Exam 1 Sample Test
Student Name: ______________________ Student ID: _______________________
Please choose the BEST answer for each of the following questions:
Shareholders receive the residual return, thus take the residual risk. This is consistent with the following finance principle that you learnt from FIN320:
Cash is the king
Efficient capital market
Trade-off between risk and return
Non of the above
The interest conflicts between shareholders and debtholders may cause:
Risk-shifting (from shareholders to debtholders);
Debt dilution;
All of the above.
Which of the following actions are likely to reduce agency conflicts between stockholders and managers?
a. Paying managers a large fixed salary.
b. Increasing the threat of corporate takeover.
c. Placing restrictive covenants in debt agreements.
d. All of the answers above are correct.
4. Assume that you will receive $2,000 a year in Years 1 through 5, $3,000 a year in Years 6 through 8, and $4,000 in Year 9, with all cash flows to be received at the end of the year. If you require a 14 percent rate of return, what is the present value of these cash flows?
a. $ 9,851
b. $13,250
c. $11,714
d. $15,129
e. $17,353
$11,714 (CF0, 2nd, CE/C, CF0=0, C01=2000, F01=5, C02=3000, F02=3,
C03=4000, F03=1, CPT, NPV, I=14, CPT)
5. You intend to purchase a 10-year, $1,000 face value bond that pays interest of $60 every 6 months. If your nominal annual required rate of return is 10 percent with semiannual compounding, how much should you be willing to pay for this bond?
a. $ 826.31
b. $1,086.15
c. $ 957.50
d. $1,431.49
e. $1,124.62
N = 20; I = 5; PMT = 60; FV = 1,000, PV?
6. A share of common stock has just paid a dividend of $3.00. If the expected long-run
growth rate for this stock is 5 percent, and if investors require an 11 percent rate of
return, what is the price of the stock?
a. $50.00
b. $50.50
c. $52.50
d. $53.00
e. $63.00
P0 =
5
0
0.
-
1
0.1
5)
0
.00(1.
3
$
= $52.50.7. DAA's stock is selling for $15 per share. The firm's income, assets, and stock price have been growing at an annual 15 percent rate and are expected to continue to grow at this rate for 3 more years. No dividends have been declared as yet, but the firm intends to declare a dividend of D3 = $2.00 at the end of the last year of its supernormal growth. After that, dividends are expected to grow at the firm's normal growth rate of 6 percent. The firm's required rate of return is 18 percent. The stock is
a. Undervalued by $3.03.
b. Overvalued by $3.03.
c. Correctly valued.
d. Overvalued by $2.25.
e. Undervalued by $2.25.
P
ˆ
3
=g
r
D
4
-
=g
r
g)
+
(1
D
3
-
=0.06
-
0.18
$2.12
= $17.67.Time line:
0
r
s
= 18%
1
2
3
4
Years
g
s
= 15%
g
n
= 6%
0
D
0
=
0
D
ˆ
1
=
0
D
ˆ
2
=
00
.
2
D
ˆ
3
=
12
.
2
D
ˆ
4
=
1.217
10.752
97
.
11
$
P
ˆ
0
=
667
.
17
06
.
0
18
.
0
12
.
2
P
ˆ
3
=
-
=
CF0 = 0, C01 = 0, F01 = 2, C02= 19.67, F02=1, CPT, NPV, I = 18, CPT
Output: NPV = $11.97.
P
ˆ
0
= $11.97.
0
0
P
ˆ
P
>
Stock is overvalued: $15.00 - $11.97 = $3.038. You have developed the following data on three stocks:
Stock Standard Deviation Beta
A 0.15 0.79
B 0.25 0.61
C 0.20 1.29
As a risk minimizer, you would choose Stock if held in isolation and Stock if held as part of a well-diversified portfolio.
a. A; A.
b. A; B.
c. B; C.
d. C; A.
9. Which of the following statements is most correct?
a. Market participants are able to eliminate virtually all market risk if they hold a large diversified portfolio of stocks.
b. Market participants are able to eliminate virtually all company- specific risk if they hold a large diversified portfolio of stocks.
10. Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, but capital raised by selling new stock or bonds does have a cost.
a. True
b. False
11. Assume that the risk-free rate is 5 percent, and that the market return is 12 percent. If a stock has a beta 1.25, what is its required rate of return?
a. 13.75 %
b. 11.35 %
c. 14.37 %
d. 15.60 %
kcs =5% + (12%-5%) * 1.25 =13.75%
12. J. Ross and Sons Inc. has a target capital structure that calls for 40 percent debt, 10 percent preferred stock, and 50 percent common equity. The firm's current after‑tax cost of debt is 6 percent, and it can sell as much debt as it wishes at this rate. The firm's preferred stock currently sells for $80 per share and pays a dividend of $10 per share. Ross's common stock currently sells for $40 per share. The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year. What is the firm's weighted average cost of capital (WACC)?
a. 9.5%
b. 10.3%
c. 10.8%
d. 11.4%
kcs =
$40.00
10%)
$2.00(1
+
+ 0.10 = 15.5%.kps =
$80
$10
= 12.5%.WACC= Wd(kd)(1 - T) + wps(kps)+ wce(kce)
= 0.40(0.06) + 0.10(0.125)+ 0.50(0.155)
= 0.024 + 0.0125 + 0.0775
= 0.114 = 11.4%.
13. Forecasting a balance sheet with percent of sales method requires two passesa first pass to determine financing needs and a second pass that shows the sources and amounts of financing.
True
False
14. Which of the following accounts may reasonably be expected to grow with sales:
I Accounts Receivable
II Accounts Payable
III Property, Plant and Equipment
IV Inventory
V Long-Term Debt
a. I, II, and III
b. I, II, and V
c. I, II and IV
d. III and V
15. Calgary Doughnuts had sales of $200 million in 2007. Its cost of sales were $160 million. If sales are expected to grow at 10% in 2008, compute the forecasted costs using the percent of sales method.
a. $160 million
b. $170 million
c. $173 million
d. $176 million
[Method 1]
Next year sales = current sales times (1 + growth rate)
Cost of sales next year = Next year sales × (last year costs / last year sales)
Next year sales = 200 × 1.10 = $220 million;
Cost of sales next year = 220 × 160 / 200 = $176 million
[Method 2]
To keep the cost to sales ratio constant, cost should also grow at 10%
Therefore, cost of sales = 160 × (1+10%) =176
16. Given the following data for a given period, compute the free cash flow to the firm:
Net Income = $10,000
After-tax Interest Expense = $1000
Depreciation = $1000
Increase in NWC = $1000
Capital Expenditures = $2000
a. $9000
b. $9500
c. $9700
d. $9900
Free cash flow = Net income + After-tax interest expense + Depreciation - Increase in NWC - Capital expenditures
Free cash flow = 10,000 + 1000 + 1000 - 1000 - 2000 = $9000
Note that: Net income + After-tax interest expense = Unlevered net income
= EBIT (1-tax rate)
We can employ the discounted FCF model to directly measure a company’s
total firm value
total enterprise value
total equity value
total debt value
18. Several methods should be used to provide an estimate of a stock's value since no single method provides a definitive value.
True
False
Use the table for the question(s) below.
FCF Forecast ($ million)
Year 0 1 2 3 4
Sales 240 270 290 310 325.5
Growth versus Prior Year 12.5% 7.4% 6.9% 5.0%
EBIT (10% of Sales) 27.00 29.00 31.00 32.55
Less: Income Tax (37%) (9.99) 10.73 11.47 12.44
Less Increase in NWC (12% of Change in Sales 3.6 2.4 2.4 1.86
Free Cash Flow 13.41 15.87 17.13 18.65
19. Banco Industries expect sales to grow at a rapid rate over the next three years, but settle to an industry growth rate of 5% in year 4. The spreadsheet above shows a simplified pro forma for Banco Industries. If Banco industries has a weighted average cost of capital of 12%, $50 million in cash, $60 million in debt, and 18 million shares outstanding, which of the following is the best estimate of Banco's stock price at the start of year 1?
a. $6.03
b. $11.12
c. $12.03
d. $20.11
FCF5 = 18.65 × 1.05 = 19.5825; Horizon Value V4 = 19.5825 / (0.12 - 0.05) = 279.75;
using a financial calculator, CF0=0, C01=13.41, C02=15.87, C03=17.13, C04= 18.65+279.75, CPT NPV, I =12, NPV( Enterprise Value V0 = 226.4561;
P0 = (226.4561 + 50 - 60) / 18 = $12.03
20. On a particular date, FedEx has a stock price of $88.66 and an EPS of $6.34. Its competitor, UPS, had an EPS of $0.40. What would be the expected price of UPS stock on this date, if estimated using the method of comparables?
a. $5.59
b. $8.39
c. $10.49
d. $13.98
FedEx P/E = 88.66 / 6.34 = 13.9842; UPS stock price = 13.9842 × 0.40 = $5.59
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Time line:
667
.
17
06
.
0
18
.
0
12
.
2
P
ˆ
3
=
-
=
ADVANCE \l20 rs = 18% 1 2 3 4 Yearsgs = 15% gn = 6%
0
D
0
=
0
D
ˆ
1
=
0
D
ˆ
2
=
00
.
2
D
ˆ
3
=
12
.
2
D
ˆ
4
=
1.217
10.752
97
.
11
$
P
ˆ
0
=
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