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Time Value of Money Problems

EXAM NUMBER: ____________

FI 3300 - CORPORATION FINANCE

FINAL EXAM

Spring 2002

NAME ________________________________________________________

STUDENT NUMBER ____________________________________________

CLASS DAYS/TIME ___________________ INSTRUCTOR__________________________

READ THE FOLLOWING DIRECTIONS VERY CAREFULLY. FAILURE TO FOLLOW THESE DIRECTIONS WILL ALMOST CERTAINLY RESULT IN YOUR EXAM BEING MIS-GRADED WHICH WILL ADVERSELY AFFECT YOUR GRADE. IF THERE IS ANYTHING ABOUT THE DIRECTIONS THAT YOU DO NOT UNDERSTAND, ASK YOUR INSTRUCTOR IMMEDIATELY.

1.Fill in your name, student number, and the days and time of the class for which you are registered (for example, T/Th at 5:00 p.m.) on the Answer Sheet as well as on the lines above.

2.In the box on the Answer Sheet titled "EXAM NUMBER" record the number that appears in the upper right hand corner of this sheet on the line "EXAM NUMBER" since there are multiple versions of the exam, failure to do so may result in your exam being graded with the wrong answer key!!! DO NOT COPY FROM SOMEONE ELSE'S EXAM - YOUR NEIGHBOR MAY HAVE A DIFFERENT VERSION OF THE EXAM!!!

3.Read each question very carefully. Consider all of the answer items and then select the best correct answer - there is only one best answer per question. Circle the letter answer on the exam and record your answers on the Answer Sheet.

NOTE WELL: ONLY THE ANSWER KEY WILL BE GRADED!!!

4.You may use a financial calculator. No notes, formula sheets, scratch paper (use back pages of exam if necessary), or stored formulae allowed.

The exam consists of 25 questions each worth 4.0 points. Choose the BEST ANSWER for each question. Your score will be computed as:

[100 - (number missed x 4.0)].

You will have 120 minutes to complete the exam. Do not leave any answers blank - an unanswered question will be graded as a wrong answer. Good Luck!

DIRECTIONS: Circle the letter corresponding to the best answer for each multiple choice question and then transfer that letter answer to the attached ANSWER SHEET. Be sure to carefully record your answers to the ANSWER SHEET. Only the ANSWER SHEET will be graded.

Goal of Financial Management

1. According to the text, the primary goal for a firms financial managers should be to:

a. Maximize the firms reported net income.

b. Increase the annual dividend paid to common stockholders.

c. Reduce to a minimum the volatility of the companys common stock price.

d. Smooth the firms earnings so they are positive and always growing.

e. Maximize shareholder wealth.

Financial Analysis Questions

Balance Sheet

Health Valley Company

Years ending December 31, 2001 and 2002

2001

2002

Cash

$ 20,000

$ 12,000

Accounts receivable

40,000

48,000

Inventory

60,000

50,000

Total current assets

$120,000

$110,000

Gross fixed assets

$400,000

$450,000

(Accumulated depreciation)

(120,000)

(150,000)

Net fixed assets

$280,000

$300,000

Total assets

$400,000

$410,000

Notes payable

5,000

10,000

Accounts payable to suppliers

25,000

30,000

Accruals

10,000

5,000

Total current liabilities

40,000

45,000

Long-term debt

100,000

140,000

Common stock ($2.00 par value)

60,000

45,000

Capital surplus

50,000

30,000

Retained earnings

150,000

150,000

Total Liabilities and Equity

$400,000

$410,000

Health Valley Company Income Statement Data:

2001 Net income = $15,000

2002 Net income = $18,000

2. Compute 2002 Net Cash Flow from Operating Activities for Health Valley Company.

a. $20,000

b. $46,000

c. $40,000

d. $50,000

e. $55,000

3. If cash decreases by $10,000 during the year, liabilities decrease by $5,000, and shareholders equity increases by $5,000, what is the change in non-cash assets for the year?

a. a decrease of $5,000

b. an increase of $10,000

c. a decrease of $10,000

d. an increase of $5,000

e. cannot be determined from the information given

4. How would the issuance of common stock during the year affect the return on equity (i.e., ROE), assuming all other factors remain unchanged?

a. An issuance of additional common stock will have no effect on ROE since the company will have additional cash equal to the amount of stock issued.

b. ROE will be increased due to the additional shares outstanding.

c. ROE will be reduced due to the addition to shareholders equity.

d. ROE will be increased because the company will have relatively less debt outstanding.

e. Both b and d are correct answers.

5. Which of the following would reduce the outside funds needed (OFN) if all other things are held constant?

a. An increase in the dividend payout ratio.

b. A decrease in the profit margin.

c. An increase in the expected sales growth rate.

d. A decrease in the firms dividend payout ratio.

e. Both c and d are correct.

Time Value of Money Problems

6. A security is currently selling for $8,000 and promises to pay $1,000 annually for the next 9 years, and $1,500 annually in the 3 years thereafter with all payments occurring at the end of each year. If your required rate of return is 7% p.a., should you buy this security?

a. Yes, because the return is greater than 7%

b. No, because the return is less than 7%

c. Yes, because the return is 7%

d. Yes, because the present value at 7% is less than $8,000.

e. There is insufficient information provided to answer this question.

7. A given rate is quoted as 12% APR, but has an effective annual rate (EAR) of 12.55%. What is the frequency of compounding during the year?

a. Annually

b. Semiannually

c. Quarterly

d. Monthly

e. Daily

8. Deryl wishes to save money to provide for his retirement. Beginning one year from now, he will begin depositing the same fixed amount each year for the next 30 years into a retirement savings account. Starting one year after making his final deposit, he will withdraw $100,000 annually for each of the following 25 years (i.e. he will make 25 withdrawals in all). Assume that the retirement fund earns 12% annually over both the period that he is depositing money and the period he makes withdrawals. In order for Deryl to have sufficient funds in his account to fund his retirement, how much should he deposit annually (rounded to the nearest dollar)?

a. $97,368

b. $2,902

c. $3,250

d. $2,730

e. $3,640

9. You have just received an advertisement from Corleone Inc., a paycheck loan service. Corleone will charge you a fee of 5% for a two-week loan (i.e. if you borrow $100, you must repay $105 in two weeks time). Assuming a 52 week year, what is the Effective Annual Rate (EAR) that Corleone charges (rounded to the nearest whole percent)?

a. 130%

b. 356%

c. 5%

d. 256%

e. 230%

10. Your neighbor offers you an investment opportunity which will pay a single lump sum of $2,000 five years from today. The investment requires a single payment of $1,500 today. What is the annual rate of return on this investment?

a. 5.71%

b. 5.92%

c. 6.18%

d. 6.67%

e. 33.33%

11. Kerri James is considering the purchase of a car. She wants to buy the new VW Beetle, which will cost her $17,600. She will finance 90% of the purchase price (i.e., make a 10% down payment) at an interest rate of 5.9 percent, with monthly payments over three years. How much money will she still owe on the loan at the end of one year (to the nearest dollar)?

a. $13,560

b. $10,868

c. $12,075

d. $15,704

e. $17,152

12. You are considering two perpetuities which are identical in every way except for the when the perpetuity payments will begin. Perpetuity A will begin making annual payments of a fixed amount, with the first payment being made two years from today. Perpetuity B pays the same fixed annual payment, but will make the first payment one year from today. Which of the following statements is most correct?

a. The PV of perpetuity A is greater than the PV of perpetuity B by the amount of the fixed payment.

b. The PV of perpetuity B is greater than the PV of perpetuity A by the amount of the fixed payment.

c. The PV of perpetuity A is equal to the PV of perpetuity B.

d. The PV of perpetuity A is greater than the PV of perpetuity B by the present value of the amount of the fixed payment.

e. The PV of perpetuity B is greater than the PV of perpetuity A by the present value of the amount of the fixed payment.

Stocks and Bonds Questions

13. Which of the following statements is correct?

a. A zero coupon bond is a promise to pay a single lump sum at some point in the future.

b. The price of a bond moves in the opposite direction to changes in market interest rates.

c. A bond that has a yield to maturity that is greater than its coupon rate will sell at a premium.

d. (a), (b), and (c) are all correct.

e. (a) and (b) are both correct.

14. Assume that investors lower their required rates of return. Assuming all other factors remain constant, which of the following scenarios is most likely?

a. The prices of stocks will increase and the prices of bonds will decrease.

b. The prices of stocks will decrease and the prices of bonds will increase.

c. The prices of stocks and bonds will both increase.

d. The prices of stocks and bonds will both decrease.

e. It is impossible to tell without more information.

15. Do It Yourself Dental Surgery Inc. just paid a $20 dividend at the end of the current year (i.e., D0 = $20). After the dividend is paid, the companys dividends are expected to grow at a 50% annual rate for each of the following two years, and then settle down to a steady state growth rate of 5% annually. If investors required rate of return is 15% on this stock, what should a share sell for today?

a. $472.50

b. $350.75

c. $380.34

d. $417.39

e. none of the above answers is within $10 of the correct answer

16. What is the price on a 20-year, 8% annual coupon bond, assuming that the market rate is 12%.

a. $1,000

b. $701.22

c. $750

d. $890.50

e. $642.43

17. Bobby Inc.s most recent dividend was $10 per share. Dividends are expected to grow at an 8% annual rate into the foreseeable future. If your required rate of return is 12% annually, how much should you pay for a share of ABC Corp?

a. $270

b. $250

c. $130

d. $83.33

e. $415

18. A 25-year bond with a $1,000 face value and a 6% coupon rate (with semi-annual payments) is currently selling for $634.88. What is the annual yield to maturity on this bond?

a. 10%

b. 10.03%

c. 5%

d. 10.25%

e. 6%

Capital Budgeting Questions

19. A five-year project, if undertaken, will require an initial investment of $95,000. The expected end-of-year cash flows are:

Year 1:

$12,000

Year 2:

$39,000

Year 3:

$39,000

Year 4:

$30,000

Year 5:

$18,000

If the appropriate discount rate for this project is 15%, which of the following is a correct statement?

a. Reject the project because its IRR is 13.56%

b. Accept the project because its NPV is $6,500

c. Accept the project because the IRR is 17.3%

d. Reject the project because its NPV is -3330.70

e. Both a and d are correct

20. The following table lists the capital budgeting analysis of four different independent projects with an equal life:

Project

NPV

IRR

Discount Rate

A

$4,500

15%

13%

B

-$3,600

17%

18%

C

$7,100

8%

6%

D

$75

23%

22.5%

Which project(s) would you choose?

a. A only

b. C only

c. A and C

d. A, C, and D

e. A, B, C, and D

21. Which of the following statements is most correct concerning a project with normal cash flows (i.e., a cash outflow in Year 0 followed by cash inflows in all subsequent years)?

a. If the NPV of a project is positive then the payback period rule will always accept the project

b. If the NPV of a project is negative, then the profitability index of the project will always be greater than one.

c. If the PI of a project is greater than one, then the IRR will always be less than the projects cost of capital

d. If the NPV of a project is zero, then the IRR of the project will be equal to the discount rate for the project.

e. If the discount rate of a project is zero, then the project will always be accepted.

22. MECCS Inc. is considering the purchase of VICX Inc. The managers of VICX estimate that the assets of VICX will generate $14 million in cash flows next year and that these cash flows will grow at a constant rate of 6 percent per year forever. The appropriate discount rate is 13 percent per year and the purchase price is $180 million. Compute the NPV of this investment.

a. $10 million

b. $20 million

c. $30 million

d. $40 million

e. $50 million

Use the following information to answer questions 23 through 25.

Truman Electronics manufactures a variety of household appliances. The company is considering introducing a new microwave oven. The unique feature of this oven is that it is capable of cooking food items 80 percent faster than conventional microwave ovens. The company's CFO has collected the following information about the proposed product.

The project has an anticipated economic life of 5 years.

The company will have to purchase a new production facility to produce the ovens which will require an immediate outlay of $16 million.

The production facility will be depreciated on a straight-line basis over 5 years to a $6 million salvage value. Truman Electronics plans to sell the production facility to a competitor for $6 million at the end of the 5-year period.

If the company goes ahead with the proposed project, it will require an immediate increase in net working capital of $200,000. The net working capital will be recovered after the project is completed.

The new ovens are expected to generate sales revenue of $40 million per year for each of the next 5 years.

Operating costs, excluding management salaries, are expected to be $32 million per year.

Last year, a market research study for the new product cost $15 million. The company has capitalized these costs and is recording them on the income statement at $3 million per year over the next 5 years.

Allocated management salaries will be $2 million per year, although no new managers will be hired for this project. If the project is not undertaken then these managers will work on the companys other projects instead of this one.

The company's interest expense each year will be $3.5 million.

The company's cost of capital (i.e., the required rate of return on this project) is 12 percent.

The company's tax rate is 30 percent.

Record your final numerical answer to each of the following questions on the answer sheet. Show your work on the back of the answer sheet for possible partial credit.

23. What is the initial investment for the project?

24. What is the second year expected incremental operating cash flow?

25. What is the 5th year incremental non-operating cash flow?

Answer Key for EXAM NUMBER Version of FI 3300 Final Exam

Spring 2002

1. E

2. D

3. B

4. C

5. E

6. A

7. C

8. C

9. D

10. B

11. B

12. E

13. E

14. C

15. D

16. B

17. A

18. A

19. E

20. D

21. D

22. B

23. (16,200,000)

24. 6,200,000

25. 6,200,000

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