Expert answer:How to answer finance exam Q3
Answer & Explanation:41. Two years ago you purchased a new SUV. You financed your SUV
for 60 months (with payments made at the end of the month) with a loan at 5.9%
APR. Your monthly payments are $617.16
and you have just made your 24th monthly payment on your SUV.
Required: Assuming
that you have made all of the first 24 payments on time, how much interest have
you paid over the first two years of your loan? (10 marks)
42. Consider the following list of projects:
Project
Investment
NPV
A
405,000
18,000
B
600,000
90,000
C
375,000
60,000
D
450,000
6,000
E
525,000
30,000
F
225,000
30,000
G
240,000
27,000
H
600,000
60,000
I
150,000
12,000
J
270,000
30,000
You are given a
budget of only $1,800,000 to invest in projects.
Required: Which
projects will you select, in what order will you select them, and why? (10
marks)
43. Consider the following three individuals’ portfolios
consisting of investments in four stocks:
Stock
Beta
Peter’s
Investment
Paul’s
Investment
Mary’s
Investment
Eenie
1.3
2,500
5,000
10,000
Meenie
1.0
2,500
5,000
10,000
Minie
0.8
2,500
5,000
-5,000
Moe
-0.5
2,500
-5,000
-5,000
Required: Assuming
that the risk-free rate is 4% and the expected return on the market is 12%,
then calculate the required return on Mary’s portfolio. (10 marks)
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Section 1: Multiple Choice (30 questions; 30 marks).
Select the best alternative for each of the multiple choice questions, and fill in your choice in the
following table.
Note: 5 marks will be deducted if your answers are not filled in the table below. You do not need
to include the questions in your submitted assignment (we’d rather you didn’t, actually), but you
must include this table, completed with your answers, in your submitted assignment.
Question
1
Choice
Question
9
Choice
Question
17
Choice
Question
25
2
10
18
26
3
11
19
27
4
12
20
28
5
13
21
29
6
14
22
30
7
15
23
8
16
24
Choice
1. Which of the following is/are an advantage(s) of incorporation?
A) Access to capital markets
B) Limited liability
C) Unlimited life
D) All of the above
2. Which of the following statements is false?
A) In bankruptcy, management is given the opportunity to reorganize the firm and renegotiate
with debt holders.
B) Because a corporation is a separate legal entity, when it fails to repay its debts, the people
who lent to the firm (the debt holders) are entitled to seize the assets of the corporation in
compensation for the default.
C) As long as the corporation can satisfy the claims of the debt holders, ownership remains in the
hands of the equity holders.
D) If the corporation fails to satisfy debt holders’ claims, equity holders may take control of the
firm.
3. Which of the following is NOT a financial statement that every public company is required by
IFRS to produce?
A) Income Statement
B) Statement of Comprehensive Income
C) Balance Sheet
D) Statement of Changes in Equity
4. The P/E ratio is not useful when the firm’s ________ are negative. In this case, it is common
to look at the firm’s ________ relative to sales.
A) operating earnings; enterprise value
B) net earnings; enterprise value
C) operating earnings; market value
D) net earnings; market value
5. Consider the following oil prices:
Alaska North Slope Crude Oil (ANS)
West Texas Intermediate Crude Oil
(WTI)
$71.75/Bbl
$73.06/Bbl
As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one barrel of
Alaska North Slope (ANS) crude oil. Because of its lower sulfur content, you can produce $77
worth of unleaded gasoline from one barrel of West Texas Intermediate (WTI) crude.
Another oil refiner is offering to trade you 10,150 Bbls of Alaska North Slope (ANS) crude oil
for 10,000 Bbls of West Texas Intermediate (WTI) crude oil. Assuming you currently have
10,000 Bbls of WTI crude, the added benefit (cost) to you if you take the trade is closest to:
A) ($1,400)
B) $1,400
C) ($3,908)
D) $3,908
6. You have an investment opportunity in Germany that requires an investment of $250,000
today and will produce a cash flow of €208,650 in one year with no risk. Suppose the risk-free
rate of interest in Germany is 6% and the current competitive exchange rate is €0.78 to $1.00.
What is the NPV of this project? Would you take the project?
A) NPV = 0; No
B) NPV = 2,358; No
C) NPV = 2,358; Yes
D) NPV = 13,650; Yes
7. Consider the following timeline detailing a stream of cash flows:
If the current market rate of interest is 6%, then the future value of this stream of cash flows is
closest to:
A) $1,723
B) $1,500
C) $1,626
D) $1,288
8. After many years teaching finance at Capilano University, Allen wants to establish a
scholarship to offer 4 $1,000 awards each year to students whose performance is excellent in
finance courses. If the university can negotiate a 12.75% effective interest rate, at least how
much does Allen need to endorse over to the scholarship (closest estimate)?
A) $32,000
B) $31,000
C) $31,500
D) $32,500
9. Consider the following investment alternatives:
Investmen
t
A
B
C
Rate
6.25%
6.10%
6.125
Compoundin
g
Annual
Daily
Quarterly
D
6.120
Monthly
The highest effective rate of return you could earn on any of these investments is closest to:
A) 6.250%
B) 6.267%
C) 6.300%
D) 6.320%
10. Which of the following statements is false?
A) The yield curve changes over time.
B) The formulas for computing present values of annuities and perpetuities cannot be used in
situations in which cash flows need to be discounted at different rates.
C) We can use the term structure to compute the present and future values of a risk-free cash
flow over different investment horizons.
D) The yield curve tends to be inverted as the economy comes out of a recession.
11. The Sisyphean Company has a bond outstanding with a face value of $1,000 that reaches
maturity in 15 years. The bond certificate indicates that the stated coupon rate for this bond is 8%
and that the coupon payments are to be made semi-annually.
Assuming that this bond trades for $903, then the YTM for this bond is closest to:
A) 8.0%
B) 6.8%
C) 9.9%
D) 9.2%
12. Consider the following four bonds that pay annual coupons:
Bond
A
B
C
D
Years to
maturity
1
5
10
20
Coupon
0%
6%
10%
0%
YTM
5%
7%
9%
8%
The percentage change in the price of the bond “A” if its yield to maturity increases from 5% to
6% is closest to:
A) -4%
B) -6%
C) -1%
D) 4%
13. You expect that Bean Enterprises will have earnings per share of $2 for the coming year.
Bean plans to retain all of its earnings for the next three years. For the subsequent two years, the
firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that
point forward. Retained earnings will be invested in projects with an expected return of 20% per
year. If Bean’s equity cost of capital is 12%, then the price of a share of Bean’s stock is closest to:
A) $17.00
B) $10.75
C) $27.75
D) $43.50
14. Defenestration Industries plans to pay a $4.00 dividend this year and you expect that the
firm’s earnings are on track to grow at 5% per year for the foreseeable future. Defenestration’s
equity cost of capital is 13%.
Suppose that Defenestration decides to pay a dividend of only $2 per share this year and use the
remaining $2 per share to repurchase stock. If Defenestration maintains this dividend and total
payout rate, then the rate at which Defenestration’s dividends and earnings per share are expected
to grow is closest to:
A) 7%
B) 13%
C) 9%
D) 5%
15. Larry the Cucumber has been offered $14 million to star in the lead role of the next three
Larry Boy adventure movies. If Larry takes this offer, he will have to forgo acting in other
Veggie movies that would pay him $5 million at the end of each of the next three years. Assume
Larry’s personal cost of capital is 10% per year.
The NPV of Larry’s three-movie Larry Boy offer is closest to:
A) 3.5 million
B) -1.6 million
C) 1.6 million
D) -1.0 million
16. Boulderado has come up with a new composite snowboard. Development will take
Boulderado four years and cost $250,000 per year, with the first of the four equal investments
payable today upon acceptance of the project. Once in production the snowboard is expected to
produce annual cash flows of $200,000 each year for 10 years. Boulderado’s discount rate is
10%.
The IRR for Boulderado’s snowboard project is closest to:
A) 10.4%
B) 10.0%
C) 11.0%
D) 15.1%
17. The Sisyphean Corporation is considering investing in a new cane manufacturing machine
that has an estimated life of three years. The cost of the machine is $30,000 and the machine
will be depreciated straight line over its three-year life to a residual value of $0.
The cane manufacturing machine will result in sales of 2,000 canes in year 1. Sales are
estimated to grow by 10% per year each year through year three. The price per cane that
Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a cost
per unit to manufacture of $9 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an
increase in various net working capital accounts. It is estimated that the Sisyphean Corporation
needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of
its annual sales in inventory, and 5% of its annual sales in accounts payable. The firm is in the
35% tax bracket, and has a cost of capital of 10%.
The depreciation tax shield (assuming the half-year rule is not applied for straight-line
depreciation) for the Sisyphean Corporation’s project in the first year is closest to:
A) $8,000
B) $3,500
C) $2,800
D) $5,200
18. You are considering adding a microbrewery onto one of your firm’s existing restaurants. This
will entail an increase in inventory of $8,000, an increase in accounts payable of $2,500, and an
increase in property, plant, and equipment of $40,000. All other accounts will remain unchanged.
The change in net working capital resulting from the addition of the microbrewery is:
A) $45,500
B) $10,500
C) $6,500
D) $5,500
19. Suppose an investment is equally likely to have a 35% return or a -20% return. The standard
deviation on the return for this investment is closest to:
A) 38.9%
B) 0%
C) 19.4%
D) 27.5%
20. Suppose that in the coming year, you expect Exxon-Mobil stock to have a volatility of 42%
and a beta of 0.9, and Merck’s stock to have a volatility of 24% and a beta of 1.1. The risk free
interest rate is 4% and the market’s expected return is 12%.
The cost of capital for a project with the same beta as Exxon Mobil’s stock is closest to:
A) 11.6%
B) 11.2%
C) 12.8%
D) 7.6%
21. Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per
share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at
$40 per share.
Suppose over the next year Ball has a return of 12.5%, Lowes has a return of 20%, and Abbott
Labs has a return of -10%. The weight of Lowes in your portfolio after one year is closest to:
A) 20.0%
B) 34.8%
C) 30.0%
D) 36.0%
22. Consider an equally weighted portfolio that contains 100 stocks. If the average volatility of
these stocks is 50% and the average correlation between the stocks is .7, then the volatility of this
equally weighted portfolio is closest to:
A) .72
B) .59
C) .40
D) .50
23. Which of the following statements is false?
A) Investors may have different information regarding expected returns, correlations, and
volatilities, but they correctly interpret that information and the information contained in market
prices and they adjust their estimates of expected returns in a rational way.
B) Investors may learn different information through their own research and observations, but as
long as they understand the differences in information and learn from other investors by
observing prices, the CAPM conclusions still stand.
C) Every investor, regardless of how much information he has access to, can guarantee himself
an alpha of zero by holding the market portfolio.
D) The CAPM requires making the strong assumptions of homogeneous expectations.
24. The only way it can be possible to earn a positive alpha and beat the market is if some
investors are holding portfolios with ________ alphas.
A) positive
B) zero
C) negative
D) none of the above
25. Consider the following graph of the security market line:
Which of the following statements regarding portfolio “C” is/are correct?
1. Portfolio “C” has a negative alpha.
2. Portfolio “C” is overpriced.
3. Portfolio “C” is less risky than the market portfolio.
4. Portfolio “C” should not exist if the market portfolio is efficient.
A) 1 and 3
B) 2 and 4
C) 1, 3, and 4
D) 3 only
26. Uninformed individuals tend to ________ the precision of their knowledge. In finance, we
call this presumptuousness the ________ hypothesis.
A) underestimate; underconfidence
B) overestimate; overconfidence
C) underestimate; overconfidence
D) overestimate; underconfidence
27. Consider a project with free cash flows in one year of $90,000 in a weak economy or
$117,000 in a strong economy, with each outcome being equally likely. The initial investment
required for the project is $80,000, and the project’s cost of capital is 15%. The risk-free interest
rate is 5%.
Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free
rate and issues new equity to cover the remainder. In this situation, the cash flow that equity
holders will receive in one year in a strong economy is closest to:
A) $117,000
B) $75,000
C) $50,000
D) $0
28. You are evaluating a new project and need an estimate for your project’s beta. You have
identified the following information about three firms with comparable projects:
Firm
Name
Lincoln
Blinkin
Nod
Equity
Beta
1.25
1.6
2.3
Debt
Beta
0
0.2
0.3
Debt to
Equity Ratio
0.25
1
1.5
20) The unlevered beta for Nod is closest to:
A) 1.00
B) 0.90
C) 0.95
D) 1.10
29. Consider the following income statement for Kroger Inc. (all figures in $ millions):
Year
Total Sales
Cost of goods sold
Selling, general & admin
expenses
Depreciation
Operating Income
Other Income
EBIT
Interest expense
Earnings before tax
Taxes (35%)
Net Income
2006
60,553
45,565
2005
56,434
42,140
2004
53,791
39,637
11,688
1,265
2,035
0
2,035
510
1,525
534
991
12,191
1,256
847
0
847
557
290
102
189
11,575
1,209
1,370
0
1,370
604
766
268
498
The interest rate tax shield for Kroger in 2006 is closest to:
A) $187 million
B) $332 million
C) $534 million
D) $179 million
30. The total amount available to pay out to all the investors in Kroger in 2006 is closest to:
A) $990 million
B) $1,525 million
C) $1,500 million
D) $2,035 million
Essay Questions – Short Answer (2-6 marks each, totaling 40 marks):
31. Advanced Micro Devices (NYSE: AMD) is currently trading at $20.75 on the NYSE.
Advanced Micro Devices is also listed on NASDAQ and assume it is currently trading on
NASDAQ at $20.50.
Required: Does an arbitrage opportunity exist and if so how would you exploit it and how much
would you make on a block trade of 1,000 shares? (4 marks)
32. Required: Can the nominal interest rate ever be negative? Can the real interest rate ever be
negative? Explain. (4 marks)
33. Required: What is the relationship between a bond’s price and its yield to maturity? (2
marks)
34. Growing Real Fast Company (GRF) is expected to have a 25 percent growth rate for the next
four years (affecting D1, D2, D3, and D4). Beginning in year five, the growth rate is expected to
drop to 7 percent per year and last indefinitely.
Required: If GRF just paid a $2.00 dividend and the appropriate discount rate is 15 percent, then
what is the value of a share of GRF? (4 marks)
35. Consider two mutually exclusive projects with the following cash flows:
Project
A
B
C/F0
C/F1
C/F2
C/F3
C/F4
C/F5
C/F6
$(41,215
)
$12,500 $14,000 $16,500 $18,000 20,000
N/A
$(46,775
)
$15,000 $15,000 $15,000 $15,000 $15,000 $15,000
Required: If the discount rate for project B is 15%, then what is the NPV for project B? (4
marks)
36. Required: What is a sunk cost? Should it be included in the incremental cash flows for a
project? Why or why not? (4 marks)
37. Consider the following realized annual returns:
Market
Realized
Return
Microsoft
Realized
Return
1996
21.2%
88.3%
1997
30.3%
56.4%
1998
22.3%
114.6%
1999
25.3%
68.4%
2000
-11.0%
-62.8%
2001
-11.3%
52.7%
Year End
2002
-20.8%
-22.0%
2003
33.1%
6.9%
2004
13.0%
9.2%
2005
7.3%
-0.9%
Required: Using the data provided in the table, calculate the average annual return, the variance
of the annual returns, and the standard deviation of the average returns for the market from 1996
to 2005. (4 marks)
38. Consider the following returns:
Lowes
Realize
d
Year End Return
2000
20.1%
2001
72.7%
2002
-25.7%
2003
56.9%
2004
6.7%
2005
17.9%
Home
Depot
Realized
Return
-14.6%
4.3%
-58.1%
71.1%
17.3%
0.9%
IBM
Realized
Return
0.2%
-3.2%
-27.0%
27.9%
-5.1%
-11.3%
Required: Calculate the variance on a portfolio that is made up of equal investments in Home
Depot and IBM stock. (6 marks)
39. The Aardvark Corporation is considering launching a new product and is trying to determine
an appropriate discount rate for evaluating this new product. Aardvark has identified the
following information for three single division firms that offer products similar to the one
Aardvark is interested in launching:
Comparable Firm
Anteater Enterprises
Armadillo Industries
Antelope Inc.
Equity
Cost of Debt Cost Debt-to-Value
Capital of Capital
Ratio
12.50%
6.50%
50%
13%
6.10%
40%
14%
7.10%
60%
Required: Based upon the three comparable firms, calculate the most appropriate unlevered cost
of capital for Aardvark to use on this new product. (4 marks)
40. Consider a project with free cash flows in one year of $90,000 in a weak economy or
$117,000 in a strong economy, with each outcome being equally likely. The initial investment
required for the project is $80,000, and the project’s cost of capital is 15%. The risk-free interest
rate is 5%.
Sisyphean Bolder Movers Incorporated has no debt, a total equity capitalization of $50 billion,
and a beta of 2.0. Included in Sisyphean’s assets are $12 billion in cash and risk-free securities.
Required: Calculate Sisyphean’s enterprise value and unlevered beta considering the fact that
Sisyphean’s cash is risk-free. (4 marks)
Problem Questions (10 marks each, totaling 30 marks):
41. Two years ago you purchased a new SUV. You financed your SUV for 60 months (with
payments made at the end of the month) with a loan at 5.9% APR. Your monthly payments are
$617.16 and you have just made your 24th monthly payment on your SUV.
Required: Assuming that you have made all of the first 24 payments on time, how much interest
have you paid over the first two years of your loan? (10 marks)
42. Consider the following list of projects:
Project
A
B
C
D
E
F
G
H
I
J
Investment
405,000
600,000
375,000
450,000
525,000
225,000
240,000
600,000
150,000
270,000
NPV
18,000
90,000
60,000
6,000
30,000
30,000
27,000
60,000
12,000
30,000
You are given a budget of only $1,800,000 to invest in projects.
Required: Which projects will you select, in what order will you select them, and why? (10
marks)
43. Consider the following three individuals’ portfolios consisting of investments in four stocks:
Stock
Beta
Peter’s
Paul’s
Mary’s
Eenie
Meenie
Minie
Moe
1.3
1.0
0.8
-0.5
Investment Investment Investment
2,500
5,000
10,000
2,500
5,000
10,000
2,500
5,000
-5,000
2,500
-5,000
-5,000
Required: Assuming that the risk-free rate is 4% and the expected return on the market is 12%,
then calculate the required return on Mary’s portfolio. (10 marks)
Section 1: Multiple Choice (30 questions; 30 marks).
Select the best alternative for each of the multiple choice questions, and fill in your choice in the
following table.
Note: 5 marks will be deducted if your answers are not filled in the table below. You do not need
to include the questions in your submitted assignment (we’d rather you didn’t, actually), but you
must include this table, completed with your answers, in your submitted assignment.
Question
1
Choice
Question
9
Choice
Question
17
Choice
Question
25
2
10
18
26
3
11
19
27
4
12
20
28
5
13
21
29
6
14
22
30
7
15
23
8
16
24
Choice
1. Which of the following is/are an advantage(s) of incorporation?
A) Access to capital markets
B) Limited liability
C) Unlimited life
D) All of the above
2. Which of the following statements is false?
A) In bankruptcy, management is given the opportunity to reorganize the firm and renegotiate
with debt holders.
B) Because a corporation is a separate legal entity, when it fails to repay its debts, the people
who lent to the firm (the debt holders) are entitled to seize the assets of the corporation in
compensation for the default.
C) As long as the corporation can satisfy the claims of the debt holders, ownership remains in the
hands of the equity holders.
D) If the corporation fails to satisfy debt holders’ claims, equity holders may take control of the
firm.
3. Which of the following is NOT a financial statement that every public company is required by
IFRS to produce?
A) Income Statement
B) Statement of Comprehensive Income
C) Balance Sheet
D) Statement of Cha …
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