Mid-term Fin 819
1. Businesses can be organized as
A)sole proprietorships
B)partnerships
C)corporations
D)any of the above
Answer: D
2. 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
3. The goal of financial managers is to:
A)Maximize sales
B)Maximize profits
C)Maximize stockholder wealth
D)Maximize the value of equity and bond holders
E) None of the above
Answer: C
4.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
5. 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 marketwith 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
6.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 $70 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)$70
C)$130
D) $60
E)None of the above.
Answer: B
Response: Take the project in the real asset market for a higher return.
7.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)
8. 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)Financial assets represent claims to the cash flows that are generated by using the underlying real assets.
D)Financial assets appreciate in value; real assets depreciate in value.
E) None of the above
C)
9. 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
10. What is the present value of the following cash flow at year zero at a zero percent 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: B
Response: PV = 100,000 + 150,000 + 200,000 = $450,000
11.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 one year 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: D
Response: PV0 = (60,000/(0.08-0.04))*(1-1.0440/1.0840) = $1,168,507
12.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 one year after the retirement)?
A)$754,153
B)$1,600,300
C)$829,568
D)None of the above
Answer: A
Response: PV0 = [(1/0.10)- (1/((0.10)(1.10^30)))]*80,000 = $754,153
13. 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 2n years?
A)$2.59
B)$1.61
C)$2.70
D)Not enough information to solve the problem
Answer: A
Response: FV = (1/0.621)*(1/0.621) = $2.59
14. 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 positive 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
15.The IRR is defined as:
A)The single 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 single discount rate that makes the initial investment cost equal to the sum of the present values of future cash flows .
D)The single discount rate used in the discounted payback period method
E) None of the above
Answer: C
16.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: A
17.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 principal in your first payment?
A)$9,464
B) $6,464
C) $7,111
D) $860
E) None of the above
Answer
B)
18. 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
19 . 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
20. For project X, year 5 inventories increase by $5,000, accounts receivables increase by $3,000 and accounts payables decrease 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 $10,000
D)there is no change
E) None of the above
Answer: C
Response: Working capital: 5000 + 3000 + 2000 = 10000
Please use the following information for 21-23
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 annual inflation is 4% and is expected to be 4% forever. Sales and costs are expected to increase at the rate of inflation in the future. The project costs $2000 now. Ignore the cash flow related to the change of net working capital.
21. What is the nominal cash flow from operations at year 1 ?
A)$350
B)$364
C)$500
D) $450
E)None of the above
B) (600*1.04 -100*1.04) *0.7= 364
22. What is the real cash flow from operations at year 1 ?
A)$350
B)$500
C)$450
D) $400
E)None of the above
A
23. What is the NPV now for this project?
A)$1,000
B)$1,850
C)$500
D) $1,365
E)None of the above
Answer: B
Response: (600-100)*0.7+ [(600*1.04/1.04-100*1.04/1.04)*0.7)] / 0.1 - 2000 = $1,850
24. 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%
25.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 now ?
A)$30
B)$50
C)$100
D)$54
E) None of the above
Answer: B
Response: P1 = 6/(0.2-0.08) = 50
Please use the following information to answer questions 26-32.
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.
26. What is the earnings per share in year 3?
A)$8.33
B)$9.16
C) $8.98
D)$ 10.08
E) None of the above
Answer D)
27. What is the investment per share in year 2?
A)$3.67
B)$4.03
C) $4.43
D)$3.33
E) None of the above
A
28. What is the NPV at year 2 per share of the project taken at year 2?
A)$2.22
B)$2.44
C) 0
D)$3.25
E) None of the above
B
29. What is the growth rate of dividends from year 1 to year 2?
A)10 %
B)12 %
C) 13%
D)14%
E) None of the above
A
30. 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
31. 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
32. 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
33. 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%
34.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
35. What is the plowback ratio for a stock with a stock price of $40 per share now, earnings of $5 per share next year, a discount rate of 15% , and a rate of return on equity of 25% ?
A)0.2
B)0.3
C)0.4
D) 0.5
E) None of the above
Answer: A
g= 0.2*0.25=5%; P0=Div1/(r-g)=0.8*5/0.1=$40
36. 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%
37. 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
38.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
39. 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
Use the following information to answer questions 40-42.
Today’s spot rates are given in the following.
Year r
11%
21.5%
32%
4 2.5%
40. 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
41. 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) $928.6
D)$1100.5
E) none of the above
Answer: C
Bond price =1000/1.0253=$928.6
42. 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) 1.5%
C) 2%
D)2.5%
E) none of the above
Answer: B
43. Beta measures:
A)the market risk or 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
44. 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
45. 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