FIN 301 Exam 1

Which one of the following terms is defined as a conflict of interest between the corporate shareholders and the corporate managers?

agency problem

Mary just purchased a bond which pays $60 a year in interest. What is this $60 called?

coupon

The nominal interest rate your bank offers is 9% per year. The expected inflation rate is 3%. What is the real interest rate you earn?

5.83%

Which of the following are decisions about working capital management?

>>determining how much inventory to keep on hand >>determining how much money should be kept in the checking account

Which of the following are features of a corporation?

>Separation of ownership & MGMT >Limited Liability >Double Taxation >Easy to raise large amounts of equity capital >Easy to transfer Ownership

Which one of the following terms is defined as the management of a firm's long-term investments?

Capital Budgeting

You just win a lottery. The lottery company promises to pay you $5000 every year forever. The first payment will be made 5 years from today. Alternatively, you can choose to get a lump sum payment of $90,000 today. Suppose the annual interest rate is 5%. Which option should you choose?

Choose the option of the lump sum payment because this option has a higher present value.

Suppose you just won a lottery. You could either choose to get a quarterly payment of $5000 for 10 years, with the first payment 1 year from today; or you can choose to get a lump sum of $130,000 today. Suppose the applicable interest rate is an APR of 8%, compounded quarterly. Which option should you choose? Why?

Choose the second option (lump sum payment) because the present value of the first option is $128,888, which is lower than $130,000 today

Which of the following statements about dividends or stock valuation is TRUE?

Constant divident growth model is typically used to value mature companies.

Which form of business organization is associated with double taxation?

Corporation

Which one of the following risk premiums compensates for the possibility of nonpayment by the bond issuer?

Default risk

A bond's coupon rate is equal to the annual interest divided by which one of the following?

FV

Bert owns a bond that will pay him $75 each year in interest plus a $1,000 principal payment at maturity. What is the $1,000 called?

Face Value

Someone wants you to lend her $3000 today. She promises to pay you $1000 one year from today, $1050 two years from today and $1100 three years from today. Alternatively, you can earn 3% compounded annually by putting the money in a savings account. Should you lend her the money? How large should the last payment be assuming the first two being the same, for you to be willing to lend her the money?

No, I will not lend because the NPV of the project is negative, −$32.74. In order

Which of the following is NOT specified in the bond indenture?

Yield to maturity.

Which one of the following is computed as next year's annual dividend divided by the current stock price?

dividend yield

Decisions made by financial managers should primarily focus on increasing which one of the following?

market value per share of outstanding stock

You are offered a 5-year contract. You will be paid $10,000 today, $30,000 in one year, $40,000 in two years, and a final payment of $10,000 in five years. What is the present value of this contract, assuming you can earn 8% per year on your investment?

$10,000 + $30,000/1.08 + $40,000/1.08^(2) + $10,000/1.08^(5) = $78,877

Company A has been listed on NYSE for five years. This company has never paid any dividend to its shareholders. It is expected that five years from now, the company will start to issue annual dividend. Suppose the first dividend is $1 per share. The dividend will grow at 20% per year for three years. After that, the growth rate will be 3% forever. Assume the appropriate discount rate is 12%. What is the price of Company A's stock today?

$10.5

Which one of the following is a primary market transaction?

Sale of a new share of stock to an individual investor

Citi-group has a 7-year coupon bond with 6% coupon rate and a $1,000 par value. Coupons are paid annually. The bond has a yield to maturity of 5.5%, compounded annually. If the yield suddenly increases to 6.5%. Which of the following statements is TRUE?

The bond price will decrease by 5.43%

Green Roof Inns is preparing a bond offering with a 6 percent, semiannual coupon and a face value of $1,000. The bonds will be repaid in 10 years and will be sold at par. Given this, which one of the following statements is correct?

The bonds will sell at a premium if the market rate is 5.5 percent

You are planning for your retirement. You expect that you can live for another 40 years after your retirement day. For the first year of your retirement, you think that you will need $50,000. The annual amount will increase by 3% a year to compensate for the inflation. Suppose the money will always be withdrawn from your bank account at the end of each year, and your bank will offer an 6% annual return on your money. How much you will need in the bank account at the retirement day?

$1,138,096

You are thinking to buy a share of Company Ames' stock and hold it for 3 years. The company pays an annual dividend. The dividends for the next 3 years are expected to be $1.2, $2, and $2.4 respectively. At the end of year 3, you expect to sell the share for $20. What is the price you are willing to pay supposed the required rate of return is 8% per year?

$20.61

You are considering to buy some stocks of Company A. This company just paid out its annual dividend yesterday. Dividend for next year is expected to be $1.2 per share. Suppose the dividend grows at a rate of 2% per year forever. Your required rate of return for this investment is 8% annually. What is the maximum price you are willing to pay today?

$20/share

ABC Inc. just paid out its annual dividend of $1.2/share today. The dividend is expected to grow at a rate of 25% per year for the next 3 years. Afterwards, the growth rate will settle down to 5% per year. Find out current stock price if the required rate of return is 12% per year.

$29.53

The bank promised to pay a fixed annual cash dividend of $72.5 per share. Suppose the appropriate annual discount rate is 12%. How much you are willing to pay for one share of such stock today?

$604.17

A 3-year zero-coupon bond has a face value of $1000. Suppose the yield is 6%, compounded annually, what is the current price of the bond?

$839.62

The price of one-year, two-year, and three-year zero coupon Treasury bond are currently $980, $860, and $780 respectively. The government plans to issue a new three-year annual coupon bond with a coupon rate of 4%. Face value of all the bonds are $1000. What is the fair price of the new coupon bond?

$884.8

The government pays $20 each year on a consol. Last year the price of the consol was $500, and the price today is $400. Find out the change in annual interest rate over last year.

1%

The annual dividends of Company ABC are growing at the rate of 4% per year. The company is expected to pay $1/share dividend next year. The stock is currently traded at $15/share. Find out the required rate of return of the company's stock.

10.67%

What is the EAR (effective annual rate) for an APR of 12% with continuous compounding?

12.75%

A 3-year zero coupon corporate bond is traded at a price of $760. A 3-year zero coupon Treasury bond is traded at $820. Both bonds have face value of $1000. What is the default risk premium for the corporate bond if yields are compounded semi-annually?

2.63%

You think that you will be able to retire when you have $1 million dollars in your retirement account. Currently, you only have $200,000 in the account. You plan to save $5000 every year, and your account can generate an annual return of 6%. How many more years you need to work before you can retire?

23 years

The decision to issue additional shares of stock is an example of which one of the following?

Capital Structure Decision

You are asked to evaluate a project for your company. The initial investment of the project is $250 million. The project can generate $40 million, $80 million, $120 million, and $90 million in each of the following four years. The appropriate discount rate for the project is 12% per year. Should the company accept the project?

No, because the project has a negative NPV of -7.90 million.

Sixteen years ago, Alicia invested $1,000. Eight years ago, Travis invested $2,000. Today, both Alicia's and Travis's investments are each worth $2,400. Assume that both Alicia and Travis continue to earn their respective rates of return. Which one of the following statements is correct concerning these investments?

One year ago, Alicia's investment was worth less than Travis's investment.

Interest earned on both the initial principal and the interest from prior periods is called

compound interest

The Fisher effect is defined as the relationship between which of the following variables?

real rates, inflation rates, and nominal rates