Multiple Choice Section
Name: _____________________________
Student ID ______________________________
Corporation Finance Room 2M73 Mid Term Test Dec. 11 ,2009 9:00 a.m. – 12:00 p.m.
Professor Haifeng Chen Total: 100 marks
I. Multiple Choice Section: Each of the following questions is followed by several suggested answers or completions. Select the best alternative and place the corresponding letter on the accompanying computerized answer sheet. (Value: 20x 2 = 40 points) 1.
One of the key differences between corporate finance and financial accounting courses is: a) the focus on cashflows instead of earnings. b) the focus on marginal tax rates versus average tax rates. c) the role of total income flow versus incremental flows. d) the focus on corporate avarice versus stewardship. e) none of the above.
2.
Money that the firm has already spent or is committed to spend regardless of whether a project is taken is called a(n): a) sunk cost. b) opportunity cost. c) erosion cost. d) fixed cost. e) none of the above.
3.
The Harlow Corporation has promised to pay its debt holders an amount of $1,700 over the next year. Calculate Harlow's debt and equity level if its assets total $1100 at the end of the year, Value of Debt =( ) Value of Equity = ( ). If asset levels is of $2,200, Value of Debt =( ) Value of Equity = ( ). This show that the value of debt and value of the equity of a corporation is contingent on ( ). It also show that a Corporate shareholder has ( ). a) 1100; 1100; 2200;2200; equity; unlimited liability b) 1100; 1100; 2200;2200; equity; limited liability c) 1100; 1100; 2200;2200; asset value; limited liability d) 1100; 1100; 2200;2200; asset value; unlimited liability e) 1100; 0; 1700;500; asset value; limited liability
4.
Given Mary’s income this year and next year and the availability of financial markets, Mary has decided that if she saves everything this year, she can spend $160,000 next year. If she borrows against all of next year’s income and spends everything now, she can spend at most $125,000 now. The implied market rate of interest is a) 28% b) 21.875% c) 18.8% d) 16.25% e) 12.625
5.
The term structure can be described as the: a) relationship of spot rates of interest and bond prices. b) relationship of coupon rates and money rates. c) relationship of spot rates of interest and term to maturity of the loan. d) relationship of coupon rates and maturity. e) None of the above.
6.
You bought one share of Pouce Coupe Resorts (PCR) one year ago for $9. Today, you received a dividend payment of $1 and sold the share for $9.50. What was your realized return on PCR over the last year? a) 11.11% b) 16.67% c) 10%
14.2319 Mid-term Examination I d) e)
9:00 a.m. – 12:00 p.m.
Page 2 of 5
5% 15%
7.
Weaknesses of the discounted payback system of evaluating investments include a) the fact that it ignores the timing of the associated cash flows. b) the fact that it ignores cash flows after the payback period. c) the fact that it uses an arbitrary cut-off period. d) the fact that it uses accounting income instead of cash flows. e) both b) and c) above.
8.
The internal rate of return (IRR): I. rule states that a typical investment project with an IRR that is less than the required rate should be accepted. II. is the rate generated solely by the cash flows of an investment. III. is the rate that causes the net present value of a project to exactly equal zero. IV. can effectively be used to analyze all investment scenarios. a) I and IV only b) II and III only c) I, II, and III only d) II, III, and IV only e) I, II, III, and IV
9.
The nominal interest rate is 18%. The inflation rate is 9%. What is the real rate? a) 27.00%. b) 9.00%. c) 7.63%. d) 28.62%. e) None of the above.
10.
The common stock of Prairie Grain Storage Inc. (PGS) just paid its annual dividend this morning. It is expected to pay a $11 dividend a year from now, and following dividends are expected to grow at a rate of 2% per annum into the foreseeable future. Given the risk of PGS shares, the required expected return is 13% per year. The price of one share of PGS stock is a) 109.09 b) 100 c) 111.2727 d) 92.3076 e) None of the above
11.
Fleetwood Mac Inc.(FM) just paid its annual dividend this morning. You expect future annual dividends to grow at a constant rate of 4% per year. Given the risk of FM’s stock, the required expected return is 13% per annum, and its current price is $19.60. The dividend that was paid this morning is a) 2.54 b) 1.96 c) 1.6962 d) 1.764 e) None of the above
12.
Bond A has a coupon rate of 10% and 10 years till maturity. Bond B has a coupon rate of 14% and 14 years till maturity. Bond C has a coupon rate of 18% and 18 years till maturity. If the yield to maturity of each of the bonds is 14%, then the bonds will sell respectively at a) a discount; a discount; a discount. b) a premium; a premium; a premium. c) par; par; par.
14.2319 Mid-term Examination I d) e) 13. a)
9:00 a.m. – 12:00 p.m.
Page 3 of 5
a discount; par; a premium. a premium; par; a discount.
The prices for IMB over the last 3 years are given below. Assuming no dividends were paid, what was the 3-year holding period return? 17.65%. b) 5.11%. c) 14.29%. d) -8.57%. e) none of the above.
Y
e Pa r r i 0 $ 7 1 6 2 6 3 8
c e 0
4 8 0
14.
Suppose you own a risky asset with an expected return of 12% and a standard deviation of 20%. If the returns are normally distributed, the approximate probability of receiving a return greater than 32% is: a) .67. b) .33. c) .05. d) .02. e) .16.
15.
The risk premium on common stocks is the: a) difference between the common equity return and the risk-free rate. b) excess return to a risky asset. c) the additional return resulting from the riskiness of common stocks. d) all of the above. e) none of the above.
16.
In shopping for a 5-year GIC that provides the best return on investment, you see that trust companies and banks have provided several options. The investment that would provide the best return to you is one that pays a) 7% per year compounded monthly. b) 7.125% per year compounded quarterly. c) 7.25% per year compounded semi-annually. d) 7.375% per year compounded annually. e) Can not tell
17.
The Government of Canada has issued 7.2% coupon bonds with semi-annual coupons and 22 years to maturity. If the yield-to-maturity for the bonds is quoted as 7.5% per year (compounded semi-annually), then the price of a $1,000 face value bond is a) $1,032.88 b) $1,032.64 c) $1,000.00 d) $968.15 e) $967.92
18.
A Government of Canada $1,000 face value bond with 14 years to maturity and an 8.4% coupon (coupons paid semi-annually) recently sold for $1,067.36. The yield to maturity of this bond is a) 3.804800% per year compounded semi-annually. b) 7.609601% per year compounded semi-annually. c) 8.400000% per year compounded semi-annually. d) 8.665209% per year compounded semi-annually. e) none of the above
19.
What should the price of the bond with two years term to maturity, annual coupon payment $80 and a face value of $1,000? The one year spot interest rate 10%, and the two year spot interest rate is 12%. a) $ 910.697 b) $ 933.697 c) $ 949.697
14.2319 Mid-term Examination I d) e) 20.
9:00 a.m. – 12:00 p.m.
Page 4 of 5
$1,000 $1,080
John Bishop, a private contractor, has an opportunity for a recycling “pickup” contract with the city over the next 5 years. The contract calls for the city to pay John $250,000 at the start of the contract and nothing for the remainder of the contract. John estimates that his expenses will be $70,000 at the end of each of the 5 years. If John uses IRR to evaluate his opportunities, he would only accept this contract if the discount rate (hurdle rate) is a) greater than 12.376241%. b) less than 12.376241%. c) greater than 17.190612%. d) less than 17.190612%. e) none of the above.
II. Long Answer Section: Answer each question in the exam Booklet provided. Show all relevant work (i.e., formulas and substitutions). Do NOT indicate which buttons were pushed on your calculator. Do not round any intermediate calculations. Final answers on dollar value may be rounded to 2 decimal points; other final answers may be rounded to 6 decimal places unless otherwise specified. Please mark clear which question you are answering on your booklet. Given a stated interest rate of 12% per year compounded monthly, find the following equivalent interest rate (12 points)
1.
a)
Monthly rate compounded monthly. ( i.e interest rate per month compound monthly)
b)
Effective annual interest rate
c)
Quarterly rate compounded quarterly.
d)
Yearly rate compound semiannually (interest rate per year compound semiannually)
Alpine Software Inc. has just introduced a new operating system into the market, which competes with Windows 98. This morning Alpine paid a $2 annual dividend per share to its stockholders. Expecting increased profitability (due to the new software), an investor believes that dividends will grow at a rate of 5% per year during the next two years. After that, the investor believes that the dividend growth rate will stabilize at a constant rate (g) forever. The investor is willing to buy Alpine Software's stock at a price of $15.3879 per share, but hold it only for two years. The appropriate rate of return on the stock is 16% p.a. (11 points) (a) What price does the investor expect to get for the stock in two years? (b) Given the price calculated in (a), what is the constant growth rate (g) s/he expects for year 3 and on? 2.
Ann took out a $500,000 mortgage with Scotiabank in Canada, and has negotiated to make monthly payments of $2,908.03 each month at an interest rate of 5%. (12 points)
3.
a) How many years will it take her to pay off her mortgage. b) What is the amount still remaining to be paid after Ann have paid for 10 years? 4. Spot rates of interest for zero-coupon Government of Canada bonds are observed for different terms to maturity as follows: Term to maturity 1 year from today 2 years from today 3 years from today
Rate (ri) 6.10% 6.20% 6.25%
14.2319 Mid-term Examination I 4 years from today
9:00 a.m. – 12:00 p.m.
Page 5 of 5
6.35%
A zero-coupon bond has a face value of $1,000 and matures 4 years from today (10 points) a)
What is its price today? If you believe in the pure expectations theory of the term structure, what do you expect the zero coupon bond’s price to be 3 years from today? b)
ABC Taxi Company is considering to expand its’ fleet. The cost of purchasing the new taxi is $1,000,000 now. Taxies fall under CCA Class 16 and are allowed a CCA rate of 10%. The tax rate for ABC is 45%. The project will generate revenues in excess of expenditures of $450,000 per year for 5 years. The net working capital will increase by $50,000, no intermediate changes and a reversion to normal working capital requirement at the end of 5 years. The taxies relevant to the project will be sold at the end of year 5 for $100,000. (The opportunity cost of capital is 15%) (10 points)
5.
a)
b) c) d) e)
What is the present value of (revenue-cost)*(1-taxrate)? What is the present value of cash flow due to the change of net working capital? What is the present value of cash flow due to the purchasing and sale of fixed assets? What is the present value of tax shield of the project? What is the total present value of the project?
Student ID ______________________________
Corporation Finance Room 2M73 Mid Term Test Dec. 11 ,2009 9:00 a.m. – 12:00 p.m.
Professor Haifeng Chen Total: 100 marks
I. Multiple Choice Section: Each of the following questions is followed by several suggested answers or completions. Select the best alternative and place the corresponding letter on the accompanying computerized answer sheet. (Value: 20x 2 = 40 points) 1.
One of the key differences between corporate finance and financial accounting courses is: a) the focus on cashflows instead of earnings. b) the focus on marginal tax rates versus average tax rates. c) the role of total income flow versus incremental flows. d) the focus on corporate avarice versus stewardship. e) none of the above.
2.
Money that the firm has already spent or is committed to spend regardless of whether a project is taken is called a(n): a) sunk cost. b) opportunity cost. c) erosion cost. d) fixed cost. e) none of the above.
3.
The Harlow Corporation has promised to pay its debt holders an amount of $1,700 over the next year. Calculate Harlow's debt and equity level if its assets total $1100 at the end of the year, Value of Debt =( ) Value of Equity = ( ). If asset levels is of $2,200, Value of Debt =( ) Value of Equity = ( ). This show that the value of debt and value of the equity of a corporation is contingent on ( ). It also show that a Corporate shareholder has ( ). a) 1100; 1100; 2200;2200; equity; unlimited liability b) 1100; 1100; 2200;2200; equity; limited liability c) 1100; 1100; 2200;2200; asset value; limited liability d) 1100; 1100; 2200;2200; asset value; unlimited liability e) 1100; 0; 1700;500; asset value; limited liability
4.
Given Mary’s income this year and next year and the availability of financial markets, Mary has decided that if she saves everything this year, she can spend $160,000 next year. If she borrows against all of next year’s income and spends everything now, she can spend at most $125,000 now. The implied market rate of interest is a) 28% b) 21.875% c) 18.8% d) 16.25% e) 12.625
5.
The term structure can be described as the: a) relationship of spot rates of interest and bond prices. b) relationship of coupon rates and money rates. c) relationship of spot rates of interest and term to maturity of the loan. d) relationship of coupon rates and maturity. e) None of the above.
6.
You bought one share of Pouce Coupe Resorts (PCR) one year ago for $9. Today, you received a dividend payment of $1 and sold the share for $9.50. What was your realized return on PCR over the last year? a) 11.11% b) 16.67% c) 10%
14.2319 Mid-term Examination I d) e)
9:00 a.m. – 12:00 p.m.
Page 2 of 5
5% 15%
7.
Weaknesses of the discounted payback system of evaluating investments include a) the fact that it ignores the timing of the associated cash flows. b) the fact that it ignores cash flows after the payback period. c) the fact that it uses an arbitrary cut-off period. d) the fact that it uses accounting income instead of cash flows. e) both b) and c) above.
8.
The internal rate of return (IRR): I. rule states that a typical investment project with an IRR that is less than the required rate should be accepted. II. is the rate generated solely by the cash flows of an investment. III. is the rate that causes the net present value of a project to exactly equal zero. IV. can effectively be used to analyze all investment scenarios. a) I and IV only b) II and III only c) I, II, and III only d) II, III, and IV only e) I, II, III, and IV
9.
The nominal interest rate is 18%. The inflation rate is 9%. What is the real rate? a) 27.00%. b) 9.00%. c) 7.63%. d) 28.62%. e) None of the above.
10.
The common stock of Prairie Grain Storage Inc. (PGS) just paid its annual dividend this morning. It is expected to pay a $11 dividend a year from now, and following dividends are expected to grow at a rate of 2% per annum into the foreseeable future. Given the risk of PGS shares, the required expected return is 13% per year. The price of one share of PGS stock is a) 109.09 b) 100 c) 111.2727 d) 92.3076 e) None of the above
11.
Fleetwood Mac Inc.(FM) just paid its annual dividend this morning. You expect future annual dividends to grow at a constant rate of 4% per year. Given the risk of FM’s stock, the required expected return is 13% per annum, and its current price is $19.60. The dividend that was paid this morning is a) 2.54 b) 1.96 c) 1.6962 d) 1.764 e) None of the above
12.
Bond A has a coupon rate of 10% and 10 years till maturity. Bond B has a coupon rate of 14% and 14 years till maturity. Bond C has a coupon rate of 18% and 18 years till maturity. If the yield to maturity of each of the bonds is 14%, then the bonds will sell respectively at a) a discount; a discount; a discount. b) a premium; a premium; a premium. c) par; par; par.
14.2319 Mid-term Examination I d) e) 13. a)
9:00 a.m. – 12:00 p.m.
Page 3 of 5
a discount; par; a premium. a premium; par; a discount.
The prices for IMB over the last 3 years are given below. Assuming no dividends were paid, what was the 3-year holding period return? 17.65%. b) 5.11%. c) 14.29%. d) -8.57%. e) none of the above.
Y
e Pa r r i 0 $ 7 1 6 2 6 3 8
c e 0
4 8 0
14.
Suppose you own a risky asset with an expected return of 12% and a standard deviation of 20%. If the returns are normally distributed, the approximate probability of receiving a return greater than 32% is: a) .67. b) .33. c) .05. d) .02. e) .16.
15.
The risk premium on common stocks is the: a) difference between the common equity return and the risk-free rate. b) excess return to a risky asset. c) the additional return resulting from the riskiness of common stocks. d) all of the above. e) none of the above.
16.
In shopping for a 5-year GIC that provides the best return on investment, you see that trust companies and banks have provided several options. The investment that would provide the best return to you is one that pays a) 7% per year compounded monthly. b) 7.125% per year compounded quarterly. c) 7.25% per year compounded semi-annually. d) 7.375% per year compounded annually. e) Can not tell
17.
The Government of Canada has issued 7.2% coupon bonds with semi-annual coupons and 22 years to maturity. If the yield-to-maturity for the bonds is quoted as 7.5% per year (compounded semi-annually), then the price of a $1,000 face value bond is a) $1,032.88 b) $1,032.64 c) $1,000.00 d) $968.15 e) $967.92
18.
A Government of Canada $1,000 face value bond with 14 years to maturity and an 8.4% coupon (coupons paid semi-annually) recently sold for $1,067.36. The yield to maturity of this bond is a) 3.804800% per year compounded semi-annually. b) 7.609601% per year compounded semi-annually. c) 8.400000% per year compounded semi-annually. d) 8.665209% per year compounded semi-annually. e) none of the above
19.
What should the price of the bond with two years term to maturity, annual coupon payment $80 and a face value of $1,000? The one year spot interest rate 10%, and the two year spot interest rate is 12%. a) $ 910.697 b) $ 933.697 c) $ 949.697
14.2319 Mid-term Examination I d) e) 20.
9:00 a.m. – 12:00 p.m.
Page 4 of 5
$1,000 $1,080
John Bishop, a private contractor, has an opportunity for a recycling “pickup” contract with the city over the next 5 years. The contract calls for the city to pay John $250,000 at the start of the contract and nothing for the remainder of the contract. John estimates that his expenses will be $70,000 at the end of each of the 5 years. If John uses IRR to evaluate his opportunities, he would only accept this contract if the discount rate (hurdle rate) is a) greater than 12.376241%. b) less than 12.376241%. c) greater than 17.190612%. d) less than 17.190612%. e) none of the above.
II. Long Answer Section: Answer each question in the exam Booklet provided. Show all relevant work (i.e., formulas and substitutions). Do NOT indicate which buttons were pushed on your calculator. Do not round any intermediate calculations. Final answers on dollar value may be rounded to 2 decimal points; other final answers may be rounded to 6 decimal places unless otherwise specified. Please mark clear which question you are answering on your booklet. Given a stated interest rate of 12% per year compounded monthly, find the following equivalent interest rate (12 points)
1.
a)
Monthly rate compounded monthly. ( i.e interest rate per month compound monthly)
b)
Effective annual interest rate
c)
Quarterly rate compounded quarterly.
d)
Yearly rate compound semiannually (interest rate per year compound semiannually)
Alpine Software Inc. has just introduced a new operating system into the market, which competes with Windows 98. This morning Alpine paid a $2 annual dividend per share to its stockholders. Expecting increased profitability (due to the new software), an investor believes that dividends will grow at a rate of 5% per year during the next two years. After that, the investor believes that the dividend growth rate will stabilize at a constant rate (g) forever. The investor is willing to buy Alpine Software's stock at a price of $15.3879 per share, but hold it only for two years. The appropriate rate of return on the stock is 16% p.a. (11 points) (a) What price does the investor expect to get for the stock in two years? (b) Given the price calculated in (a), what is the constant growth rate (g) s/he expects for year 3 and on? 2.
Ann took out a $500,000 mortgage with Scotiabank in Canada, and has negotiated to make monthly payments of $2,908.03 each month at an interest rate of 5%. (12 points)
3.
a) How many years will it take her to pay off her mortgage. b) What is the amount still remaining to be paid after Ann have paid for 10 years? 4. Spot rates of interest for zero-coupon Government of Canada bonds are observed for different terms to maturity as follows: Term to maturity 1 year from today 2 years from today 3 years from today
Rate (ri) 6.10% 6.20% 6.25%
14.2319 Mid-term Examination I 4 years from today
9:00 a.m. – 12:00 p.m.
Page 5 of 5
6.35%
A zero-coupon bond has a face value of $1,000 and matures 4 years from today (10 points) a)
What is its price today? If you believe in the pure expectations theory of the term structure, what do you expect the zero coupon bond’s price to be 3 years from today? b)
ABC Taxi Company is considering to expand its’ fleet. The cost of purchasing the new taxi is $1,000,000 now. Taxies fall under CCA Class 16 and are allowed a CCA rate of 10%. The tax rate for ABC is 45%. The project will generate revenues in excess of expenditures of $450,000 per year for 5 years. The net working capital will increase by $50,000, no intermediate changes and a reversion to normal working capital requirement at the end of 5 years. The taxies relevant to the project will be sold at the end of year 5 for $100,000. (The opportunity cost of capital is 15%) (10 points)
5.
a)
b) c) d) e)
What is the present value of (revenue-cost)*(1-taxrate)? What is the present value of cash flow due to the change of net working capital? What is the present value of cash flow due to the purchasing and sale of fixed assets? What is the present value of tax shield of the project? What is the total present value of the project?
