Exam I
Name
FINANCE 5023
Summer 2010
Multiple Choice -- Circle the letter of the BEST answer (3 points each)
1. The yield to maturity of a bond is
a.
b.
c.
d.
e.
the rate of interest that equates the price of the bond with the discounted cash flows
the expected rate to be earned if held to maturity
the rate that is used to determine the market price of the bond
equal to the current yield for bonds priced at par
all of the above
2. Which of the following is NOT true about the Net Present Value (NPV) of a project?
a.
b.
c.
d.
e.
It assumes that the cash flows are reinvested at the Internal Rate of Return (IRR).
It tells you the increase in the value of the firm that will occur by accepting the project.
If the NPV is greater than zero, then the IRR is greater than the required rate of return.
It does not indicate how efficiently funds have been invested.
All of the above are true.
3. If interest rates increase, one would expect
a.
b.
c.
d.
e.
bond prices to increase
stock prices to increase
stock prices to decrease
bond and stock prices to move in opposite directions
none of the above
4. As the discount rate increases without limit, the present value of a future cash flow
a.
b.
c.
d.
e.
approaches infinity
remains unchanged
approaches zero
approaches negative infinity
none of the above
5. A conversion option on a convertible bond acts as a
a.
b.
c.
d.
e.
put option on the underlying stock
call option on the underlying stock
put option on the underlying bond
call option on the underlying bond
none of the above
6. Which of the following would tend to RAISE the rating of a firm's bond issue?
a.
b.
c.
d.
e.
including a call provision
issuing additional debt
issuing preferred stock
investing in above average risk projects
none of the above would raise a bond's rating
7. A Treasury bond has an 8% annual coupon and a 7½% yield to maturity. Which of the
following statements is true?
a.
b.
c.
d.
The bond sells at a price below par.
The bond has a current yield greater than 8%.
The bond’s required rate of return is less than 7½%.
If the yield to maturity remains constant, the price of the bond will decline over
time.
e. None of the above is true.
8. Other things held constant, which of the following alternatives would increase a company’s
cash flow for the current year?
a. Increase the number of years over which fixed assets are depreciated for tax purposes.
b. Pay down the accounts payable.
c. Reduce the days’ sales outstanding (or average collection period) without affecting
sales or operating costs.
d. Pay workers more frequently to decrease the accrued wages balance.
e. Reduce the inventory turnover ratio without affecting sales or operating costs.
9. Warrants are:
a.
b.
c.
d.
e.
an option to buy a stated number of shares at a specified price
a technique of issuing stock usually used by small, rapidly growing firms
a form of sweetener used in selling debt or preferred stock
all of the above
none of the above
10. Stocks A and B have the same price, but investors require a higher rate of return for Stock A.
Which of the following statements is true?
a. If Stock A has a lower dividend yield than Stock B, its expected capital gains yield
must be higher than Stock B’s.
b. Stock B must have a higher dividend yield than Stock A.
c. Stock A must have a higher dividend yield than Stock B.
d. Stock A must have both a higher dividend yield and a higher capital gains yield than Stock
B.
e. None of the above is true.
11. You are considering buying a $1,000 par value bond that pays an 8% coupon rate of interest
and matures in ten years. You intend to hold the bond for five years and then sell it. Although
current interest rates on bonds are 6%, you anticipate that long-term bond rates will have risen
to 10% by the time you sell it.
A.
What price do you expect the bond to sell for in five years? (5 points)
$ 924.18
B.
Assume your answer to part A above was $900. If you want a rate of return of 10% for the
five-year holding period, how much should you be willing to pay for the bond today?
(5 points)
$ 862.09
12. Jane is planning for her retirement in five years. Currently, she has savings of $500,000 that
earns 4% annually. Jane believes that she will only be able to save $15,000 per year while
she is working and intends to add this to her 4% savings account each year until she retires.
Although she only expects to live for 10 years after retirement, Jane wants to leave a nest
egg of $100,000 for her children. What annual amount can Jane withdraw each year of her
retirement and still leave a $100,000 balance in her account when she dies? Assume all
cash deposits and withdrawals are at year-end. (15 points)
$ 76,689
13. InterTune, Inc., just paid a dividend of $3.00 per share. You expect the dividend to increase
by 15% next year, 10% the following two years, and then 4% thereafter.
A.
If you require a rate of return of 10%, what is the most you should be willing to pay for a
share of InterTune stock? (10 points)
$ 63.75
B.
How would your answer to part (A) change if you only intended to hold the stock for
five years? Don't do any calculations, just explain in words and why. (5 points)
14. You are considering replacing the plastic extrusion machine that creates the basic moldings of
the outdoor pool furniture your company produces. The current extrusion machine was
purchased two years ago for $240,000 and is being depreciated using the 5-year MACRS
schedule (20%, 32%, 19.2%, 11.52%, 11.52%, 5.76%). Although the old machine is
anticipated to have a salvage value of $40,000 three years from now, it can be sold today for
$150,000. The new machine costs $400,000 and will be depreciated over its three-year useful
life using the MACRS schedule (33%, 45%, 15%, 7%) for 3-year assets. At the end of three
years, you expect to be able to sell it for an estimated $50,000. You have estimated that the
more modern forms of furniture will result in sales increasing from an estimated $1,500,000 to
$1,720,000 per year. Manufacturing costs are anticipated to increase from $800,000 per year
to $920,000 per year. The new machine will require an additional $10,000 of investment in
working capital initially, but this additional working capital will be recovered at the end of the
third year. The firm is in the 40% tax bracket. What are the relevant cash flows for capital
budgeting purposes? (15 points)
Year 0
Net Cash Flows $(273,920)
Year 1
Year 2
Year 3
$ 94,368
$ 120,941
$ 94,611
15. You are about to start your own company. Your initial investment in the small electronics firm
will be $100,000. You have several potential customers for your product lined up and you
estimate first year's sales to be about $400,000. Bank financing will be required to get your
company started. To provide support for your request for a short-term loan from a local bank
you intend to construct a pro forma balance sheet for presentation to the loan officer. Using
the following industry averages of small electronics firms such as yours that you obtained from
Dun & Bradstreet, set up your end of the first year pro forma balance sheet. (15 points)
Current ratio
Inventory turnover
(based on sales)
Average collection period
Fixed asset turnover
Total asset turnover
Debt/asset ratio
Net profit margin
A/P as a percent of sales
1.5x
6.67x
27 days
5x
2x
40%
5%
10%
No dividends will be paid.
Cash
30,441
Accounts Payable
40,000
Accounts Receivable
29,589
Short-term Debt
40,000
Inventory
59,970
Tot. Curr. Assets
Fixed Assets
Total Assets
120,000
80,000
200,000
Total Debt
Common Stock
Retained Earnings
80,000
100,000
20,000
Total Equity
120,000
Total Liabilities
& Owners' Equity
200,000