Final Exam Prep
PRACTICE QUESTIONS
Multiple Choice
A mature firm has stable dividends and announces that, going forward, it will cut its dividend payout ratio but offset this by larger share repurchases, holding total cash outflow to shareholders unchanged. Which valuation approach is most likely to change its computed equity value even though business value is unchanged?
A. Free Cash Flow (EV-based) DCF model�B. Asset-based valuation using replacement cost�C. Constant-growth Dividend Growth Model (DGM) applied to per-share dividends�D. Total Payout Model that discounts (dividends + repurchases) at the equity cost of capital
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Multiple Choice
A mature firm has stable dividends and announces that, going forward, it will cut its dividend payout ratio but offset this by larger share repurchases, holding total cash outflow to shareholders unchanged. Which valuation approach is most likely to change its computed equity value even though business value is unchanged?
A. Free Cash Flow (EV-based) DCF model�B. Asset-based valuation using replacement cost�C. Constant-growth Dividend Growth Model (DGM) applied to per-share dividends�D. Total Payout Model that discounts (dividends + repurchases) at the equity cost of capital
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Multiple Choice
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Multiple Choice
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Multiple Choice
Which statement best captures a core drawback of relying on constant-growth dividend or total-payout models for valuation?
A. They ignore taxes entirely, so they cannot be used even as rough benchmarks�B. They value only distributed cash, so payout-policy changes can move the model’s value even when underlying business cash flows are unchanged�C. They automatically incorporate the effects of share issuance and option dilution in per-share terms�D. They are always more stable than free-cash-flow models because they use accounting dividends instead of economic cash flows
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Multiple Choice
Which statement best captures a core drawback of relying on constant-growth dividend or total-payout models for valuation?
A. They ignore taxes entirely, so they cannot be used even as rough benchmarks�B. They value only distributed cash, so payout-policy changes can move the model’s value even when underlying business cash flows are unchanged�C. They automatically incorporate the effects of share issuance and option dilution in per-share terms�D. They are always more stable than free-cash-flow models because they use accounting dividends instead of economic cash flows
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Multiple Choice
You have computed the Enterprise Value (EV) of a firm using a free-cash-flow-to-firm DCF model. The firm has $400m of interest-bearing debt at market value and $60m of excess cash on its balance sheet. Ignoring non-operating assets or other claims, which expression gives the equity value implied by your EV estimate?
A. Equity value = EV − Debt − Cash�B. Equity value = EV + Debt − Cash�C. Equity value = EV − (Debt − Cash)�D. Equity value = EV + (Debt + Cash)
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Multiple Choice
You have computed the Enterprise Value (EV) of a firm using a free-cash-flow-to-firm DCF model. The firm has $400m of interest-bearing debt at market value and $60m of excess cash on its balance sheet. Ignoring non-operating assets or other claims, which expression gives the equity value implied by your EV estimate?
A. Equity value = EV − Debt − Cash�B. Equity value = EV + Debt − Cash�C. Equity value = EV − (Debt − Cash)�D. Equity value = EV + (Debt + Cash)
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Multiple Choice
You are valuing a capital-intensive trucking company that owns a large, easily appraised fleet and operates in a very competitive market with thin margins. Intangibles (brand, software, IP) are minimal. Which primary valuation anchor is most defensible in this setting?
A. Asset-based valuation using replacement cost / liquidation value of the fleet�B. Price/Sales multiples applied to industry-average margins�C. A dividend discount model with assumed perpetual growth above GDP�D. A residual-income model built entirely from book equity and ROE forecasts
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Multiple Choice
You are valuing a capital-intensive trucking company that owns a large, easily appraised fleet and operates in a very competitive market with thin margins. Intangibles (brand, software, IP) are minimal. Which primary valuation anchor is most defensible in this setting?
A. Asset-based valuation using replacement cost / liquidation value of the fleet�B. Price/Sales multiples applied to industry-average margins�C. A dividend discount model with assumed perpetual growth above GDP�D. A residual-income model built entirely from book equity and ROE forecasts
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Multiple Choice
Consider the Theft vs. Roof insurance example. Both lines have a 1% claim probability per home and 100,000 policies outstanding. Which statement best explains why the roof/hail portfolio requires dramatically more capital than the theft portfolio?
A. Roof claims are individually larger than theft claims, so expected loss is higher�B. Theft is systematic risk while roof damage is idiosyncratic, so theft risk cannot be diversified�C. Roof damage is a common shock, so claims are highly correlated and the risk does not disappear with pooling�D. Both are independent risks, but roof insurance has higher accounting volatility
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Multiple Choice
Consider the Theft vs. Roof insurance example. Both lines have a 1% claim probability per home and 100,000 policies outstanding. Which statement best explains why the roof/hail portfolio requires dramatically more capital than the theft portfolio?
A. Roof claims are individually larger than theft claims, so expected loss is higher�B. Theft is systematic risk while roof damage is idiosyncratic, so theft risk cannot be diversified�C. Roof damage is a common shock, so claims are highly correlated and the risk does not disappear with pooling�D. Both are independent risks, but roof insurance has higher accounting volatility
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Multiple Choice
A firm adds a new, highly volatile product line whose cash flows are uncorrelated with the market but very risky on their own. According to CAPM, what happens to the firm’s required return on equity if this is the only change?
A. It increases, because investors hate any kind of volatility, systematic or not�B. It decreases, because the new product line is uncorrelated with the firm’s existing operations�C. It stays roughly the same, because CAPM prices only market (systematic) risk, not purely idiosyncratic volatility�D. It becomes undefined, because CAPM cannot handle multiple product lines
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Multiple Choice
A firm adds a new, highly volatile product line whose cash flows are uncorrelated with the market but very risky on their own. According to CAPM, what happens to the firm’s required return on equity if this is the only change?
A. It increases, because investors hate any kind of volatility, systematic or not�B. It decreases, because the new product line is uncorrelated with the firm’s existing operations�C. It stays roughly the same, because CAPM prices only market (systematic) risk, not purely idiosyncratic volatility�D. It becomes undefined, because CAPM cannot handle multiple product lines
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Multiple Choice
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Multiple Choice
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Multiple Choice
Your firm’s current WACC is 9%, based on its diversified portfolio of “average risk” projects. You are evaluating a much riskier new project in an unrelated, highly cyclical industry, financed with the same target D/E ratio as the firm overall. According to the Module 6 guidance, which is the best way to choose a discount rate?
A. Use the firm’s 9% WACC, because that is always the correct hurdle rate for any project�B. Estimate a project-specific cost of equity using CAPM with a high-beta peer group, then build a project-specific WACC�C. Use the risk-free rate because the new project is unrelated to what the firm currently does�D. Use the average of the firm’s WACC and the risk-free rate to reflect “partial diversification”
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Multiple Choice
Your firm’s current WACC is 9%, based on its diversified portfolio of “average risk” projects. You are evaluating a much riskier new project in an unrelated, highly cyclical industry, financed with the same target D/E ratio as the firm overall. According to the Module 6 guidance, which is the best way to choose a discount rate?
A. Use the firm’s 9% WACC, because that is always the correct hurdle rate for any project�B. Estimate a project-specific cost of equity using CAPM with a high-beta peer group, then build a project-specific WACC�C. Use the risk-free rate because the new project is unrelated to what the firm currently does�D. Use the average of the firm’s WACC and the risk-free rate to reflect “partial diversification”
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Multiple Choice
When computing WACC for an NPV analysis of a typical project with risk similar to the firm’s existing business, which set of choices is most consistent with the Module 6 notes?
A. Use book-value weights, the firm’s historical average borrowing rate, and pre-tax cost of debt�B. Use current market-value weights, target D/E going forward, and after-tax cost of debt�C. Use target market-value weights, after-tax cost of debt, and a cost of equity from CAPM based on the project’s systematic risk�D. Use equal 50/50 weights on debt and equity, the coupon rate on outstanding bonds, and a cost of equity equal to last year’s ROE
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Multiple Choice
When computing WACC for an NPV analysis of a typical project with risk similar to the firm’s existing business, which set of choices is most consistent with the Module 6 notes?
A. Use book-value weights, the firm’s historical average borrowing rate, and pre-tax cost of debt�B. Use current market-value weights, target D/E going forward, and after-tax cost of debt�C. Use target market-value weights, after-tax cost of debt, and a cost of equity from CAPM based on the project’s systematic risk�D. Use equal 50/50 weights on debt and equity, the coupon rate on outstanding bonds, and a cost of equity equal to last year’s ROE
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True or False
Under the pure expectations theory of the term structure (ignoring any term premium), an inverted yield curve—where long-term yields are below short-term yields—implies that market participants expect future short-term interest rates to fall over time.
True or False
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True or False
Under the pure expectations theory of the term structure (ignoring any term premium), an inverted yield curve—where long-term yields are below short-term yields—implies that market participants expect future short-term interest rates to fall over time.
True or False
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True or False
All else equal, if investor demand for outstanding corporate bonds shifts left (investors want to hold fewer bonds at each price) while the supply of those bonds is unchanged, bond prices will rise and yields will fall.
True or False
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True or False
All else equal, if investor demand for outstanding corporate bonds shifts left (investors want to hold fewer bonds at each price) while the supply of those bonds is unchanged, bond prices will rise and yields will fall.
True or False
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True or False
According to the three-factor DuPont Identity, a firm can increase its ROE even if its net profit margin falls, as long as it increases either its asset turnover or its financial leverage enough to more than offset the lower margin.
True or False
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True or False
According to the three-factor DuPont Identity, a firm can increase its ROE even if its net profit margin falls, as long as it increases either its asset turnover or its financial leverage enough to more than offset the lower margin.
True or False
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True or False
Holding sales constant, if a firm reduces its net working capital by collecting receivables faster and managing inventory more efficiently, its asset turnover ratio will increase.
True or False
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True or False
Holding sales constant, if a firm reduces its net working capital by collecting receivables faster and managing inventory more efficiently, its asset turnover ratio will increase.
True or False
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True or False
When using the constant-growth Dividend Growth Model (DGM), if the required return on equity Re is less than the dividend growth rate g, the stock is clearly undervalued because the model still produces a positive but very large price.
True or False
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True or False
When using the constant-growth Dividend Growth Model (DGM), if the required return on equity Re is less than the dividend growth rate g, the stock is clearly undervalued because the model still produces a positive but very large price.
True or False
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Multiple Choice
You will receive $100 one year from today. Using a negative discount rate of -2% per year, the present value today is closest to:
A. $96�B. $98�C. $100�D. $102
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Multiple Choice
You will receive $100 one year from today. Using a negative discount rate of -2% per year, the present value today is closest to:
A. $96�B. $98�C. $100�D. $102
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Multiple Choice
Suppose the current yield curve is strongly upward sloping (for example, the 1-year Treasury yield is 3% while the 10-year Treasury yield is 6%). Under the pure expectations theory (ignoring term premia), which statement is most accurate?
A. The market expects future short-term interest rates to be roughly constant at 3%.�B. The market expects future short-term interest rates to be below 3% on average.�C. The shape of the yield curve says nothing about expectations of future short-term interest rates�D. The market expects future short-term interest rates to rise above 3% on average; the long-term yield reflects an average of current and expected future short rates.
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Multiple Choice
Suppose the current yield curve is strongly upward sloping (for example, the 1-year Treasury yield is 3% while the 10-year Treasury yield is 6%). Under the pure expectations theory (ignoring term premia), which statement is most accurate?
A. The market expects future short-term interest rates to be roughly constant at 3%.�B. The market expects future short-term interest rates to be below 3% on average.�C. The shape of the yield curve says nothing about expectations of future short-term interest rates�D. The market expects future short-term interest rates to rise above 3% on average; the long-term yield reflects an average of current and expected future short rates.
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Multiple Choice
Last year a firm had: net profit margin = 10%, asset turnover = 1.0, and equity multiplier = 1.5, so ROE was 15%. This year, net profit margin remains 10% and the equity multiplier rises to 2.0, but asset turnover falls to 0.8. According to the DuPont Identity, which statement is correct?
A. ROE falls to 12% because the decline in asset turnover dominates.�B. ROE rises to 16% because higher leverage more than offsets the lower asset turnover.�C. ROE remains 15% because the net profit margin did not change.�D. ROE rises above 20% because both asset turnover and leverage increased.
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Multiple Choice
Last year a firm had: net profit margin = 10%, asset turnover = 1.0, and equity multiplier = 1.5, so ROE was 15%. This year, net profit margin remains 10% and the equity multiplier rises to 2.0, but asset turnover falls to 0.8. According to the DuPont Identity, which statement is correct?
A. ROE falls to 12% because the decline in asset turnover dominates.�B. ROE rises to 16% because higher leverage more than offsets the lower asset turnover.�C. ROE remains 15% because the net profit margin did not change.�D. ROE rises above 20% because both asset turnover and leverage increased.
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Multiple Choice
Which of the following ratios is most directly a measure of how efficiently a firm uses its asset base to generate sales, and is one of the three components in the standard DuPont decomposition of ROE?
A. Net profit margin�B. Asset turnover�C. Debt-to-equity ratio�D. Current ratio
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Multiple Choice
Which of the following ratios is most directly a measure of how efficiently a firm uses its asset base to generate sales, and is one of the three components in the standard DuPont decomposition of ROE?
A. Net profit margin�B. Asset turnover�C. Debt-to-equity ratio�D. Current ratio
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Multiple Choice
A 10-year annual coupon bond with face value $1,000 and a 4% coupon rate is issued and sells today for $922.78. (Assume annual coupons.) Three years from now, immediately after the third coupon is paid, the yield to maturity on similar 7-year, 4% coupon bonds has increased by 0.5 percentage points relative to this bond’s original yield. The bond’s new price at that time will be closest to:
A. $890�B. $915�C. $950�D. $1,000
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Multiple Choice
A 10-year annual coupon bond with face value $1,000 and a 4% coupon rate is issued and sells today for $922.78. (Assume annual coupons.) Three years from now, immediately after the third coupon is paid, the yield to maturity on similar 7-year, 4% coupon bonds has increased by 0.5 percentage points relative to this bond’s original yield. The bond’s new price at that time will be closest to:
A. $890�B. $915�C. $950�D. $1,000
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