FIN350 Practice Problems for the Final First Name______Last Name ______
The following is a final exam from the past, with some step by step explanations added.
The solution is at the bottom of page 15. I will review this handout in class.
To toggle between END and BEGIN model for the Texas calculator, press 2nd, BGN, 2nd, ENTER
EVA = After-tax __ After-tax
Operating Income Capital costs
= NOPAT – After-tax Cost of Capital
MVA = Market value __Equity capital
of equity supplied (book value)
Value of a Firm= Present Value of Future FCFs for all Investors
FCFs for all investors = OCF-Gross Investment in Operating Capital
= (OCF-Dep)-(Gross Investment in Operating Capital-Dep)
= NOPAT-Net Investment in Operating Capital
= NOPAT- Change in Total Operating Capital
Value of Equity= Present Value of Future FCFs for Common Stock Investors
FCFs for Common Stock Investors = NCF-Gross Investment in Operating Capital
= (NCF-Dep)-(Gross Investment in Operating Capital-Dep)
= NI-Net Investment in Operating Capital
= NI- Change in Total Operating Capital
Net Operating Working Capital (NOWC)
= Current Assets-Non-interest Bearing Current Liabilities
Total Operating Capital = Net Operating Working Capital (NOWC) + Net Fixed Assets
= Current Assets-Non-interest Bearing Current Liabilities
+Net Fixed Assets
Change in Total Operating Capital = Total Operating Capital in Year t+1
- Total Operating Capital in Year t
NOPAT = EBIT*(1-Tax Rate)=EBIT-Tax Expense
Current ratio = Current assets / Current liabilities
FA turnover= Sales / Net fixed assets
TA turnover= Sales / Total assets
Inv. turnover = Sales / Inventories
Days Sales Outstanding= Receivables / Average sales per day
Debt ratio (D/A)= Total debt / Total assets
Profit margin = Net income / Sales
BEP = EBIT / Total assets
ROA= Net income / Total assets
ROE= Net income / Total common equity
P/E= Price / Earnings per share
M/B= Mkt price per share / Book value per share
ROE = (NI/Sales) x (Sales/TA) x (TA/Equity)
PV = FVn / ( 1 + i )n
iPER = iNOM / m
iNOM=APR=iPER*m
EAR%=EFF%= ( 1 + iNOM / m )m - 1
WACC = wdrd(1-T) + wprp + wcrs
rp = D / P
rs = D1 / P0 + g
CAPM: rs = rRF + (rM – rRF) β
Rd (before tax): YTM
Firm value=FCF1/(WACC-g) if free cash flows grow at a constant rate
For bond: YTM = Current yield + Capital gains yield, Current yield=annual coupon/bond price
For stocks: rs = D1 / P0 (dividend yield) + g (capital gain yield)
1.A sole proprietor:
a.earns income which is subject to double taxation.
b.incurs significant legal costs to form his or her business entity.
c. assumes personal liability for all of the debts of the business.
d.creates a business entity with an unlimited life.
e.can generally raise unlimited equity to finance his or her business activities.
2.An agency problem frequently exists in situations where there is a separation of:
a.treasury and controller functions.
b.working capital and capital structure management.
c. company ownership and company management.
d.marketing and financial management.
e.investment and working capital management.
3.The present value of $10,000 to be received in 10 years will ______if the discount rate is increased.
a.remain constant
b. decrease
c.increase
d.either remain constant or increase
e.either remain constant or decrease
Present value and discount rate go opposite to each other.
4. You hope to buy a car 5 years from now, and you plan to save $4,000 per year, beginning immediately. You will make 5 deposits in an account that pays 8% interest. Under these assumptions, how much will you have 5 years from today?
a.$23,952.54
b.$35,851.92
c.$30,846.58
d.$26,698.30
e.$25,343.72
Under BGN mode: 5 N, 4000 PMT, 8 I/Y, 0 PV, CPT FV
Do not forget to return to END model after the above question.
5. What’s the present value of $4,000 discounted back 3 years if the appropriate interest rate is 12%, compounded quarterly?
a.$2,982.90
b.$3,149.02
c.$2,805.52
d.$2,023.74
e.$2,847.12
quarterly interest =3%
=4000/(1+0.03)^12, (or: 4000 FV, 12 N, 3 I/Y, 0 PMT, CPT PV)
6. You are going to withdraw $5,000 at the end of each year for the next four years from an account that pays interest at a rate of 9% compounded annually. The account balance will reduce to zero when the last withdrawal is made. How much money will be in the account immediately after the second withdrawal is made?
a.$ 9185.50
b.$ 8795.56
c.$ 5,000.00
d.$ 9174.31
e.$10,000.00
After the second withdrawal, there are 2 more withdrawals for the remaining money in account. So the balance should equal the present value of an annuity with two payments:
5000, PMT, 2 N, 9 I/Y, 0 FV, CPT PV
7.Which of the following bank accounts has the highest effective annual return?
a.An account that pays 5.2% nominal interest with monthly compounding.
b.An account that pays 4% nominal interest with quarterly compounding.
c.An account that pays 4.5% nominal interest with daily compounding.
d.An account that pays 5.4% nominal interest with annual compounding.
e.An account that pays 4.5% nominal interest with monthly compounding.
For a: EAR=(1+iPer)^m-1=(1+0.052/12)^12-1=0.05327
Can also use the “2nd”, “ICONV” key in calculator.
b,c,d,e are calculated similarly.
8. The balance sheet of Downtown, Inc., has the following balances:
What is the amount of the total operating capital at year end?
a. $1335,400
b.$904,300
c.$926,600
d. $433,900
e.$345,400
Total Operating Capital = Net Operating Working Capital (NOWC) + Net Fixed Assets
= Current Assets-Non-interest Bearing Current Liabilities
+Net Fixed Assets
At yearend: =46900+132400+254600-408800+901500
Note: Chapter 3 will not be covered in this year’s final.
9. Based on the following term structure, what is the price of a treasury bond with 6% annual coupon and face value of $1000?
Year Spot rate
1 4%
2 5%
3 5%
4 6%
a.$1000
b.$1036
c.$1024
d.$998
e.$1004
Annual coupon=$1000*6%=$60
10. Find the current yield and the capital gains yield for a 10-year, 10% annual coupon bond that sells for $950, and has a face value of $1,000.
A)10%, 0.67%
B)11.11%, 0.64%
C)10.53,0.31%
D)9.5%, 0.76%
E)9.5%, 1.34%
current yield =1000*10%/950=10.53%, YTM= 10.84 (10 N, 100 PMT, - 950 PV, 1000 FV, CPT I/Y)
capital gains yield=YTM- current yield=10.84-10.53=0.31%
11. / If investors are uncertain that they will be able to sell a corporate bond quickly, the investors will demand a higher yield in the form of a(n) ______.A) / inflation premium
B) / liquidity risk premium
C) / interest rate risk premium
D) / default risk premium
12. Miller Brothers needs to raise $12 million for an expansion project. They propose raising this money by selling zero coupon bonds with a par value of $1,000 that mature in 15 years. The market yield on similar bonds is 7.4 percent. How many bonds must Miller Brothers sell to raise the money they need?
A.12,000 bonds
B.16,216 bonds
C.18,009 bonds
D.28,919 bonds
E.35,015 bonds
Bond price: 1000 FV, 15 N, 7.4 I/Y, 0 PMT, CPT PV, PV=$342.72
Need to raise $12,000,000, so need to sell 12,000,000/342.72=35014 bonds
13. An 8 percent $1,000 bond matures in 13 years, pays interest semi-annually, and has a yield to maturity of 9.45 percent (nominal rate). What is the current market price of the bond?
A.$601.58
B.$647.76
C.$892.76
D.$909.09
E.$930.75
Similar to lecture slides example. There are 26 coupon payments. Each coupon=$1000*8%/2=$40, interest rate in half a year is 9.45/2=4.725
40 PMT, 26 N, 4.725 I/Y, 1000, FV, CPT PV
14. You determine that XYZ common stock will return 8 percent. XYZ has a beta of 0. Risk free rate is 5%. The market expected return is 10 percent. Which of the following is most likely to happen:
A)You and other investors will sell XYZ stock and its return will fall.
B)You and other investors will buy up XYZ stock and its price will rise.
C)You and other investors will buy up XYZ stock and its return will rise.
D)You and other investors will sell XYZ stock and its price will fall.
(Similar to in class work) Expected return=8%> required return=5+0*(10-5)=5%, so undervalued, buy and price will increase.
15.Which of the following statements best describes what would be expected to happen as you randomly select stocks and add them to your portfolio?
a.Adding more such stocks will reduce the portfolio’s unsystematic, or diversifiable, risk.
b.Adding more such stocks will reduce the portfolio’s beta.
c.Adding more such stocks will increase the portfolio’s expected return.
d.Adding more such stocks will reduce the portfolio’s market risk.
e.Adding more such stocks will have no effect on the portfolio’s risk.
(From in class work)
16. Over the past 75 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of their annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following lists correctly ranks investments from highest to lowest returns and risk (thus, the highest risk security should be shown first, the lowest risk securities shown last)?
a.Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills.
b.Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.
c.Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds.
d.U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks.
(See graph in chapter 8 lecture slides)
17. A stock has a beta of 1.12 and a required return of 11.6 percent. The risk-free rate is 4.2 percent. What is the market risk premium?
A.5.45 percent
B.6.61 percent
C.7.40 percent
D.8.28 percent
E.10.32 percent
According to CAPM, 11.6=4.2+1.12*Market risk premium,
11.6-4.2=1.12*Market risk premium
(11.6-4.1)/1.12=Market risk premium
18. Which of the following is/are true of the Capital Asset Pricing Model?
A)Its graph is referred to as the Security Market Line
B)It usually uses the T-bill rate as the risk-free rate
C)It uses beta as a measure of market risk
D)all of the above
(From quiz)
19.Currently, you own a portfolio comprised of the following. What is the portfolio beta?
a.1.225
b.1.133
c.1.000
d. 0.980
2000/(2000+2000+4000)=0.25, 2000/(2000+2000+4000)=0.25, 4000/(2000+2000+4000)=0.5
The weights are 25%, 25%, and 50%, respectively
0.25*0.9+0.25*1+0.5*1.5=1.225
20.The beta of a Treasury bill is _____ and the beta of the overall market index is____:
a.risk free rate; 1.
b.1; 0.
c.1; 1.
d.0; 1.
e.infinite; 1.
(From in class work)
21. If a stock's beta is -1 during a period when the market portfolio was down by 10%, then, in advance, we could expect the return on this individual stock to:
A)go down by 10% .
B)go up by 10%.
C)have no change.
D)go in no direction
(Negative beta stock goes opposite to market movement.)
22.Womack Toy Company’s stock is currently trading at $10 per share. The stock’s dividend is projected to increase at a constant rate of 7 percent per year. What is the expected price of the stock 4 years from today?
a.$10.00
b.$13.11
c.$10.70
d.$12.77
e.$10.63
The price will appreciate at the dividend growth rate, so after 4 years: 10*1.07^4=13.11
23.An analyst is trying to estimate the intrinsic value of the stock of Harkleroad Technologies. The analyst estimates that Harkleroad’s free cash flow during the next year will be $25 million. The analyst also estimates that the company’s free cash flow will maintain at this level forever and the company’s WACC is 10 percent. Harkleroad has $200 million of debt , and 30 million outstanding shares of common stock. What is the estimated per-share price of Harkleroad Technologies’ common stock?
a.$21.11
b.$18.37
c.$ 1.67
d. $27.78
e.$ 5.24
Using the corporate model:
Total firm value: FCF/(WACC-g)=25/(0.1-0)=$250 mm
Debt is worth $200 million, (250-200)/30=$1.67
24.Lucky K Enterprises is growing by leaps and bounds. As a result, the company expects to increase their dividend to $.80, $1.00, and $2.20 over the next three years, respectively. After that, the dividend is projected to increase by 5 percent annually. The last annual dividend the firm paid was $.25 a share. What is the current value of this stock if the required return is 18 percent?
a.$12.43
b.$13.18
c. $16.58
d.$14.05
e.$13.55
Price at year 3 can be based on next year (year 4) dividend, so
P3=2.20*1.05/(0.18-0.05)=17.769
Price at time zero=present value of ( next 3 year dividends and price at year 3)
P0=0.80/(1.18) +1.00/(1.18)^2 +2.20/(1.18)^3 +P3/1.18^3
Similar to in example on lecture slide 9-17 and in-class-work No. 3 question 10.
25. If the financial markets are strong form efficient, then:
A.only the most talented analysts can determine the true value of a security.
B.only company insiders have a marketplace advantage.
C.technical analysis provides the best tool to use to gain a marketplace advantage.
D.no one person has an advantage in the marketplace.
E.the only true advantage in the marketplace is having insider information.
If market is efficient in strong form, even insider information will not help one to beat market.
26.
You have discovered from looking at charts of past stock prices that if you buy just after a stock price has increased for five consecutive days, you make money every time! This is clearly a violation of ______market efficiency. For another example, suppose that firms with high earnings earn abnormally high returns for several months after the earnings announcement. This is clearly a violation of ______market efficiency.A) / strong form; semi-strong form
B) / semi-weak form; weak form
C) / semi-strong form; strong form
D) / weak form; semi-strong form
E) / strong form; weak form
27. Given the stock trading information shown in the graph below, what is the ratio of stock price over twelve trailing month EPS (PE ratio) ? What is the highest stock price during the past year?
A)2.16%;47.25
B)17.25;47.25
C)2.655;46.72
D)1.4608;45.83
E)45.83;46.72
The ratio of stock price over twelve trailing month EPS is the P/E ratio=17.25
28. A stock now sells for $100. The stock has an expected return of 20%. It is expected to pay no dividend next year and $5 dividends two years from now. What is the expected stock price one year from now?
A)$120.00
B)$186.00
C)$115.00
D)$110.00
E) None of the above
Current price of $100 is equal to the present value of (year 1 dividend and year 1 stock price)
So:
P0=(D1+P1)/(1+r)
So: 100=(0+P1)/(1+0.2) > 100=P1/1.2 >P1=1.20*100=120
29.Which of the following should NOT be considered when calculating a firm's WACC?
a.YTM on a firm's bonds.
b.Cost of preferred stock.
c.Cost of common stock.
d.Cost of accounts payable.
e.Corporate tax rate.
Cost of payable is not included in the formula of WACC.
30.A common stock issue is currently selling for $31 per share. You expect the next dividend to be $1.40 per share. If the firm has a dividend growth rate of 5% that is expected to remain constant indefinitely, what is the firm’s cost of equity?
a. 9.5%
b.11.3%
c.13.8%
d.14.2%
e.15.1%
=D1/P+g=1.40/31+0.05=0.095
31.A company estimates that a below-average risk project has a discount rate of 9 percent, an average-risk project has a discount rate of 10 percent, and an above-average risk project has a discount rate of 11 percent. Which of the following independent projects should the company accept?
a.Project A has average risk and a return of 9.5 percent.
b.Project C has above-average risk and a return of 10.5 percent.
c.Project B has below-average risk and a return of 8.5 percent.
d.Project A and C should be accepted.
e.None of the projects above should be accepted.
Project A, 9.5<10 (expected return<required return), reject
Project B, 8.5<9, reject
Project C, 10.5<11 , reject
Reject all projects.
- Billick Brothers is estimating its WACC. The company has collected the following information:
- Its capital structure consists of 40 percent debt and 60 percent common equity.
- The company has 20-year bonds outstanding with a 9 percent annual coupon that are trading at par ($1000).
- The company’s tax rate is 40 percent.
- The risk-free rate is 5.5 percent.
- The market risk premium is 5 percent.
- The stock’s beta is 1.4.
What is the company’s WACC?
a. 9.71%
b. 9.66%
c. 8.31%
d.11.18%
e.11.10%
rd=YTM=9%, (When price is at par, YTM=coupon rate=9%),
Using CAPM, rs=rf+beta*market risk premium, so: re=5.5+1.4*5=12.5%
WACC=40%*0.09*(1-0.4)+60%*0.125=0.0966
33.Braun Industries is considering an investment project that has the following cash flows:
YearCash Flow
0-$1,000
1400
2300
3500
4400
The company’s WACC is 10%. What is the project’s payback, IRR, and NPV?
a.Payback = 2.4, IRR = 10.00%, NPV = $600.
b.Payback = 2.4, IRR = 21.22%, NPV = $260.
c.Payback = 2.6, IRR = 21.22%, NPV = $300.
d.Payback = 2.6, IRR = 21.22%, NPV = $260.
e.Payback = 2.6, IRR = 24.12%, NPV = $300.
Payback = 2+(1000-400-300)/500=2.6
NPV= -1000+400/1.1+300/1.1^2+500/1.1^3+400/1.1^4=260
To clear historical data:
CF, 2nd ,CE/C
To get PV:
CF , 1000 , “+/- ”, Enter , ↓,400 , Enter, ↓,↓,
300, Enter, ↓, ↓, 500, Enter, ↓, ↓, 400, Enter, ↓, ↓, NPV,10,Enter, ↓,CPT
“NPV=260.43300305”
IRR, CPT
34. A project has the following cash flows:
Project
YearCash Flow
0-$3,000
1 1,000
2 1,000
3 1,000
4 1,000
If its WACC is 10%, what is the project’s discounted payback period?
a.3.00 years
b.3.30 years
c.3.52 years
d.3.75 years
e.4.75 years
Discounted cashflows:
0: -$3000
1: 1000/1.1=909.09
2: 1000/1.1^2=826.45
3: 1000/1.1^3=751.31
4: 1000/1.1^4=683.01
DISCOUNTED PAYBACK=3+(3000-909.09-826.45-751.31)/683.01=3.75
35. In order for a manager to correctly decide to take an investment, the NPV of the investment should be:
A)positive.
B)larger than the cost of capital.
C) less than the cost of capital
D) same as the cost of capital
E) none of the above
Take a project if NPV is positive.
36. You are considering twoindependent investment projects. If you require a 15% return, which investment should you choose? Assume you have plenty of cash to make the investments.
Year / ACash Flow / B
Cash Flow
0 / –$100,000 / –$125,000
1 / 20,000 / 75,000
2 / 40,000 / 45,000
3 / 80,000 / 40,000
A)Neither A nor B.
B)Project B, because it has a higher NPV.
C)Project A, because it has a smaller initial investment.
D)Project A, because it has the higher internal rate of return.
E)Project A and project B.
NPV of project A= -100+20/1.15+40/1.15^2+80/1.15^3=0.238>0
NPV of project B= -125+75/1.15+45/1.15^2+40/1.15^3=0.544>0
So take both projects.
37. A company estimates that its weighted average cost of capital (WACC) is 10 percent. Which of the following independent projects should the company accept? (The projects have the same risk as the firm’s existing assets. Also assume these projects are normal projects. )
a.Project A requires an up-front expenditure of $3,000,000 and has a net present value of - $200.
b.Project B has an internal rate of return of 9.5 percent.
c.Project C requires an up-front expenditure of $5,000,000 and generates a positive internal rate of return of 9.7 percent.
d.Project D has an internal rate of return of 9 % and generates a net present value of
- $6, 000.
e.None of the projects above should be accepted.
NPV of project A and project D are <0
Project B andproject C: IRR<WACC, IRR is something like “expected return”, WACC is something like “required return”, so not good investment deals.
All rejected.
38.ABC Plastics currently produces plastic plates. The company is considering expanding their production to include plastic silverware. Payment for which of the following are relevant to this project?
I. the plastic used to make the silverware
II. the labor involved in making the silverware
III. the mortgage on the existing building used for production
IV. the plastic needed to produce the additional plates they expect to sell if they expand their product offerings
a.I and II only
b.III and IV only
c. I, II, and IV only
d.I, II, and III only
e.I, II, III, and IV
I,II, and IV are relevant cost; will incur III regard less of whether to expand the production, so III is irrelevant.
39.The firm of Mitchell and Mitchell owns a small truck. The truck has a market value of $9,500 today. New, it cost $24,900. Last week, the company spent $3,500 repairing the engine and replacing the brake pads. The company still owes $1,200 in truck payments. If the company decides to use this vehicle for a new project, the cost assigned to that project for this truck should be:
a.$8,300.
b. $9,500.
c.$11,800.
d.$13,000.
e.$14,200.