final 1 fundamentals of corporate finance, 4th edition brealey

Lacey Inc.’s common stock is expected to have extraordinary growth of 20% per year for two years, after which time the growth will settle into a constant 5% rate.. Approximately how much

Name Section ID #

Professor Alagurajah’s Section A (Fridays, 2.30-5.30 pm), Professor King’s Section G (Internet), Professor Kohen’s Section F (Tuesdays, 2:30-5:30 pm), Professor Li’s Section E (Wednesdays, 2:30-5:30 pm), Professor Okonkwo’s Section B (Tuesdays,

7-10 pm), Professor Patterson’s Section D (Thursdays, 4-7 pm), and Professor Tahani’s Section C (Wednesdays, 7-10 pm)

AP/ADMS 3530.03 Finance

Final Exam Fall 2009 December 16, 2009

Exam – Type A

This exam consists of 50 multiple choice questions 2 points each for a total of 100 points Choose the response which best answers each question Circle your answers

below, and fill in your answers on the bubble sheet Only the bubble sheet is used to determine your exam score BE SURE TO BLACKEN THE BUBBLES

CORRESPONDING TO YOUR STUDENT NUMBER

Please note the following eight points:

1) Please use your time efficiently and start with the questions that you are most

comfortable with first Remember: every question carries the same weight, so

please do NOT spend too much time on one particular question;

2) Read the exam questions carefully;

3) Choose the answers that are closest to yours, because of possible rounding;

4) Keep at least 2 decimal places in your calculations and final answers, and at least

4 decimal places for interest rates;

5) Interest rates are annual unless otherwise stated;

6) Bonds pay semi-annual coupons unless otherwise stated;

7) Bonds have a par value (or face value) of $1,000;

8) Assume cash flows or payments occur at the end of a period or year, unless

otherwise stated; and

9) You may use the back of the exam paper as your scrap paper

10) Non-programmable financial and/or scientific calculators are allowed

Numerical Questions

1 You have agreed to pay $1,500 per month on a one-year loan with a principal of

$16,300 What is the EAR of this loan?

A) 9.09%

B) 16.80%

C) 18.72%

D) 20.42%

E) 22.82%

2 You are planning to buy a $320,000 home with a 20% deposit You finance the remainder with a 25 year mortgage that has a stated rate of 5.40% (APR compounded semi-annually) What is your monthly payment?

A) $1,470.49

B) $1,547.70

C) $1,738.78

D) $1,946.24

E) $2,145.87

3 A 10-year bond was issued four years ago with a coupon rate of 5% and a face value of $1,000 The coupons are paid semi-annually What is the yield to maturity if the bond is selling at $876.00 today?

E) 7.61%

4 How much would an investor lose if she purchased a 20-year zero-coupon bond with

a $1,000 par value and 4% yield to maturity, then sold it one year later when market interest rates increased to 6%?

C) $155.98

D) $167.70

E) $170.51

5 A stock that will pay a $5 dividend next year sells today for $80 If the stock’s required return is 14%, what should investors expect to pay for the stock one year from now?

A) $80.00

B) $84.30

C) $86.20

D) $91.20

E) $95.59

6 Lacey Inc.’s common stock is expected to have extraordinary growth of 20% per year for two years, after which time the growth will settle into a constant 5% rate If the discount rate is 11% and the most recent dividend was $1.50, what should be the current share price?

A) $21.27

B) $22.20

C) $30.68

D) $34.05

E) $37.80

7 What is the minimum number of years that an investment costing $400,000 must return $48,000 per year at a discount rate of 12 percent in order to be an acceptable investment?

A) 4.29 years

B) 7.40 years

C) 9.26 years

D) 27.01 years

E) An infinite number of years

8 Cranberry Inc has been presented with an investment opportunity which will yield cash flows of $36,000 for Year 1, $27,000 for Year 2, $34,000 for Year 3 and $X for year 4 This investment will cost the firm $120,000 today and the payback period for this investment is 3.215 years What is the approximate projected cash flow for Year

4 if the company’s opportunity cost of capital is 4%?

9 A firm is considering the following project Its opportunity cost of capital is 8%

Cash Flow -3000 2000 400 1900 3200

What is the discounted payback period of the project?

A) 2.29 years

B) 2.53 years

C) 2.72 years

D) 2.95 years

E) 3.15 years

10 As the Director of Finance for Bozo Corporation, you are evaluating two mutually exclusive projects with the net cash flows given below If Bozo's cost of capital is 13 percent, which project would you choose?

Year Project A Project B

1 11,000 9,000

2 12,000 10,000

3 21,000 15,000

4 17,000 22,000

A) Project A, since it has the higher IRR

B) Project A, since it has the higher NPV

C) Project B, since it has the higher IRR

D) Project B, since it has the higher NPV

E) Neither project

11 You have a choice between using your old machine at a cost of $5,500 annually for the next five years Alternatively, you can purchase a new machine for $8,000 plus

$3,500 in annual maintenance for the next five years If the cost of capital is 14%, you should:

A) Buy the new machine and save $400 in equivalent annual costs

B) Buy the new machine and save $330 in equivalent annual costs

C) Keep the old machine and save $400 in equivalent annual costs

D) Keep the old machine and save $330 in equivalent annual costs

E) None of the above statements are correct

12 If a project has a cost of $70,000 and a profitability index of 0.2, then:

A) Its NPV is $14,000

B) The present value of its cash inflows is $25,000

C) Its IRR is 15%

D) Its cash inflows are $70,000

E) None of the above are correct

Please use the following information to answer Questions 13 – 16

Jensen Industries is considering purchasing a new numerically controlled drilling press The press costs $100,000, and belongs to a 15% CCA rate asset class (declining balance method) and the half-year rule applies The press is estimated to have before-tax cash flow savings of $34,000 per year for six years and will require an immediate increase in net working capital of $5,000, which will be recovered when the machine is sold at the end of Year 6 Initially assume there is zero salvage value The discount rate

is 10% and the tax rate is 40%

13 What is Jensen’s CCA in Year 1 and Year 2?

A) $7,500; $12,750

B) $7,500; $13,875

C) $7,500; $15,000

D) $15,000; $12,750

E) $15,000; $13,875

14 What is the present value of Jensen’s CCA tax shield?

A) $5,367

B) $11,667

C) $19,419

D) $22,909

E) $23,609

15 Should Jensen accept the project?

A) Yes, because the NPV is positive, and it exceeds $10,000

B) Yes, because the NPV is positive, although it is less than $10,000

C) No, because the NPV is negative, and it is between 0 and -$10,000

D) No, because the NPV is negative, and it is between -$10,000 and -$100,000 E) None of the above

16 By how much will the NPV increase if Jensen is able to obtain a $10,000 salvage value at the end of Year 6?

A) $1,824

B) $4,290

C) $5,645

D) $6,000

E) $7,123

17 Calculate the NPV break-even level of sales for a project requiring an investment of

$3,000,000 and providing as annual cash flows: (0.15 × sales - $250,000) Assume the project will last 10 years and that the discount rate is 10%

A) $3,254,890

B) $3,504,630

C) $4,536,150

D) $4,921,504

E) $4,998,405

18 What percentage change in sales occurs if profits increase by 3 percent when the firm's degree of operating leverage is 4.5?

A) 0.33 percent

B) 0.67 percent

C) 1.50 percent

D) 3.33 percent

E) 3.67 percent

19 Approximately how much was paid to invest in a project that has a NPV break-even level of sales of $8 million, an eight-year life, a 10 percent discount rate, and annual cash flows determined by (0.28 × sales – $450,000)?

20 A decision tree shows a 30% probability of $2 million in returns and a 70% chance of

$1 million in returns occurring one year in the future What is the maximum amount you would invest today in this project if the discount rate is 10%?

A) $1,181,818

Please use the following information to answer Questions 21 – 24

State Probability Return on A Return on B

21 What is the expected return on security B?

22 What is the standard deviation of security A?

23 What is the expected return on a portfolio that is 40% invested in A and 60% invested in B?

24 What is the correlation between securities A and B?

A) -1

B) -0.5

C) 0

D) 0.5

E) 1

25 The return on the market portfolio is 12% and the risk-free rate of return is 6% The standard deviation of the market portfolio is 24% What is the standard deviation of a stock that plots on the Security Market Line (SML) with an expected return of 10% and a correlation to the market portfolio of 2/3?

A) 5%

B) 8%

C) 10%

D) 16%

E) 24%

26 Where will the following two projects plot in relation to the security market line (SML)

if the risk-free rate is 6% and the market risk premium is 9%? Which project should

be undertaken?

Project A: Beta =2; Actual rate of return = 25%

Project B: Beta =1.1; Actual rate of return = 15%

A) Project A plots above the SML and should be accepted; Project B plots below the SML and should be rejected

B) Project A plots above the SML and should be rejected; Project B plots below the SML and should be accepted

C) Project A plots below the SML and should be accepted; Project B plots above the SML and should be rejected

D) Project A plots below the SML and should be rejected; Project B plots above the SML and should be accepted

E) None of the above

27 The historical relationship between stock A and the market portfolio can be stated as follows When stock A has gone up by 1.6% the market portfolio has gone up by 1.2%; and when stock A has gone down by 1.6% the market portfolio has gone down by 1.2% The expected return associated with stock A for the upcoming year is 13% The prevailing market risk premium is 3% Based on the above information, what is the prevailing rate of return on a t-bill if all financial instruments are priced correctly?

A) 7.6%

B) 8.2%

C) 9%

D) 9.4%

E) Cannot be determined without additional information

28 What is the beta of the following portfolio?

Amount Invested $5,000 $10,000 $15,000

29 Calculate the weighted average cost of capital (WACC) for Julia Corp Julia has both debt and common equity financing The market value of debt represents 40% of its capital structure Julia has 8 year bonds outstanding with a 9% annual coupon which currently trade at par The company’s tax rate is 40% T-bills currently provide a rate

of return of 5.5% and the rate of return on the market portfolio is 10.5% The equity beta of the stock is 1.4

A) 8.31%

B) 9.66%

C) 11.10%

D) 11.18%

E) 11.96%

30 Kamal Ltd finances its operations using $1.50 of debt for every $2 of common stock The pre-tax cost of debt is 7.5%, the cost of equity is 11%, and the tax rate is 34% Currently, the firm is considering a small project that it considers to be equally as risky as the overall firm The project has an initial cash outlay of $18,500 (non-depreciable) and is expected to have a single cash inflow of $25,000 at the end of year two What is the net present value of this project?

E) $2,835

31 A company has 2 million shares of common stock outstanding at a book value of $2 per share The stock trades for $3.00 per share It also has $2 million in face value

of debt that trades at 90% of par The company’s 1 million preferred shares, which offer a 2% dividend out of a par value of $10 per share and has a required rate return of 5% What is its debt-to-firm value ratio for WACC purposes?

A) 10.1%

B) 15.3%

C) 16.7%

D) 18.4%

E) 20.05%

32 What is the WACC for a firm with equal amounts of debt and equity financing, a 16% before-tax cost of capital, a 35% tax rate, and a 10% coupon rate on its debt that is selling at par?

A) 10.4%

B) 12.66%

C) 14.25%

D) 16%

E) 22%

Conceptual Questions

33 The risk premium that is offered on common stock is equal to the:

A) Expected return on the stock

B) Real rate of return on the stock

C) Excess of expected return over a risk-free return

D) Expected return on the S&P/TSX index

E) Risk free rate times the beta of the stock

34 What will happen to a stock that offers a lower risk premium than predicted by the CAPM?

A) Its beta will increase

B) Its beta will decrease

C) Its price will decrease until yield is increased

D) Its price will increase until yield is reduced

E) Its beta and price will both increase

35 The correct method to handle overhead costs in capital budgeting is to:

A) Allocate a portion to each project

B) Allocate the entire amount to the corresponding project

C) Allocate them to projects with the highest NPVs

D) Ignore all except identifiable incremental amounts

E) Ignore them in all cases

36 Which of the following statements is most correct?

A) If the stock market is weak-form efficient, this means you cannot use private information to outperform the market

B) If the stock market is semi-strong-form efficient, this means the expected returns on stocks and bonds should be the same

C) If the stock market is strong-form efficient, this means that high beta stocks should have the same expected return as low beta stocks

D) None of the statements above is correct

E) All of the statements above are correct

37 Which of the following changes would be likely to increase the NPV of a project?

A) Increasing the firm's opportunity cost of capital

B) Spreading the total cash inflows over a longer interval

C) Decreasing the cash flows to be received over the life of the project

D) Increasing the project's estimated expenses

E) Permitting a net decrease in working capital

38 What happens to a firm with a high degree of operating leverage when the overall level of sales is very high?

A) The firm will experience high losses

B) The firm will enjoy high profits

C) The firm will not break even in accounting terms

D) The firm will have a reduced level of fixed costs

E) The firm will have increased variable costs

39 A cost should be considered as sunk when it:

A) is fully depreciated

B) produces no additional sales revenues

C) contributes to a negative NPV for the project

D) is replaced by costs that are not yet sunk

E) has no effect on future cash flows

40 Risk in a revenue-producing project can best be adjusted for by:

A) ignoring it

B) adjusting the discount rate upward for increasing risk

C) adjusting the discount rate downward for increasing risk

D) picking a risk factor equal to the average discount rate

E) increasing the cash flows associated with the project

41 All else the same, a higher corporate tax rate:

A) will increase the WACC of a firm with debt and equity in its capital structure B) will decrease the WACC of a firm with only equity in its capital structure

C) will not affect the WACC of a firm with debt in its capital structure

D) will decrease the WACC of a firm with some debt in its capital structure

E) will increase the WACC of a firm with some debt in its capital structure

42 The cost of capital in a firm that has both debt and equity:

A) is equal to the cost of debt or equity, depending on which type of financing the firm uses more

B) depends on the source of the funds for a project

C) is what a firm must earn on a project to compensate investors for the

use of their funds

D) will be the equity cost or the debt cost, whichever is higher

E) will vary depending on the weighted average cost of capital for the firm

43 Why would a stock market investor not be concerned with unique risks when calculating expected rates of return?

A) There is no method to quantify unique risks

B) Beta includes a component to compensate unique risk

C) Unique risks are compensated by the risk-free rate

D) Unique risks are assumed to be diversified away

E) Unique risk is usually very negligible

44 Why is debt financing said to include a tax shield for the company?

A) Taxes are reduced by the amount of the debt

B) Taxable income is reduced by the amount of the interest

C) Taxable income is reduced by the amount of the debt

D) Taxes are reduced by the amount of the interest