Financial Management Final

A 4-year bond pays annual coupons with a 9% coupon rate and a $1,000 par value. The yield to maturity of the bond is 9%. What is the price of the bond? A) $3,000 B) $4,000 C) $90 D) $1,000

D

What is the present value of $36,300 expected to be received 2 years from today at an interest rate (discount rate) of 10% per year?

$30,000 (PV = C/((1+R)^n))

What is the value of a 1-year discount factor at a discount rate of 25% per year?

.80 (DF = 1/(1+r))

If the discount factors for years 1, 2, and 3 are .9, .7, and .5 what is the value of the 3 year annuity factor?

2.1 (AF = DF1 + ...)

If the average annual rates of return for the market of common stocks during the last 111 years is 11% and for treasury bills is 4%, what is the average market risk premium?

7% (Average annual rates of return 1 - Average annual rates of return 2)

A 10 year bond with a 9% coupon rate and a $1,000 par value has a yield of 7% per year. Which of the following statements is most correct? A) The bond will sell at a premium to par B) The bond will sell at the par value C) The bond will sell at a discount to par D) Unable to determine

A

A project to build a new plant will make use of land owned by the company. By undertaking this project you will not be able to use the land for something else. This is an example of A) Opportunity cost B) Sunk cost C) Incidental effect D) Fixed cost E) None of the above

A

Capital markets are sources of financing and a place to invest money for firms, whereas derivatives markets provide opportunities for corporations to reduce financial risk. A) True B) False

A

In the Enron example, although the company collapsed on December 2, 2001 it still had an investment grade credit rating as late as November 28, 2001. A) True B) False

A

In the GM example that was discussed in class, the shareholders in the original company were not given shares in the new GM that emerged from bankruptcy. A) True B) False

A

Most corporate bonds are issued with a coupon rate approximately equal to the yield to maturity on the day of issue. A) True B) False

A

Most long term corporate bonds in the USA that have a coupon rate greater than zero pay coupons twice a year A) True B) False

A

The board of directors usually have to approve large investment decisions for the firm. A) True B) False

A

The internal rate of return is defined as A) The discount rate that makes NPV equal to zero B) The discount rate used in the NPV method C) The difference between cost of capital and the present value of the cash flows D) The discount rate used in the discounted payback method

A

The process of deriving an Arbitrage Pricing Theory model involves the following 3 steps (1) identifying a number of macreconomic factors, (2) estimating the risk premium for each factor, and (3) measuring the sensitivity of a stock to the factors A) True B) False

A

The value of a share of common stock today depends mainly on the present value of future dividends per share A) True B) False

A

The yield to maturity for a zero coupon bond is the same as its A) Spot rate B) Real rate C) Forward rate D) Inflation rate

A

Which portfolio had the smallest standard deviation of returns during the last 111 years? A) Treasury bills B) Common stocks C) Government bonds

A

Which portfolio has had the largest average risk premium during the last 111 years? A) Common stocks B) Government bonds C) Treasury bills

A

If the one-year discount factor is .8333, what is the discount rate per year? A) 20% B) 25% C) 30% D) 10%

A (DF = 1/(1+r))

Two machines, A and B, which perform the same functions, have the following costs and lives Type A: PV Costs [$5,200], Life 5 Type B: PV Costs [$6,000], Life 7 The annuity factors for annuities of 5 and 7 years, using the company cost of capital, are 4.0 and 5.0. Which machine would you choose? A) Machine B, as its equivalent annual cost is smaller B) Machine B, as its equivalent annual cost is larger C) Machine A, as its equivalent annual cost is larger D) Machine A, as its equivalent annual cost is smaller E) Don't buy either machine

A (EAC = PV Costs/Annuity Factors, want smaller one)

If the 6 year spot rate is 3.5% per year and the 3 year spot rate is 3% per year, both with continuous compounding, then what is the forward rate of interest for 3 years, starting 3 years from now? A) 4% per year B) 6% per year C) 7% per year D) 5% per year

A (F = ((R2*T2)-(R1*T1))/(T2-T1))

A perpetuity with growth has a cash flow at the end of the first year of $80,000. The opportunity cost of capital is 12% and the annual cash flows will grow at a rate of 4% per year. What is the present value of this perpetuity? A) $1,000,000 B) $2,666,667 C) $266,667 D) $727,000

A (PV = C/(r-g))

If the probability of an economic recession is .2, normal economic growth is .4, and a boom is .4 and the payoff of a recession is $400, of normal growth is $500, and of boom is $600 what is the expected payoff? A) $520 B) $480 C) $500 D) $460

A (Payoff = (probability 1 x payoff 1) + ...)

If the depreciation amount on a project is $100,000 and the tax rate is 35%, what is the tax shield due to depreciation? A) $35,000 B) $65,000 C) $100,000 D) None of the above

A (Tax shield = depreciation x tax rate)

A company pays out 60% of its earnings as dividends. Its return on equity is 15%. What is the sustainable dividend growth rate for the firm? A) 6% B) 3% C) 9% D) 4%

A (g = (1 - %paid out) x return on equity)

Suppose that you borrow at the risk-free rate an amount equal to your initial wealth and invest all your money in the market portfolio. The market portfolio has an expected return of 10% and the risk-free return is 5%. What is the expected return on the resulting portfolio? A) 15% B) 30% C) 20% D) 25%

A (r = (wealth weight1 x expected return1) - (wealth weight2 x expected return 2))

What is an annuity?

A financial asset that pays equal cash flows at equal intervals for a specified period of time starting at the end of the first period

Specify one disadvantage of using internal rate of return to evaluate capital investment projects

A project can have many IRR's or none at all

If the expected rate of return for IBM is 15%, the risk-free rate is 2% and the market rate of return is 12%, what is the beta for IBM? A) 1.2 B) 1.3 C) 1.4 D) 1.5

B (B = (r-rf)/(rm-rf))

What is an annuity due?

An annuity where the first payment occurs now

Bonds are traded primarily on an exchange. A) True B) False

B

Consider the formula for present value of a perpetuity with growth. Which of the following statements is most correct? A) The growth rate (g) must be greater than the cost of capital (r) B) The growth rate (g) must be less than the cost of capital (r) C) The growth rate must be greater than zero D) None of the above

B

Corporate Finance is concerned primarily with managing a firm's: A) Tax returns B) Cash Flows C) Accounts D) Accounting Profits

B

If an investment project with "normal" cash flows has an IRR less than the cost of capital, the NPV for that project is A) Zero B) Negative C) Positive D) Unable to determine

B

If the discount rate is stated in real terms, then in order to calculate the NPV in a consistent manner: A) Project cash flows should be estimated in nominal terms B) Project cash flows should be estimated in real terms C) Accounting income should be used

B

Important points to remember when estimating cash flows of projects are A) Don't worry about the treatment of inflation B) Estimate cash flows on an incremental basis C) Only accounting profits are relevant D) All of the above E) None of the above

B

Money that a firm has already spent or committed regardless of whether a project is taken is called A) Opportunity cost B) Sunk cost C) Fixed cost D) Incidental effects E) None of the above

B

Preferably, cash flows for a project are estimated as A) Accounting profits before taxes B) Cash flows after taxes C) Cash flows before taxes D) Accounting profits after taxes

B

Profitability index is the ratio of A) Present value of cash flows to IRR B) Net present value of cash flows to initial investment C) Present value of cash flows to initial investment D) Net present value of cash flows to IRR

B

The daily returns of two financial assets move in the same direction with no exceptions. That is, when the first asset has a positive return on one day, the second asset also has a positive return. The same goes for negative returns. What is the correlation coefficient between the two assets? A) 0 B) +1 C) -1 D) Unable to determine

B

The expectations hypothesis for the term structure of interest rates states that the A) Forward rate is lower than the expected future spot rate B) Forward rate is equal to the expected future spot rate C) Forward rate is higher than the expected future spot rate D) The forward rate is sometimes higher and sometimes lower than the expected future spot rate

B

The net present value of a project depends upon A) The managers tastes and preferences B) Forecast cash flows and the opportunity cost of capital C) The company's choice of accounting method D) None of the above

B

The treasurer's responsibilities include preparing quarterly financial statements for the firm. A) True B) False

B

What has been the average annual nominal rate of interest on common stocks over the past 111 years? A) Between 8% and 10% B) Greater than 10% C) Between 5% and 7% D) Less than 5%

B

Which one of the following is not a factor in the Fama and French three-factor model? A) Return on high book-to-market ratio stocks minus return on low book-to-market ratio stocks B) Return on long-term government bonds minus return on short-term government bonds C) Return on small-firm stocks minus return on large firm stocks D) Return on market minus risk-free interest rate

B

Which one of the following statements regarding the NPV rule is correct? A) Accept a project if NPV < 0 B) Accept a project if NPV > 0 C) Accept a project if NPV > PV of future cash flows D) Accept a project if NPV > initial investment

B

Consider the bond with a duration 6.3 years and a yield of 5% with a volatility of 6%. If the yield decreases by .5% what happens to the price of the bond? A) The bond price decreases by 6% B) The bond price increases by 3% C) The bond price increases by 6% D) The bond price decreases by 3%

B (1% decrease in yield would increase the bond price by % volatility)

A portfolio contains three stocks A, B, and C with 25% invested in stock A, 40% in stock B, and 35% in stock C. The betas are 1.2, 1.5, and 2.0. What is the beta of the portfolio? A) 1.4 B) 1.6 C) 1.7 D) 1.5

B (Bp = (%A x Ba) +...)

The liquidity theory for the term structure of interest rates states that the A) Long-term rates are usually lower than the short term rates B) Long-term rates are usually higher than the short-term rates C) Long term rates are usually equal to the short-term rates D) Long-term rates are sometimes higher and sometimes lower than the short-term rates

B (Encourages investors to tie up their money for longer periods)

The price to earnings ratio for a corporation equals 12. Next year's earnings are estimated to be $2 million. What is the estimated price of stock next year? A) $10 million B) $24 million C) $14 million D) $6 million

B (earnings * PE ratio)

Managers, shareholders, and the firm's debt holders have equal information about the firm. A) True B) False

B (managers have insider knowledge)

A firm's stockholders expect to receive a dividend of $5 per share, and the current value of the stock is $100. If the required rate of return for the stock is 15%, what is the expected value of the stock at the end of the year? A) $100 B) $110 C) $115 D) $105

B (r = (Div1/P0) + (P1-P0)/P0)

A company's stock is selling for $100 per share today. It is expected that this stock will pay a dividend of $2 per share this year, and sell for $102 per share at the end of the year. Calculate the expected rate of return for the shareholders. A) 3% B) 4% C) 5% D) 6%

B (r = (P1 + Div - P0)/P0)

A perpetuity that pays $6,000 per year indefinitely currently costs $100,000. What is the rate of return for this asset? A) 7% B) 6% C) 4% D) 3%

B (r = C/PV)

Stock A has an expected return of 15% per year and stock B has an expected return of 10% per year. If 80% of your funds are invested in stock A and the remainder in stock B, what is the expected return on the portfolio consisting of stock A and stock B? A) 13% B) 14% C) 15% D) 16%

B (r = w1*r1 + w2*r2...)

A reduction in sales of existing products caused by the introduction of a new product is an example of A) Opportunity cost B) Sunk cost C) Incidental effect D) Fixed cost E) None of the above

C

Consider an amortized loan with monthly payments. Which of the following statement is most correct? A) The monthly payments decrease from one month to the next B) The monthly principal repayments decrease from one month to the next C) The monthly interest payments decrease from one month to the next D) All of the above E) None of the above

C

In the event of a liquidation of a company which has the highest priority claim on the company's assets? A) Preferred stock B) Common stock C) Secured creditors D) Unsecured creditors

C

The US Treasury Inflation Protected securities (TIPs) have the following features A) Coupon payments are adjusted for inflation B) The final principal payment is adjusted for inflation C) A and B are true D) A and B are false

C

When estimating the value of a firm using the discounted cash flow method we calculate the present value using A) Earnings B) Interest payments C) Free cash flows D) Profits before taxes

C

Which of the following statements regarding rate of return rule is correct? A) Accept a project if its return > 0 B) Accept a project if its return > return on US Treasury bonds C) Accept a project if its return > opportunity cost of capital D) Accept a project if its return < opportunity cost of capital

C

What is the future value of an investment of $2,000 for 3 years that will earn an interest rate of %20 per year? A) $3,906 B) $2,880 C) $3,456 D) $1,728

C (FV = C*(1+r)^n)

Casino Inc. is expected to pay a dividend of $6 per share at the end of year one and these dividends are expected to grow at a constant rate of 2% per year indefinitely. If the required rate of return on the stock is 7%, what is the current value of the stock today? A) $100 B) $80 C) $120 D) $40

C (P = Div1/(r-g))

You would like to have enough money saved to receive $120,000 per year from a perpetuity after retirement. How much would you need to save in your retirement fund? Interest rate is 5% per year. A) $240,000 B) $24,000,000 C) $2,400,000 D) $3,000,000

C (PV = C/r)

The real interest rate is 2% and the inflation rate is 3%. What is the approximate nominal interest rate? A) 6% B) 2% C) 5% D) 3%

C (nominal = real + inflation)

Suppose that you invest 20% of your money in an account that pays the risk-free rate of return, and the remainder in the market portfolio. The market portfolio has an expected return of 10% and the risk free return is 5%. What is the expected return on the resulting portfolio? A) 8% B) 10% C) 9% D) 25%

C (r = decimal money x expected return 1 + decimal money left x expected return 2)

If the beta of Microsoft is 1.4, and the risk-free rate is 2% and the market risk-premium is 5%, what is the expected return for Microsoft? A) 12% B) 10% C) 9% D) 11%

C (r = rf + B x MRP)

A bond has a duration 6.3 years and a yield of 5%. What is the volatility of the bond? A) 4% B) 5% C) 6% D) 3%

C (volatility = .01x(Duration/(1+yield)))

A 7-year corporate bond has an annual coupon rate of 4%. The yield to maturity is 6%. Which of the following statements is most correct? A) If market interest rates increase, the price of the bond will decrease B) The bond is currently selling at a price below its par value C) If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today D) Statements A and B are correct E) Statements B and C are correct F) All of the above are correct

D

A corporation may incur agency costs because: A) Managers may not attempt to maximize the value of the firm to shareholders B) Shareholders incur monitoring costs C) There is a separation between ownership and management D) All of the above

D

Consider a bond with a face value of $1,000, a zero coupon rate, and four years to maturity. What is the duration of the bond? A) 2 years B) 0 years C) 8 years D) 4 years

D

In general, as the number of stocks in an equally-weighted portfolio is increased A) Specific risk decreases and becomes equal to market risk B) Specific risk decreases and approaches 0 C) Portfolio variance is approximately equal to the average covariance of stocks in the portfolio D) Statements B and C are true E) Statements A and C are true

D

The distribution of stock returns, measured over a short interval of time, can be approximated by A) Binomial distribution B) Lognormal distribution C) Poisson distribution D) Normal distribution

D

The following groups are some of the claimants to a firm's income stream: (1) Shareholders (2) Bondholders (3) Employees (4) Management (5) Customers, A) 1 only B) 1 and 2 only C) 1, 2, and 3 only D) 1, 2, 3, and 4 E) 1, 2, 3, 4, and 5

D

The net present value formula for one period is: A) NPV = PV - required investment B) NPV = C + (C1/(1+r)) C) NPV = C0/C1 D) Statements A and B are true E) Statements A and C are true

D

The opportunity cost of capital (discount rate) used for valuing a corporate bond is its: A) Coupon rate B) Current yield C) Risk-free rate D) Yield to maturity

D

The portion of a stock's risk that can be eliminated by diversification is called A) Interest rate risk B) Market risk C) Systematic risk D) Specific risk

D

The term structure of interest rates can be described as the A) Relationship between spot interest rates and the prices of zero-coupon bonds B) Relationship between spot interest rates and stock prices C) Relationship between spot interest rates and the maturity of coupon-bearing bonds D) Relationship between spot interest rates and the maturity of zero-coupon bonds

D

What is the beta of the market portfolio? A) 2 B) 0 C) -1 D) 1

D

Which of the following cash flows should be treated as incremental cash flows when deciding whether or not to go ahead on a project? A) Dividend payments B) The annual depreciation charge C) The cost of research and development undertaken on the electric car last year D) The reduction in taxes resulting from depreciation charges

D

Which of the following is not used as a measure by firms when making capital budgeting decisions? A) Payback period B) Internal rate of return C) Net Present Value D) Return on capital

D

Which of the following statements is most correct A) Hard rationing may be used if the company doesn't want to issue new shares B) Soft rationing may be used to control managers' behavior and expectations C) Ranking profitability indices doesn't always work as a selection method D) All of the above

D

Which of the following statements is most correct? A) If a company issues new stock then this is done with the primary market B) A publicly owned corporation is simply a company whose shares are held by the investing public, which may include other corporations and institutions as well as individuals C) An IPO occurs whenever a company buys back its stock on the open market D) Statements A and B are correct E) Statements A and C are correct F) All of the above

D

Which one of the following statements is most correct (PVGO = Present value of growth opportunities) A) The PVGO of growth stocks is a greater percentage of the share price than the PVGO of income (value) stocks B) The PVGO of income (value) stocks is a greater percentage of the share price than the PVGO of growth stocks C) Growth stocks tend to pay low or no dividends D) Statements A and C are correct E) Statements B and C are correct

D

Ms. Anderson has $40,000 income this year and $50,000 next year. The market interest rate is 10% per year. Suppose Ms. Anderson wants to consume $60,000 this year, so she will need to borrow from next year's income. How much will be available for consumption next year? A) $50,000 B) $30,000 C) $32,000 D) $28,000

D (Borrow $20,000 this year, must pay back $22,000 next year with interest, so $50,000-$22,000)

A nominal rate of 20% per year compounded semi-annually is equivalent to an annual rate of: A) 18% B) 19% C) 20% D) 21%

D (EAR = 1+ (r/n)^n - 1)

Jane has taken a $400,000 mortgage on her house. The mortgage calls for monthly payments of $2,000 over 30 years. What is the value of the annuity factor? A) 15 B) 150 C) 20 D) 200

D (PV = Payment x Annuity Factor)

Using the "Rule of 72" approximately how long will it take to double your initial investment if the interest rate is 8% per year? A) 12 years B) 18 years C) 24 years D) 9 years

D (Rule of 72 = 72/r)

An initial investment of $400 produces a cash flow $432 one year from today. Calculate the return on the project. A) 5% B) 6% C) 7% D) 8%

D (r = (C1-C0)/C0)

Short term US Treasury bills have substantial A) Interest rate risk B) Credit risk C) Liquidity risk D) Default risk E) None of the above

E

Suppose a firm has $100 million in excess cash. In order to meet the goal of increasing value to shareholders it could A) Pay higher dividends to the shareholders B) Invest the funds in projects with positive NPVs C) Buy another firm, if the investment had a positive NPV D) Repurchase shares E) All of the above

E

Which of the following statements is most correct? A) Efficient portfolios provide the lowest returns for a given level of risk B) Efficient portfolios provide the highest returns for a given level of risk C) Efficient portfolios provide the least risk for a given level of return D) Efficient portfolios provide the most risk for a given level of return E) Statements B and C are true F) Statements A and D are true

E

Which one of the following statements is most correct? A) The duration of a zero coupon bond is less than the bond's maturity B) The longer a bond's duration, the smaller its volatility C) If there is no inflation, the nominal rate of interest is greater than the real rate of interest D) All of the above E) None of the above

E

The returns from stocks, exchange rates, bonds, and commodities are often modeled as being from a normal probability distribution. However, when this model is tested it is commonly found that real distributions have "fat tails". What is meant by this?

Extreme values are more likely to occur than would be expected

Which one of the following statements is most correct? The constant dividend growth formula P0 = D1/(r-g) assumes: A) Dividends are growing at a constant rate g forever B) Market capitalization rate r is greater than the growth rate g C) The growth rate, g, can be negative D) Statements A and B are true E) Statements A and C are true F) All of the above

F

Specify one disadvantage of using the accounting rate of return to evaluate capital investment projects

It does not take into account the time value of money

Specify one advantage of using the internal rate of return to evaluate capital investment projects

It is a measure of risk in a project with regards to forecast cash flows

What is the primary financial goal of the corporation?

Maximize wealth of shareholders which is maximizing the share price

What is meant by opportunity cost of capital?

Return an investor would get from a different investment with similar risks