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FIN 3290\Final Exam\Review Questions

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Chapters 1 and 2
1.

Decisions made by financial managers should primarily focus on increasing which


one of the following?
a. size of the firm
b. growth rate of the firm
c. gross profit per unit produced
d. market value per share of outstanding stock
e. total sales
Chapters 5 and 6

2.

Based on your income and savings you are able to pay $250 a month for 5 years on
a car loan. If the interest rate is 6.4 percent, how much can you afford to borrow to
buy a car?
a.
b.
c.
d.
e.

$12,265.17
$12,408.67
$12,654.54
$12,807.81
$13,228.28

Solution:
250
6.4/12
PMT
I/Y

3.

5*12
N

0
FV

NPV
12,807.81

You are buying your house for $280,000, and are paying $50,000 as a down payment.
You have arranged to finance the remaining $230,000 30-year mortgage with a 6.8%
nominal interest rate and monthly payments. What are the equal monthly payments
you must make if payments are made at the beginning of each period? (round answer
to nearest dollar)
a.
b.
c.
d.
e.

$1,349
$1,110
$1,499
$1,513
$1,257

Solution:
360
N

0.5667 230,000
I/Y
PV

0
FV

PMT

-$1,499.43
4.

Which of the following investments will have the highest future value at the end of 10
years? Assume that the effective annual rate for all investments is the same.
a. pays $250 at the beginning of every year for the next 10 years (a total of 10
payments).
b. pays $125 at the end of every 6-month period for the next 10 years (a total of 20
payments).
c. pays $125 at the beginning of every 6-month period for the next 10 years (a total of
20 payments).
d. pays $2,500 at the end of 10 years (just one payment).
e. pays $250 at the end of every year for the next 10 years (a total of 10 payments).

5.

You are the beneficiary of a life insurance policy. The insurance company informs
you that you have two options for receiving the insurance proceeds. You can
receive a lump sum of $50,000 today or receive payments of $641 a month for 10
years. You can earn 6.5% on your money. Which option should you take and why?
(round answer to 2 decimal places)
a. You should accept the payments because they are worth $56,451.91 to you
today.
b. You should accept the $50,000 because the payments are only worth $47,141.17
to you today.
c. You should accept the payments because they are worth $54,311.12 to you
today.
d. You should accept the $50,000 because the payments are only worth $44,808.17
to you today.
e. You should accept the payments because they are worth $53,417.68 to you
today.

Solution:
120
N

0.5417
I/Y

641
PMT

0
FV

PV
56,451.91

6.

You won an award and get to select one of two payout offers. The first offer
includes annual gifts of $9,000, $12,000, and $15,000 at the end of each of the next
three years, respectively. The other offer is the payment of one lump sum amount
today. You are trying to decide which offer to accept given the fact that your
discount rate is 8 percent. What is the minimum amount that you will accept today
if you are to select the lump sum offer?
a.
b.
c.
d.
e.

$29,407
$30,691
$28,216
$31,137
$30,439

Solution:
CF0 = 0
C01 = 9,000
F01 = 1
C02 = 12,000
F02 = 1
C03 = 15,000
F03 = 1
I = 7, NPV = CPT = 31,136.95

7.

Wayne.Inc would like to buy some additional land and build a new assisted living
center. The anticipated total cost is $28 million. The CEO of the firm is quite
conservative and will only do this when the company has sufficient funds to pay
cash for the entire construction project. Management has decided to save $1.7
million a quarter for this purpose. The firm earns 6 percent compounded quarterly
on the funds it saves. How many years does the company have to wait before
expanding its operations?
a.
b.
c.
d.
e.

3.21 years
3.71 years
3.94 years
4.09 years
4.22 years

Solution:
0
PV

1.5
I/Y

1.7
PMT

-28
FV

# of years = 14.8129/4 = 3.71

N
14.8129

Chapter 7
8.

Fifteen years ago you purchased 20-year Wesley-Townsend bonds at a quoted price
of 100.54 per bond have an 7.5 percent coupon and pay interest annually. Today
you can sell the bond for $1,000. What is the realized yield to maturity?
a.
b.
c.
d.
e.

7.16 percent
7.42 percent
7.97 percent
7.82 percent
8.24 percent

Solution:
15
N

-1005.4
PV

75
PMT

1,000
FV
I/Y
7.42

9. The Wayne has a 8 percent coupon bond outstanding that matures in 13.5 years. The
bond pays interest semi-annually. What is the market price per bond if the face value
is $1,000 and the yield to maturity is 15.54 percent?
a.
b.
c.
d.
e.

$631.66
$455.27
$754.92
$650.40
$579.14
Solution:
27
N

1000
FV

40
PMT

7.77
I/Y

PV
-$579.14

10. Which of the following statements is True?


a. A real rate is a nominal rate which has been adjusted for interest rate risk.
b. A real rate is a nominal rate which has been adjusted for inflation.
c. The nominal interest rate is the stated interest rate of a given bond or loan.
d. The effective interest rate is the true rate of interest earned.
e. A real rate is a nominal rate which has been adjusted for changes in the market
rate of interest.

Chapter 8
11.

The common stock of OSU corp. pays a constant annual dividend. Thus, the market
price of OSU corp.s stock will:
a.
b.
c.
d.
e.

12.

also remain constant.


increase over time.
decrease over time.
increase when the market rate of return decreases.
decrease when the market rate of return decreases.

Assume that you plan to buy a share of XYZ stock today and to hold it for 2 years.
Your expectations are that you will not receive a dividend at the end of Year 1, but
you will receive a dividend of $9.25 at the end of Year 2. In addition, you expect to
sell the stock for $150 at the end of Year 2. If your expected rate of return is 15
percent, how much should you be willing to pay for this stock today? (round answer
to 2 decimal places)
a.
b.
c.
d.
e.

$164.19
$ 75.29
$118.35
$107.53
$131.74

Solution:
CF0 = 0
C01 = 0
F01 = 1
C02 = 9.25
F02 = 1
I = 15, NPV = CPT = 118.35

13.

Elegante Homes stock just paid an annual dividend of $4.3 a share and is expected
to increase that amount by 5.4 percent per year. If you are planning to buy 1,000
shares of this stock now, how much should you expect to pay per share if the beta
of the stock is 0.75, the market risk premium is 8%, and the risk-free rate is 2.9% at
the time of your purchase? (round answer to 2 decimal places)
a.
b.
c.
d.
e.

$124.00
$125.32
$129.49
$134.25
$163.83

Solution:
Er = 2.90 + 0.75*8 = 8.9%
P = 4.3*(1.054)/(0.089 0.054) = $129.49
Answer questions 14 and 15 using the following problem

Wayne announced today that it will begin paying annual dividends. The first
dividend will be paid next year in the amount of $.20 a share. The following
dividends will be $.30, $.45, and $.60 a share annually for the following three years,
respectively. After that, dividends are projected to increase by 4.4 percent per year.
14.

How much are you willing to pay to buy one share of this stock at time 4 if your
desired rate of return is 13 percent? (round answer to 2 decimal places)
a.
c.
c.
d.
e.

$6.98
$7.03
$5.83
$7.28
$7.37

Solution:
Div5 = 0.6*1.044 = $0.6264
P5 = 0.6264/(0.13 0.044) = $7.28
15.

Assume that the answer to the above question is $7.03. How much are you willing to
pay to buy one share of Slim Waist today if your desired rate of return is 12
percent? (round answer to 2 decimal places)
a.
b.
c.
d.
e.

$5.40
$5.92
$5.34
$6.12
$5.62

Solution:
P0 =

0.20
0.30
0.45
0.60 7.03

= $5.40

2
3
1.13 1.13 1.13
1.134

Chapter 9
16.

The Net After-Tax Cash Flows were 87,000, 99,000, 69,000, 61,000, and 92,800.
What is the MIRR if the cost of capital and the reinvestment rate is 10% per year?
a.
b.
c.
d.
e.

13.57 percent
12.57 percent
14.84 percent
15.37 percent
12.81 percent

Solution:
CF0 = 87,000
CF1 = 87,000
FO1 = 1
CF2 = 69,000
FO2 = 1
CF3 = 61,000
FO3 = 1
CF4 = 92,800
FO4 = 1
I = 10, RI = 10, M IRR = 12,81%

17.

You are considering two independent projects with the following cash flows. The
required return for both projects is 15 percent. Given this information, which one of
the following statements is correct?
Year
0
1
2
3
a.
b.
c.
d.
e.

Project A
-$545,000
280,000
350,000
180,000

Project B
-$200,000
85,000
80,000
75,000

You should reject project A because it has the lower NPV and accept project B.
You should accept project B because it has the higher IRR and reject project A.
You should accept project B because it has the higher NPV and reject project A.
You should accept both projects based on both the NPV and IRR rules.
You should accept project A since it has positive NPV and reject project B
because it has negative NPV.

Solution:
Project A:
CF0 = -545,000
CF1 = 280,000
CF2 = 350,000

FO1 = 1
FO2 = 1

CF3 = 180,000
FO3 = 1
I = 10, NPV = 134,038.32, IRR = 24.37%
Project B:
CF0 = -200,000
CF1 = 85,000
FO1 = 1
CF2 = 80,000
FO2 = 1
CF3 = 75,000
FO3 = 1
I = 10, NPV = -262.96, IRR = 9.92%
18.

Creighton, Inc., has invested $2,250,000 on equipment. The firm uses payback
period criteria of not accepting any project that takes more than four years to
recover costs. The company anticipates cash flows of $420,000, $510,000,
$561,000, $764,000, $816,500, and $825,000 over the next six years. What is the
payback period, and does this investment meet the firm's payback criteria?
a.
b.
c.
d.
e.

4.13 years, no.


4.24 years, yes.
3.54 years, no
3.87 years, no.
3.99 years, yes.

Solution:
PB = 3.99 < 4, Accept

19.

The Seattle Corporation has been presented with an investment opportunity that will
yield end-of-year cash flows of $25,000 per year in Years 1 through 5, $40,000 per
year in Years 6 through 9, and $45,000 in Year 10. This investment will cost the firm
$170,000 today, and the firms cost of capital is 10 percent. What is the NPV for this
investment? (round to the nearest $)
a.
b.
c.
d.
e.

$41,138
$112,284
$32,140
$20,849
$200,012

Solution:
CF0 = -170,000
CF1 = 25,000
CF2 = 40,000
CF3 = 45,000
I = 10, NPV = 20,849

FO1 = 5
FO2 = 4
FO3 = 1

Chapter 10
20.

Wayne, Inc. uses machines to manufacture windshields for automobiles. One


machine costs $150,000 and lasts about 6 years before it needs replaced. The
operating cost per machine is $8,500 a year. What is the equivalent annual cost of a
machine if the required rate of return is 12 percent? (Round your answer to whole
dollar)
a.
b.
c.
d.
e.

$30,500
$38,400
$35,600
$44,984
$45,212

Solution:
CF0 = $150,000
C01 = $8,500
F01 = 6
I = 12, NPV = 184,946.96
6
N

184,946.96
PV

0
FV

12
I/Y

PMT
-$44,983.86

Answer questions 21 and 22 using the following problem


A project will produce operating cash flows of $50,000 a year for four years. At the
time of the investment, current assets will increase by $15,000 and current
liabilities will decrease by $8,000. The project requires the purchase of equipment
at an initial cost of $220,000. The equipment will be depreciated straight-line to a
zero book value over the life of the project. The equipment will be salvaged at the
end of the project creating a $35,000 after-tax cash flow. At the end of the project,
net working capital will return to its normal level.
21.

What is the initial investment at time 0?


a.
b.
c.
d.
e.

$204,000
$227,000
$195,000
$228,000
$230,000

Solution:
CF0 = $220,000 + 15,000 8,000 = 227,000
10

22.

Assume that the increase in NWC is $25,000 and hence the initial investment is
$245,000. What is the net present value (NPV) of this project given a required
return of 10 percent? (round answer to 2 decimal places)
a.
b.
c.
d.
e.

-$18,693.50
-$45,525.92
-$43,983.14
$2,839.27
-$35,259.05

Solution:
CF0 = -$245,000
C01 = $50,000
F01 = 3
CF4 = $50,000 + 25,000 + 35,000 = 110,000
I = 10, NPV = -$45,525.92
23.

F02 = 1

You own some equipment which you purchased four years ago at a cost of
$223,000. The equipment is 5-year property for MACRS. You are considering
selling the equipment today for $85,000. Which one of the following statements is
correct if your tax rate is 30 percent?
MACRS 5-year Property
Year
Rate
1
21.00%
2
29.00%
3
19.50%
4
11.20 %
5
11.52%
6
5.76%
a.
b.
c.
d.
e.

The tax due on the sale is $26,425.00.


The after-tax salvage value (ATSV) is $62,000.68.
The taxable amount on the sale is $37,324.80.
The book value to date is $43,039.
The accumulated depreciation to date is $37,324.80.

Solution:
Book Value = 223,000*(1 - 0.21 - 0.29 - 0.195 0.112) = $43,039
Profit on sale = 85,000 43,039= $41,961
Tax = 41,961*0.3 = 12,588.3
ATSV = 85,000 12588.3 = 72,411.7

11

24.

Ben's Ice Cream Parlor is considering a project which will produce sales of $12,000
and increase cash expenses by $5,500. If the project is implemented, taxes will
increase by $1,500. The additional depreciation expense will be $1,200. An initial
cash outlay of $2,500 is required for net working capital. What is the amount of the
annual operating cash flow?
a.
b.
c.
d.
e.

$1,600
$2,800
$2,000
$3,300
$300

Solution:
OCF = $12,000 - $5,500 - $1,500 = $5,000
Chapter 7
25.

Wayne Stock has exhibited a standard deviation in stock returns of 65 percent,


whereas Green Lantern Stock has exhibited a standard deviation of 75 percent. The
correlation coefficient between the stock returns is 0.1. What is the standard
deviation of a portfolio composed of 60 percent Aquaman and 40 percent Green
Lantern?
a.
b.
c.
d.
e.

50.25 percent
51.53 percent
52.12 percent
61.00 percent.
73.00 percent

Solution:
VarianceP = (wA*A)2 + (wA*A)2 + 2*wA*wB*A,B *A*B
= (0.6*65)2 + (0.4*75)2 + 2*0.6*0.4*0.1*65*75 = 2,655
P =

26.

2 = 51.53 percent

Ronald's Fast Food just paid their annual dividend of $1.05 a share. The stock has a
market price of $26 and a beta of 1.09. The return on the U.S. Treasury bill (riskfree rate) is 5 percent and the market risk premium is 6.5 percent. What is the cost
of equity?
a.
b.
c.
d.

10.00 percent
9.23 percent
12.09 percent
11.03 percent

12

e. 11.84 percent
Solution:
ER = RF + *(ERM RF) = 5 + 1.09*6.5 = 12.09%
27.

You recently purchased a stock that is expected to earn 12 percent in a booming


economy, 8 percent in a normal economy and lose 5 percent in a recessionary
economy. There is a 15 percent probability of a boom, a 75 percent chance of a
normal economy, and a 10 percent chance of a recession. What is your expected
rate of return on this stock?
a.
b.
c.
d.
e.

5.00 percent
6.45 percent
7.30 percent
7.65 percent
8.30 percent

Solution:
E[R] = 0.12*0.15 + 0.08*0.75 + 0.02*0.1 = 0.073

28.

Which one of the following stocks lies on the security market line (SML) if the riskfree rate of return is 3.5 percent and the market rate of return is 13 percent? (Round
your answer to 2 decimal places)
Stock
A
B
C
D
E
a.
b.
c.
d.
e.

Beta
0.85
1.13
1.47
0.76
1.87

Expected Return
11.57%
13.54%
17.20%
10.55%
19.28%

A
B
C
D
E

Solution:
ER = RF + *(ERM RF)
ERA = 3.5 + 0.85*(13 3.5) = 11.57% - correctly priced
ERB = 3.5 + 1.13*(13 3.5) = 14.23%

13

ERC = 3.5 + 1.47*(13 3.5) = 16.82%


ERD = 3.5 + 0.76*(13 3.5) = 10.39%
ERE = 3.5 + 1.87*(13 3.5) = 20.44%
29.

Which of the following statements about systematic risk is TRUE:


a.
b.
c.
d.
e.

30.

is measured by beta.
is not compensated for by the risk premium.
is not related to the overall economy.
can be effectively eliminated by portfolio diversification.
is measured by standard deviation.

What is the beta of a portfolio comprised of the following securities? What is the
Expected Return on the portfolio if the risk-free rate of return is 3 percent and the
market rate of return is 12 percent? (Round your answer to 2 decimal places)
Stock
A
B
C

Weight
0.30
0.10
0.65

Beta
1.15
1.81
0.93

a = 1.13, ER = 13.17%
b. = 0.95, ER = 11.54%
c. = 1.32, ER = 11.82%
d. = 1.13, ER = 11.82%
e. = 1.15, ER = 14.76%
Solution:
Portfolio = (0.30*1.15) + (0.10*1.814) + (0.65*0.93) = 1.13%
ERPortfolio = RF + *(ERM RF) = 3 + 1.13*(12 3) = 13.17%
31.

You have invested 45 percent of your portfolio in an investment with an expected


return of 15 percent and 60 percent of your portfolio in an investment with an
expected return of 18 percent. What is the expected return of your portfolio?
a.
b.
c.
d.
e.

15.34 percent.
16.17 percent.
16.44 percent.
15.75 percent.
16.65 percent.

14

Solution:
E(RP) = (0.45*15) + (0.55*18) = 16.65 percent.
Chapter 13
32.

Facebook is analyzing a project with an initial cost of $65,500 and cash inflows of
$24,000 a year for two years. This project is an extension of the firm's current
operations and thus is equally as risky as the current firm. The firm uses only debt
and common stock to finance their operations and has 25 percent debt and 75
percent common equity. The after-tax cost of debt is 6 percent and the cost of
equity is 11 percent. The tax rate is 34 percent. What is the projected net present
value of this project (round the answer to the nearest dollar)? (Hint: first calculate
the WACC and then use the answer as the discount rate to calculate the projects
NPV).
a. $2,400
b. -$22,913
c. $3,011
d. -$23,424
e. $2,950
Solution:
WACC = wD*RD*(1- TC) + wE*RE = 0.35*6 + 0.65*11 = 9.25 percent.
CF0 = -65,500
C01 = 24,000
F01 = 2
I = 9.25, NPV = CPT = -23,424

33.

Twitter has a capital structure which is based on 25 percent debt, 10 percent


preferred stock, and 65 percent common stock. The pre-tax cost of debt is 6 percent,
the cost of preferred is 10 percent, and the cost of common stock is 12 percent. The
company's tax rate is 34 percent. The company is considering a project that is
equally as risky as the overall firm and has an IRR of 9 percent. What is the
companys WACC and should it invest in the project?
a.
b.
c.
d.
e.

10.20 percent, yes because WACC is greater than IRR


10.20 percent, No because WACC is greater than IRR
10.20 percent, yes because IRR is positive
9.79 percent, no because WACC is greater than IRR
9.15 percent, no because WACC is greater than IRR

Solution:

15

WACC = wD*RD*(1- TC) + wE*RE + wP*RP


= 0.25*6*(1 0.34) + 0.1*10 + 0.65*12 = 9.79 percent > 9.0 reject.

34.

The Fine Leather Co. has bonds outstanding that mature in ten years, have a 6
percent coupon, and pay interest annually. These bonds have a face value of $1,000
and a current market price of $1,100. What is the company's after-tax cost of debt if
their tax rate is 35 percent?
a.
b.
c.
d.
e.

5.04 percent
7.58 percent
3.54 percent
3.07 percent
5.83 percent

Solution:
10
N

1,000
FV
I/Y
4.72
kDAT = kBAT*(1 T) = 4.72*(1 0.35) = 3.07%

35.

-1100
PV

60
PMT

Reingaart Systems is expected to pay a $3.00 dividend at year end (D1 = $4.00), the
dividend is expected to grow at a constant rate of 6.5% a year, and the common stock
currently sells for $50 a share. The before-tax cost of debt is 7.5%, and the tax rate is
35%. The target capital structure consists of 60% debt and 40% common equity. What
is the companys WACC?
a.
b.
c.
d.
e.

7.22%
7.65%
7.05%
7.35%
8.73%

Solution:
WACC = wD*RD*(1- TC) + wE*RE

16

RE = (Div1/P0) + g = (4/50) + 0.065 = 14.50%


RD*(1- TC) = 7.5*(1 0.35) = 4.88%
WACC = 0.6*4.88 + 0.4*14.5 = 8.73%
36.

The weighted average cost of capital for a firm is the:


a. discount rate which the firm should apply to all of the projects it undertakes.
b. coupon rate the firm should expect to pay on its next bond issue.
c. the rate that a company is expected to pay on average to all its security
holders to finance its assets
d. maximum rate which the firm should require on any projects it undertakes.
e. required rate which every project's internal rate of return must exceed.

37.

Wood Inc. has 600 bonds outstanding with a face value of $1,000 and a market
price of $1,000. Company has 18,000 shares of common stock outstanding at a
market price of $15/share and 8,000 shares of 8% preferred stock at a market price
of $30/share. What weight should be assigned to the cost of common stock when
computing the weighted average cost of capital?
a.
b.
c.
d.
e.

30.55%
40.30%
58.11%
24.32%
None of the above

Solution
MV(Debt) = 600*1000 = $600,000
MV(Equity) = 18,000*15= $270,000
MV(Pref.) = 8000*30 = $240,000
V(Firm) = $1,110,000
W(Equity) = 270,000/1,110,000 = 24.32%
38.

The Long Brothers pay $10 as the annual dividend on their preferred stock.
Currently, this stock has a market value per share of $54 and the firms tax rate is
30 percent. What is the cost of preferred stock?
a.
b.
c.
d.
e.

12.60 percent
14.00 percent
14.55 percent
14.50 percent
18.52 percent

Solution
Rp = $10/$54 = 18.52 percent
17

39.

You were hired as a consultant to Wayne Company, and you were provided with the
following data: Target capital structure: 35% debt, 15% preferred, and 50% common
equity. The after-tax cost of debt is 5.00%, the cost of preferred is 6.50%, and the cost
of equity is 10%. What is the firms WACC?
a.
b.
c.
d.
e.

8.44%
11.00%
7.73%
8.50%
WACC requires the pre-tax cost of debt.

Solution:
WACC = wD*RD*(1- TC) + wE*RE + wP*RP
WACC = 0.35*5 + 0.15*6.5 + 0.5*10 = 7.73

40.

McKean, Inc. has a debt-equity ratio of 0.60 and a tax rate of 34 percent. The firm
does not issue preferred stock. The cost of equity is 10 percent and the after-tax cost
of debt is 5 percent. What is McKean's weighted average cost of capital (WACC)?
a.
b.
c.
d.
e.

7.54 percent
9.25 percent
8.13 percent
8.00 percent
7.80 percent

Solution:
D + E = 0.6 + 1 = 1.6
WD = (0.6/1.6) = 37.50%, WE = (1/1.6) = 62.50%
WACC = wD*RD*(1- TC) + wE*RE
WACC = 0.3750*5 + 0.6250*10 = 8.13%

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