MBA 8622
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Practice Final Exam (Fall 1999)
MBA 8622: Practice Final Exam (Fall 1999)
1.
According to the textbook, what should be the main objective of the management of a
firm?
a. Maximize net income
b. Minimize risk
c. Maximize customer satisfaction
d. Build a strong team of well-trained, motivated employees
e. Maximize shareholder’s wealth
2.
Which of the following statements is most correct?
a. The present value of an annuity due will exceed the present value of an ordinary
annuity (assuming all else equal).
b. The future value of an annuity due will exceed the future value of an ordinary
annuity (assuming all else equal).
c. The nominal interest rate will always be greater than or equal to the effective annual
interest rate.
d. Statements a and b are correct.
e. All of the statements above are correct.
3.
Frank Lewis has a conventional, 30-year, fixed-rate, $100,000 mortgage with a nominal
interest rate of 10 percent and monthly compounding. Which of the following statements
regarding his mortgage is most correct?
a.
b.
c.
d.
e.
4.
The monthly payments will decline over time.
The proportion of the monthly payment which represents interest will be lower for
the last payment than for the first payment on the loan.
The total dollar amount of principal being paid off each month gets larger as the
loan approaches maturity.
Statements a and c are correct.
Statements b and c are correct.
Your uncle has agreed to deposit $3,000 in your brokerage account at the beginning of
each of the next five years (t = 1, t = 2, t = 3, t = 4 and t = 5). You estimate that you can
earn 9 percent a year on your investments. How much will you have in your account
immediately after your uncle makes his last deposit (at the beginning of year 5)? (Hint:
This is more complex than it seems and you should draw a timeline).
a. $13,719.39
b. $16,719.39
c. $17,954.13
d. $19,570.00
e. $21,430.45
MBA 8622
5.
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Practice Final Exam (Fall 1999)
An investment pays you annual stated rate (=nominal rate) of 9 percent interest,
compounded annually. A second investment of equal risk, pays interest compounded
quarterly. What nominal annual rate of interest would you have to receive on the second
investment in order to make you indifferent between the two investments?
a. 2.18%
b. 8.71%
c. 9.00%
d. 9.20%
e. 9.31%
6.
You have been offered an investment that pays $500 at the end of every 6 months for
the next 3 years (the first payment will be received 6 months from today). The nominal
interest rate is 12 percent; however, interest is compounded quarterly. What is the
present value of the investment?
a. $2,458.66
b. $2,444.67
c. $2,451.73
d. $2,463.33
e. $2,437.56
7.
You have a conventional, $175,000, fixed-rate 30-year mortgage with a 9 percent
nominal rate and monthly payments/compounding. What will be the remaining balance
on your mortgage after 6 years (that is, immediately after the 72nd payment)?
a. $90,514.62
b. $165,918.32
c. $167,79.15
d. $173,804.41
e. $174,514.83
8.
Stock A has a Beta = 0.8, while Stock B has a Beta = 1.6. Which of the following
statements is most correct:
a.
b.
c.
d.
e.
Stock B’s required return is double that of Stock A’s
An equally weighted portfolio of Stock A and Stock B will have a Beta of less
than 1.2
If market participants become more risk averse, the required return on Stock B
will increase more than the required return for Stock A.
The standard deviation of the expected returns of Stock B is higher than the
standard deviation of the expected returns of stock A
Answers a and c are correct
MBA 8622
9.
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Practice Final Exam (Fall 1999)
If the risk-free rate is 7 percent, the expected return on the market is 10 percent, and the
expected return on Security J is 13 percent, what is the beta of Security J?
a.
b.
c.
d.
e.
1.0
1.5
2.0
2.5
3.0
10. A mutual fund manager has a $200,000,000 portfolio with a Beta = 1.2. Assume that the
risk-free rate is 6 percent and that the market risk premium is also 6 percent. The
manager expects to receive an additional $50,000,000 in funds soon. She wants to
invest these funds in a variety of stocks. After making these additional investments, she
wants the fund’s expected return to be 13.5%. What should be the average Beta of the
new stocks added to the portfolio?
a.
1.10
b.
1.33
c.
1.45
d.
1.64
e.
1.87
11. The current price of a 10-year, $1,000 par value bond is $1,158.91. Interest on this bond
is paid every six months, and the nominal annual yield is 14 percent. Given these facts,
what is the annual coupon rate on this bond?
a. 10%
b. 12%
c. 14%
d. 17%
e. 21%
12.
Which of the following statements is most correct?
a. If a bond is selling for a premium, this implies that the bond’s yield to maturity
exceeds its coupon rate.
b. If a coupon bond is selling at par, its current yield equals its yield to maturity.
c. If rates fall after its issue, a zero coupon bond could trade for an amount above its
par value.
d. Statements b and c are correct.
e. None of the statements above is correct.
13.
Waters Corporation has a stock price of $20 a share. The stock's last dividend, which
has just been paid out, is $2 a share (D0 = $2.00). The stock's required rate of return is
15 percent and the stock's dividend is expected to grow at the same constant rate
forever. What is the expected dividend of the stock seven years from now (=D 7)?
a. $2.00
b. $2.40
c. $2.73
d. $3.44
e. $5.32
MBA 8622
14.
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Practice Final Exam (Fall 1999)
Rogers Robotics currently (1998) does not pay a dividend. However, the company is
expected to pay a $1.00 dividend two years from today (2000). The dividend is then
expected to grow at a rate of 20 percent a year for the following three years. After the
dividend is paid in 2003, it is expected to grow forever at a constant rate of 7 percent.
Currently, the risk-free rate is 6 percent, the market risk premium (kM – kRF) is 5
percent, and the stock's beta is 1.4. What should be the price of the stock today?
a. $22.91
b. $21.20
c. $30.82
d. $28.80
e. $20.16
Use the following information to answer questions 15-18
Sata Steel is a steel manufacturer that finances its operations with 40 percent debt, 10
percent preferred stock, and 50 percent equity. The company‘s bonds have a 8% coupon,
paid semiannually, a current maturity of 10 years, and actually sell for $1,080. The preferred
stock pays an annual dividend of $2 and actually sells for $20 per share. The flotation cost
on preferred stock is 10 percent. The company‘s common stock trades at $30 per share, and
its current dividend (D0) of $2 per share is expected to grow at a constant rate of 8% per year.
Sata‘s Beta is 1.4 and the expected return on the market is 12 percent. The company‘s
marginal tax rate is 40%.
15. What is Sata’s after-tax cost of debt?
a)
b)
c)
d)
e)
16.
2.75%
4.00%
4.13%
6.88%
8.80%
What is Sata’s cost of preferred stock?
a)
b)
c)
d)
e)
5.00%
8.30%
10.00%
11.11%
12.50%
MBA 8622
17.
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What is Sata’s cost of common stock (ks) using the DCF-approach?
a)
b)
c)
d)
e)
18.
8.00%
14.67%
14.93%
15.20%
16.50%
Sata’s financial manager has calculated the cost of the firm’s common stock (ks), using
the CAPM approach. His calculations showed that ks = 15.20%. What is the
corresponding risk-free rate, which was used in his calculation of (ks).
a)
b)
c)
d)
e)
19.
Practice Final Exam (Fall 1999)
3%
4%
5%
6%
7%
Delprato Inc. wants to purchase an asset costing $10 million. The firm just reported a
net income of $8 million: its payout ratio is 25%, and the firm has 1 million shares
outstanding. Delprato’s market value structure, shown below, is considered to be
optimal (assume that there is no short-term debt):
Long-term Debt $33,000,000
Equity $27,000,000
Total Capital $60,000,000
Delprato expects its earnings (and therefore its dividends) to continue to grow at their
historical rate of 6 percent per year for the indefinite future. Delprato’s pre-tax cost of
debt is 7.5 percent and the firm’s tax rate is 40 percent. Calculate Delprato’s weighted
average cost of capital (WACC).
a)
b)
c)
d)
e)
4.50%
7.88%
8.71%
10.63%
13.85%
MBA 8622
20.
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Practice Final Exam (Fall 1999)
The following table lists the capital budgeting analysis of four different, mutually
exclusive projects with an equal life:
Project
A
B
C
D
NPV
IRR
$3,000
$5,050
$4,800
$3,100
10.5% and 17%
13.4%
14.4%
21.5%
Discount rate
(based on project’s beta)
11%
12%
13%
14%
Which project should you choose?
a.
b.
c.
d.
e.
21.
Two normal projects A and B are mutually exclusive. Project A has a higher net present
value if the WACC is less than 12 percent, whereas Project B has a higher net present
value if the WACC exceeds 12 percent. The NPV’s of both projects are identical if the
WAAC equals 12 percent. Which of the following statements is most correct:
a.
b.
c.
d.
e.
22.
Project A
Project B
Project C
Project D
A, B, C, and D, since all have NPV>0
Project B has a higher internal rate of return (IRR) than Project A
The crossover-rate is higher than 12 percent
Project B is probably larger in scale than Project A
Project A probably has a faster payback
None of the statements above is correct
Two mutually exclusive projects are being considered. Both cost $100,000, have a 4
year life, and should be evaluated with a 10% discount rate. Project AA will produce a
single cash flow of $200,000 at the end of 4 years. Project BB will produce cash flows
of $40,000 at the end of each year.
Which of the following is most correct?
a.
b.
c.
d.
e.
The IRR of project AA is 18.92%, greater then that of project BB.
The IRR analysis says take project BB, and the NPV indicates AA.
The NPV of project BB is -$50,987, less than that of Project AA.
All of the above
None of the above
MBA 8622
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Practice Final Exam (Fall 1999)
Use the following information to answer questions 23 - 25
Delco Inc. is considering the purchase of a new leather-cutting machine to replace an existing
machine. The old machine has a current book value of $3,000. It is being depreciated on a
straight-line basis to a zero salvage value. Annual depreciation on the old machine is $1,000
per year. The old machine can be sold today for $1,500.
The new machine will reduce costs (before taxes) by $8,000 per year. The new machine has
a 3-year life, it costs $18,000, and it can be sold for an expected $4,000 at the end of the
third year. The new machine would be depreciated over its 3-year life using the MACRS
method (33%, 45%, 15%, and 7% for Years 1, 2, 3, and 4, respectively). Use of the new
machine would require a $2,500 increase in net working capital.
If Delco does not replace the old machine, the company estimates that the old machine could
be sold for $1,000 three years from today. Assume a 40 percent tax rate and a cost of capital
of 14 percent.
23.
What is the amount of the initial cash flow at Year 0?
a.
($13,400)
b.
($15,900)
c.
($18,400)
d.
($19,900)
e.
($20,500)
24.
What incremental operating cash flow will occur at the end of Year 2 as a result of
replacing the old machine?
a.
b.
c.
d.
e.
25.
$7,460
$7,640
$8,000
$8,040
$8,060
What incremental non-operating cash flow will occur at the end of Year 3 if the new
machine is purchased?
a.
$2,604
b.
$2,904
c.
$4,804
d.
$5,404
e.
$6,004
Solutions:
1) E
8) C
15) C
22) B
2)
9)
16)
23)
D
C
D
C
3)
10)
17)
24)
E
C
D
B
4)
11)
18)
25)
C
D
B
C
5) B
12) B
19) C
6) C
13) C
20) B
7) B
14) E
21) A