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1. Is Annisquam most likely correct in regard to his comments on calibrating a binomial interest rate tree?

. Annisquam is correct with regards to his comments on calibrating a binomial interest rate tree. because his comments are correct. because his comments are correct.

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2. Who makes the most accurate statement in regard to Wadgett’s current valuation?

. Covey’s statement is based on the idea that a firm’s stock price increases if it is the target of an acquisition (i.e., a control premium). Consequently, when the acqui- sition failed with no apparent future threat of a takeover, the stock price decreases as the control premium vanishes. . The subsidiary of a conglomerate generally has a value that is below its stand-alone value due to a conglomerate discount.

. Pairs trading is a relative value strategy that does not consider the actual intrinsic value of a given firm.

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3. Based on the data in Exhibit 2, the GDP growth rate in Country A using Hollingsworth’s preferred method of calculation is closest to:

Hollingsworth;s preferred method of calculating the GDP growth rate is the Solow growth accounting equation, and the rate is calculated as follows:

ΔY/Y = ΔA/A + α(ΔK/K) + (1 – α)(ΔL/L) where

ΔY/Y = Growth in gross domestic product, GDP ΔA/A = Growth in total factor productivity = 1/5% ΔK/K = Growth rate of capital = 3.2%

ΔL/L = Growth rate of labor = 0.4%

α = Output elasticity of capital = 0.3

1 – α = Output elasticity of labor = 0.7

Thus, ΔY/Y = 1.5 + (0.3 × 3.2) + (0.7 × 0.4) = 1.5 + 0.96 + 0.28 = 2.74. The calculation did not apply (1 – α).

ΔY/Y = 1.5 + (0.3 × 3.2) + 0.4 = 1.5 + 0.96 + 0.4 = 2.86

The inflation rate was incorrectly used in place of TFP in the calculation.

ΔY/Y = 1.7 + (0.3 × 3.2) + (0.7 × 0.4) = 1.7 + 0.96 + 0.28 = 2.94

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4. In regard to calculating Wadgett’s FCFF, the comment that is most appropriate is the one dealing with:

. Cash flow from operations (CFO) already reflects changes in working capital items, therefore Paschel’s first comment is correct. EBITDA has the non-cash charges of depreciation and amortization added back, so Covey’s statement is incorrect, not all non-cash charges will need to be added back. Net borrowing is added back for FCFE not FCFF, so Paschel’s second statement is incorrect.

. Depreciation has already been added back to EBITDA, though there may be other items that still need to be added back.

. Adjusting for net borrowing is not necessary for FCFF (just FCFE).

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5. Betta is least likely correct with regard to which statement regarding traditional credit models?

. Neither model depends on current economic conditions. Credit scores do not explicitly depend on current economic conditions. Credit ratings do not explicitly depend on the business cycle, which, in turn, is affected by current economic conditions.

because the statement is correct. because the statement is correct.

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