I.D. : ____________________________
The Interdisciplinary Center Herzliya
Fundamentals of Finance
Dr. Erez Levy
Sample Final Exam (2)
Please Read:
1. IDC Honor Code applies in the exam.
2. Do not go beyond this page until you are instructed to begin.
3. You are allowed up to 3 hours to complete this exam.
4. When you are instructed to stop writing, please stop writing immediately.
5. Please write your student identification number.
6. You should write your answers on this exam. There should be plenty of space to show your
work. Extra space is on page 10.
7. Please do not unstaple your exam booklet.
8. Please show all work required to obtain each answer. Answers without justification will
receive no credits, unless otherwise instructed in the question.
9. There are 5 questions. The points for each part of each question are indicated. There are a total
of 100 possible points.
10. This exam is close book, close notes but you may use two sheets of writings (on both sides,
total 4 pages). You may use a calculator in the exam.
11. If you make any additional assumptions, state them clearly.
12. Good luck!
DO NOT START THE EXAM UNTIL YOU ARE INSTRUCTED TO DO SO
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Question 1 (25 points)
"Gisny" is an owner of numerous amusement parks in many states throughout the U.S.A. The firm
is considering a new project – undersea amusement park. The firm hired you in order to evaluate
the new project. For this job you will receive 1 million dollars in one year. You received the
following data from the firm:
In the last 3 years the firm has spent $22 million on research and development of the undersea
amusement park.
The firm expects that it will take one year to construct the undersea amusement park. At the end of
that year the amusement park will become operational. Due to the damage of salt water, the firms
expects that the park will have to be shut down after 4 years of operations.
The investment in equipment and construction is $270 million and will be paid upon termination of
construction (in one year). The investment will be depreciated over 2 years with no salvage value.
In order to finance the project, the firm will take a four-year loan (for the required amount). The
cost of borrowing for the firm (for any amount) is 4% APR. Interest payments will be made at the
end of each year and the principal will be paid in full at maturity of the loan.
"Gisny" expects revenues of $125 million for the first operating year. These revenues are expected
to grow by 20% each year until the end of the project. The operating costs are 30% of the revenues.
In addition, the firm expects that due to the opening of the new undersea amusement park, the
operating profit from its other amusement park operations will decrease by $15 million per year
throughout the life of the project.
To support the project, the firm will invest 12% of the revenues in working capital, at the beginning
of each year, which will be recovered at the end of the project.
In order to operate the undersea amusement park the firm will need an undersea site. The firm
possess an undersea plot which can be used for this project: a year ago the firm bought the right to
use an oil and gas concession in one plot at the Atlantic Ocean. For this concession the firm paid
$30 million and invested additional $10 million in oil and gas exploration. Based on the results of
this exploration it was determined that there is no oil and gas at this site.
Additional data:
- The corporate tax rate is 20%.
-
The cost of capital of the firm is 10%.
-
The firm has other profitable projects.
-
Unless stated otherwise, all cash flows occur at the end of each year.
The CEO asks you to present your opinion. Please present your recommendation and justification?
Answer: “Gisny” should / should not (circle one) undertake the project
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Question 2 (22 points):
River Dry Inc. is a manufacturer of mineral water bottles. Today, the company issued a 5-year
inflation linked (real) bond with a face value of $1,000. The bond has an annual stated real interest
rate of 4% and pays semi-annual coupon payments (every 6 months). The face value of the bond
is paid at the maturity of the bond.
The company has a similar nominal bond which is traded with YTM of 6.64%.
The annual expected inflation is 1.5%.
a. What is the price of the bond?
Answer: The price of the bond is $
.
Suppose that you bought the bond when it was issued and sold it after one year, right after the
coupon payment, for $975.
Assume that the actual inflation was the same as the expected one.
b. What is the real annual realized return from your investment in the bond?
Answer: The real annual realized return from your investment in the bond is ______%.
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c. What is the nominal annual realized return from your investment in the bond?
Answer: The nominal annual realized return from your investment in the bond is
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___%.
Question 3 (15 points)
The following table presents expected cash flow from three mutually exclusive one time
projects you consider investing in:
Year 0 Year 1 Year 2 Year 3
IRR
Project A
-600
0
726
0
10%
Project B
-700
770
11
11
12.63%
Project C
-100
105
0
0
5%
The company that examines the NPV of the projects arrived at the conclusion that it remains
indifferent as to whether to invest in project C (i.e. – its NPV is zero).
a)
In which of the projects (A, B or C), if any, should the company invest in?
Answer: The company should invest in project/s:
b) How will your reply to (a) change if the projects are independent of each other?
Answer: The company should invest in project/s:
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Question 4 (18 points)
Today, 31/12/2017, you have just finished the fundamental of finance course. You decided to
examine your savings and loans for the next year and found the following:
• Loans:
• A mortgage with an outstanding balance of $50,000 and a 4.75% APR (compounded
monthly).
• Credit card loan with an outstanding balance of $10,000 and a 4% APR (compounded
daily) and $150 of annual fee (paid at the beginning of each year).
• A loan which you took for a family vacation, with a $15,000 balance and a 5.00% APR
(compounded semi-annually).
• Savings:
• Weakly renewable savings account with an outstanding balance of $20,000 and a 5%
APR.
• Regular savings account with an outstanding balance of $50,000 and a 5.25% EAR.
a. In which loan do you pay the highest interest rate?
Answer: You pay the highest interest rate in ____________________
b. looking forward to 2018, Should you use your savings to pay off any of your outstanding
loans? Explain.
Answer: You should use your savings to pay off ____________________
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Question 5 (20 points)
Suppose that the expected return of the market is 10% and the standard deviation of the market is
18%. In addition, the risk free rate is 4%.
You own a portfolio which is not efficient in which you invest 1/3 of your money in stock A and
2/3 of your money in a risk free asset. Stock A has an expected return of 12% and standard
deviation of 40%.
a. Calculate the beta of your portfolio.
Answer: The beta of your portfolio is ____________________
b. Calculate the standard deviation of your portfolio
Answer: The standard deviation of your portfolio is ___________________%.
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c. Suppose that you would like to construct a portfolio with the same standard deviation (as
your portfolio today), but with higher expected return. How can you do it (present the
investments you will make)?
Answer: You will invest _______ % (of your portfolio value) in asset _______ and _______
% (of your portfolio value) in asset _______.
d. Calculate the expected return of the portfolio in C.
Answer: The expected return of the portfolio is _________________%.
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