Fight Finance

Question 349  CFFA, depreciation 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 - \Delta NWC+IntExp###

(a) An increase in revenue (Rev).

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

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

(d) An decrease in net working capital (ΔNWC).

(e) An increase in dividends.

Question 350  CFFA

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

Sidebar Corp
Income Statement for
year ending 30th June 2013
	$m
Sales	405
COGS	100
Depreciation	34
Rent expense	22
Interest expense	39
Taxable Income	210
Taxes at 30%	63
Net income	147

Sidebar Corp
Balance Sheet
as at 30th June	2013	2012
	$m	$m
Cash	0	0
Inventory	70	50
Trade debtors	11	16
Rent paid in advance	4	3
PPE	700	680
Total assets	785	749
Trade creditors	11	19
Bond liabilities	400	390
Contributed equity	220	220
Retained profits	154	120
Total L and OE	785	749

 

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

The cash flow from assets was:

(a) $138m

(b) $142m

(c) $143m

(d) $172m

(e) $176m

Question 351  CFFA

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

• Achieve firm free cash flow (FFCF or CFFA) of $1m.
• Pay dividends of $1.8m
• Complete a $1.3m share buy-back.
• Spend $0.8m on new buildings without buying or selling any other fixed assets. This capital expenditure is included in the CFFA figure quoted above.

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 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) $2.1m

(b) $1.3m

(c) $0.8m

(d) $0.3m

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

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 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 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 206  CFFA, interest expense, interest tax shield

Interest expense (IntExp) is an important part of a company's income statement (or 'profit and loss' or 'statement of financial performance').

How does an accountant calculate the annual interest expense of a fixed-coupon bond that has a liquid secondary market? Select the most correct answer:

Annual interest expense is equal to:

(a) the bond's face value multiplied by its annual yield to maturity.

(b) the bond's face value multiplied by its annual coupon rate.

(c) the bond's market price at the start of the year multiplied by its annual yield to maturity.

(d) the bond's market price at the start of the year multiplied by its annual coupon rate.

(e) the future value of the actual cash payments of the bond over the year, grown to the end of the year, and grown by the bond's yield to maturity.

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 506  leverage, accounting ratio

A firm has a debt-to-equity ratio of 25%. What is its debt-to-assets ratio?

(a) 20%

(b) 36%

(c) 60%

(d) 75%

(e) 93.75%

Question 507  leverage, accounting ratio

A firm has a debt-to-equity ratio of 60%. What is its debt-to-assets ratio?

(a) 64%

(b) 40%

(c) 37.5%

(d) 25%

(e) 6.25%

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 113  WACC, CFFA, capital budgeting

The US firm Google operates in the online advertising business. In 2011 Google bought Motorola Mobility which manufactures mobile phones.

Assume the following:

• Google had a 10% after-tax weighted average cost of capital (WACC) before it bought Motorola.
• Motorola had a 20% after-tax WACC before it merged with Google.
• Google and Motorola have the same level of gearing.
• Both companies operate in a classical tax system.

You are a manager at Motorola. You must value a project for making mobile phones. Which method(s) will give the correct valuation of the mobile phone manufacturing project? Select the most correct answer.

The mobile phone manufacturing project's:

(a) Unlevered CFFA should be discounted by Google's 10% WACC after tax.

(b) Unlevered CFFA should be discounted by Motorola's 20% WACC after tax.

(c) Levered CFFA should be discounted by Google's 10% WACC after tax.

(d) Levered CFFA should be discounted by Motorola's 20% WACC after tax.

(e) Unlevered CFFA by 15%, the average of Google and Motorola's WACC after tax.

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 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 413  CFFA, interest tax shield, depreciation tax shield

There are many ways to calculate a firm's free cash flow (FFCF), also called cash flow from assets (CFFA).

One method is to use the following formulas to transform net income (NI) into FFCF including interest and depreciation tax shields:

###FFCF=NI + Depr - CapEx -ΔNWC + IntExp###

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

Another popular method is to use EBITDA rather than net income. EBITDA is defined as:

###EBITDA=Rev - COGS - FC###

One of the below formulas correctly calculates FFCF from EBITDA, including interest and depreciation tax shields, giving an identical answer to that above. Which formula is correct?

(a) ##FFCF=EBITDA+ Depr - CapEx -ΔNWC + IntExp##

(b) ##FFCF=EBITDA.(1-t_c )+Depr- CapEx -ΔNWC##

(c) ##FFCF=EBITDA.(1-t_c )+ Depr.t_c - CapEx -ΔNWC + IntExp.t_c##

(d) ##FFCF=EBITDA.(1-t_c )+Depr.(1-t_c )- CapEx -ΔNWC+IntExp.(1-t_c)##

(e) ##FFCF=EBITDA.(1-t_c )- CapEx -ΔNWC##

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 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 370  capital budgeting, NPV, interest tax shield, WACC, CFFA

Project Data
Project life	2 yrs
Initial investment in equipment	$600k
Depreciation of equipment per year	$250k
Expected sale price of equipment at end of project	$200k
Revenue per job	$12k
Variable cost per job	$4k
Quantity of jobs per year	120
Fixed costs per year, paid at the end of each year	$100k
Interest expense in first year (at t=1)	$16.091k
Interest expense in second year (at t=2)	$9.711k
Tax rate	30%
Government treasury bond yield	5%
Bank loan debt yield	6%
Levered cost of equity	12.5%
Market portfolio return	10%
Beta of assets	1.24
Beta of levered equity	1.5
Firm's and project's debt-to-equity ratio	25%

Notes

1. The project will require an immediate purchase of $50k of inventory, which will all be sold at cost when the project ends. Current liabilities are negligible so they can be ignored.

Assumptions

• The debt-to-equity ratio will be kept constant throughout the life of the project. The amount of interest expense at the end of each period has been correctly calculated to maintain this constant debt-to-equity ratio. Note that interest expense is different in each year.
• Thousands are represented by 'k' (kilo).
• All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
• All rates and cash flows are nominal. The inflation rate is 2% pa.
• All rates are given as effective annual rates.
• The 50% capital gains tax discount is not available since the project is undertaken by a firm, not an individual.

What is the net present value (NPV) of the project?

(a) $684.222k

(b) $690.919k

(c) $697.616k

(d) $698.713k

(e) $710.601k

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 78  WACC, capital structure

A company issues a large amount of bonds to raise money for new projects of similar risk to the company's existing projects. The net present value (NPV) of the new projects is positive but small. Assume a classical tax system. Which statement is NOT correct?

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

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

(c) Firm value is likely to have increased due to the higher amount of interest tax shields, assuming that there will not be any costs of financial distress.

(d) The company's after-tax WACC is likely to have decreased.

(e) The company's before-tax WACC is likely to have decreased.

Question 69  interest tax shield, capital structure, leverage, WACC

Which statement about risk, required return and capital structure is the most correct?

(a) The before-tax cost of debt is less than the before-tax cost of equity. Therefore debt is a cheaper form of financing than equity so companies should try to finance their projects with debt only.

(b) Debt makes a firm's equity more risky. Therefore the higher the amount of debt, the higher the cost of equity.

(c) The more debt a firm has, the higher its tax shields. Therefore firms should seek to have as much debt and as little equity as possible.

(d) The more debt, the lower the firm's after tax WACC. The after tax WACC is the discount rate that discounts the firm's cash flows, so the lower it is the more the firm is worth. Therefore firms should try to make their after tax WACC as low as possible by using as much debt as possible.

(e) The less debt, the lower the chance of bankruptcy. Therefore firms should try to pay off all of their debt so that they are financed by equity only.

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 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 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 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 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 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%

Question 558  portfolio weights, portfolio return, short selling

An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of 16% pa.

• Stock A has an expected return of 8% pa.
• Stock B has an expected return of 12% pa.

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

(a) 200%, -100%

(b) 200%, 100%

(c) -100%, 200%

(d) 100%, 200%

(e) -100%, 100%

Question 565  correlation

What is the correlation of a variable X with a constant C?

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

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

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

(c) 1

(d) 0

(e) Mathematically undefined

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 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 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 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 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 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 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 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 72  CAPM, portfolio beta, portfolio risk

Portfolio Details
Stock	Expected return	Standard deviation	Correlation	Beta	Dollars invested
A	0.2	0.4	0.12	0.5	40
B	0.3	0.8		1.5	80

What is the beta of the above portfolio?

(a) 0.75

(b) 0.833333333

(c) 1

(d) 1.166666667

(e) 1.4

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 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 98  capital structure, CAPM

A firm changes its capital structure by issuing a large amount of debt and using the funds to repurchase shares. 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 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 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 408  leverage, portfolio beta, portfolio risk, real estate, CAPM

You just bought a house worth $1,000,000. You financed it with an $800,000 mortgage loan and a deposit of $200,000.

You estimate that:

• The house has a beta of 1;
• The mortgage loan has a beta of 0.2.

What is the beta of the equity (the $200,000 deposit) that you have in your house?

Also, if the risk free rate is 5% pa and the market portfolio's return is 10% pa, what is the expected return on equity in your house? Ignore taxes, assume that all cash flows (interest payments and rent) were paid and received at the end of the year, and all rates are effective annual rates.

(a) The beta of equity is 5 and the expected return on equity is 30% pa.

(b) The beta of equity is 4.2 and the expected return on equity is 26% pa.

(c) The beta of equity is 0.86 and the expected return on equity is 9.3% pa.

(d) The beta of equity is 1 and the expected return on equity is 10% pa.

(e) The beta of equity is 0.6 and the expected return on equity is 8% pa.

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 100  market efficiency, technical analysis, joint hypothesis problem

A company selling charting and technical analysis software claims that independent academic studies have shown that its software makes significantly positive abnormal returns. Assuming the claim is true, which statement(s) are correct?

(I) Weak form market efficiency is broken.

(II) Semi-strong form market efficiency is broken.

(III) Strong form market efficiency is broken.

(IV) The asset pricing model used to measure the abnormal returns (such as the CAPM) had mis-specification error so the returns may not be abnormal but rather fair for the level of risk.

Select the most correct response:

(a) Only III is true.

(b) Only II and III are true.

(c) Only I, II and III are true.

(d) Only IV is true.

(e) Either I, II and III are true, or IV is true, or they are all true.

Question 119  market efficiency, fundamental analysis, joint hypothesis problem

Your friend claims that by reading 'The Economist' magazine's economic news articles, she can identify shares that will have positive abnormal expected returns over the next 2 years. Assuming that her claim is true, which statement(s) are correct?

(i) Weak form market efficiency is broken.

(ii) Semi-strong form market efficiency is broken.

(iii) Strong form market efficiency is broken.

(iv) The asset pricing model used to measure the abnormal returns (such as the CAPM) is either wrong (mis-specification error) or is measured using the wrong inputs (data errors) so the returns may not be abnormal but rather fair for the level of risk.

Select the most correct response:

(a) Only (iii) is true.

(b) Only (ii) and (iii) are true.

(c) Only (i), (ii) and (iii) are true.

(d) Either (ii) and (iii) are true, or (iv) is true, or (ii), (iii) and (iv) are true.

(e) Either (i), (ii) and (iii) are true, or (iv) is true, or all are true.

Question 242  technical analysis, market efficiency

Select the most correct statement from the following.

'Chartists', also known as 'technical traders', believe that:

(a) Markets are weak-form efficient.

(b) Markets are semi-strong-form efficient.

(c) Past prices cannot be used to predict future prices.

(d) Past returns can be used to predict future returns.

(e) Stock prices reflect all publically available information.

Question 48  IRR, NPV, bond pricing, premium par and discount bonds, market efficiency

The theory of fixed interest bond pricing is an application of the theory of Net Present Value (NPV). Also, a 'fairly priced' asset is not over- or under-priced. Buying or selling a fairly priced asset has an NPV of zero.

Considering this, which of the following statements is NOT correct?

(a) The internal rate of return (IRR) of buying a fairly priced bond is equal to the bond's yield.

(b) The Present Value of a fairly priced bond's coupons and face value is equal to its price.

(c) If a fairly priced bond's required return rises, its price will fall.

(d) Fairly priced premium bonds' yields are less than their coupon rates, prices are more than their face values, and the NPV of buying them is therefore positive.

(e) The NPV of buying a fairly priced bond is zero.

Question 63  bond pricing, NPV, market efficiency

The theory of fixed interest bond pricing is an application of the theory of Net Present Value (NPV). Also, a 'fairly priced' asset is not over- or under-priced. Buying or selling a fairly priced asset has an NPV of zero.

Considering this, which of the following statements is NOT correct?

(a) The internal rate of return (IRR) of buying a bond is equal to the bond's yield.

(b) The present value of a fairly priced bond's coupons and face value is equal to its price.

(c) If the required return of a bond falls, its price will fall.

(d) Fairly priced discount bonds' yield is more than the coupon rate, price is less than face value, and the NPV of buying them is zero.

(e) The NPV of buying a fairly priced bond is zero.

Question 339  bond pricing, inflation, market efficiency, income and capital returns

Economic statistics released this morning were a surprise: they show a strong chance of consumer price inflation (CPI) reaching 5% pa over the next 2 years.

This is much higher than the previous forecast of 3% pa.

A vanilla fixed-coupon 2-year risk-free government bond was issued at par this morning, just before the economic news was released.

What is the expected change in bond price after the economic news this morning, and in the next 2 years? Assume that:

• Inflation remains at 5% over the next 2 years.
• Investors demand a constant real bond yield.
• The bond price falls by the (after-tax) value of the coupon the night before the ex-coupon date, as in real life.

(a) Today the price would have increased significantly.
Over the next 2 years, the bond price is expected to increase, measured on each ex-coupon date.

(b) Today the price would have increased significantly.
Over the next 2 years, the bond price is expected to be unchanged, measured on each ex-coupon date.

(c) Today the price would have been unchanged.
Over the next 2 years, the bond price is expected to increase, measured on each ex-coupon date.

(d) Today the price would have decreased significantly.
Over the next 2 years, the bond price is expected to increase, measured on each ex-coupon date.

(e) Today the price would have decreased significantly.
Over the next 2 years, the bond price is expected to be unchanged, measured on each ex-coupon date.

Question 105  NPV, risk, market efficiency

A person is thinking about borrowing $100 from the bank at 7% pa and investing it in shares with an expected return of 10% pa. One year later the person intends to sell the shares and pay back the loan in full. Both the loan and the shares are fairly priced.

What is the Net Present Value (NPV) of this one year investment? Note that you are asked to find the present value (##V_0##), not the value in one year (##V_1##).

(a) $10

(b) $3

(c) $2.8037

(d) $2.7273

(e) $0

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 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 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 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 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 246  foreign exchange rate, forward foreign exchange rate, cross currency interest rate parity

Suppose the Australian cash rate is expected to be 8.15% pa and the US federal funds rate is expected to be 3.00% pa over the next 2 years, both given as nominal effective annual rates. The current exchange rate is at parity, so 1 USD = 1 AUD.

What is the implied 2 year forward foreign exchange rate?

(a) 1 USD = 1.1025 AUD

(b) 1.1025 USD = 1 AUD

(c) 1 USD = 1.05 AUD

(d) 1 USD = 1.1 AUD

(e) 1.1 USD = 1 AUD

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 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 494  franking credit, personal tax on dividends, imputation tax system

A firm pays a fully franked cash dividend of $100 to one of its Australian shareholders who has a personal marginal tax rate of 15%. The corporate tax rate is 30%.

What will be the shareholder's personal tax payable due to the dividend payment?

(a) -$21.4286

(b) -$7.563

(c) $15

(d) $21.4286

(e) $78.5714

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 212  rights issue

In mid 2009 the listed mining company Rio Tinto announced a 21-for-40 renounceable rights issue. Below is the chronology of events:

• 04/06/2009. Share price opens at $69.00 and closes at $66.90.

• 05/06/2009. 21-for-40 rights issue announced at a subscription price of $28.29.

• 16/06/2009. Last day that shares trade cum-rights. Share price opens at $76.40 and closes at $75.50.

• 17/06/2009. Shares trade ex-rights. Rights trading commences.

All things remaining equal, what would you expect Rio Tinto's stock price to open at on the first day that it trades ex-rights (17/6/2009)? Ignore the time value of money since time is negligibly short. Also ignore taxes.

(a) $28.29

(b) $35.8625

(c) $44.5426

(d) $47.2100

(e) $59.2473

Question 214  rights issue

In late 2003 the listed bank ANZ announced a 2-for-11 rights issue to fund the takeover of New Zealand bank NBNZ. Below is the chronology of events:

• 23/10/2003. Share price closes at $18.30.

• 24/10/2003. 2-for-11 rights issue announced at a subscription price of $13. The proceeds of the rights issue will be used to acquire New Zealand bank NBNZ. Trading halt announced in morning before market opens.

• 28/10/2003. Trading halt lifted. Last (and only) day that shares trade cum-rights. Share price opens at $18.00 and closes at $18.14.

• 29/10/2003. Shares trade ex-rights.

All things remaining equal, what would you expect ANZ's stock price to open at on the first day that it trades ex-rights (29/10/2003)? Ignore the time value of money since time is negligibly short. Also ignore taxes.

(a) 17.3492

(b) 17.2308

(c) 14.8418

(d) 13.7908

(e) 13.7692

Question 476  income and capital returns, idiom

The saying "buy low, sell high" suggests that investors should make a:

(a) Positive income return.

(b) Positive capital return.

(c) Negative income return.

(d) Negative capital return.

(e) Positive total return.

Question 478  income and capital returns

Total cash flows can be broken into income and capital cash flows. What is the name given to the income cash flow from owning shares?

(a) Dividends.

(b) Rent.

(c) Coupons.

(d) Loan payments.

(e) Capital gains.

Question 477  income and capital returns

An asset's total expected return over the next year is given by:

###r_\text{total} = \dfrac{c_1+p_1-p_0}{p_0} ###

Where ##p_0## is the current price, ##c_1## is the expected income in one year and ##p_1## is the expected price in one year. The total return can be split into the income return and the capital return.

Which of the following is the expected capital return?

(a) ##c_1##

(b) ##p_1-p_0##

(c) ##\dfrac{c_1}{p_0} ##

(d) ##\dfrac{p_1}{p_0} -1##

(e) ##\dfrac{p_1}{p_0} ##

Question 151  income and capital returns

A share was bought for $30 (at t=0) and paid its annual dividend of $6 one year later (at t=1).

Just after the dividend was paid, the share price fell to $27 (at t=1). What were the total, capital and income returns given as effective annual rates?

The choices are given in the same order:

##r_\text{total}## , ##r_\text{capital}## , ##r_\text{dividend}##.

(a) -0.1, -0.3, 0.2.

(b) -0.1, 0.1, -0.2.

(c) 0.1, -0.1, 0.2.

(d) 0.1, 0.2, -0.1.

(e) 0.2, 0.1, -0.1.

Question 404  income and capital returns, real estate

One and a half years ago Frank bought a house for $600,000. Now it's worth only $500,000, based on recent similar sales in the area.

The expected total return on Frank's residential property is 7% pa.

He rents his house out for $1,600 per month, paid in advance. Every 12 months he plans to increase the rental payments.

The present value of 12 months of rental payments is $18,617.27.

The future value of 12 months of rental payments one year in the future is $19,920.48.

What is the expected annual rental yield of the property? Ignore the costs of renting such as maintenance, real estate agent fees and so on.

(a) 3.1029%

(b) 3.3201%

(c) 3.7235%

(d) 3.9841%

(e) 7%

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 353  income and capital returns, inflation, real and nominal returns and cash flows, real estate

A residential investment property has an expected nominal total return of 6% pa and nominal capital return of 3% pa.

Inflation is expected to be 2% pa. All rates are given as effective annual rates.

What are the property's expected real total, capital and income returns? The answer choices below are given in the same order.

(a) 3.9216%, 2.9412%, 0.9804%.

(b) 3.9216%, 0.9804%, 2.9412%.

(c) 3.9216%, 0.9804%, 0.9804%.

(d) 1.9804%, 1.0000%, 0.9804%.

(e) 1.9608%, 0.9804%, 0.9804%.

Question 407  income and capital returns, inflation, real and nominal returns and cash flows

A stock has a real expected total return of 7% pa and a real expected capital return of 2% pa.

Inflation is expected to be 2% pa. All rates are given as effective annual rates.

What is the nominal expected total return, capital return and dividend yield? The answers below are given in the same order.

(a) 11.100%, 4.000%, 7.100%.

(b) 11.140%, 4.040%, 7.100%.

(c) 4.902%, 0.000%, 4.902%.

(d) 9.140%, 4.040%, 5.100%.

(e) 9.140%, 4.040%, 7.100%.

Question 525  income and capital returns, real and nominal returns and cash flows, inflation

Which of the following statements about cash in the form of notes and coins is NOT correct? Assume that inflation is positive.

Notes and coins:

(a) Pay no income cash flow.

(b) Have a nominal total return of zero.

(c) Have a nominal capital return of zero.

(d) Have a nominal income return of zero.

(e) Have a real total return of zero.

Question 526  real and nominal returns and cash flows, inflation, no explanation

How can a nominal cash flow be precisely converted into a real cash flow?

(a) ##C_\text{real, t}=C_\text{nominal,t}.(1+r_\text{inflation})^t##

(b) ##C_\text{real,t}=\dfrac{C_\text{nominal,t}}{(1+r_\text{inflation})^t} ##

(c) ##C_\text{real,t}=\dfrac{C_\text{nominal,t}}{r_\text{inflation}} ##

(d) ##C_\text{real,t}=C_\text{nominal,t}.r_\text{inflation} ##

(e) ##C_\text{real,t}=C_\text{nominal,t}.r_\text{inflation}.t##

Question 575  inflation, real and nominal returns and cash flows

You expect a nominal payment of $100 in 5 years. The real discount rate is 10% pa and the inflation rate is 3% pa. Which of the following statements is NOT correct?

(a) The nominal cash flow of $100 in 5 years is equivalent to a real cash flow of $86.2609 in 5 years. This means that $86.2609 will buy the same amount of goods and services now as $100 will buy in 5 years.

(b) The real discount rate of 10% pa is equivalent to a nominal discount rate of 13.3333% pa.

(c) The nominal price of goods and services will increase by 3% every year.

(d) The real price of goods and services will increase by 3% every year.

(e) The present value of your payment will increase by the nominal discount rate every year.

Question 577  inflation, real and nominal returns and cash flows

What is the present value of a real payment of $500 in 2 years? The nominal discount rate is 7% pa and the inflation rate is 4% pa.

(a) $472.3557

(b) $471.298

(c) $436.7194

(d) $435.7415

(e) $405.8112

Question 554  inflation, real and nominal returns and cash flows

On his 20th birthday, a man makes a resolution. He will put $30 cash under his bed at the end of every month starting from today. His birthday today is the first day of the month. So the first addition to his cash stash will be in one month. He will write in his will that when he dies the cash under the bed should be given to charity.

If the man lives for another 60 years, how much money will be under his bed if he dies just after making his last (720th) addition?

Also, what will be the real value of that cash in today's prices if inflation is expected to 2.5% pa? Assume that the inflation rate is an effective annual rate and is not expected to change.

The answers are given in the same order, the amount of money under his bed in 60 years, and the real value of that money in today's prices.

(a) $21,600,     $95,035.46

(b) $21,600,     $49,515.44

(c) $21,600,     $4,909.33

(d) $21,600,     $2,557.86

(e) $11,254.05,     $2,557.86

Question 221  credit risk

You're considering making an investment in a particular company. They have preference shares, ordinary shares, senior debt and junior debt.

Which is the safest investment? Which has the highest expected returns?

(a) Junior debt is the safest. Preference shares have the highest expected returns.

(b) Preference shares are the safest. Ordinary shares have the highest expected returns.

(c) Senior debt is the safest. Ordinary shares have the highest expected returns.

(d) Junior debt is the safest. Ordinary shares have the highest expected returns.

(e) Senior debt is the safest. Junior debt have the highest expected returns.

Question 466  limited liability, business structure

Which business structure or structures have the advantage of limited liability for equity investors?

(a) Sole traders.

(b) Partnerships.

(c) Corporations.

(d) All of the above.

(e) None of the above

Question 531  bankruptcy or insolvency, capital structure, risk, limited liability

Who is most in danger of being personally bankrupt? Assume that all of their businesses' assets are highly liquid and can therefore be sold immediately.

(a) Alice has $6,000 cash, owes $10,000 credit card debt due immediately and 100% owns a sole tradership business with assets worth $10,000 and liabilities of $3,000.

(b) Billy has $10,000 cash, owes $6,000 credit card debt due immediately and 100% owns a corporate business with assets worth $3,000 and liabilities of $10,000.

(c) Carla has $6,000 cash, owes $10,000 credit card debt due immediately and 100% owns a corporate business with assets worth $10,000 and liabilities of $3,000.

(d) Darren has $10,000 cash, owes $6,000 credit card debt due immediately and 100% owns a sole tradership business with assets worth $3,000 and liabilities of $10,000.

(e) Ernie has $1,000 cash, lent $3,000 to his friend, and doesn't have any personal debt or own any businesses.

Question 467  book and market values

Which of the following statements about book and market equity is NOT correct?

(a) The market value of equity of a listed company's common stock is equal to the number of common shares multiplied by the share price.

(b) The book value of equity is the sum of contributed equity, retained profits and reserves.

(c) A company's book value of equity is recorded in its income statement, also known as the 'profit and loss' or the 'statement of financial performance'.

(d) A new company's market value of equity equals its book value of equity the moment that its shares are first sold. From then on, the market value changes continuously but the book value is recorded at historical cost which typically only changes due to retained profits.

(e) To buy all of the firm's shares, generally a price close to the market value of equity will have to be paid.

Question 473  market capitalisation of equity

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 market capitalisation of equity?

(a) $431.18 billion

(b) $429 billion

(c) $134.07 billion

(d) $8.44 billion

(e) $3.21 billion

Question 444  investment decision, corporate financial decision theory

The investment decision primarily affects which part of a business?

(a) Assets.

(b) Liabilities and owner's equity.

(c) Current assets and current liabilities.

(d) Dividends and buy backs.

(e) Net income, also known as earnings or net profit after tax.

Question 445  financing decision, corporate financial decision theory

The financing decision primarily affects which part of a business?

(a) Assets.

(b) Liabilities and owner's equity.

(c) Current assets and current liabilities.

(d) Dividends and buy backs.

(e) Net income, also known as earnings or net profit after tax.

Question 443  corporate financial decision theory, investment decision, financing decision, working capital decision, payout policy

Business people make lots of important decisions. Which of the following is the most important long term decision?

(a) Investment decision.

(b) Financing decision.

(c) Working capital decision.

(d) Payout policy decision.

(e) Capital or labour decision.

Question 515  corporate financial decision theory, idiom

The expression 'you have to spend money to make money' relates to which business decision?

(a) Investment decision.

(b) Financing decision.

(c) Working capital decision.

(d) Payout policy decision.

(e) Diversification decision.

Question 490  expected and historical returns, accounting ratio

Which of the following is NOT a synonym of 'required return'?

(a) total required yield

(b) cost of capital

(c) discount rate

(d) opportunity cost of capital

(e) accounting rate of return

Question 508  income and capital returns

Which of the following equations is NOT equal to the total return of an asset?

Let ##p_0## be the current price, ##p_1## the expected price in one year and ##c_1## the expected income in one year.

(a) ##r_\text{total} = \dfrac{c_1+p_1-p_0}{p_0} ##

(b) ##r_\text{total} = \dfrac{c_1+p_1}{p_0} - 1##

(c) ##r_\text{total} = \dfrac{c_1}{p_0} + \dfrac{p_1-p_0}{p_0}##

(d) ##r_\text{total} = \dfrac{c_1}{p_0} + \dfrac{p_1}{p_0} ##

(e) ##r_\text{total} = \dfrac{c_1}{p_0} + \dfrac{p_1}{p_0} - 1##

Question 136  income and capital returns

A stock was bought for $8 and paid a dividend of $0.50 one year later (at t=1 year). Just after the dividend was paid, the stock price was $7 (at t=1 year).

What were the total, capital and dividend returns given as effective annual rates? The choices are given in the same order:

##r_\text{total}##, ##r_\text{capital}##, ##r_\text{dividend}##.

(a) 0.0625, -0.0625, -0.125.

(b) 0.0625, 0.125, -0.0625.

(c) -0.0625, 0.0625, -0.125.

(d) -0.0625, -0.125, 0.0625.

(e) -0.125, -0.1875, 0.0625.

Question 21  income and capital returns, bond pricing

A fixed coupon bond was bought for $90 and paid its annual coupon of $3 one year later (at t=1 year). Just after the coupon was paid, the bond price was $92 (at t=1 year). What was the total return, capital return and income return? Calculate your answers as effective annual rates.

The choices are given in the same order: ## r_\text{total},r_\text{capital},r_\text{income} ##.

(a) -0.0556, -0.0222, -0.0333

(b) 0.0222, -0.0111, 0.0333.

(c) 0.0333, 0.0556, 0.0222.

(d) 0.0556, 0.0222, 0.0333.

(e) 0.0556, 0.0333, 0.0222.

Question 456  inflation, effective rate

In the 'Austin Powers' series of movies, the character Dr. Evil threatens to destroy the world unless the United Nations pays him a ransom (video 1, video 2). Dr. Evil makes the threat on two separate occasions:

• In 1969 he demands a ransom of $1 million (=10^6), and again;
• In 1997 he demands a ransom of $100 billion (=10^11).

If Dr. Evil's demands are equivalent in real terms, in other words $1 million will buy the same basket of goods in 1969 as $100 billion would in 1997, what was the implied inflation rate over the 28 years from 1969 to 1997?

The answer choices below are given as effective annual rates:

(a) 0.5086% pa

(b) 1.5086% pa

(c) 5.0859% pa

(d) 50.8591% pa

(e) 150.8591% pa

Question 295  inflation, real and nominal returns and cash flows, NPV

When valuing assets using discounted cash flow (net present value) methods, it is important to consider inflation. To properly deal with inflation:

(I) Discount nominal cash flows by nominal discount rates.

(II) Discount nominal cash flows by real discount rates.

(III) Discount real cash flows by nominal discount rates.

(IV) Discount real cash flows by real discount rates.

Which of the above statements is or are correct?

(a) I only.

(b) III only.

(c) IV only.

(d) I and IV only.

(e) II and III only.

Question 574  inflation, real and nominal returns and cash flows, NPV

What is the present value of a nominal payment of $100 in 5 years? The real discount rate is 10% pa and the inflation rate is 3% pa.

(a) $71.2986

(b) $62.0921

(c) $61.5028

(d) $54.276

(e) $53.5612

Question 576  inflation, real and nominal returns and cash flows

What is the present value of a nominal payment of $1,000 in 4 years? The nominal discount rate is 8% pa and the inflation rate is 2% pa.

(a) $795.62

(b) $792.0937

(c) $735.0299

(d) $731.7721

(e) $683.0135

Question 120  credit risk, payout policy

A newly floated farming company is financed with senior bonds, junior bonds, cumulative non-voting preferred stock and common stock. The new company has no retained profits and due to floods it was unable to record any revenues this year, leading to a loss. The firm is not bankrupt yet since it still has substantial contributed equity (same as paid-up capital).

On which securities must it pay interest or dividend payments in this terrible financial year?

(a) Preferred stock only.

(b) The senior and junior bonds only.

(c) Common stock only.

(d) The senior and junior bonds and the preferred stock.

(e) No payments on any security is required since the firm made a loss.

Question 452  limited liability, expected and historical returns

What is the lowest and highest expected share price and expected return from owning shares in a company over a finite period of time?

Let the current share price be ##p_0##, the expected future share price be ##p_1##, the expected future dividend be ##d_1## and the expected return be ##r##. Define the expected return as:

##r=\dfrac{p_1-p_0+d_1}{p_0} ##

The answer choices are stated using inequalities. As an example, the first answer choice "(a) ##0≤p<∞## and ##0≤r< 1##", states that the share price must be larger than or equal to zero and less than positive infinity, and that the return must be larger than or equal to zero and less than one.

(a) ##0≤p<∞## and ##0≤r< 1##

(b) ##0≤p<∞## and ##-1≤r< ∞##

(c) ##0≤p<∞## and ##0≤r< ∞##

(d) ##0≤p<∞## and ##-∞≤r< ∞##

(e) ##-∞<p<∞## and ##-∞<r< ∞##

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

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

In the year since then, the firm:

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

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

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

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

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

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

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

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

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

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

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

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

Similarly for equity and debt.

Question 482  market capitalisation of equity

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 market capitalisation of equity?

(a) $395.11 million

(b) $21.01 billion

(c) $121.92 billion

(d) $393.95 billion

(e) $1.02935 trillion

Question 446  working capital decision, corporate financial decision theory

The working capital decision primarily affects which part of a business?

(a) Assets.

(b) Liabilities and owner's equity.

(c) Current assets and current liabilities.

(d) Dividends and buy backs.

(e) Net income, also known as earnings or net profit after tax.

Question 447  payout policy, corporate financial decision theory

Payout policy is most closely related to which part of a business?

(a) Assets.

(b) Liabilities and owner's equity.

(c) Current assets and current liabilities.

(d) Dividends and buy backs.

(e) Net income, also known as earnings or net profit after tax.

Question 516  corporate financial decision theory

Which of the following decisions relates to the current assets and current liabilities of the firm?

(a) Investment decision.

(b) Financing decision.

(c) Working capital decision.

(d) Payout policy decision.

(e) Capital or labour decision.

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 499  NPV, Annuity

Some countries' interest rates are so low that they're zero.

If interest rates are 0% pa and are expected to stay at that level for the foreseeable future, what is the most that you would be prepared to pay a bank now if it offered to pay you $10 at the end of every year for the next 5 years?

In other words, what is the present value of five $10 payments at time 1, 2, 3, 4 and 5 if interest rates are 0% pa?

(a) $0

(b) $10

(c) $50

(d) Positive infinity

(e) Priceless

Question 479  perpetuity with growth, DDM, NPV

Discounted cash flow (DCF) valuation prices assets by finding the present value of the asset's future cash flows. The single cash flow, annuity, and perpetuity equations are very useful for this.

Which of the following equations is the 'perpetuity with growth' equation?

(a) ##V_0=\dfrac{C_t}{(1+r)^t} ##

(b) ##V_0=\dfrac{C_1}{r}.\left(1-\dfrac{1}{(1+r)^T} \right)= \sum\limits_{t=1}^T \left( \dfrac{C_t}{(1+r)^t} \right) ##

(c) ##V_0=\dfrac{C_1}{r-g}.\left(1-\left(\dfrac{1+g}{1+r}\right)^T \right)= \sum\limits_{t=1}^T \left( \dfrac{C_t.(1+g)^t}{(1+r)^t} \right) ##

(d) ##V_0=\dfrac{C_1}{r} = \sum\limits_{t=1}^\infty \left( \dfrac{C_t}{(1+r)^t} \right) ##

(e) ##V_0=\dfrac{C_1}{r-g} = \sum\limits_{t=1}^\infty \left( \dfrac{C_t.(1+g)^t}{(1+r)^t} \right) ##

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 7  DDM

For a price of $1040, Camille will sell you a share which just paid a dividend of $100, and is expected to pay dividends every year forever, growing at a rate of 5% pa.

So the next dividend will be ##100(1+0.05)^1=$105.00##, and the year after it will be ##100(1+0.05)^2=110.25## and so on.

The required return of the stock is 15% pa.

Would you like to the share or politely ?

Question 497  income and capital returns, DDM, ex dividend date

A stock will pay you a dividend of $10 tonight if you buy it today. Thereafter the annual dividend is expected to grow by 5% pa, so the next dividend after the $10 one tonight will be $10.50 in one year, then in two years it will be $11.025 and so on. The stock's required return is 10% pa.

What is the stock price today and what do you expect the stock price to be tomorrow, approximately?

(a) $200 today and $210 tomorrow.

(b) $210 today and $220 tomorrow.

(c) $220 today and $230 tomorrow.

(d) $210 today and $200 tomorrow.

(e) $220 today and $210 tomorrow.

Question 289  DDM, expected and historical returns, ROE

In the dividend discount model:

###P_0 = \dfrac{C_1}{r-g}###

The return ##r## is supposed to be the:

(a) Expected future total return of the market price of equity.

(b) Expected future total return of the book price of equity.

(c) Actual historical total return on the market price of equity.

(d) Actual historical total return on the book price of equity.

(e) Actual historical return on equity (ROE) defined as (Net Income / Owners Equity).

Question 36  DDM, perpetuity with growth

A stock pays annual dividends which are expected to continue forever. It just paid a dividend of $10. The growth rate in the dividend is 2% pa. You estimate that the stock's required return is 10% pa. Both the discount rate and growth rate are given as effective annual rates. Using the dividend discount model, what will be the share price?

(a) $127.5

(b) $125

(c) $102

(d) $101.98

(e) $100

Question 40  DDM, perpetuity with growth

A stock is expected to pay the following dividends:

Cash Flows of a Stock
Time (yrs)	0	1	2	3	4	...
Dividend ($)	0.00	1.00	1.05	1.10	1.15	...

After year 4, the annual dividend will grow in perpetuity at 5% pa, so;

• the dividend at t=5 will be $1.15(1+0.05),
• the dividend at t=6 will be $1.15(1+0.05)^2, and so on.

The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates.

What will be the price of the stock in three and a half years (t = 3.5)?

(a) $27.7567

(b) $24.1226

(c) $23.5680

(d) $22.4457

(e) $3.6341

Question 441  DDM, income and capital returns

A fairly valued share's current price is $4 and it has a total required return of 30%. Dividends are paid annually and next year's dividend is expected to be $1. After that, dividends are expected to grow by 5% pa in perpetuity. All rates are effective annual returns.

What is the expected dividend income paid at the end of the second year (t=2) and what is the expected capital gain from just after the first dividend (t=1) to just after the second dividend (t=2)? The answers are given in the same order, the dividend and then the capital gain.

(a) $1.3, $0.26

(b) $1.25, $0.25

(c) $1.1025, $0.2205

(d) $1.05, $0.21

(e) $1, $0.2

Question 52  IRR, pay back period

A three year project's NPV is negative. The cash flows of the project include a negative cash flow at the very start and positive cash flows over its short life. The required return of the project is 10% pa. Select the most correct statement.

(a) The payback period is negative.

(b) The project's IRR is negative.

(c) The project's IRR is less than its required return.

(d) The project's IRR is more than its required return.

(e) The project's IRR is equal to its required return.

Question 501  NPV, IRR, pay back period

The below graph shows a project's net present value (NPV) against its annual discount rate.

Which of the following statements is NOT correct?

(a) When the project's discount rate is 18% pa, the NPV is approximately -$30m.

(b) The payback period is infinite, the project never pays itself off.

(c) The addition of the project's cash flows, ignoring the time value of money, is approximately $20m.

(d) The project's IRR is approximately 5.5% pa.

(e) As the discount rate rises, the NPV falls.

Question 496  NPV, IRR, pay back period

A firm is considering a business project which costs $10m now and is expected to pay a single cash flow of $12.1m in two years.

Assume that the initial $10m cost is funded using the firm's existing cash so no new equity or debt will be raised. The cost of capital is 10% pa.

Which of the following statements about net present value (NPV), internal rate of return (IRR) and payback period is NOT correct?

(a) The NPV is zero.

(b) The IRR is 10% pa, equal to the 10% cost of capital.

(c) The payback period is two years assuming that the whole $12.1m cash flow occurs at t=2, or 1.826 years if the $12.1m cash flow is paid smoothly over the second year.

(d) The project could be accepted or rejected, the owners would be indifferent.

(e) If the project is accepted then the market value of the firm's assets will increase by $2.1m more than it would otherwise if the project was rejected.

Question 489  NPV, IRR, pay back period, DDM

A firm is considering a business project which costs $11m now and is expected to pay a constant $1m at the end of every year forever.

Assume that the initial $11m cost is funded using the firm's existing cash so no new equity or debt will be raised. The cost of capital is 10% pa.

Which of the following statements about net present value (NPV), internal rate of return (IRR) and payback period is NOT correct?

(a) The NPV is negative $1m.

(b) The IRR is 9.09% pa, less than the 10% cost of capital.

(c) The payback period is infinite, the project will never pay itself off.

(d) The project should be rejected.

(e) If the project is accepted then the market value of the firm's assets will fall by $1m.

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 191  NPV, IRR, profitability index, pay back period

A project's Profitability Index (PI) is less than 1. Select the most correct statement:

(a) The project should be rejected.

(b) The project's IRR is more than its required return.

(c) The project's payback period will be less than 3 years.

(d) The project's IRR is equal to its required return.

(e) The project's NPV is greater than 1.

Question 580  price gains and returns over time, time calculation, effective rate

How many years will it take for an asset's price to quadruple (be four times as big, say from $1 to $4) if the price grows by 15% pa?

(a) 1.3685 years

(b) 3.4783 years

(c) 4.4808 years

(d) 9.919 years

(e) 11.5156 years

Question 579  price gains and returns over time, time calculation, effective rate

How many years will it take for an asset's price to double if the price grows by 10% pa?

(a) 1.8182 years

(b) 3.3219 years

(c) 7.2725 years

(d) 11.5267 years

(e) 13.7504 years

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 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 488  income and capital returns, payout policy, payout ratio, DDM

Two companies BigDiv and ZeroDiv are exactly the same except for their dividend payouts.

BigDiv pays large dividends and ZeroDiv doesn't pay any dividends.

Currently the two firms have the same earnings, assets, number of shares, share price, expected total return and risk.

Assume a perfect world with no taxes, no transaction costs, no asymmetric information and that all assets including business projects are fairly priced and therefore zero-NPV.

All things remaining equal, which of the following statements is NOT correct?

(a) BigDiv is expected to have a lower capital return than ZeroDiv in the future.

(b) BigDiv is expected to have a lower total return than ZeroDiv in the future.

(c) ZeroDiv's assets are likely to grow faster than BigDiv's.

(d) ZeroDiv's share price will increase faster than BigDiv's.

(e) BigDiv currently has a higher payout ratio than ZeroDiv.

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 217  NPV, DDM, multi stage growth model

A stock is expected to pay a dividend of $15 in one year (t=1), then $25 for 9 years after that (payments at t=2 ,3,...10), and on the 11th year (t=11) the dividend will be 2% less than at t=10, and will continue to shrink at the same rate every year after that forever. The required return of the stock is 10%. All rates are effective annual rates.

What is the price of the stock now?

(a) $361.78

(b) $236.33

(c) $237.93

(d) $348.69

(e) $223.24

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 333  DDM, time calculation

When using the dividend discount model, care must be taken to avoid using a nominal dividend growth rate that exceeds the country's nominal GDP growth rate. Otherwise the firm is forecast to take over the country since it grows faster than the average business forever.

Suppose a firm's nominal dividend grows at 10% pa forever, and nominal GDP growth is 5% pa forever. The firm's total dividends are currently $1 billion (t=0). The country's GDP is currently $1,000 billion (t=0).

In approximately how many years will the company's total dividends be as large as the country's GDP?

(a) 1,443 years

(b) 1,199 years

(c) 955 years

(d) 674 years

(e) 148 years

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