Deck 7: Risk, Capital Budgeting and Raising Long-Term Financing

Question 1

Smith Enterprises
Smith Enterprises recently conducted an IPO. In this, Smith received $14 per share from the underwriter, the offering price per share was $16 and the stock price rose to $19 on the first day of trading.

-Refer to Smith Enterprises. What is the first day return on an investment in the IPO?

A) 21.42%
B) 15.79%
C) 18.75%
D) 12.56%

Answer 1

18.75%

Question 2

The following data have been computed for a firm: when sales are $20,000, EBIT is $5,000 and operating leverage is 2.5. Suppose sales increase to $23,000; what is the new level of EBIT?

A) $1,875
B) $6,875
C) $3,000
D) $8,435

Answer 2

$6,875

Question 3

What is Never-crash Airline's WACC, if their marginal tax rate equals 34%?

A) 19.22%
B) 24.45%
C) 18.50%
D) 4.62%

Answer 3

18.50%

Question 4

What is the Never-crash Airline's after tax cost of debt?

A) 7.00%
B) 4.62%
C) 2.38%
D) 4.50%

Question 5

What is the Never-crash Airline's cost of equity?

A) 33.00%
B) 7.05%
C) 24.45%
D) 28.50%

Question 6

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-What is Bavarian Brewhouse's cost of preferred stock?

A) 8.00%
B) 15.5%
C) 10.7%
D) 12.6%

Question 7

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-What is Bavarian Brewhouse's cost of common equity?

A) 10.67%
B) 12.55%
C) 16.23%
D) 15.48%

Question 8

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-What percentage of Bavarian Brewhouse's capital structure consists of total equity?

A) 6.67%
B) 60.00%
C) 33.33%
D) 66.67%

Question 9

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-Assuming no corporate taxes, what is Bavarian Brewhouse's WACC?

A) 16.23%
B) 12.99%
C) 13.44%
D) 5.28%

Question 10

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-What is Bavarian Brewhouse's WACC if their marginal tax rate equals 34%

A) 12.08%
B) 12.99%
C) 13.44%
D) 5.28%

Question 11

Miller's Dairy Products reported sales of $1.5 million in 2002 and $2.25 million in 2003. Their EBIT in 2002 was $550,000 and in 2003 the EBIT rose to $925,000. What is the company's operating leverage?

A) 2.36
B) 1.36
C) 1.96
D) 2.86

Question 12

Running Shoes, Inc.
Running Shoes, Inc. has 2 million shares of stock outstanding. The stock currently sells for $12.50 per share. The firm's debt is publicly traded and was recently quoted at 90% of face value. It has a total face value of $10 million, and it is currently priced to yield 8%. The risk free rate is 2% and the market risk premium is 8%. You've estimated that the firm has a beta of 1.20. The corporate tax rate is 40%.

-Refer to Running Shoes, Inc. What is the cost of equity?

A) 9.20%
B) 9.60%
C) 10.40%
D) 11.60%

Question 13

Running Shoes, Inc.
Running Shoes, Inc. has 2 million shares of stock outstanding. The stock currently sells for $12.50 per share. The firm's debt is publicly traded and was recently quoted at 90% of face value. It has a total face value of $10 million, and it is currently priced to yield 8%. The risk free rate is 2% and the market risk premium is 8%. You've estimated that the firm has a beta of 1.20. The corporate tax rate is 40%.

-What is the percentage of equity used by Running Shoes, Inc.?

A) 74.63%
B) 73.53%
C) 72.46%
D) 68.97%

Question 14

A project under consideration for a firm has several possible outcomes shown in the table below. Given the assumptions below, what is the expected NPV for the project?

A) -$8.00
B) -$2.50
C) $1.20
D) $1.40

Question 15

A project under consideration for a firm has several possible outcomes shown in the table below. Given the assumptions below, what is the expected NPV for the project?

A) -$9.00
B) -$3.00
C) -$0.75
D) $1.20

Question 16

You are given the opportunity to play a game of high stakes gambling. The game begins by you paying an entry fee of $35,000,000 followed by a fair coin toss. If the coin toss is "heads" then you have an 80% probability of receiving a perpetuity of $10,000,000 per year and a 20% probability of receiving a perpetuity of $1,000,000 per year. Assume that the proper discount rate for the perpetual cash flow is 10%. If the coin toss is "tails"you can continue to play but you will lose $50,000,000 with certainty. Alternatively, you can make a make an opt-out payment of $10,000,000 after a "tail" to prevent you from going down such a costly path. What is the present value of playing such a game?

A) $1,000,000
B) -$1,000,000
C) -$39,000,000
D) none of the above

Question 17

You are a professional football running back who is eligible to be a free agent. You are offered a two-year contract to play for your current team for $3,000,000. If you accept that contract, the firm retains your rights and you will not be able to play for another team at the conclusion of the contract. Otherwise, you can play for you current team for two years at a price of $2,000,000 but you have the ability to play for any team at the expiration of this agreement. What is the value of the option to pay for any team you like after two years? Assume a discount rate of 5%.

A) $5,578,231
B) $3,718,821
C) $1,859,410
D) none of the above