FIN2004 Midterm

Seat No. ____________

FIN2004/X
MID-TERM
Semester I, 2014/2015
SOLUTIONS

INSTRUCTIONS:

1. This is a restricted open-book examination, consisting of 30 Multiple Choice Questions

on ELEVEN printed pages. You are allowed to refer to TWO A4-sized sheets of
printed/written materials and up to two calculators.
2. You are given 80 MINUTES to complete the examination.
3. Use a PENCIL to fully shade the most appropriate answer for each question in the
answer sheet provided.
4. Remember to write your matriculation number and shade the appropriate bubbles on the
MCQ answer sheet as previously instructed.
5. Write your assigned seat number on this page in the space provided above.
6. ANSWER ALL QUESTIONS. There are no penalties for wrong answers.

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1. Which of the following statements is false according to the CAPM?

A) Markovitz efficient market frontier is not efficient once a risk-free asset is available
at which to borrow or lend
B) The CML and the SML have the same y – axis.
C) Total risk includes unsystematic risk.
D) The tangent risky asset portfolio on the CML must be the market portfolio.
E) None of the above (all are true statements).

2. J and K with the following estimates: 


E(RJ) = 8%; σJ = 10%;
E(RK) = 12%; σK = 6%

If a portfolio comprises 80% of J and 20% of K, and if the correlation between the returns
on J and K
is -0.5, what is the portfolio’s expected standard deviation?

A) 13.1%

B) 11.10%

C) 7.47%

D) 8.02%

E) None of the above choices are correct

Answer:
c. 7.47%
Variance = (0.8)*(0.8)*(0.10)*(0.10) + (0.2)*(0.2)*(0.06)*(0.06) + 2*(0.8)*(0.2)*(0.10)*(0.06)*(-0.5)
= 0.005584
Standard Deviation = SQRT(0.005584) = 0.07473 = 7.47%

3. You are a risk-averse investor and are considering the following three stocks:

Beta Expected Return

%
Stock A 2.0 17
Stock B 1.6 12
Stock C 2.3 16
Stock D 1.8 15

Which stock would you naturally eliminate?

A) Stock A
B) Stock B
C) Stock C
D) Stock D
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E) Insufficient information

4. Your firm has the following balance sheet statement items: total current liabilities of
$805,000; total assets of $2,655,000; fixed and other assets of $1,770,000; and long-term
debt of $200,000. What is the amount of the firm's net working capital?

A) $25,000
B) $325,000
C) $770,000
D) $80,000
E) $96,000

5. You presently own stock that you purchased one year ago for $40.00. Just today you
received your first dividend payment of $2.00. You also heard on the financial news your
stock is now worth $48.00 and that inflation over the past year was 10%. You calculate
your

I. nominal return on investment to be 25%.

II. nominal dividend yield to be 4.16%.
III. real return on investment to be 13.63%.
IV. nominal paper capital gain to be 20%.

A) I and II only.
B) I, II and III only
C) I, II and IV only
D) I, III and IV only
E) I, II, III and IV
D

6. Suppose you want to retire 45 years from today. You determine that you would need
$30,000 per year after you retire, with funds withdrawn starting one year from the day you
retire. You estimate that you can earn 10% annually on these funds and that you would
need funds for 25 years after your retirement. How much must you deposit each year into a
savings account starting one year from today until retirement so that you will have enough
funds in your retirement?
A) $378.79
B) $3,590.66
C) $300.16
D) $3,819.83
E) $557.80

Answer:
a. $378.79

Step 1)
Determine how much funds are required for retirement:
I/Y = 10%

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 FIN2004 Midterm

PMT = $30,000
N = 25
PV = ?
 PV = $272,311.20

Step 2)
Work out PMT:
N = 45
I/Y = 10%
FV = $272,311.20
PMT = ?
 PMT = $378.79

7. Answer the following two questions concerning portfolio risk/return measures versus the
risk/return measures of the individual securities that make-up the portfolio. Assume all
weights are positive. (1) Can the return on the portfolio ever be more than the highest
return on an individual security in the portfolio? (2) Can the variance of the portfolio ever
be less than the lowest variance of an individual security in the portfolio?

A) (1) yes; (2) yes

B) (1) yes; (2) no
C) (1) no; (2) yes
D) (1) no; (2) no

Answer C

8. You work for a furniture store. You normally sell a living room set for $2,500 and finance
the full purchase price for 36 monthly payments at 22% APR. You are planning to run a
zero-interest financing sale during which you will finance the set over 36 months at 0%
interest. How much do you need to charge for the set during the sale in order to earn your
usual combined return on the sale and the financing?

A) $2,500
B) $2,827
C) $3,360
D) $3,437
E) $3,784
D

9. Which of the following would decrease a portfolio's systematic risk?

I. Common stock is sold and replaced with Treasury bills.
II. High-beta stocks are sold and replaced with low-beta stocks.
III. Low-beta stocks are sold and replaced with high-beta stocks.

A) I only
B) II only
C) III only
D) I and II only
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E) I, II and III
D

10. Assume that the following three [TYPO: four] assets are fairly priced according to the
capital asset pricing model. Which of the assets has the greatest beta?

Expected
Return A
D
C
B

Total risk
A) Security A
B) Security B
C) Security C
D) Security D
E) Not possible to tell from the chart

Due to TYPO, Choice E also accepted.

11. An investor invested in a portfolio that consists entirely of assets on the efficient frontier.
His portfolio will have a beta factor of:
A) –1
B) 0
C) 1
D) Greater than 1
E) Insufficient information

12. Compute the value of cost of goods sold for Ong’s Organic Grocer.

Current liabilities $340,000

Quick ratio 1.8 times
Inventory turnover 6 times
Current ratio 3.3 times

A) $2,111,000
B) $3,060,000
C) $3,999,999
D) $4,180,222
E) $5,888,100
B

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13. Suppose you have a $3 million loan with monthly installments over 7 years. How much
interest do you pay in the second installment if the interest rate of this loan is 2.5%
compounded semi-annually?
A) $6,217.69
B) $7,183.63
C) $6,842.40
D) $6,149.85
E) $5,824.84

Answer:
d. $6,149.85

Step 1)
Find monthly period rate:
EAR = (1+0.025/2)2 – 1 = 2.5156%
 (1 + NOM/12)12 – 1 = 2.5156%
 NOM/12 = (1.025156)1/12 – 1 = 0.2073%

Step 2)
Find the monthly installment:
N = 7*12 = 84
I/Y = 0.2073%
PV = $3,000,000
PMT = ?
 PMT = $38,950.16

Step 3)
Construct amortization table:
Month Principal PMT Interest Reduction of Remaining
Principal Principal
1 3,000,000.00 38,950.16 6,217.69 32,732.47 2,967,267.53
2 2,967,267.53 38,950.16 6,149.85
 Interest in 2nd installment is $6,149.85.

14. Ultimately, the total value of the firm is determined by .

A) the corporate treasurer

B) the firm's financial managers
C) non-stockholder stakeholders
D) investors in the financial markets
E) regulatory authorities
D

15. Which of the following would explain a low fixed asset turnover ratio?
I. An increase in sales
II. The replacement of old, fully-depreciated equipment with new equipment
III. The substitution of equipment for laborers
IV. More dollars of fixed asset sold than purchased

A) I only
B) II only

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C) II and III only

D) I, II, III only
E) II, III, IV only
C

16. Given a profit margin = 10%, ROE = 20% and a D/E = 1.5, what is total asset turnover?

A) 0.80 times
B) 1.01 times
C) 2.00 times
D) 2.13 times
E) 3.72 times
A

17. You have the following data for the Leo’s Luxuries.

Sales $400,000 Earnings before taxes $30,000

Total asset turnover 0.80 Marginal tax rate 35%
Return on equity 15% Profit margin 4.875%

What is Leo’s return on assets (ROA)?

A) 9.3%
B) 8.1%
C) 5.7%
D) 3.9%
E) 4.5%
D

18. Which of the following statements concerning the SML and the CML is false?

A) CML and SML both measure risk on the horizontal axis

B) Both may contain efficient and inefficient portfolios
C) The slope of both change over time
D) Both measure risk versus return
E) Market portfolio is completely diversified portfolio

19. KeeYean owns the following portfolio:

100 shares of JNC @$70/shares with a beta of 1.1

100 shares of XZX @$100/shares with a beta of 0.8
100 shares of ZZZ @$20/shares with a beta of 1.5
100 shares of LZX @$10/shares with a beta of 1.3

If the stock market index produced a return that was 10 percentage points greater than the
risk-free rate, how much would KeeYean’s portfolio be expected to outperform the risk-
free rate?

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A) 11.75%
B) 10.00%
C) 21.75%
D) 25.00%
E) Insufficient information to answer the question

20. Which of the following statement about the market portfolio is false?

A) It has a beta of one

B) It must plot on the security market line (SML)
C) It is a completely diversified portfolio
D) The difference between expected return of the market portfolio and the risk-free
rate determines the slope of the SML
E) None of the above statements is false.

21. Ebenezer is an analyst who must make specific trade recommendations. Currently 90-day
T-bills yield 3% and the equity market is expected to return 10%. Ebenezer’s primary tool
for valuing stock is the security market line. He must recommend the purchase of only
one of the four stocks below. Which stock is the best choice to purchase?

Beta Expected Return

Stock A 0.50 6.5%
Stock B 1.20 12.4%
Stock C 1.50 15.1%
Stock D 0.75 7.3%

A) Buy Stock A
B) Buy Stock B
C) Buy Stock C
D Buy Stock D
E) None of the above since they are overpriced.

22. An investor has $30,000 which he can invest today. In addition to this amount, he can
also invest $9,000 per year for twenty years (beginning one year from now) at which time
he will retire. He plans on living for twenty-five years after he retires. If interest rates are
8%, what size annual annuity payment can he obtain for his retirement years?
A) $31,686
B) $44,674
C) $47,248
D) $56,190
E) $51,681

ANS:

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 FIN2004 Midterm

PV=30,000, n=20, i=8, FV1=139,828.71

PMT=9,000, n=20, i=8, FV2=411857.68
PV=FV1+FV2, n=25, i=8, PMT=51,681

23. You borrow $965 today for six and a half weeks. You must repay $1000 at loan maturity.
What is the effective annual rate on this loan?
A) 50.73%
B) 40.00%
C) 32.98%
D) 27.95%
E) 37.93%

ANS: [1+(1000-965)/965]^8 - 1

24. How long does it take your money to grow 25 times its original value if interest rate is 6%
compounded quarterly?
A) 10 years
B) 12 years
C) 8 years
D) 14 years
E) 9 years

Answer: ALL CHOICES ACCEPTED AS CORRECT

NONE

Step 1)
Find the EAR:
EAR = (1+0.06/4)^4 – 1 = 6.14%

Step 2):
I/Y = 6.14%
PV = -$1
FV = $25
PMT = 0
N=?
⇨ N = 54.02 years

25. Suppose you win a $5 million lottery prize. The money is paid in equal annual beginning-
of-year installments over 10 years. If the appropriate discount rate is 6%, how much is the
sweepstakes actually worth today?
A) 3,400,846.14
B) 3,680,043.53
C) 3,900,846.14
D) None of the above
E) Not enough information

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 FIN2004 Midterm

Use the following information to answer questions #26-30:

ZZZ Company
2013 and 2014 Balance Sheet

2013 2014 2013 2014

Cash $35,000 $40,000 Accounts Payable $20,000 $25,000
Accounts Receivable 15,000 10,000 Notes Payable 12,000 15,000
Inventory 20,000 20,000 Total $32,000 $40,000
Total $70,000 $70,000 Long-Term Debt 30,000 32,000
Net Fixed Assets 40,000 50,000 Common Stock 25,000 22,000
Retained Earnings 23,000 26,000
Total Assets $110,000 $120,000 Total Liab & Equity $110,000 $120,000

ZZZ Company
2014 Income Statement

Net Sales $70,000

Cost of Goods Sold 30,000
Depreciation Expense 3,000
Earnings before Interest and Tax $37,000
Interest Expense 7,000
Taxable Income $30,000
Less: Taxes (40%) 12,000
Net Income $18,000

26. What is the cash flow from assets (CFFA) for 2014 (please refer to CFFA as defined and
applied in your class notes)?

A) $22,000

B) $17,200
C) $19,800

D) $20,600

E) None of the above choices are correct
Answer:
b. $17,200

Operating cash flow = $37,000*(1-0.4) + $3,000 = $25,200

Net capital spending = $50,000 - $40,000 + $3,000 = $13,000
Change in net operating working capital = ($70,000 - $25,000) - ($70,000 - $20,000) = - $5,000
Cash flow from assets = $25,200 - $13,000 – (-$5,000) = $17,200.

27. What is the amount of net new borrowing for 2014 (as defined and applied in your class
notes)?
A) -$5,000

B) $3,500

C) $5,000

D) -$2,000

E) None of the above choices are correct
Answer:
c. $5,000

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Net new borrowing = ($32,000+$15,000) – ($30,000+$12,000) = $5,000

28. What is the cash flow to creditors for 2014 (as defined and applied in your class notes)?
A) $1,000
B) $1,300
C) $1,800

D) $2,000

E) None of the above choices are correct

Answer:
d. $2,000

Cash flow to creditors = $7,000 – [($32,000+$15,000) – ($30,000+$12,000)] = $2,000

29. What is the amount of the interest tax shield for 2014?
A) $2,800

B) $1,800

C) $1,000

D) $800

E) None of the above choices are correct
Answer:
a. $2,800

Interest Tax Shield = $7,000*0.40 = $2,800

30. What is the cash flow to stockholders for 2014?

A) $5,000

B) $12,000

C) $15,000

D) $18,000

E) None of the above choices are correct

Answer:
d. $18,000

Cash flow to stockholders = [$18,000 – ($26,000-$23,000)] – [($22,000-$25,000)] = $15,000 – (-

$3,000) = $18,000

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