cash flow will be lower.

Question 66  CAPM, SML

Government bonds currently have a return of 5% pa. A stock has an expected return of 6% pa and the market return is 7% pa. What is the beta of the stock?

(a) -0.5

(b) 0

(c) 0.5

(d) 1

(e) 7

Question 71  CAPM, risk

Stock A has a beta of 0.5 and stock B has a beta of 1. Which statement is NOT correct?

(a) Stock A has less systematic risk than stock B, so stock A's return should be less than stock B's.

(b) Stock B has the same systematic risk as the market, so its return should be the same as the market's.

(c) Stock B has the same beta as the market, so it also has the same total risk as the market.

(d) If stock A and B were combined in a portfolio with weights of 50% each, the beta of the portfolio would be 0.75.

(e) Stocks A and B have more systematic risk than the risk free security (government bonds) so their return should be greater than the risk free rate.

Question 74  WACC, capital structure, CAPM

A firm's weighted average cost of capital before tax (##r_\text{WACC before tax}##) would increase due to:

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

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

(c) The firm's industry becoming more systematically risky, for example if it was a mining company whose performance became more sensitive to countries' GDP growth, so the correlation of the firm's returns with the market was higher.

(d) The firm's industry becoming less systematically risky, for example if it was a child care centre and the government announced higher subsidies for parents using child care centres, so the correlation of the firm's returns with the market was lower.

(e) None of the above.

Question 75  WACC, CAPM

A company has:

• 50 million shares outstanding.
• The market price of one share is currently $6.
• The risk-free rate is 5% and the market return is 10%.
• Market analysts believe that the company's ordinary shares have a beta of 2.
• The company has 1 million preferred stock which have a face (or par) value of $100 and pay a constant dividend of 10% of par. They currently trade for $80 each.
• The company's debentures are publicly traded and their market price is equal to 90% of their face value.
• The debentures have a total face value of $60,000,000 and the current yield to maturity of corporate debentures is 10% per annum. The corporate tax rate is 30%.

What is the company's after-tax weighted average cost of capital (WACC)? Assume a classical tax system.

(a) 11.75%

(b) 11.82%

(c) 13.54%

(d) 13.78%

(e) 20.84%

Question 76  CAPM, SML

Government bonds currently have a return of 5%. A stock has a beta of 2 and the market return is 7%. What is the expected return of the stock?

(a) 5%

(b) 7%

(c) 9%

(d) 12%

(e) 19%

Question 79  CAPM, risk

Which statement is the most correct?

(a) The risk free rate has zero systematic risk and zero idiosyncratic risk.

(b) The market portfolio has zero idiosyncratic risk.

(c) The market portfolio has zero systematic risk.

(d) a and b are true.

(e) a and c are true.

Question 80  CAPM, risk, diversification

Diversification is achieved by investing in a large amount of stocks. What type of risk is reduced by diversification?

(a) Idiosyncratic risk.

(b) Systematic risk.

(c) Both idiosyncratic and systematic risk.

(d) Market risk.

(e) Beta risk.

Question 85  WACC, CAPM

A company has:

• 140 million shares outstanding.
• The market price of one share is currently $2.
• The company's debentures are publicly traded and their market price is equal to 93% of the face value.
• The debentures have a total face value of $50,000,000 and the current yield to maturity of corporate debentures is 12% per annum.
• The risk-free rate is 8.50% and the market return is 13.7%.
• Market analysts estimated that the company's stock has a beta of 0.90.
• The corporate tax rate is 30%.

What is the company's after-tax weighted average cost of capital (WACC) in a classical tax system?

(a) 13.18%

(b) 11.10%

(c) 12.50%

(d) 14.24%

(e) 15.00%

Question 86  CAPM

Treasury bonds currently have a return of 5% pa. A stock has a beta of 0.5 and the market return is 10% pa. What is the expected return of the stock?

(a) 5% pa

(b) 7.5% pa

(c) 10% pa

(d) 12.5% pa

(e) 20% pa

Question 88  WACC, CAPM

A firm can issue 3 year annual coupon bonds at a yield of 10% pa and a coupon rate of 8% pa.

The beta of its levered equity is 2. The market's expected return is 10% pa and 3 year government bonds yield 6% pa with a coupon rate of 4% pa.

The market value of equity is $1 million and the market value of debt is $1 million. The corporate tax rate is 30%.

What is the firm's after-tax WACC? Assume a classical tax system.

(a) 8.40%

(b) 10.50%

(c) 10.80%

(d) 12.00%

(e) 21.00%

Question 90  CAPM, risk

According to the theory of the Capital Asset Pricing Model (CAPM), total variance can be broken into two components, systematic variance and idiosyncratic variance. Which of the following events would be considered the most diversifiable according to the theory of the CAPM?

(a) Global economic recession.

(b) A major terrorist attack, grounding all commercial aircraft in the US and Europe.

(c) An increase in corporate tax rates.

(d) The outbreak of world war.

(e) A company's poor earnings announcement.

Question 106  CAPM

A fairly priced stock has an expected return of 15% pa. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. What is the beta of the stock?

(a) 0

(b) 0.5

(c) 1

(d) 1.5

(e) 2

Question 110  CAPM, SML, NPV

The security market line (SML) shows the relationship between beta and expected return.

Buying investment projects that plot above the SML would lead to:

(a) A positive NPV.

(b) A zero NPV.

(c) A negative NPV.

(d) A large amount of diversifiable risk.

(e) Zero diversifiable risk.

Question 111  portfolio risk, correlation

All things remaining equal, the variance of a portfolio of two positively-weighted stocks rises as:

(a) The correlation between the stocks' returns rise.

(b) The correlation between the stocks' returns decline.

(c) The portfolio standard deviation declines.

(d) Both stocks' individual variances decline.

(e) Both stocks' individual standard deviations decline.

Question 112  CAPM, risk

According to the theory of the Capital Asset Pricing Model (CAPM), total risk can be broken into two components, systematic risk and idiosyncratic risk. Which of the following events would be considered a systematic, undiversifiable event according to the theory of the CAPM?

(a) A decrease in house prices in one city.

(b) An increase in mining industry tax rates.

(c) An increase in corporate tax rates.

(d) A case of fraud at a major retailer.

(e) A poor earnings announcement from a major firm.

Question 116  capital structure, CAPM

A firm changes its capital structure by issuing a large amount of equity and using the funds to repay debt. Its assets are unchanged. Ignore interest tax shields.

According to the Capital Asset Pricing Model (CAPM), which statement is correct?

(a) The beta of the firm's assets will increase.

(b) The beta of the firm's assets will decrease.

(c) The beta of the firm's equity will increase.

(d) The beta of the firm's equity will decrease.

(e) The beta of the firm's equity will be unchanged.

Question 231  CAPM

A fairly priced stock has a beta that is the same as the market portfolio's beta. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. What is the expected return of the stock?

(a) 5%

(b) 7.5%

(c) 10%

(d) 15%

(e) 20%

Question 232  CAPM, DDM

A stock has a beta of 0.5. Its next dividend is expected to be $3, paid one year from now. Dividends are expected to be paid annually and grow by 2% pa forever. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. All returns are effective annual rates.

What is the price of the stock now?

(a) $55.6364

(b) $54.5455

(c) $40.8

(d) $40

(e) $37.5

Question 235  SML, NPV, CAPM, risk

The security market line (SML) shows the relationship between beta and expected return.

Investment projects that plot on the SML would have:

(a) A positive NPV and should be accepted.

(b) A zero NPV.

(c) A negative NPV and should be rejected.

(d) A large amount of diversifiable risk.

(e) Zero diversifiable risk.

Question 244  CAPM, SML, NPV, risk

Examine the following graph which shows stocks' betas ##(\beta)## and expected returns ##(\mu)##:

Assume that the CAPM holds and that future expectations of stocks' returns and betas are correctly measured. Which statement is NOT correct?

(a) Asset A is underpriced.

(b) Asset B has a negative alpha (a negative excess return or abnormal return).

(c) Buying asset C would be a positive NPV investment.

(d) Asset D has less systematic variance than the market portfolio (M).

(e) Asset E is fairly priced.

Question 248  CAPM, DDM, income and capital returns

The total return of any asset can be broken down in different ways. One possible way is to use the dividend discount model (or Gordon growth model):

###p_0 = \frac{c_1}{r_\text{total}-r_\text{capital}}###

Which, since ##c_1/p_0## is the income return (##r_\text{income}##), can be expressed as:

###r_\text{total}=r_\text{income}+r_\text{capital}###

So the total return of an asset is the income component plus the capital or price growth component.

Another way to break up total return is to use the Capital Asset Pricing Model:

###r_\text{total}=r_\text{f}+β(r_\text{m}- r_\text{f})###

###r_\text{total}=r_\text{time value}+r_\text{risk premium}###

So the risk free rate is the time value of money and the term ##β(r_\text{m}- r_\text{f})## is the compensation for taking on systematic risk.

Using the above theory and your general knowledge, which of the below equations, if any, are correct?

(I) ##r_\text{income}=r_\text{time value}##

(II) ##r_\text{income}=r_\text{risk premium}##

(III) ##r_\text{capital}=r_\text{time value}##

(IV) ##r_\text{capital}=r_\text{risk premium}##

(V) ##r_\text{income}+r_\text{capital}=r_\text{time value}+r_\text{risk premium}##

Which of the equations are correct?

(a) I, IV and V only.

(b) II, III and V only.

(c) V only.

(d) All are true.

(e) None are true.

Question 302  WACC, CAPM

Which of the following statements about the weighted average cost of capital (WACC) is NOT correct?

(a) WACC before tax ##= r_D.\dfrac{D}{V_L} + r_{EL}.\dfrac{E_L}{V_L}##

(b) WACC before tax ##= r_f + \beta_{VL}.(r_m - r_f)##

(c) WACC after tax ##= r_D.(1-t_c).\dfrac{D}{V_L} + r_{EL}.\dfrac{E_L}{V_L}##

(d) WACC after tax ##= r_f + \beta_{VL}.(r_m - r_f) - \dfrac{r_D.D.t_c}{V_L}##

(e) WACC after tax ##= r_f + \beta_{VL}.(r_m - r_f)##

Question 303  WACC, CAPM, CFFA

There are many different ways to value a firm's assets. Which of the following will NOT give the correct market value of a levered firm's assets ##(V_L)##? Assume that:

• The firm is financed by listed common stock and vanilla annual fixed coupon bonds, which are both traded in a liquid market.
• The bonds' yield is equal to the coupon rate, so the bonds are issued at par. The yield curve is flat and yields are not expected to change. When bonds mature they will be rolled over by issuing the same number of new bonds with the same expected yield and coupon rate, and so on forever.
• Tax rates on the dividends and capital gains received by investors are equal, and capital gains tax is paid every year, even on unrealised gains regardless of when the asset is sold.
• There is no re-investment of the firm's cash back into the business. All of the firm's excess cash flow is paid out as dividends so real growth is zero.
• The firm operates in a mature industry with zero real growth.
• All cash flows and rates in the below equations are real (not nominal) and are expected to be stable forever. Therefore the perpetuity equation with no growth is suitable for valuation.

(a) ##V_L = n_\text{shares}.P_\text{share} + n_\text{bonds}.P_\text{bond}##

(b) ##V_L = n_\text{shares}.\dfrac{\text{Dividend per share}}{r_f + \beta_{EL}(r_m - r_f)} + n_\text{bonds}.\dfrac{\text{Coupon per bond}}{r_f + \beta_D(r_m - r_f)}##

(c) ##V_L = \dfrac{\text{CFFA}_{L}}{r_\text{WACC before tax}}##

(d) ##V_L = \dfrac{\text{CFFA}_{U}}{r_\text{WACC after tax}}##

(e) ##V_L = \dfrac{\text{CFFA}_{L}}{r_\text{WACC after tax}}##

Where:

###r_\text{WACC before tax} = r_D.\frac{D}{V_L} + r_{EL}.\frac{E_L}{V_L} = \text{Weighted average cost of capital before tax}### ###r_\text{WACC after tax} = r_D.(1-t_c).\frac{D}{V_L} + r_{EL}.\frac{E_L}{V_L} = \text{Weighted average cost of capital after tax}### ###NI_L=(Rev-COGS-FC-Depr-\mathbf{IntExp}).(1-t_c) = \text{Net Income Levered}### ###CFFA_L=NI_L+Depr-CapEx - \varDelta NWC+\mathbf{IntExp} = \text{Cash Flow From Assets Levered}### ###NI_U=(Rev-COGS-FC-Depr).(1-t_c) = \text{Net Income Unlevered}### ###CFFA_U=NI_U+Depr-CapEx - \varDelta NWC= \text{Cash Flow From Assets Unlevered}###

Question 326  CAPM

A fairly priced stock has an expected return equal to the market's. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. What is the stock's beta?

(a) 0

(b) 0.5

(c) 1

(d) 1.5

(e) 2

Question 338  market efficiency, CAPM, opportunity cost, technical analysis

A man inherits $500,000 worth of shares.

He believes that by learning the secrets of trading, keeping up with the financial news and doing complex trend analysis with charts that he can quit his job and become a self-employed day trader in the equities markets.

What is the expected gain from doing this over the first year? Measure the net gain in wealth received at the end of this first year due to the decision to become a day trader. Assume the following:

• He earns $60,000 pa in his current job, paid in a lump sum at the end of each year.
• He enjoys examining share price graphs and day trading just as much as he enjoys his current job.
• Stock markets are weak form and semi-strong form efficient.
• He has no inside information.
• He makes 1 trade every day and there are 250 trading days in the year. Trading costs are $20 per trade. His broker invoices him for the trading costs at the end of the year.
• The shares that he currently owns and the shares that he intends to trade have the same level of systematic risk as the market portfolio.
• The market portfolio's expected return is 10% pa.

Measure the net gain over the first year as an expected wealth increase at the end of the year.

(a) $110,000

(b) $50,000

(c) $45,000

(d) -$15,000

(e) -$65,000

Question 410  CAPM, capital budgeting

The CAPM can be used to find a business's expected opportunity cost of capital:

###r_i=r_f+β_i (r_m-r_f)###

What should be used as the risk free rate ##r_f##?

(a) The current central bank policy rate (RBA overnight money market rate).

(b) The current 30 day federal government treasury bill rate.

(c) The average historical 30 day federal government treasury bill rate over the last 20 years.

(d) The current 30 year federal government treasury bond rate.

(e) The average historical 30 year federal government treasury bond rate over the last 20 years.

Question 416  real estate, market efficiency, income and capital returns, DDM, CAPM

A residential real estate investor believes that house prices will grow at a rate of 5% pa and that rents will grow by 2% pa forever.

All rates are given as nominal effective annual returns. Assume that:

• His forecast is true.
• Real estate is and always will be fairly priced and the capital asset pricing model (CAPM) is true.
• Ignore all costs such as taxes, agent fees, maintenance and so on.
• All rental income cash flow is paid out to the owner, so there is no re-investment and therefore no additions or improvements made to the property.
• The non-monetary benefits of owning real estate and renting remain constant.

Which one of the following statements is NOT correct? Over time:

(a) The rental yield will fall and approach zero.

(b) The total return will fall and approach the capital return (5% pa).

(c) One or all of the following must fall: the systematic risk of real estate, the risk free rate or the market risk premium.

(d) If the country's nominal wealth growth rate is 4% pa and the nominal real estate growth rate is 5% pa then real estate will approach 100% of the country's wealth over time.

(e) If the country's nominal gross domestic production (GDP) growth rate is 4% pa and the nominal real estate rent growth rate is 2% pa then real estate rent will approach 100% of the country's GDP over time.

Question 247  cross currency interest rate parity, no explanation

In the so called 'Swiss Loans Affair' of the 1980's, Australian banks offered loans denominated in Swiss Francs to Australian farmers at interest rates as low as 4% pa. This was far lower than interest rates on Australian Dollar loans which were above 10% due to very high inflation in Australia at the time.

In the late-1980's there was a large depreciation in the Australian Dollar. The Australian Dollar nearly halved in value against the Swiss Franc. Many Australian farmers went bankrupt since they couldn't afford the interest payments on the Swiss Franc loans because the Australian Dollar value of those payments nearly doubled. The farmers accused the banks of promoting Swiss Franc loans without making them aware of the risks.

What fundamental principal of finance did the Australian farmers (and the bankers) fail to understand?

(a) Home-made leverage.

(b) Diversification.

(c) Cross-currency interest rate parity.

(d) Time value of money.

(e) The undiversifiable nature of systematic risk.

Question 358  PE ratio, Multiples valuation

Estimate the Chinese bank ICBC's share price using a backward-looking price earnings (PE) multiples approach with the following assumptions and figures only. Note that the renminbi (RMB) is the Chinese currency, also known as the yuan (CNY).

• The 4 major Chinese banks ICBC, China Construction Bank (CCB), Bank of China (BOC) and Agricultural Bank of China (ABC) are comparable companies;
• ICBC 's historical earnings per share (EPS) is RMB 0.74;
• CCB's backward-looking PE ratio is 4.59;
• BOC 's backward-looking PE ratio is 4.78;
• ABC's backward-looking PE ratio is also 4.78;

Note: Figures sourced from Google Finance on 25 March 2014. Share prices are from the Shanghai stock exchange.

(a) RMB 6.4595

(b) RMB 6.3739

(c) RMB 6.3311

(d) RMB 3.4903

(e) RMB 3.3966

Question 402  PE ratio, no explanation

Which of the following companies is most suitable for valuation using PE multiples techniques?

(a) A company with positive earnings that does not have any comparable firms.

(b) A company with positive earnings that has comparable firms with positive earnings.

(c) A company with positive earnings that has comparable firms with negative earnings.

(d) A company with negative earnings that has comparable firms with negative earnings.

(e) A company with negative earnings that has comparable firms with positive earnings.

Question 403  PE ratio, no explanation

Which of the following investable assets is the LEAST suitable for valuation using PE multiples techniques?

(a) Common equity in a small private company.

(b) Common equity in a listed public company.

(c) Commercial real estate.

(d) Ten year commercial real estate lease.

(e) Residential real estate.

Question 414  PE ratio, pay back period, no explanation

A mature firm has constant expected future earnings and dividends. Both amounts are equal. So earnings and dividends are expected to be equal and unchanging.

Which of the following statements is NOT correct?

(a) This firm's expected capital return equals zero.

(b) This firm's expected total return and income return are equal.

(c) This firm's forward looking PE ratio will equal the inverse of the firm's expected income return.

(d) This firm's forward looking PE ratio will equal the inverse of the firm's expected capital return.

(e) This firm's forward looking PE ratio is equal to the expected payback period, which is the time it will take for the sum of the cash flows to equal the share price.

Question 468  PE ratio

A firm has 1 million shares which trade at a price of $30 each. The firm is expected to announce earnings of $3 million at the end of the year and pay an annual dividend of $1.50 per share.

What is the firm's (forward looking) price/earnings (PE) ratio?

(a) 20

(b) 10

(c) 3

(d) 2

(e) 0.5

Question 474  PE ratio

The below screenshot of Commonwealth Bank of Australia's (CBA) details were taken from the Google Finance website on 7 Nov 2014. Some information has been deliberately blanked out.

What was CBA's backwards-looking price-earnings ratio?

(a)17.06

(b) 0.063

(c) 15.88

(d) 3.21

(e) 8.44

Question 483  PE ratio

The below screenshot of Microsoft's (MSFT) details were taken from the Google Finance website on 28 Nov 2014. Some information has been deliberately blanked out.

What was MSFT's backwards-looking price-earnings ratio?

(a) $21.01

(b) 21.01

(c) $18.75

(d) 18.75

(e) 18.75%

Question 493  PE ratio

A firm has 2m shares and a market capitalisation of equity of $30m. The firm just announced earnings of $5m and paid an annual dividend of $0.75 per share.

What is the firm's (backward looking) price/earnings (PE) ratio?

(a) 2.5

(b) 3

(c) 6

(d) 15

(e) 20

Question 547  PE ratio, Multiples valuation, DDM, income and capital returns, no explanation

A firm pays out all of its earnings as dividends. Because of this, the firm has no real growth in earnings, dividends or stock price since there is no re-investment back into the firm to buy new assets and make higher earnings. The dividend discount model is suitable to value this company.

The firm's revenues and costs are expected to increase by inflation in the foreseeable future. The firm has no debt. It operates in the services industry and has few physical assets so there is negligible depreciation expense and negligible net working capital required.

Which of the following statements about this firm's PE ratio is NOT correct? The PE ratio should:

(a) Equal the inverse of the firm's nominal income return.

(b) Equal the inverse of the firm's real total return.

(c) Equal the inverse of the firm's real capital return.

(d) Equal the expected payback period of an investor who intends to buy the firm's equity at the current price.

(e) Be lower than that of faster growing firms that pay lower dividends and re-invest in themselves.

Note: The inverse of x is 1/x.

Question 188  CFFA

Find Trademark Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Trademark Corp
Income Statement for
year ending 30th June 2013
	$m
Sales	100
COGS	25
Operating expense	5
Depreciation	20
Interest expense	20
Income before tax	30
Tax at 30%	9
Net income	21

Trademark Corp
Balance Sheet
as at 30th June	2013	2012
	$m	$m
Assets
Current assets	120	80
PPE
Cost	150	140
Accumul. depr.	60	40
Carrying amount	90	100
Total assets	210	180
Liabilities
Current liabilities	75	65
Non-current liabilities	75	55
Owners' equity
Retained earnings	10	10
Contributed equity	50	50
Total L and OE	210	180

 

Note: all figures are given in millions of dollars ($m).

(a) -19

(b) 21

(c) 41

(d) 61

(e) 121

Question 208  CFFA

Find UniBar Corp's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

UniBar Corp
Income Statement for
year ending 30th June 2013
	$m
Sales	80
COGS	40
Operating expense	15
Depreciation	10
Interest expense	5
Income before tax	10
Tax at 30%	3
Net income	7

UniBar Corp
Balance Sheet
as at 30th June	2013	2012
	$m	$m
Assets
Current assets	120	90
PPE
Cost	360	320
Accumul. depr.	40	30
Carrying amount	320	290
Total assets	440	380
Liabilities
Current liabilities	110	60
Non-current liabilities	190	180
Owners' equity
Retained earnings	95	95
Contributed equity	45	45
Total L and OE	440	380

 

Note: all figures are given in millions of dollars ($m).

(a) 12

(b) 2

(c) -8

(d) -18

(e) 48

Question 401  capital budgeting, CFFA

The hardest and most important aspect of business project valuation is the estimation of the:

(a) Diversifiable standard deviation of asset returns.

(b) Systematic standard deviation of asset returns.

(c) Proportion of debt and equity used to fund the assets.

(d) Cash flows from assets.

(e) Risk free rate.

Question 555  capital budgeting, CFFA

Find the cash flow from assets (CFFA) of the following project.

Project Data
Project life	2 years
Initial investment in equipment	$8m
Depreciation of equipment per year for tax purposes	$3m
Unit sales per year	10m
Sale price per unit	$9
Variable cost per unit	$4
Fixed costs per year, paid at the end of each year	$2m
Tax rate	30%

Note 1: Due to the project, the firm will have to purchase $40m of inventory initially (at t=0). Half of this inventory will be sold at t=1 and the other half at t=2.

Note 2: The equipment will have a book value of $2m at the end of the project for tax purposes. However, the equipment is expected to fetch $1m when it is sold. Assume that the full capital loss is tax-deductible and taxed at the full corporate tax rate.

Note 3: The project will be fully funded by equity which investors will expect to pay dividends totaling $10m at the end of each year.

Find the project's CFFA at time zero, one and two. Answers are given in millions of dollars ($m).

(a) -48,   54.5,   55.8

(b) -48,   54.5,   74.5

(c) -48,   74.5,   35.8

(d) -48,   74.5,   75.8

(e) -8,   74.5,   75.8

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 237  WACC, Miller and Modigliani, interest tax shield

Which of the following discount rates should be the highest for a levered company? Ignore the costs of financial distress.

(a) Cost of debt (##r_\text{D}##).

(b) Unlevered cost of equity (##r_\text{E, U}##).

(c) Levered cost of equity (##r_\text{E, L}##).

(d) Levered before-tax WACC (##r_\text{V, LxITS}##).

(e) Levered after-tax WACC (##r_\text{V, LwITS}##).

Question 81  risk, correlation, diversification

Stock A and B's returns have a correlation of 0.3. Which statement is NOT correct?

(a) If stock A's return increases, stock B's return is also expected to increase.

(b) If stock A's return decreases, stock B's return is also expected to decrease.

(c) If stock A and B were combined in a portfolio, there would be no diversification at all since they are positively correlated.

(d) Stock A and B's returns have positive covariance.

(e) a and b.

Question 236  diversification, correlation, risk

Diversification in a portfolio of two assets works best when the correlation between their returns is:

(a) -1

(b) -0.5

(c) 0

(d) 0.5

(e) 1

Question 283  portfolio risk, correlation, needs refinement

Three important classes of investable risky assets are:

• Corporate debt which has low total risk,
• Real estate which has medium total risk,
• Equity which has high total risk.

Assume that the correlation between total returns on:

• Corporate debt and real estate is 0.1,
• Corporate debt and equity is 0.1,
• Real estate and equity is 0.5.

You are considering investing all of your wealth in one or more of these asset classes. Which portfolio will give the lowest total risk? You are restricted from shorting any of these assets. Disregard returns and the risk-return trade-off, pretend that you are only concerned with minimising risk.

(a) Most money in corporate debt, with some money in equity and real estate.

(b) Most money in equity, with some money in corporate debt and real estate.

(c) Most money in real estate, with some money in corporate debt and equity.

(d) Most money in corporate debt, with some money in real estate and none in equity.

(e) All money in corporate debt.

Question 293  covariance, correlation, portfolio risk

All things remaining equal, the higher the correlation of returns between two stocks:

(a) The more diversification is possible when those stocks are combined in a portfolio.

(b) The lower the variance of returns of an equally-weighted portfolio of those stocks.

(c) The lower the volatility of returns of an equal-weighted portfolio of those stocks.

(d) The higher the covariance between those stocks' returns.

(e) The more likely that when one stock has a positive return, the other has a negative return.

Question 559  variance, standard deviation, covariance, correlation

Which of the following statements about standard statistical mathematics notation is NOT correct?

(a) The arithmetic average of variable X is represented by ##\bar{X}##.

(b) The standard deviation of variable X is represented by ##\sigma_X##.

(c) The variance of variable X is represented by ##\sigma_X^2##.

(d) The covariance between variables X and Y is represented by ##\sigma_{X,Y}^2##.

(e) The correlation between variables X and Y is represented by ##\rho_{X,Y}##.

Question 561  covariance, correlation

The covariance and correlation of two stocks X and Y's annual returns are calculated over a number of years. The units of the returns are in percent per annum ##(\% pa)##.

What are the units of the covariance ##(\sigma_{X,Y})## and correlation ##(\rho_{X,Y})## of returns respectively?

(a) Percentage points per annum ##(\text{pp pa})## and percentage points per annum ##(\text{pp pa})##.

(b) Percentage points per annum ##(\text{pp pa})## and percentage points per annum all squared ##\left( (\text{pp pa})^2 \right)##.

(c) Percentage points per annum all squared ##\left( (\text{pp pa})^2 \right)## and percentage points per annum ##(\text{pp pa})##.

(d) Percentage points per annum all squared ##\left( (\text{pp pa})^2 \right)## and percentage points per annum all squared ##\left( (\text{pp pa})^2 \right)##.

(e) Percentage points per annum all squared ##\left( (\text{pp pa})^2 \right)## and a pure number with no units.

Hint: Visit Wikipedia to understand the difference between percentage points ##(\text{pp})## and percent ##(\%)##.

Question 563  correlation

What is the correlation of a variable X with itself?

The corr(X, X) or ##\rho_{X,X}## equals:

(a) var(X) or ##\sigma_X^2##

(b) sd(X) or ##\sigma_X##

(c) 1

(d) 0

(e) Mathematically undefined

Question 228  DDM, NPV, risk, market efficiency

A very low-risk stock just paid its semi-annual dividend of $0.14, as it has for the last 5 years. You conservatively estimate that from now on the dividend will fall at a rate of 1% every 6 months.

If the stock currently sells for $3 per share, what must be its required total return as an effective annual rate?

If risk free government bonds are trading at a yield of 4% pa, given as an effective annual rate, would you consider buying or selling the stock?

The stock's required total return is:

(a) 9.55%, so buy the stock since its required return is too high for its low risk.

(b) 7.37%, so buy the stock since its required return is too high for its low risk.

(c) 7.37%, so sell the stock since its required return is too high for its low risk.

(d) 3.62%, so buy the stock since its required return is too low for its low risk.

(e) 3.62%, so sell the stock since its required return is too low for its low risk.

Question 292  standard deviation, risk

Find the sample standard deviation of returns using the data in the table:

Stock Returns
Year	Return pa
2008	0.3
2009	0.02
2010	-0.2
2011	0.4

The returns above and standard deviations below are given in decimal form.

(a) 0.277075

(b) 0.272519

(c) 0.239954

(d) 0.236008

(e) 0.162070

Question 307  risk, variance

Let the variance of returns for a share per month be ##\sigma_\text{monthly}^2##.

What is the formula for the variance of the share's returns per year ##(\sigma_\text{yearly}^2)##?

Assume that returns are independently and identically distributed (iid) so they have zero auto correlation, meaning that if the return was higher than average today, it does not indicate that the return tomorrow will be higher or lower than average.

(a) ##\sigma_\text{yearly}^2 = \sigma_\text{monthly}^2##

(b) ##\sigma_\text{yearly}^2 = \sigma_\text{monthly}^2 \times 12##

(c) ##\sigma_\text{yearly}^2 = \sigma_\text{monthly}^2 \times 12^2##

(d) ##\sigma_\text{yearly}^2 = \sigma_\text{monthly}^2 \times \sqrt{12}##

(e) ##\sigma_\text{yearly}^2 = \sigma_\text{monthly}^2 \times {12}^{1/3}##

Question 308  risk, standard deviation, variance, no explanation

A stock's standard deviation of returns is expected to be:

• 0.09 per month for the first 5 months;
• 0.14 per month for the next 7 months.

What is the expected standard deviation of the stock per year ##(\sigma_\text{annual})##?

Assume that returns are independently and identically distributed (iid) and therefore have zero auto-correlation.

(a) ##\sigma_\text{annual} = 0.09 \times 5 + 0.14 \times 7##

(b) ##\sigma_\text{annual} = (0.09 \times 5 + 0.14 \times 7)^{1/2}##

(c) ##\sigma_\text{annual} = (0.09^2 \times 5 + 0.14^2 \times 7)^{1/2}##

(d) ##\sigma_\text{annual} = (1+0.09)^5\times (1+0.14)^7 - 1##

(e) ##\sigma_\text{annual} = \left( \dfrac{0.09^2 \times 5 + 0.14^2 \times 7}{12} \right)^{1/2}##

Question 471  risk, accounting ratio

High risk firms in danger of bankruptcy tend to have:

(a) Low debt to assets ratios.

(b) High quick ratios.

(c) Low interest coverage ratios.

(d) Positive amounts of net working capital.

(e) High net profit margins.

Question 524  risk, expected and historical returns, bankruptcy or insolvency, capital structure, corporate financial decision theory, limited liability

Which of the following statements is NOT correct?

(a) Stocks are higher risk investments than debt.

(b) Stocks have higher expected returns than debt.

(c) Firms' past realised stock returns are always higher than their past realised debt returns.

(d) In the event of bankruptcy, stock holders are paid after debt holders are fully paid.

(e) Stock holders have a residual claim on the firm's assets.

Question 272  NPV

Suppose you had $100 in a savings account and the interest rate was 2% per year.

After 5 years, how much do you think you would have in the account if you left the money to grow?

than $102, $102 or than $102?

Question 278  inflation, real and nominal returns and cash flows

Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year.

After one year, would you be able to buy , exactly the as or than today with the money in this account?

Question 279  diversification

Do you think that the following statement is or ? “Buying a single company stock usually provides a safer return than a stock mutual fund.”

Question 1  NPV

Jan asks you for a loan. He wants $100 now and offers to pay you back $120 in 1 year. You can borrow and lend from the bank at an interest rate of 10% pa, given as an effective annual rate.

Ignore credit risk. Remember:

### V_0 = \frac{V_t}{(1+r_\text{eff})^t} ###

Will you or Jan's deal?

Question 2  NPV, Annuity

Katya offers to pay you $10 at the end of every year for the next 5 years (t=1,2,3,4,5) if you pay her $50 now (t=0). You can borrow and lend from the bank at an interest rate of 10% pa, given as an effective annual rate. Ignore credit risk.

Will you or politely Katya's deal?

Question 3  DDM, income and capital returns

The following equation is called the Dividend Discount Model (DDM), Gordon Growth Model or the perpetuity with growth formula: ### P_0 = \frac{ C_1 }{ r - g } ###

What is ##g##? The value ##g## is the long term expected:

(a) Income return of the stock.

(b) Capital return of the stock.

(c) Total return of the stock.

(d) Dividend yield of the stock.

(e) Price-earnings ratio of the stock.

Question 4  DDM

For a price of $13, Carla will sell you a share paying a dividend of $1 in one year and every year after that forever. The required return of the stock is 10% pa.

Would you like to Carla's share or politely ?

Question 5  DDM

For a price of $6, Carlos will sell you a share which will pay a dividend of $1 in one year and every year after that forever. The required return of the stock is 10% pa.

Would you like to his share or politely ?

Question 6  DDM

For a price of $102, Andrea will sell you a share which just paid a dividend of $10 yesterday, and is expected to pay dividends every year forever, growing at a rate of 5% pa.

So the next dividend will be ##10(1+0.05)^1=$10.50## in one year from now, and the year after it will be ##10(1+0.05)^2=11.025## and so on.

The required return of the stock is 15% pa.

Would you like to the share or politely ?

Question 11  bond pricing

For a price of $100, Vera will sell you a 2 year bond paying semi-annual coupons of 10% pa. The face value of the bond is $100. Other bonds with similar risk, maturity and coupon characteristics trade at a yield of 8% pa.

Would you like to her bond or politely ?

Question 125  option, speculation, market efficiency

Suppose that the US government recently announced that subsidies for fresh milk producers will be gradually phased out over the next year. Newspapers say that there are expectations of a 40% increase in the spot price of fresh milk over the next year.

Option prices on fresh milk trading on the Chicago Mercantile Exchange (CME) reflect expectations of this 40% increase in spot prices over the next year. Similarly to the rest of the market, you believe that prices will rise by 40% over the next year.

What option trades are likely to be profitable, or to be more specific, result in a positive Net Present Value (NPV)?

Assume that:

• Only the spot price is expected to increase and there is no change in expected volatility or other variables that affect option prices.
• No taxes, transaction costs, information asymmetry, bid-ask spreads or other market frictions.

(a) Buy one year call options on fresh milk.

(b) Buy one year put options on fresh milk.

(c) Sell one year call options on fresh milk.

(d) All of the above option trades are likely to have a positive NPV.

(e) None of the above option trades are likely to have a positive NPV.

Question 310  foreign exchange rate

Is it possible for all countries' exchange rates to appreciate by 5% in the same year, including the USD? or ?

Question 311  foreign exchange rate

When someone says that they're "buying American dollars" (USD), what type of asset are they probably buying? They're probably buying:

(a) Short term debt denominated in USD, for example lending to a US bank as a USD deposit.

(b) Long term debt denominated in USD, for example lending to a US company by buying their USD bonds.

(c) Shares denominated in USD, for example buying shares in Coca-Cola which is listed on the NYSE.

(d) Real estate denominated in USD, for example buying an apartment in Chicago.

(e) Commodities with USD, for example buying gold, wheat, or coal.

Question 570  foreign exchange rate

An American wishes to convert USD 1 million to Australian dollars (AUD). The exchange rate is 0.8 USD per AUD. How much is the USD 1 million worth in AUD?

(a) AUD 0.2 million.

(b) AUD 0.8 million

(c) AUD 1 million

(d) AUD 1.25 million.

(e) AUD 1.8 million.

Question 571  foreign exchange rate

An Indonesian lady wishes to convert 1 million Indonesian rupiah (IDR) to Australian dollars (AUD). Exchange rates are 13,125 IDR per USD and 0.79 USD per AUD. How many AUD is the IDR 1 million worth?

(a) AUD 16,613,924,050.63

(b) AUD 10,368,750,000.00

(c) AUD 10,368.75

(d) AUD 96.44

(e) AUD 60.19

Question 313  foreign exchange rate, American and European terms

If the AUD appreciates against the USD, the American terms quote of the AUD will or ?

Question 314  foreign exchange rate, American and European terms

If the USD appreciates against the AUD, the American terms quote of the AUD will or ?

Question 315  foreign exchange rate, American and European terms

If the current AUD exchange rate is USD 0.9686 = AUD 1, what is the European terms quote of the AUD against the USD?

(a) 0.9686 USD per AUD

(b) 0.9686 AUD per USD

(c) 1.0324 USD per AUD

(d) 1.0324 AUD per USD

(e) 1.0324 AUD per EUR

Question 316  foreign exchange rate, American and European terms

If the AUD appreciates against the USD, the European terms quote of the AUD will or ?

Question 317  foreign exchange rate, American and European terms

If the USD appreciates against the AUD, the European terms quote of the AUD will or ?

Question 318  foreign exchange rate, American and European terms

How is the AUD normally quoted in Australia? Using or terms?

Question 319  foreign exchange rate, monetary policy, American and European terms

Investors expect the Reserve Bank of Australia (RBA) to keep the policy rate steady at their next meeting.

Then unexpectedly, the RBA announce that they will increase the policy rate by 25 basis points due to fears that the economy is growing too fast and that inflation will be above their target rate of 2 to 3 per cent.

What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar is likely to:

(a) Appreciate against the USD, so the 'European terms' quote of the AUD (AUD per USD) will increase.

(b) Depreciate against the USD, so the 'European terms' quote of the AUD (AUD per USD) will decrease.

(c) Appreciate against the USD, so the 'European terms' quote of the AUD (AUD per USD) will decrease.

(d) Depreciate against the USD, so the 'European terms' quote of the AUD (AUD per USD) will increase.

(e) Appreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will decrease.

Question 320  foreign exchange rate, monetary policy, American and European terms

Investors expect the Reserve Bank of Australia (RBA) to decrease the overnight cash rate at their next meeting.

Then unexpectedly, the RBA announce that they will keep the policy rate unchanged.

What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar is likely to:

(a) Appreciate against the USD, so the 'European terms' quote of the AUD (AUD per USD) will increase.

(b) Depreciate against the USD, so the 'European terms' quote of the AUD (AUD per USD) will decrease.

(c) Appreciate against the USD, so the 'European terms' quote of the AUD (AUD per USD) will decrease.

(d) Depreciate against the USD, so the 'European terms' quote of the AUD (AUD per USD) will increase.

(e) Be unaffected by the change in the policy rate, so the exchange rate will remain the same.

Question 321  foreign exchange rate, monetary policy, American and European terms

The market expects the Reserve Bank of Australia (RBA) to increase the policy rate by 25 basis points at their next meeting.

Then unexpectedly, the RBA announce that they will increase the policy rate by 50 basis points due to high future GDP and inflation forecasts.

What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar will:

(a) Appreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will increase.

(b) Depreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will decrease.

(c) Appreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will decrease.

(d) Depreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will increase.

(e) Be unaffected by the change in the policy rate, so the exchange rate will remain the same.

Question 323  foreign exchange rate, monetary policy, American and European terms

The market expects the Reserve Bank of Australia (RBA) to increase the policy rate by 25 basis points at their next meeting.

As expected, the RBA increases the policy rate by 25 basis points.

What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar will:

(a) Appreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will increase.

(b) Depreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will decrease.

(c) Appreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will decrease.

(d) Depreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will increase.

(e) Be unaffected by the change in the policy rate, so the exchange rate will remain the same.

Question 325  foreign exchange rate

In the 1997 Asian financial crisis many countries' exchange rates depreciated rapidly against the US dollar (USD). The Thai, Indonesian, Malaysian, Korean and Filipino currencies were severely affected. The below graph shows these Asian countries' currencies in USD per one unit of their currency, indexed to 100 in June 1997.

Of the statements below, which is NOT correct? The Asian countries':

(a) Exports denominated in domestic currency became cheaper to foreigners.

(b) Imports denominated in domestic currency became more expensive.

(c) Citizens would have to pay more in their own currency when holidaying in the US.

(d) USD interest payments on USD fixed-interest bonds became more expensive in their own currency.

(e) Domestic currency interest payments on fixed-interest bonds denominated in domestic currency became cheaper in their own currency.

Question 324  foreign exchange rate

The Chinese government attempts to fix its exchange rate against the US dollar and at the same time use monetary policy to fix its interest rate at a set level.

To be able to fix its exchange rate and interest rate in this way, what does the Chinese government actually do?

1. Adopts capital controls to prevent financial arbitrage by private firms and individuals.
2. Adopts the same interest rate (monetary policy) as the United States.
3. Fixes inflation so that the domestic real interest rate is equal to the United States' real interest rate.

Which of the above statements is or are true?

(a) I only.

(b) II only.

(c) III only.

(d) I and II.

(e) II and III.

Question 572  bond pricing, zero coupon bond, term structure of interest rates, expectations hypothesis, forward interest rate, yield curve

In the below term structure of interest rates equation, all rates are effective annual yields and the numbers in subscript represent the years that the yields are measured over:

###(1+r_{0-3})^3 = (1+r_{0-1})(1+r_{1-2})(1+r_{2-3}) ###

Which of the following statements is NOT correct?

(a) ##r_{0-3}## is the three year spot rate, given as an effective annual rate.

(b) ##r_{0-1}## is the one year forward rate, given as an effective annual rate.

(c) ##r_{1-2}## is the one year forward rate one year ahead, given as an effective annual rate.

(d) ##r_{2-3}## is the one year forward rate two years ahead, given as an effective annual rate.

(e) ##r_{1-3} = \left((1+r_{1-2})(1+r_{2-3})\right)^{1/2}-1## is the two year forward rate, one year ahead, given as an effective annual rate.

Question 573  bond pricing, zero coupon bond, term structure of interest rates, expectations hypothesis, liquidity premium theory, forward interest rate, yield curve

In the below term structure of interest rates equation, all rates are effective annual yields and the numbers in subscript represent the years that the yields are measured over:

###(1+r_{0-3})^3 = (1+r_{0-1})(1+r_{1-2})(1+r_{2-3}) ###

Which of the following statements is NOT correct?

(a) If the expectations hypothesis is true, then the forward rates are the expected future spot rates.

(b) If the liquidity premium theory is true, then the forward rates are lower than the expected future spot rates due to the liquidity premium.

(c) The yield curve is normal when: ##r_{0-1} < r_{1-2} < r_{2-3}##.

(d) The yield curve is flat when: ##r_{0-1} = r_{1-2} = r_{2-3}##.

(e) The yield curve is inverse when: ##r_{0-1} > r_{1-2} > r_{2-3}##.

Question 35  bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

A European company just issued two bonds, a

• 1 year zero coupon bond at a yield of 8% pa, and a
• 2 year zero coupon bond at a yield of 10% pa.

What is the company's forward rate over the second year (from t=1 to t=2)? Give your answer as an effective annual rate, which is how the above bond yields are quoted.

(a) 0.0185

(b) 0.0374

(c) 0.0604

(d) 0.1204

(e) 0.1250

Question 25  bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

A European company just issued two bonds, a

• 2 year zero coupon bond at a yield of 8% pa, and a
• 3 year zero coupon bond at a yield of 10% pa.

What is the company's forward rate over the third year (from t=2 to t=3)? Give your answer as an effective annual rate, which is how the above bond yields are quoted.

(a) 0.0374

(b) 0.0604

(c) 0.1204

(d) 0.1250

(e) 0.1411

Question 267  term structure of interest rates

A European company just issued two bonds, a

• 3 year zero coupon bond at a yield of 6% pa, and a
• 4 year zero coupon bond at a yield of 6.5% pa.

What is the company's forward rate over the fourth year (from t=3 to t=4)? Give your answer as an effective annual rate, which is how the above bond yields are quoted.

(a) 0.1634

(b) 0.0801

(c) 0.0704

(d) 0.07

(e) 0.0095

Question 143  bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

An Australian company just issued two bonds:

• A 6-month zero coupon bond at a yield of 6% pa, and
• A 12 month zero coupon bond at a yield of 7% pa.

What is the company's forward rate from 6 to 12 months? Give your answer as an APR compounding every 6 months, which is how the above bond yields are quoted.

(a) 0.0400

(b) 0.0500

(c) 0.0660

(d) 0.0800

(e) 0.1321

Question 569  personal tax

The average weekly earnings of an Australian adult worker before tax was $1,542.40 per week in November 2014 according to the Australian Bureau of Statistics. Therefore average annual earnings before tax were $80,204.80 assuming 52 weeks per year. Personal income tax rates published by the Australian Tax Office are reproduced for the 2014-2015 financial year in the table below:

Taxable income	Tax on this income
0 – $18,200	Nil
$18,201 – $37,000	19c for each $1 over $18,200
$37,001 – $80,000	$3,572 plus 32.5c for each $1 over $37,000
$80,001 – $180,000	$17,547 plus 37c for each $1 over $80,000
$180,001 and over	$54,547 plus 45c for each $1 over $180,000

The above rates do not include the Medicare levy of 2%. Exclude the Medicare levy from your calculations

How much personal income tax would you have to pay per year if you earned $80,204.80 per annum before-tax?

(a) $36,092.16

(b) $29,675.78

(c) $21,185.56

(d) $17,622.78

(e) $3,638.56

Question 448  franking credit, personal tax on dividends, imputation tax system

A small private company has a single shareholder. This year the firm earned a $100 profit before tax. All of the firm's after tax profits will be paid out as dividends to the owner.

The corporate tax rate is 30% and the sole shareholder's personal marginal tax rate is 45%.

The Australian imputation tax system applies because the company generates all of its income in Australia and pays corporate tax to the Australian Tax Office. Therefore all of the company's dividends are fully franked. The sole shareholder is an Australian for tax purposes and can therefore use the franking credits to offset his personal income tax liability.

What will be the personal tax payable by the shareholder and the corporate tax payable by the company?

(a) Personal tax of $6.43 and corporate tax of $45.

(b) Personal tax of $15 and corporate tax of $30.

(c) Personal tax of $16.5 and corporate tax of $45.

(d) Personal tax of $31.5 and corporate tax of $30.

(e) Personal tax of $45 and corporate tax of $0.

Question 449  personal tax on dividends, classical tax system

A small private company has a single shareholder. This year the firm earned a $100 profit before tax. All of the firm's after tax profits will be paid out as dividends to the owner.

The corporate tax rate is 30% and the sole shareholder's personal marginal tax rate is 45%.

The United States' classical tax system applies because the company generates all of its income in the US and pays corporate tax to the Internal Revenue Service. The shareholder is also an American for tax purposes.

What will be the personal tax payable by the shareholder and the corporate tax payable by the company?

(a) Personal tax of $6.43 and corporate tax of $45.

(b) Personal tax of $15 and corporate tax of $30.

(c) Personal tax of $16.5 and corporate tax of $45.

(d) Personal tax of $31.5 and corporate tax of $30.

(e) Personal tax of $45 and corporate tax of $0.

Question 309  stock pricing, ex dividend date

A company announces that it will pay a dividend, as the market expected. The company's shares trade on the stock exchange which is open from 10am in the morning to 4pm in the afternoon each weekday. When would the share price be expected to fall by the amount of the dividend? Ignore taxes.

The share price is expected to fall during the:

(a) Day of the payment date, between the payment date's morning opening price and afternoon closing price.

(b) Night before the payment date, between the previous day's afternoon closing price and the payment date's morning opening price.

(c) Day of the ex-dividend date, between the ex-dividend date's morning opening price and afternoon closing price.

(d) Night before the ex-dividend date, between the last with-dividend date's afternoon closing price and the ex-dividend date's morning opening price.

(e) Day of the last with-dividend date, between the with-dividend date's morning opening price and afternoon closing price.

Question 409  NPV, capital structure, capital budgeting

A pharmaceutical firm has just discovered a valuable new drug. So far the news has been kept a secret.

The net present value of making and commercialising the drug is $200 million, but $600 million of bonds will need to be issued to fund the project and buy the necessary plant and equipment.

The firm will release the news of the discovery and bond raising to shareholders simultaneously in the same announcement. The bonds will be issued shortly after.

Once the announcement is made and the bonds are issued, what is the expected increase in the value of the firm's assets (ΔV), market capitalisation of debt (ΔD) and market cap of equity (ΔE)?

The triangle symbol is the Greek letter capital delta which means change or increase in mathematics.

Ignore the benefit of interest tax shields from having more debt.

Remember: ##ΔV = ΔD+ΔE##

(a) ##ΔV=800m, ΔD = 600m, ΔE=200m##

(b) ##ΔV=200m, ΔD = 600m, ΔE= 0##

(c) ##ΔV=200m, ΔD =0m, \quad ΔE=200m##

(d) ##ΔV=400m, ΔD = 600m, ΔE=-200m##

(e) ##ΔV=800m, ΔD = 800m, ΔE= 0##

Question 454  NPV, capital structure, capital budgeting

A mining firm has just discovered a new mine. So far the news has been kept a secret.

The net present value of digging the mine and selling the minerals is $250 million, but $500 million of new equity and $300 million of new bonds will need to be issued to fund the project and buy the necessary plant and equipment.

The firm will release the news of the discovery and equity and bond raising to shareholders simultaneously in the same announcement. The shares and bonds will be issued shortly after.

Once the announcement is made and the new shares and bonds are issued, what is the expected increase in the value of the firm's assets ##(\Delta V)##, market capitalisation of debt ##(\Delta D)## and market cap of equity ##(\Delta E)##? Assume that markets are semi-strong form efficient.

The triangle symbol ##\Delta## is the Greek letter capital delta which means change or increase in mathematics.

Ignore the benefit of interest tax shields from having more debt.

Remember: ##\Delta V = \Delta D+ \Delta E##

(a) ##\Delta V = 250m##, ##ΔD = 300m##, ##ΔE= 250##

(b) ##\Delta V = 250m##, ##ΔD = 300m##, ##ΔE= 750##

(c) ##\Delta V = 400m##, ##ΔD = 300m##, ##ΔE= -250##

(d) ##\Delta V = 1,050m##, ##ΔD = 300m##, ##ΔE= 750##

(e) ##\Delta V = 1,050m##, ##ΔD = 300m##, ##ΔE= 250##

Question 513  stock split, reverse stock split, stock dividend, bonus issue, rights issue

Which of the following statements is NOT correct?

(a) A 3 for 2 stock split means that for every 2 existing shares, all shareholders will receive 1 extra share.

(b) A 3 for 10 bonus issue means that for every 10 existing shares, all shareholders will receive 3 extra shares.

(c) A 20% stock dividend means that for every 10 existing shares, all shareholders will receive 2 extra shares.

(d) A 1 for 10 reverse stock split means that for every 10 existing shares, all shareholders will lose 9 shares, so they will only be left with 1 share.

(e) A 3 for 10 rights issue at a subscription price of $8 means that for every 10 existing shares, all shareholders can sell 3 of their shares back to the company at a price of $8 each, so shareholders receive money.

Question 566  capital structure, capital raising, rights issue, on market repurchase, dividend, stock split, bonus issue

A company's share price fell by 20% and its number of shares rose by 25%. Assume that there are no taxes, no signalling effects and no transaction costs.

Which one of the following corporate events may have happened?

(a) $1 cash dividend when the pre-announcement stock price was $5.

(b) On-market buy-back of 20% of the company's outstanding stock.

(c) 5 for 4 stock split.

(d) 1 for 5 bonus issue.

(e) 1 for 4 rights issue at a subscription price of $3 when the pre-announcement stock price was $5.

Question 567  stock split, capital structure

A company conducts a 4 for 3 stock split. What is the percentage change in the stock price and the number of shares outstanding? The answers are given in the same order.

(a) -33.33%, 50%

(b) -25%, 33.33%

(c) -25%, 25%

(d) -20%, 25%

(e) 33.33%, -25%

Question 455  income and capital returns, payout policy, DDM, market efficiency

A fairly priced unlevered firm plans to pay a dividend of $1 next year (t=1) which is expected to grow by 3% pa every year after that. The firm's required return on equity is 8% pa.

The firm is thinking about reducing its future dividend payments by 10% so that it can use the extra cash to invest in more projects which are expected to return 8% pa, and have the same risk as the existing projects. Therefore, next year's dividend will be $0.90. No new equity or debt will be issued to fund the new projects, they'll all be funded by the cut in dividends.

What will be the stock's new annual capital return (proportional increase in price per year) if the change in payout policy goes ahead?

Assume that payout policy is irrelevant to firm value (so there's no signalling effects) and that all rates are effective annual rates.

(a) 2.7% pa.

(b) 3.0% pa.

(c) 3.5% pa.

(d) 3.3% pa.

(e) 3.8% pa.

Question 82  portfolio return

Portfolio Details
Stock	Expected return	Standard deviation	Correlation	Dollars invested
A	0.1	0.4	0.5	60
B	0.2	0.6		140

What is the expected return of the above portfolio?

(a) 0.15

(b) 0.17

(c) 0.1908

(d) 0.2412

(e) 0.34

Question 83  portfolio risk, standard deviation

Portfolio Details
Stock	Expected return	Standard deviation	Correlation ##(\rho_{A,B})##	Dollars invested
A	0.1	0.4	0.5	60
B	0.2	0.6		140

What is the standard deviation (not variance) of returns of the above portfolio?

(a) 0.4368

(b) 0.4911

(c) 0.6331

(d) 0.6564

(e) 0.7348

Question 73  portfolio risk, standard deviation

Portfolio Details
Stock	Expected return	Standard deviation	Covariance ##(\sigma_{A,B})##	Beta	Dollars invested
A	0.2	0.4	0.12	0.5	40
B	0.3	0.8		1.5	80

What is the standard deviation (not variance) of the above portfolio? Note that the stocks' covariance is given, not correlation.

(a) 0.5497

(b) 0.5651

(c) 0.5963

(d) 0.6156

(e) 0.8165

Question 285  covariance, portfolio risk

Two risky stocks A and B comprise an equal-weighted portfolio. The correlation between the stocks' returns is 70%.

If the variance of stock A's returns increases but the:

• Prices and expected returns of each stock stays the same,
• Variance of stock B's returns stays the same,
• Correlation of returns between the stocks stays the same.

Which of the following statements is NOT correct?

(a) The variance of the portfolio returns will increase.

(b) The standard deviation of the portfolio returns will increase.

(c) The covariance of returns between stocks A and B will stay the same.

(d) The portfolio expected return will stay the same.

(e) The portfolio value will stay the same.

Question 294  short selling, portfolio weights

Which of the following statements about short-selling is NOT true?

(a) Short sellers benefit from price falls.

(b) To short sell, you must borrow the asset from person A and sell it to person B, then later on buy an identical asset from person C and return it to person A.

(c) Short selling only works for assets that are 'fungible' which means that there are many that are identical and substitutable, such as shares and bonds and unlike real estate.

(d) An investor who short-sells an asset has a negative weight in that asset.

(e) An investor who short-sells an asset is said to be 'long' that asset.

Question 557  portfolio weights, portfolio return

An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of 6% pa.

• Stock A has an expected return of 5% pa.
• Stock B has an expected return of 10% pa.

What portfolio weights should the investor have in stocks A and B respectively?

(a) 80%, 20%

(b) 60%, 40%

(c) 40%, 60%

(d) 20%, 80%

(e) 20%, 20%