EBF 401 EBF401 Midterm 3 Answers (Penn State University)

c. I and II;
d. III and IV;
e. I and IV.
7. If the efficient market hypothesis holds, investors should expect:
a. To earn only a normal return;
b. To receive a fair price for their securities;
c. To always be able to pick stocks that will outperform the market averages;
d. Both to earn only a normal return and to receive a fair price for their securities;
e. Both to receive a fair price for their securities and to always be able to pick stocks that will outperform the
market averages.
8. Insider trading does not offer any advantages if the financial markets are:
a. Weak form efficient;
b. Semiweak form efficient;
c. Semistrong form efficient;
d. Strong form efficient;
e. Inefficient.
9. The proposition that the value of the firm is independent of its capital structure is called:
a. The capital asset pricing model;
b. M&M Proposition I;
c. M&M Proposition II;
d. The law of one price;
e. The efficient market hypothesis.
10. According to the efficient market hypothesis, financial markets fluctuate daily because they:
a. Are inefficient;
b. Slowly react to new information;
c. Are continually reacting to new information;
d. Offer many arbitrage opportunities;
e. Only reflect historical information.
Short questions
Please answer 2 questions worth 5 points.
11. Define the three forms of market efficiency.
12. What are the implications of the efficient market hypothesis for investors who buy and sell stocks in an
attempt to “beat the market”?
13. State the law of one price. Does this result always hold in a perfect market? Do we expect it to hold in an
efficient market?
Please answer 2 questions worth 10 points.
14. Define the three main factors that determine beta and explain how they affect betas.
(10 points)
15. How can firms create value through financing opportunities? Describe the three methods discussed in
class.
16. What does Proposition I of Modigliani and Miller state (in a world without taxes)? What is the key
assumption that lies behind the theory, and what does this assumption imply?
Problems
Please answer 1 question worth 20 points.
17. Online Text Co. has four new text publishing products that it must decide on publishing to expand its
services. The firm’s WACC has been 17%. The projects are of equal risk, and all of their β are equal to 1.6.
The risk-free rate is 7% and the market rate is expected to be 12%. The projects are expected to earn as
follows:
Projec
t
W 14%
X 18%
Y 17%
Z 15%
18. Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company
expects to earn $29 million before interest per year in perpetuity, with each company distributing all its earnings
as dividends. Levered’s perpetual debt has a market value of $91 million and costs 8% per year. Levered has
2.3 million shares outstanding, currently worth $105 per share. Unlevered has no debt and 4.5 million shares
outstanding, currently worth $80 per share. Neither firm pays taxes. Is Levered’s stock a better buy than
Unlevered’s stock?
Please answer 3 questions worth 10 points.
19. You own 25% of Unique Vacations, Inc. You have decided to retire and want to sell your shares in this allequity
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 the all-equity firm today, if you ignore taxes?