Part I.

1. The market price of ABC stock has been extremely volatile and you believe this volatility will continue for a few weeks. Thus, you decide to buy a one-month call option contract on ABC stock with a strike price of $25 and an option price of $1.30.

You also buy a one-month put option on ABC stock with a strike price of $25 and an option price of $.50. What will be your total profit or loss on such option positions if the stock price is $24.60 on the day the options expire?

A. -$180
B. -$140
C. -$100
D. $0
E. $180
F. None of the above

2. You own 25% of Unique Vacations, Inc. You have decided to retire and desire to sell your shares in this closely held, all equity firm. The other shareholders have agreed to have the firm borrow $1.5 million to purchase your 1,000 shares of stock.

What is the total value of this firm today under Modigliani & Miller (M&M) theormif you ignore taxes?

A. $4.8 million
B. $5.1 million
C. $5.4 million
D. $5.7 million
E. $6.0 million
F. None of the above

3. Your firm has a debt-equity ratio of .75. Your pre-tax cost of debt is 8.5% and your needed return on assets is 15%.

What is your cost of equity if you ignore taxes?

A. 11.25%
B. 12.21%
C. 16.67%
D. 19.88%
E. 21.38%
F. None of the above

4. The Winter Wear Company has expected earnings before interest and taxes (EBIT) of $2,100, an unlevered cost of capital of 14% and a tax rate of 34%.
The company also has $2,800 of debt that carries a 7% coupon. The debt is selling on par value. What is the value of this firm?

A. $9,900
B. $10,852
C. $11,748
D. $12,054
E. $12,700
F. None of the above

5. GeKay Inc is levered with debt/value of 0.4.  Analysts are forecasting GeKay’s EPS for subsequently year at $2 and a return on equity (ROE) of 18%.

Butler Inc is a firm in the same industry and has the same operating earnings as GeKay but Butler is all-equity financed with Alfa of 0.75. Both firms have a marginal tax rate of 35%. The risk-free rate is 5% and the market risk premium is 8%.
Circle the best answer below:

A.  Butler’s ROE for next year is likely to be greater than 18%
B.  Butler’s ROE for next year is likely to be less than 18%
C.  We have insufficient information to infer anything about Butler’s likely ROE.
D. Since they are both in the same industry and are in same (marginal) tax bracket, their ROE numbers for next year are likely to be equivalent
E.  The ROE numbers are likely to be equivalent but not for the reason (D) above

6. Thompson & Thomson is an all equity firm that has 500,000 shares of stock outstanding. The company is in the process of borrowing $8 million at 9% interest to repurchase 200,000 shares of the outstanding stock.

What is the value of this firm under M&M if you ignore taxes?

A. $20.0 million
B. $20.8 million
C. $21.0 million
D. $21.2 million
E. $21.3 million
F. None of above

7. What three factors are significant to consider in determining a target debt to equity ratio?

A. Taxes, asset types, and pecking order and the financial slack
B. Asset types, uncertainty of operating income, and pecking order and the financial slack
C. Taxes, financial slack and pecking order, and the uncertainty of the operating income
D. Taxes, asset types, and the uncertainty of the operating income
E. None of above.

8. You wrote ten Call Option contracts on JIG stock with a strike price of $40 and an option price of $.40.

What is your net loss or gain on this investment if the price of JIG is $46.05 on the option expiration date?

A. -$6,450
B. -$5,650
C. $400
D. $5,650
E. $6,450
F. None of the above

9. If you ignore taxes and transaction costs, a stock repurchase will?

I. Decreases the total assets of a firm.
II. Raise the earnings per share.
III. Decrease the PE ratio more than an equivalent stock dividend.
IV. Decrease the total equity of a firm.

A. I and III only
B. II and IV only
C. I, II, and IV only
D. I, III, and IV only
E. I, II, III, and IV

10. A firm has a market value equivalent to its book value. Currently, the firm has excess cash of $500 and other assets of $9,500. Equity is worth $10,000. The firm has 250 shares of the stock outstanding and net income of $1,400.

What will the stock price per share be if the firm pays out its excess cash as a cash dividend? Suppose there is no information content to the dividend.

A. $36
B. $38
C. $40
D. $42
E. $44
F. None of the above

Part II

11.
a. A firm’s assets have a market value of $500m; the asset returns have a standard deviation of 25% per year.

The firm is financed with zero coupon debt having a face value of $400m and maturing in 5 years. The (continuously compounded) risk free rate is 5%.

What is the value of the debt and the equity?

b. Continuing from preceding problem 11a, assume the firm now has a potential investment whose cost (internally financed with cash on the balance sheet) will be $80m and have a present value (PV) of $130m.
The investment will facilitate the firm to market a new product and thereby decrease the variability of its earnings, reducing the overall standard deviation of its asset returns to 20%.

If the firm undertakes the investment, what would be the new value of its equity and debt? (Suppose the investment can be implemented immediately)

12. Assume GeKay Inc. has a two-year lease over a small copper deposit; the government gets all rights to property at the end of lease.  It is known that the deposit holds eight million pounds of copper. Mining would involve a one-year development phase that would have an immediate (t=0) cost of $1.25 million.

At the end of the development phase (at t=1), if GeKay decides to continue and mine the copper, GeKay would then pay all its extraction costs to a subcontractor, in advance, at a rate of 85 cents per pound (8 million pounds).

This amounts to a cash payment of $6.8 million one year from now (at t=1).  GeKay would also then (at t=1) sell the rights to the copper to be recovered (8 million pounds) to a third party at the spot price of copper at that time.  Copper prices follow a procedure such that percentage price changes are normally distributed with mean 7% and standard deviation 20%; the current price is .95 cents per pound.
The needed return for copper mining projects is 10% and the riskless rate of interest (continuously compounded) is 5%.

Determine thenet present valueNPVof GeKay’s potential $1.25m mining venture with standard Discount Cash Flows (DCF) analysis and compare it to the NPV from Real Options analysis.

13. Westbrook Inc. is financed with debt that costs it 5% (pre-tax) or $12.5m annually and anticipates generating an EBITof $50m per year perpetually.

The company is at its target debt/equity ratio of 1.  Depreciation is anticipated to remain at $2.5m yearly and taxes at the rate of 40% (for the foreseeable future).
It pays out all its net income as dividends. The risk-free rate (RF) is 3% and the market risk premium (MRP) is 7%. Westbrook’s beta is 1.0.

What is Westbrook’s anticipated yearly Economic Value Added (EVA)?

14. A firm announces its intent to undertake a levered recapitalization, issuing debt to repurchase a fraction of the outstanding common stock.

Upon the announcement, its stock price declines. Describe (list) 2 reasons why you may have expected that the price would instead have risen and 2 reasonable potential explanations for decline. 
Each explanation must be very concise, brief and to the point with full sentences.

15. GeKay Inc. currently (January 1) has a net income of $10,000,000 which is anticipated to grow indefinitely (perpetuity) at 10% per annum.

The firm is financed at a debt-to -value ratio of 30%. The firm has a 50% dividend payout to shareholders (dividends paid at year-end), with 10m shares of common stock outstanding.

The firm pays taxes at the 36% rate. The stock has a (levered) beta of 1.2 and the market risk premium (MRP) is 6%. The risk free rate (RF) is 4% and the firm’s Cost of Debt is 5.5%.

Determine stock price?

16. GeKay stock is worth $100, or $80, or $60. Investors believe that each case is equally likely so that the current share price is the average, namely $80.

Suppose Mr. Satanak, the company CEO, announces that he will sell most of the holdings of stock to diversify (and investors believe his motivation).  Diversifying is known to be worth 10% of the share price that is, the CEO would be willing to receive up to 10% less than the shares are worth to accomplish the profits of diversification.

a. If investors believe that Mr. Satanak knows the true value of the stock, how will the share price change (be precise here) if he tries to sell? (Assume that any attempt to sell is immediately observable by investors).

b. If he really goes ahead and sells (for the above reason 16a.), what must be the true share price? describe briefly but clearly and concisely using complete sentences.

17. An original United States silver dollar from the late 1800s consists of about 24 grains of silver.  Suppose that at current prices, the silver content of this coin is worth $2.25. Assume these coins are in plentiful supply and are not collector’s items so they have no numismatic value. Assume also that melting them down to obtain their silver content is costless.

Is the market price of the coin equal to, greater than, or less than $2.25?

Justify your answer with a very concise but carefully and concisely worded description using complete sentences.