Finance 3321 (Moore)
Third Examination
Fall 2004
Third Examination – Finance 3321
Fall 2004 (Moore)
Printed Name:
____________________
Section (time): ____________
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of Student Conduct is in force during this exam. Students providing or accepting unauthorized
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unauthorized materials during the exam will result in the same penalty. Ours’ should be a selfmonitoring profession. It is the obligation of all students to report violations of the honor code
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statement and agree to abide by the stipulated terms.
Student’s Signature:
______________________________
Where indicated, use the financial statement for Dell-U-Dead, Inc. (a large computer
manufacturer and distributor that sells in both the wholesale and retail markets).
Multiple Choice Format Examples:
Clearly Circle the BEST response (letter) for each of the following questions:
1. Which of the following types of market return measures would be most appropriate for
estimating Beta for a medium sized high-tech firm ($100 million market capitalization)?
a. S&P 500 monthly return
b. New York Stock Exchange Monthly Return
c. Dow Jones Industrial Average’s monthly return
d. A broad-based market composite return with representation of small, medium and large
cap firms
e. The 3-month treasury yield
2. Assume the market return and risk-free rate (both positive) remain unchanged. Which of
the following must be true if the firm’s Beta suddenly changes from 0.75 to 1.50?
a. The firms cost of equity doubles
b. The firm’s cost of debt decreases in direct proportion to the increase in the cost of
equity because the WACC must remain constant
c. The WACC of the firm increases
d. The value of the equity is reduced by half
e. The share price will increase
3. Which of the following types of investment funds would have bonds rate at least BBB
representing a high percentage of its portfolio value?
a. Income Funds
b. Balanced Funds
c. Municipal Funds
d. Investment Grade Corporate Bond Funds
e. Hi Yield Corporate Bond Funds
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Finance 3321 (Moore)
Third Examination
Fall 2004
4. Which component(s) of an Interest and Principal strip faces interest rate risk?
a. The interest payment stream
b. The principal payment
c. Both principal and interest payment streams
d. Neither
e. The interest payment stream and only when principal is defaulted
5. Old Reliable Manufacturing Company's stock has a book value of $15 per share. You have
estimated its cost of equity capital to be 6 percent and its book value is expected to grow at 1
percent per year indefinitely. Compute Old Reliable’s intrinsic share value using the long run
average residual income perpetuity method?
a. $25.00
b. $25.56
c. $500.00
d. $70.00
e. $178.57
6. Old Reliable Manufacturing Company's stock has a market price of $52.50 per share and a
book value of $15 per share. You have estimated its steady state ROE to be 4 percent per year
and its cost of equity capital is 8 percent. What expected growth rate in book value (in
perpetuity) supports the current stock price?
a. 5%
b. 4%
c. 3%
d. 2%
e. 1%
7. You have just computed the Beta of a stock to be 2.0 and the estimate of the relevant riskfree rate is 3%. The expected market return next period is 2% and the long-run market
risk premium is expected to hold at its historical level of 4%. What is the appropriate
estimate of the firm’s Ke?
a. 1.0%
b. 4%
c. 9%
d. 11%
e. 13%
8. Which of the following items would a rail car manufacturer factor with recourse:
a. Accounts Receivable
b. Inventory
c. Working Capital
d. Leased rail cars
e. Buildings
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Finance 3321 (Moore)
Third Examination
Fall 2004
9. The appropriate collateral a bank would use on a 10-year term loan to a rail car
manufacturer would be:
e. Accounts Receivable
f. Inventory
g. Working Capital
h. Lease rail cars
e. all of the above
Use the following information to answer questions 10-12
Altman’s Z-Score model for Credit Ratings is defined as follows:
 Working Capital 
 Retained Earnings 
Z  score = 1.2
. 
  14

 Total Assets 

Total Assets 
EBIT 
Sales 

 Market Value Equity 

 3.3
. 
  0.6
  10

 Total Assets
 Book Value Liabilities
 Total Assets
10. Which of the following is correct regarding the use of Altman’s Z-Score?
a. A company with a score of 2.6 is twice as likely to get credit as a company with a 1.3
b. A company with a score of 1.0 is more credit worthy than a company with a 5.0
c. A company with a 3.3 is considered to be a high credit risk (in terms of bankruptcy)
d. A company with a 2.3 is considered to be a high credit risk (in terms of bankruptcy)
e. A company with a 1.3 is considered to be a high credit risk (in terms of
bankruptcy)
11. Which of the following corporate activities will unambiguously raise the firm’s Z-score
a. Decreasing Inventory while sales decline
b. Selling un-needed Assets and using the proceeds to pay of debt
c. Increasing working capital without incurring more current liabilities
d. Increasing total assets with borrowed funds
e. Increasing dividends (assuming no information asymmetry or signalling)
12. Use the following financial information (stated in per share amounts) to compute the Zscore of Dell-U-Dead.
Current Assets
Current Liabilities
$0.35
Total Assets $2.80
Retained Earnings: $0.14
EBIT
$0.28
Sales
Total Liabilities:
Share Price
$3.50
a.
b.
c.
d.
$0.70
$2.10
1.05
1.80
2.05
2.81
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$1.40
Finance 3321 (Moore)
Third Examination
Fall 2004
e. 3.05
13. Which of the following would best describe the problems associated with loan officers and
bankers focusing only on the current z-score to make credit decisions?
a. It becomes a self-fulfilling prophecy
b. Established, profitable companies will be denied credit funds while risky young firms
without a long track-record have too easy access to traditional cost-effective financing
c. It reduces firms’ incentives to manage earnings and accounts for the purpose of making
the z-score look better than it really is (cooking the books)
d. all of the above
e. none of the above
14. You are comparing the published P/E multiple with the intrinsic P/E multiple based on your
valuation of a company and they differ. Both ratios use the same earnings denominator.
Which of the following must be true?
a. Intrinsic P/E > Published P/E implies you believe the firm is overvalued
b. Intrinsic P/E < Published P/E implies you believe the firm is undervalued
c. The published P/E must be wrong
d. The intrinsic P/E must be wrong
e. None of the above must be true
15. Which of the following is correct regarding passive investors?
a. They spend more time performing fundamental analysis than active investors
b. Portfolio diversification and rebalancing is key to their investment style
c. They choose their investments based on intrinsic security values
d. They spend a lot of time trying to find mis-priced securities
e. They are not strong believers in market efficiency
16. Which of the following results from a firm having its debt rating raised from B to AA grade?
a. Access to capital in the debt market will become more restricted
b. Assessed default risk has increased
c. The WACC will likely decrease
d. All of the above
e. None of the above
Use the following information to answer questions 17-18
An interest and principal strip was created from a 3-year mortgage loan that has a principal
balance of $300,000. The interest rate 18% and the annual payments are $137,977.
17. Compute the initial price of the principal only strip.
a. $300,000
b. $54,000
c. $137,977
d. $213,505
e. $86,499
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Finance 3321 (Moore)
Third Examination
Fall 2004
18. How much will the value of the principal strip change by if interest rates immediately drop
to 12%?
a. $23,703 gain
b. $23,703 loss
c. $237,204 gain
d. $54,128 gain
e. no effect since interest rate risk only applies to the interest strip
Use the following information to answer questions 19-20
You have made the following forecast of EPS and DPS for Hi-Flyer Corp. Note the cost of
equity is estimated to be 10%
Ke
0.1
2004
eps
dps
2005(E)
2.00
0.50
1
2006(E)
2.50
0.50
2
2007(E)
2.75
0.50
19. Use the AEG model to value High-Flyer. Assume no abnormal earnings growth after 2007.
What is the estimated price per share for High-Flyer at the end of 2004?
a. $3.59
b. $20.00
c. $21.77
d. $23.59
e. $27.70
20. After computing (19), you want to assess the impact of potential terminal value AEG in
perpetuity. How much would the share price increase if AEG were assumed to be $0.05
per year from 2008 on? (again, this is the impact on your end of 2004 valuation)
a. $0.05
b. $0.50
c. $0.41
d. $4.13
e. $5.36
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