Exam revision

Question 1

In the context of relative valuation, the PB ratio can never be greater than the
EV/Book value of capital ratio. (Assume all other inputs stay the same.)

Answer 1

False

Question 2

In the context of a single-stage growth model, the PE ratio always increases when the
reinvestment rate increases. (Assume all other inputs except the growth rate stay the
same.

Answer 2

False only if ROE is greater than Cost of equity

Question 3

Assuming all other variables except the growth rate stay constant, an increase in the
forecast for ROC will result in higher EV/EBIT(1-t), EV/BV and EV/Sales ratios

Answer 3

True

Question 4

A two-state one-period binomial option pricing model with PV$1u= 0:00 andPV$1d= 0:50 contains an arbitrage opportunity.

Answer 4

True U>R>D

Question 5

If a company decreases the maturity of its debt, everything else being equal, the value
of the company’s equity will increase in the context of real option valuation.

Answer 5

False: maturity decreases, leads to increase in value of debt, decreases value of equity

A = L + E

Question 6

A risky corporate bond will always trade at a discount to its face value due to the
possible losses to bondholders in case of default.

Answer 6

False: if coupon rate > ytm it will trade at a premium

Question 7

Risky corporate convertible bonds oering negative promised yields to maturity entail
an arbitrage opportunity, provided an investor can sell the bonds short.

Answer 7

false, convertable means they can make the price exceed the face value.

Question 8

A puttable bond is worth more than an otherwise identical non-puttable bond to the issuing firm.

Answer 8

True: bondholders are willing to pay more for the put option bond as they can demand their money back earlier incase of an increase in i and reinvest at a higher rate.

Question 9

In the context of real option pricing, a government guarantee to pay back all deposits
of a bank’s customers will increase the value today of the bank’s equity

Answer 9

False, garuntee does nothing to increase the banks equity

Question 10

The ability to increase output at no additional fixed cost is an example of a real option.

Answer 10

True: flexibility

Question 11

A negative enterprise value of the firm implies an arbitrage opportunity.

Answer 11

False

Question 12

Convertible bonds are more risky than non-convertible bonds but less risky than preferred stock issued by the same firm.

Answer 12

True: debt safer than equity

Question 13

A risk-neutral probability of 0% implies there is no arbitrage opportunity.

Answer 13

False

Question 14

The forward P/FCFE ratio will always increase when ROE goes up. (All else but the
growth rate stays the same.)

Answer 14

True: ROE increase, G increases, P/FCFE increases

Question 15

An option on stock price volatility will be more valuable when the stock price volatility
is less volatile.

Answer 15

false, worth more when more volatile

Question 16

A risk-free government bond that has an infinite time to maturity will still have a finite modified duration as well as a finite convexity measure

Answer 16

True

Question 17

If two stocks have the same P/E ratio but are trading at different market prices then
there must be an arbitrage opportunity.

Answer 17

false: PE has nothing to do with arbitrage

Question 18

In the context of the adjusted present value (APV) model, it is wrong to use the
unlevered cost of equity to discount future cash
ows to the firm in finding the
unlevered firm value.

Answer 18

True

Question 19

A two-state one-period binomial option pricing model with PV$1u= 1:00 andPV$1d= 1:00 contains an arbitrage opportunity

Answer 19

True U=D when U>R>D

Question 20

In theory, a company with a negative enterprise value (EV) is an example of an
arbitrage opportunity.

Answer 20

True

Question 21

One major assumption in the cost of capital approach to rm valuation is that the
business will maintain its level of debt constant in perpetuity

Answer 21

False, it is not expected that a firm hold its debt to equity ratio constant

Question 22

In the context of binomial option pricing model of valuing a firm’s equity and debt,
an increase in the volatility of the assets will lead to a lower value of equity.

Answer 22

False, pricing equity is similar to pricing a call option, as volatility increases so too does the value of the option/ in this case equity

Question 23

A European call option on the ASX index maturing in December 2015 will be more
valuable today if the expected return on the ASX index is revised upwards.

Answer 23

False, value of a call option has nothing to do with expected return of the market, only if the price of the stock increases above the exercise price.

Question 24

All else being equal, a convertible bond’s promised yield-to-maturity is higher than
the promised yield-to-maturity of an equivalent non-convertible bond.

Answer 24

False, value of the bond is more when it is convertible therefore we would expect the ytm to be lower to increase PV

Question 25

If two companies have the same EV/S ratio but their after-tax operating margins are
different, then there must be an arbitrage opportunity.

Answer 25

False, perhaps mispricing but no arbitrage

Question 26

Between two risk-free bonds with the same time to maturity, the one with the higher
coupon rate will have a greater modified duration

Answer 26

False, higher coupon means lower duration as you recieve your money back earlier.

Question 27

Usage of regression-adjusted multiples when the regression coeficients are statistically
insignificant despite having the right signs is inappropriate.

Answer 27

True

Question 28

Between two risk-free bonds with the same coupon rate, the one with the longer time
to maturity will have a lower convexity measure and a higher modified duration.

Answer 28

False

Question 29

The government offer to privatize a state-owned enterprise for a fixed amount of money
is an example of a real option from the point of view of taxpayers.

Answer 29

True, fixed amount of money for an offer which has fleibility

Question 30

A low value for the forward EV=EBIT(1-t) ratio can be caused by:

(a) a high expected growth rate.
(b) a high after-tax operating margin.
(c) a high cost of capital.
(d) a low value for the risk-free rate.

Answer 30

a high cost of capital, increases the denominator and reduces final value

Question 31

A large value for the current EV/Sales ratio can be caused by:

(a) a high cost of capital.
(b) a high value of sales.
(c) a high expected growth rate.
(d) a high corporate income tax rate.

Answer 31

(c) a high expected growth rate.

Question 32

A biotech company is currently trading at a P/D ratio of 8 and a P/E ratio of 8. The company has
an ROE of 25%. This company’s P/B ratio must be equal to.

Answer 32

2 ie. PE x ROE = 8 x 0,25 = 2

Question 33

Shares in stock A are currently trading at 64 and shares in stock B are currently worth 54. Stock A
is expected to be worth either 110 or 66 next year. Similarly, stock B is expected to be worth either 99
or 55 next year. The one-year risk-free interest rate is equal to:

Answer 33

10%

                       110-99
64-54
                       66-55
\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
                       11
10
                       11  therefore 11-10/10= 0.10= 10%

Question 34

The Sleepfield Press is expected to generate free cash
ow to the firm of $150,000 next year. The
consensus among analysts is that the free cash
ow to the firm will be decreasing in perpetuity at the
rate of 5% per year. If the cost of capital for the Sleepfield Press is 10% what is the present value of the
firm today equal to?

Answer 34

$1,000,000

150/0.1-(-0.05)

Question 35

A high value for the forward EV/EBIT ratio can be caused by:

(a) a high value for the marginal corporate tax rate.
(b) a high turnover rate of working capital.
(c) a high cost of capital.
(d) none of the above

Answer 35

none of the above

Question 36

A low value for the current EV/Sales ratio can be caused by:

(a) a high cost of capital.
(b) a high book value of capital.
(c) a high expected growth rate.
(d) a high value of the after-tax operating margin, ATOM

Answer 36

a high cost of capital.

Question 37

A corporation has a current P/D ratio of 10 and a current P/E ratio of 10. The company has a cost
of equity of 10%, a realized rate of return on equity, ROE, of 20%, and a net profit margin of 10%. The
P/B and P/S ratio of this corporation must be equal to:
(a) the P/B ratio is 2 and new P/S ratio is 1.
(b) the P/B ratio is 1 and new P/S ratio is 2.
(c) the P/B ratio is 1 and new P/S ratio is 1.
(d) the P/B ratio is 2 and new P/S ratio is 2

Answer 37

the P/B ratio is 2 and new P/S ratio is 1

Question 38

A high value for the current PEG ratio is consistent with:

(a) a high value of the dividend payout ratio.
(b) a high value of the company’s equity beta.
(c) a high value of the company’s leverage ratio.
(d) a high value of the stock market risk premium

Answer 38

a high value of the dividend payout ratio.

high DPS = high PE = high PEG

Question 39

Shares in stock A are currently trading at 77 and shares in stock B are currently worth 66. Stock A
is expected to be worth either 110 or 66 next year. Similarly, stock B is expected to be worth either 99
or 55 next year. The one-year risk-free interest rate is equal to:
(a) 0%.
(b) 10%.
(c) 12.5%.
(d) 25%

Answer 39

0%

Question 40

when trying to determin which bond to sell and which bond to buy, what should we consider?

Answer 40

look at Face value and see if the bond is trading at discount or premium compared to selling value. if this doesn’t help check the NPV of the bond and its coupon payments, buy all low and sell all high.

Question 41

if you get a negative value at time zero when you complete your calculations what should you do?

Answer 41

the opposite, ie sell whatever you where buying and buy whatever you were selling.