Quiz 1: Fin 819-02



Sample mid-term exam for Fin 819

The actual mid-term has about 45 questions

1. Businesses can be organized as

A) sole proprietorships

B) partnerships

C) corporations

D) any of the above

Answer: D

2. Which of the following would be the characteristic associated with the sole proprietorship form of organization?

A) Wide access to capital markets

B) Unlimited liability

C) A pool of expertise

D) Profits taxed at more than one levels

E) None of the above

B)

3. Conflicts of interest between shareholders and managers of a firm result in:

A) Principal-agent problem

B) Increased agency costs

C) Both A and B

D) None of the above

Answer: C

4. The goal of financial managers is to:

A) Maximize sales

B) Maximize profits

C) Maximize the value of the firm

D) Maximize the value of equity and bond holders

E) None of the above

Answer: E

5. The following groups share a firm's cash stream:

A) Shareholders

B) Bondholders

C) Government

D) All the above

E) None of the above

Answer: D

6. Which of the following would be considered a capital budgeting decision?

A) Planning to issue common stock rather than issuing preferred stock

B) A decision to expand into a new line of products, at a cost of $5 million

C) Repurchasing shares of common stock

D) Issuing debt in the form of long-term bonds

E) None of the above

B)

7. What is the present value of $1 you will receive two years from now at a discount rate of 10% per year ?

A) 1.1

B) 1.0

C) 0.909

D) 0.826

E) None of the above

Answer: D

Response: PV = 1/1.12 = 0.826

8. The following statements regarding the NPV rule and the rate of return rule are true except:

A) Reject a project if its rate of return < opportunity cost of capital

B) Reject a project if its NPV < 0

C) Reject a project if NPV < opportunity cost of capital

D) Accept a project if its rate of return > opportunity cost of capital

E) None of the above

Answer: C

9. The opportunity cost of capital for taking a risky project is

A) The expected rate of return on a government security having the same maturity as the project

B) The expected rate of return on a well diversified portfolio of common stocks

C) The expected rate of return on a portfolio of securities in the final market with the same risk.

D) The expected rate of return on a portfolio of projects in the real asset market with the same risk.

E) None of the above

Answer: C

10. Mr. Dell has $100 income this year and zero income next year. The financial market interest rate is 30% per year. In addition to the investment opportunity in the market, Mr. Dell also has another investment opportunity to take a project in the real asset market in which he has to invest $50 this year and receive $65 next year. Suppose Mr. Dell consumes $50 this year and invests the remaining in the project or in the financial market. What is the maximum amount of money Mr. Dell has next year ?

A) $65

B) $50

C) $130

D) $ 60

E) None of the above.

Answer: A

Response: Take the project in the real asset market or invest in the market

11. Firms that do not issue financial securities such as stock or debt obligations:

A) will not be able to increase sales.

B) cannot be profitable.

C) have no funds to take NPV-positive projects .

D) can use internal cash flows to finance good projects.

E) None of the above

D)

12. Which of the following statements best distinguishes the difference between real and financial assets?

A) Real assets have less value than financial assets.

B) Real assets are tangible; financial assets are not.

C) Real assets represent claims to the cash flows that are generated by financial assets.

D) Financial assets appreciate in value; real assets depreciate in value.

E) None of the above

E)

13. The managers of a firm can maximize stockholder wealth by:

A) Taking all projects with positive NPVs

B) Taking all projects with NPVs greater than the cost of investment

C) Taking all projects with NPVs greater than present value of cash flow

D) All of the above

Answer: A

14. What is the present value of the following cash flow at a 12% discount rate?

Year (-1) Year 2 Year 3

100,000 150,000 200,000

A) $373,935

B) $450,000

C) $493,440

D) $673,200

E) None of the above

Answer: A

Response: PV = 100,000*1.12 + (150,000/(1.12^2)) + 200,000/(1.12^3) = $373,935.1

15. What is the net present value of the following cash flows at a discount rate of 10%?

[pic]

A) $101,221

B) $200,000

C) $142,208

D) $115,139

E) none of the above

Answer: E

Response: NPV = -250,000 + (100,000/1.1^2) + (150,000/(1.1^3)) + 200,000/(1.1^4) = $81,945

16. You would like to have enough money saved to receive a growing annuity of 40 years, growing at a rate of 4% per year, the first payment being $60,000, after retirement so that you can lead a good life. How much would you need to save in your retirement fund to achieve this goal (assume that the growing annuity payments start three years from the date of your retirement. The interest rate is 8%)?

A) $927,599

B) $1,001,806

C) $1,100,006

D) $1,168,507

E) None of the above

Answer: B

Response: C2=PV2 = (60,000/(0.08-0.04))*(1-1.0440/1.0840) = $1,168,507

PV=C2/(1.08^2) =$1,001,806

17. After retirement, you expect to live for 30 years. You would like to have $80,000 income each year. How much should you have saved in the retirement to receive this income, if the interest is 10% per year (assume that the payments start at the year of the retirement)?

A) $754,153

B) $1,600,300

C) $829,568

D) None of the above

Answer: D

Response: PV = 80000+[(1/0.10)- (1/((0.10)(1.10^30)))]*80,000 = $834,153

18. If the present value of $1.00 received n years from today at an interest rate of r is 0.621, then what is the future value of $1.00 invested today at an interest rate of r for n years?

A) $2.59

B) $1.61

C) $2.70

D) Not enough information to solve the problem

Answer: B

Response: FV = 1/0.621 = $1.61

19. Which of the following statements is true?

A) Present value of an annuity due is always less than the present value of an equivalent annuity for a given interest rate ( an annuity due means immediate cash flows now)

B) The present value of an annuity approaches the present value of a perpetuity as n goes to infinity for a given interest rate

C) Both A and B are true

D) Both A and B are false

Answer: B

20. Which of the following statements regarding simple interest and compound interest are true?

A) Problems in finance generally use the simple interest concept

B) Problems in finance generally use the compound interest concept

C) It does not really matter whether you use simple interest or compound interest for solving problems in finance

D) None of the above

Answer: B

21. If we use the payback period rule with a required payback period of 4 years to examine the projects being taken by many small firms, which of the following may be the reason for us to reject these projects? (assume that all the projects require initial investments)

A) The cash flow at year 1 is larger than the initial investment cost

B) The sum of the cash flows in the first three years is less than the initial cost

C) These projects don’t produce any positive cash flows in the first four years

D) A and B

E) None of the above

Answer: C

22. Given the following cash flows for project A: C0 = -2000, C1 = +500 , C2 = +1400 and C3 = 5000, C4=$200,000, which of the following is true for the payback period?

A) The payback period is one year

B) The payback period is 2 years

C) The payback period is 3 years

D) The payback period is larger than 3 years

E) none of the above

Answer: C

23. The IRR is defined as:

A) The discount rate that makes the initial investment cost equal to the sum of future cash flows

B) The difference between the cost of capital and the present value of the cash flows

C) The discount rate that makes the initial investment cost equal to the sum of the present values of future cash flows .

D) The discount rate used in the discounted payback period method

E) None of the above

Answer: C

24. Project A has the following cash flows: C0 = 100, C1 = -120. The IRR of the project is 20% and if the cost of capital is 15%, you would:

A) Accept the project since IRR is larger than the cost of capital

B) Reject the project, even though the IRR is larger than the cost of capital.

C) There is no enough information

D) None of the above

Answer: B

25. You have a car loan of $30,000 (which is called the principal) with the interest rate of 10%. You decide to pay off this loan in next four years with equal payment each year, how much do you pay for the interest in your last payment?

A) $9,464

B) $8,604

C) $7,111

D) $860

E) None of the above

Answer

D)

26. Company Imagine has a cost of capital at 12% and $10 million to take some projects from the following available projects (units in million US dollars) to maximize the profits:

Project C0 NPV at 12%

A -7 14

B -8 16

C -2 6

D -3 12

Which set of projects should company Imagine take?

A) A

B) B

C) B and C

D) A and D

E) none of the above

Answer: D

27. Net Working Capital (simply referred to as working capital) is the:

A) Difference between short-term assets and short term liabilities

B) Difference between long-term assets and long term liabilities

C) Difference between long-term assets and short term liabilities

D) None of the above

Answer: A

28 . Capital equipment costing $200,000 today has $50,000 salvage book value at the end of year 5. In addition, (net) working capital of $10,000 is built up today. If the straight line depreciation method is used and the capital equipment is sold at the end of year 3 for a market price of $150,000, what is the tax the firm has to pay at year 3 related to this sale if the tax rate is 50% ?

A) $75,000

B) $60,000

C) $30,000

D) $20,000

E) none of the above

Answer: D

Response:

Annual depreciation = (200,000 -50,000)/5 = 30,000

Book value at the end of year three = 200,000 -90,000 = 110,000

Tax=50%*(150000-110000)=$20,000

29. For project X, year 5 inventories Increase by $5,000, accounts receivables increase by $3,000 and accounts payables increase by $2,000. Calculate the increase or decrease in working capital for year 5.

A) Increases by $6,000

B) Decreases by $6,000

C) Increases by $8,000

D) there is no change

E) None of the above

Answer: A

Response: Working capital: 5000 + 3000 -2000 = 6000

30. You have been asked to evaluate a project with an infinite life. Sales and costs are now $600 and $100 respectively. There is no depreciation and the tax rate is 30%. The real required rate of return is 10%. The inflation rate is 4% and is expected to be 4% forever. Sales and costs are expected to increase at the rate of inflation in the future. If the project costs $2000, what is the NPV?

A) $1,000

B) $1,500

C) $500

D) $1,365

E) None of the above

Answer: E

Response: (600-100)*0.7+ [(600*1.04/1.04-100*1.04/1.04)*0.7)] / 0.1 - 2000 = $1,850

31. Super Computer Company's stock is selling for $100 per share today. It is expected that this stock will pay a dividend of 10 dollars per share next year, and then be sold for $110 per share next year. Calculate the expected rate of return if you buy the stock now and sell it next year.

A) 20%

B) 25%

C) 10%

D) 15%

E) None of the above

Answer: A

Response: r = (110+10-100)/100 = 20%

32. Casino Co. is expected to pay a dividend of $6 per share one year from now and dividends always grow at a constant rate of 8% per year. If the required rate of return on the stock is 20%, what is the stock price one year from now ?

A) $30

B) $50

C) $100

D) $54

E) None of the above

Answer: D

Response: P1 = (6*1.08/(0.2-0.08) = 54

Please use the following information to answer questions 33-40 to understand the hidden details behind the simple dividend growth model.

Firm B has a market capitalization rate of 15%. The earnings are expected to be $8.33 per share next year. The plowback ratio is 0.4 and ROE is 25%. Every investment in year i (>0) is to yield a simple perpetuity starting in year (i+1) with each cash flow equal to total investment times ROE. All the investments have the same capitalization rate. You are at year zero.

33. What is the earnings per share in year 2?

A) $8.33

B) $9.16

C) $8.98

D) $ 10.08

E) None of the above

Answer B)

34. What is the investment per share in year 3?

A) $3.67

B) $4.03

C) $4.43

D) $3.33

E) None of the above

B

35. What is the NPV at year 1 per share of the project taken at year 1?

A) $2.22

B) $2.44

C) 0

D) $3.25

E) None of the above

A

36. What is the growth rate of earnings from year 1 to year 2?

A) 10 %

B) 12 %

C) 13%

D) 14%

E) None of the above

A

37. What is the present value at year 2 per share of the cash flows produced by taking a project at year 2?

A) $2.12

B) $2.44

C) $2.22

D) $6.11

E) None of the above

D

38. What is the dividend per share at year 2?

A) $5.0

B) $5.5

C) $6.0

D) $6.5

E) None of the above

B

39 What is NPV at year 2 per share of the project taken at year 2?

A) $2.12

B) $2.55

C) $2.22

D) $2.89

E) None of the above

E) $2.44

40. What is the present value per share at year zero of all the NPVs of all the projects taken in the future? (remember every year starting from year 1, one project is taken)

A) $44.44

B) $100.00

C) $55.10

D) $50.00

E) None of the above

A

41. The required rate of return or the market capitalization rate is estimated as follows:

A) Dividend yield -expected rate of growth in dividends

B) Dividend yield + expected rate of growth in dividends

C) Dividend yield / expected rate of growth in dividends

D) (Dividend yield) * (expected rate of growth in dividends)

E) None of the above

Answer: B

42. MJ Co. pays out 50% of its earnings as dividends. Its return on equity is 20%. What is the dividend growth rate for the firm?

A) 3%

B) 5%

C) 8%

D) 10%

E) None of the above

Answer: D

Response: g = (1 - 0.5)*20 = 10%

43. Woe Co. is expected to pay a dividend or $4.00 per share out of earnings of $7.50 per share next year. If the required rate of return on the stock is 15% and dividends are growing at a constant rate of 10% per year, calculate the present value of the growth opportunity for the stock (PVGO).

A) $80

B) $50

C) $30

D) $26

E) None of the above

Answer: C

Response: No growth value = 7.5/0.15 = 50; Po = 4/ (0.15-0.1) = 80; PVGO = 80-50 = 30

44. What is the plowback ratio for a stock with a stock price of $42 per share next year, earnings of $5 per share next year, a discount rate of 15% , and a rate of return on equity of 25% ?

A) 0.4

B) 0.3

C) 0.2

D) 0.5

E) None of the above

Answer: C

g= 0.2*0.25=5%; P1=Div2/(r-g)=0.8*5*1.05/0.1=$42

45. What is the expected constant growth rate of dividends for a stock currently priced at $50, that is expected to pay a dividend of $5.5 per share two years from now, and has a required return of 20%?

A) 13%

B) 12%

C) 11%

D) 10%

E) none of the above

Answer: D

$50 = (5.5/(1+g))/(.2 – g)

(g = 0.1=10%

46. What would be the price of a stock now when dividends are expected to grow at a 25% rate for the next two years (years 1 and 2), then grow at a constant rate of 5% per year, if the stock’s required return is 13% and the dividend is $5.25 per share three years from now?

A) $52.65

B) $58.85

C) $56.65

D) $55.65

E) None of the above

Answer: B

Po =[pic]

= 3.54 + [pic]

= 3.54 + 3.92 + 51.39

= $58.85

47. The yield to maturity of a bond can be thought of as the:

A) Net present value (NPV) of the bond

B) Internal rate of return (IRR) of the bond

C) Modified internal rate of return (MIRR) of the bond

D) Payback period

E) None of the above

Answer: B

48. Consider a bond with a face value of $2,000, a coupon rate of 0%, a yield to maturity of 9%, and seven years to maturity. This bond's duration is:

A) 6.7 years

B) 7.5 years

C) 9.6 years

D) 7.0 years

E) None of the above

Answer: D

Response: Duration: n = 7 years

49. Consider a bond with a duration of 15.5 years and a yield of 6%. This bond's volatility is:

A) 9.3%

B) 6.8%

C) 14.6%

D) 6.0%

E) None of the above

Answer: C

Response: Volatility (%) = Duration/(1 + i) = 15.5/1.06 = 14.6%

50. If the 3-year spot rate is 12% and the 2-year spot rate is 10%, what is the one-year forward rate of interest three years from now?

A) 3.7%

B) 16.1%

C) 9.5%

D) no enough information to calculate

E) None of the above

Answer: D

51. Interest represented by "r2" is:

A) spot rate on a three -year investment(APR)

B) spot rate on a two- year investment(APR)

C) expected spot rate 2 years from today

D) expected spot rate one year from today

E) None of the above

Answer: B

52. The term structure of interest rates can be described as the:

A) Relationship between the spot interest rates and the bond prices

B) Relationship between spot interest rates and stock prices

C) Relationship between spot interest rates and their maturities

D) Any of the above

E) None of the above

Answer: C

53. Which of the following statements is true?

A) The spot interest rate is a complicated weighted average of yields to maturity

B) Yield to maturity is the complicated weighted average of spot interest rates

C) The yield to maturity is always higher than the spot rates

D) All of the above

E) None of the above

Answer: B

54. A forward rate prevailing from period 0 to period 1 can be:

A) observed in the market place

B) Extracted from spot interest rate with 1 and 2 years to maturity

C) Extracted from 2 and 3 year spot interest rates

D) All the above

E) None of the above

Answer: A

55. If the forward rate of interest from year 1 to year 2 is the same as the 1-year spot rate, what is the 2-year spot rate?

A) Smaller than the 1-year spot rate

B) Larger than the 1-year spot rate

C) Can't say without knowing the 3-year spot rate

D) The same as the forward rate from year 1 to year 2

E) None of the above

Answer: D

Use the following information to answer questions 56-60.

Today’s spot rates are given in the following.

Year r

1. 5%

2. 5.5%

3. 6%

4 6.5%

56. What is the today’s shape of the yield curve for the term structure of interest rates?

A) flat

B) downward sloped

C) upward sloped

D) cannot be decided

E) none of the above

Answer: C

57. What is now the price of a zero coupon bond with a maturity of three years, a face value of $1000 ?

A) $839.6

B) $ 1,000.0

C) $580.5

D) $1100.5

E) none of the above

Answer: A

Bond price =1000/1.063=$839.6

58. What is the yield to maturity for a zero coupon bond with a maturity of two years?

A) cannot be decided, since the market price of the bond is not given.

B) 5.5%

C) 6%

D) 4.5%

E) none of the above

Answer: B

59. What is the tomorrow’s spot rate of two years ?

A) 5.5%

B) 6%

C) cannot be decided by using today’s term structure of the interest rates

D) 4.5%

E) none of the above

Answer: C

60. What is the forward rate from year 2 to year 3?

A) 5.01%

B) 8.01%

C) 7.01%

D) 6.01%

E) none of the above

Answer: C

f3 =1.063/1.0552-1=7.01%

Use the following to answer questions 61-63.

A new project will generate sales of $80 million, costs of $30 million, and depreciation expense of $10 million in the coming year. The firm’s tax rate is 40%.

61. What is the tax payment in the coming year?

A) $40 million

B) $16 million

C) $20 million

D) None of the above

Answer: B

62. What is the net profit (or net income or accounting profit) in the coming year ?

A) $34 million

B) $ 40 million

C) $24 million

D) None of the above

Answer: C

63. What is the cash flow ( or cash flow from operations) in the coming year?

A) $34 million

B) $40 million

C) $16 million

D) None of the above

Answer: A

Use the following to answer questions 64-70

Revenues generated by a new product are forecasted as follows:

Year Revenues

______________________________

1 $40,000

2 30,000

3 20,000

4 10,000

thereafter 0

_____________________________

Expenses are expected to be 40 percent of revenues in that year, and working capital required in each year is expected to be 20 percent of revenues in that year. The product requires an immediate investment of $50,000 in plant and equipment. Suppose the plant and equipment are depreciated over next four years to a salvage value of zero using straight-line depreciation. The tax rate is 40%.

64. What is the initial (year 0) investment in working capital ?

A) $8,000

B) 0

C) $5,000

D) None of the above

Answer: B

65. What is the initial (year 0) total investment in product ?

A) $48,000

B) $58,000

C) $50,000

D) None of the above

Answer: C

66. What is depreciation in each year ?

A) $8,000

B) $10,000

C) $12,500

D) None of the above

Answer: C

67. What is the cash flow in year 1?

A) $11,400

B) $30,000

C) $21,400

D) None of the above

Answer: A

68. What is the cash flow in year 4 ?

A) $18,000

B) $10,600

C) $11,000

D) None of the above

Answer: B

69. What is the cash flow in year 5 ?

A) $2,000

B) 0

C) $500

D) None of the above

Answer: A

70. What is the cash flow in year 2 ?

A) $17,800

B) $16,800

C) $15,800

D) None of the above

Answer: A

71. Efficient frontier portfolios are those, which offer:

A) Minimum risk for a given level of return

B) highest risk for a given level of expected return

C) The maximum risk and the lowest expected return

D) All of the above

E) None of the above

Answer: A

72. The minimum variance portfolio

A) is also an efficient frontier portfolio

B) is not an efficient frontier portfolio

C) may or may not be an efficient frontier portfolio

D) all of the above

E) none of the above

Answer: A

73. Beta measures:

A) the systematic risk of a security return

B) the risk of a security return

C) the total risk of a security return

D) the firm-level risk of a security return

E) none of the above

Answer: A

74. If the beta of Microsoft is 1.5, risk-free rate is 6% and the expected return on the market portfolio is 12%, calculate the expected return for Microsoft.

A) 14%

B) 15%

C) 16%

D) 17%

E) none of the above

Answer: B

Response: E(r) = 6 + 1.5*6 = 15

75. The capital asset pricing model (CAPM) establishes the relation

A) between the expected return of a security and its risk

B) between the expected return of a security and its market risk

C) between the expected return of a security and its firm-level risk

D) all the above

E) none of the above

Answer: B

76. The security market line (SML) is the graph of:

A) Expected rate of return on investment (Y-axis) vs. variance of return (X-axis)

B) Expected rate of return on investment (Y-axis) vs. Betas of investment (X-axis)

C) Realized rate of return on investment (Y-axis) vs. beta (X-axis)

D) A and B

E) None of the above

Answer: B

77. The Cost of capital is smaller than the cost of debt for firms that are

A) financed entirely by debt

B) financed entirely by equity

C) financed by both debt and equity

D) None of the above

Answer: A

78. The cost of equity can be estimated using:

A) Discounted cash flow (DCF) approach

B) Capital Asset Pricing Model (CAPM)

C) A and B

D) none of the above

Answer: C

79. The market value of Charter Cruise Company's equity is $150 million, and the market value of its risk-free debt is $50 million. If the required expected return on the equity is 20% and that on the debt is 8%, calculate the company's cost of capital. (Assume no taxes.)

A) 17%

B) 20%

C) 8.1%

D) None of the above

Answer: A

Company cost of capital = (150/200)*(20) + (50/200)*(8) = 17%

80. The market value of Charcoal Corporation's common stock is $20 million, and the market value of its risk-free debt is $5 million. The beta of the company's common stock is 1.25, and the risk premium on the market portfolio is 8%. If the treasury bill rate is 5%, what is the company's cost of capital. (Assume no taxes.)

A) 14%

B) 15%

C) 13%

D) None of the above

Answer: C

rc = 5+1.25(8) = 15 ; rd = 5%

Company Cost of capital = 5 *(5/25) + 15*(20/25) = 1 + 12 = 13%

-----------------------

t = 0

t = 2

t=3

t=4

-250,000

100,000

150,000

200,000

................
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