Question 1

Louisiana Enterprises, an all-equity firm, is considering a new capital investment. Analysis has indicated that the proposed investment has a beta of 0.5 and will generate an expected return of 7%. The firm currently has a required return of 10.75% and a beta of 1.25. The investment, if undertaken, will double the firm's total assets. If rRF is 7% and the market risk premium is 3%, should the firm undertake the investment?

Accepted Answer

A)  Yes; the expected return of the asset (7%) exceeds the required return (6.5%). 
B)  Yes; the beta of the asset will reduce the risk of the firm. 
C)  No; the expected return of the asset (7%) is less than the required return (8.5%). 
D)  No; the risk of the asset (beta) will increase the firm's beta. 
E)  No; the expected return of the asset is less than the firm's required return, which is 10.75%.

Question 2

Given the following returns on Stock J and the "market" during the last three years, what is the beta coefficient of Stock J? (Hint: Think rise over run.)
$$\begin{array} { c r r } 
 \text { Year }&  \text { Stock J }& \underline { \text { Market } } \
1 & -13.85 \% & -8.63 \% \
2 & 22.90 \% & 12.37 \% \
3 & 35.15 \% & 19.37 \%
\end{array}$$

Accepted Answer

A)  1.58 
B)  1.66 
C)  1.75 
D)  1.84 
E)  1.93

Question 3

For a 10-year deposit, what annual rate payable semiannually will produce the same effective rate as 4% compounded continuously?

Accepted Answer

A)  3.46% 
B)  3.65% 
C)  3.84% 
D)  4.04% 
E)  4.24%

Question 4

Mulroney Corp. is considering two mutually exclusive projects. Both require an initial investment of $10,000, and their risks are average for the firm. Project X has an expected life of 2 years with after-tax cash inflows of $5,300 and $7,000 at the end of Years 1 and 2, respectively. Project Y has an expected life of 4 years with after-tax cash inflows of $3,500 at the end of each of the next 4 years. The firm's WACC is 8%. Use the replacement chain to determine the NPV of the most profitable project.

Accepted Answer

A)  $1,603.52 
B)  $1,687.91 
C)  $1,772.31 
D)  $1,860.92 
E)  $1,953.97

Question 5

Maxvill Motors has annual sales of $15,000. Its variable costs equal 60% of its sales and its fixed costs equal $1,000. If the company's sales increase 10%, what will be the percentage increase in the company's earnings before interest and taxes (EBIT)?

Accepted Answer

A)  13.89% 
B)  14.59% 
C)  13.23% 
D)  12.60% 
E)  12.00%

Question 6

Refer to Exhibit 7A.1. What is the nominal dollar value of the interest tax savings to the firm in the third year of the issue?

Accepted Answer

A)  $38.27 
B)  $40.29 
C)  $42.30 
D)  $44.42 
E)  $46.64

Question 7

You place $1,000 in an account that pays 7% interest compounded continuously. You plan to hold the account exactly 3 years. Simultaneously, in another account you deposit money that earns 8% compounded semiannually. If the accounts are to have the same amount at the end of the 3 years, how much of an initial deposit do you need to make now in the account that pays 8% interest compounded semiannually?

Accepted Answer

A)  $ 835.94 
B)  $ 879.93 
C)  $ 926.24 
D)  $ 974.99 
E)  $1,023.74

Exam 18: Financial and Operating Leverage: Analysis and Calculation

For a 10-year deposit, what annual rate payable semiannually will produce the same effective rate as 4% compounded continuously?

Maxvill Motors has annual sales of $15,000. Its variable costs equal 60% of its sales and its fixed costs equal $1,000. If the company's sales increase 10%, what will be the percentage increase in the company's earnings before interest and taxes (EBIT) ?

Refer to Exhibit 7A.1. What is the nominal dollar value of the interest tax savings to the firm in the third year of the issue?