GSBA 548 Corporate Finance J. K. Dietrich MBA.PM Core A
LA A
GSBA 548 Corporate Finance -- J. K. Dietrich – MBA.PM Core A
Midterm Examination – April 10, 2006
A N S W E R S
PART I - MULTIPLE CHOICE - WRITE YOUR NAME AND MARK THE BEST ANSWER ON SCANTRON SHEET. 20 QUESTIONS - 3 POINTS EACH - 60 POINTS TOTAL
Use the following list in answering the following five multiple-choice questions using the indicated letter as you choice of answer on the Scantron sheet for each question:
a) perpetuity formula
b) growing perpetuity formula
c) annuity formula
d) growing annuity formula
e) present value of a sum of individual cash flows
1) The most appropriate formula for a preferred stock. (a)
2) The formula does not have a meaningful answer if the growth rate is larger than the discount rate. (b)
3) The formula used to calculate mortgage or car-loan payments. (c)
4) A good formula to use to calculate the present value of a savings plan over a career where income is growing at a constant rate. (d)
5) A formula that can always be used to estimate the present value of the cash flows from an investment.(e)
6) All value in finance is derived from
a) Increasing amounts of cash in bank accounts.
b) High returns on investment.
c) Current and/or future consumption.
d) Current consumption.
e) Future consumption.
7) A fixed income security in the United State is characterized by the following:
a) Claims on income are fixed by terms in a loan agreement, indenture, or similar contract.
b) Pays coupon interest semiannually.
c) The interest rate is fixed at a given level over the term of the fixed-come contract.
d) Principal is repaid in a lump sum at maturity on fixed incomes.
e) All fixed incomes have an equal claim on the assets of the firm in case of bankruptcy.
8) The book value of equity consists of
a) Additional paid-in capital.
b) Accumulated other comprehensive income or loss.
c) Par value of common stock.
d) Retained earnings.
e) All of the above.
9) Coupon-bearing corporate bonds in the United States are characterized by all of the following except
a) An indenture contract containing covenants and other legal obligations and restrictions to be enforced by a designated trustee in the case of publicly traded bonds.
b) Redemption of principal at maturity.
c) Semi-annual payment of interest at a contract rate.
d) Guaranteed holding-period return if sold at any time before maturity.
e) All of the above.
10) Maximizing shareholder wealth leads to all of the following except
a) An inefficient allocation of productive resources.
b) The rich getting richer.
c) Beneficiaries of pension funds holding shares getting richer.
d) Not-for-profits and foundations holding shares having more funds to finance good works.
e) Firms choosing positive net-present-value projects.
11) It is tricky to assess the impact on present value calculations to changes in assumptions mainly because
a) They are expressed as mathematical formulas.
b) Changes in assumptions produce non-proportional changes in answers (i.e. they are non-linear).
c) They are calculated using assumptions that may prove to be wrong.
d) Rounding errors can be very important in calculations.
e) All of the above.
12) A coupon bearing bond with a 6% coupon, priced at a 250 basis point yield spread over the comparable maturity U.S. Treasury bond currently yielding 3.5%, is trading
a) At a discount.
b) At par.
c) At a premium.
d) Cannot be determined with data provided.
e) Is too risky to trade (is below investment grade).
13) The differential growth rate model of share prices can be used to value the present value of dividends when
a) There is a high-growth period followed by a low-growth or average-growth period for earnings.
b) No dividends are paid in the initial period.
c) The high-growth period has a discount rate smaller than the assumed growth rate.
d) Dividend payout rates change between and early and late discount rate period.
e) Differential growth rate model can handle all of the above conditions.
14) A preferred stock paying a quarterly dividend of $3 discounted at 12% is valued at
a) $300.
b) $100.
c) $36.
d) $30.
e) $25.
15) Which of the following projects’ discounted cash flows has the higher present value?
Project A Project B
Period 1 0 $33
Period 2 0 $34
Period 3 $100 $34
a) The present values are equal.
b) The project with the higher present value depends on discount rate
c) A
d) B
e) Not enough information to determine the answer.
16) Which of the following projects’ discounted cash flows has the higher present value?
Project A Project B
Period 1 0 0
Period 2 0 $75
Period 3 $100 0
a) The present values are equal.
b) The project with the higher present value depends on discount rate
c) A
d) B
e) Not enough information to determine the answer.
17) For purposes of Sarbanes-Oxley Act, a financial expert
a) Must be named as CEO of the corporation.
b) Is defined as a business-school professor.
c) Must chair the audit committee of a publicly traded corporation.
d) Should not be allowed to talk to the auditors of the firm.
e) None of the above.
18) A callable bond protects the investor from
a) Increases in market interest rates.
b) Decreased in market interest rates.
c) Adverse changes and is a benefit to bondholders reflected in the bond valuation.
d) Attempts by the issuer to exercise flexibility in controlling its costs of debt.
e) None of the above.
19) Depreciation is important in estimating incremental cash flows because it is
a) Measuring a real cost of doing business involving fixed assets.
b) A legitimate allowance for wear and tear on capital equipment.
c) Factor in the tax liability of firms.
d) Required by GAAP accounting rules for long-term investments.
e) All of the above.
20) The goal of management and the board of directors is to
a) Maximize share value.
b) Maximize the ability of investors to consume.
c) Increase market value added.
d) Maximize economic value added.
e) All of the above are true and equivalent.
GSBA 548 Corporate Finance -- J. K. Dietrich – MBA.PM Core A
Midterm Examination – April 10, 2006
Name______Student No.______Core______
PART II - LONGER ANSWERS - WRITE ANSWERS IN SPACE PROVIDED. ANSWER BOTH QUESTIONS - 20 POINTS EACH - 40 POINTS TOTAL.
1) In 2004, the median income of families with head of household between 55 and 64 years (final working years) was $54,400 and the family had accumulated median financial assets (total) of $332,000. All data are from the 2004 Federal Reserve Board Survey of Consumer Finances. (Show all calculations and describe any intermediate steps using calculators.)
[7 points]
a) Assume that the average investor can expect to earn 6% on assets and that a 65-year old retiree has the median financial assets and a 20-year life expectancy. How much could the retiree draw at the end of each year (assuming no remaining assets) for 20 years?
[7 points]
b) Assuming the retiree would like $100,000 per year rather than the answer to a) above, how much would he have to have then end of age 64 (beginning of age 65) to finance the higher annual payments?
He would need approximately $815,000 more than he has.
[6 points]
c) To accumulate the additional sum the retiree wants as discussed in b) above, how much more would the retiree have had to have saved each year of his working life from age 25 to 64 (40 years)?
He would have to save $5,266 a year more from
2)
A firm is considering producing a product with a machine costing $100,000 to be depreciated over 10 years, although the plan is to cease production of the product after four years and sell the machine for a price expected to be equal to its original cost. Sales, operating costs, and required inventories associated with the planned product are provided below. The firm thinks an appropriate discount rate for this project is 14% and pays taxes at a 40% rate. (Show all calculations in the space provided.)
[4 points]
a) What are the cash flows from operations from the machine (show all details in order to get partial credit in case of errors).
[4 points]
b) What are the cash flows from investments in working capital and from the required machine investment? Include the details of the after-tax cash flows from sale of the machine.
where the after-tax sale value of the machine is $100,000-.4*$40,000=$84,000
[4 points]
c) What are the total cash flows from the production of the product over four years?
[4 points]
d) What is net present value of this business strategy? What do you recommend?
Invest in the machine since the NPV is positive.
[4 points]
e) If the sale price of the machine and value of inventories in year four are subject to substantial changes (i.e. could be substantially higher or lower, would this influence the decision to produce the product?The sale price and liquidation value of the machine and inventory are a significant amount relative to the net present value and changes could influence the decision.
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