How to answer finance exam Q1
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1. Which of the
following is/are an advantage(s) of incorporation?
A) Access to capital
markets
B) Limited liability
C) Unlimited life
D) All of the above
2. Which of the
following statements is false?
A) In bankruptcy,
management is given the opportunity to reorganize the firm and renegotiate with
debt holders.
B) Because a
corporation is a separate legal entity, when it fails to repay its debts, the
people who lent to the firm (the debt holders) are entitled to seize the assets
of the corporation in compensation for the default.
C) As long as the
corporation can satisfy the claims of the debt holders, ownership remains in
the hands of the equity holders.
D) If the corporation
fails to satisfy debt holders’ claims, equity holders may take control of the
firm.
3. Which of the
following is NOT a financial statement that every public company is required by
IFRS to produce?
A) Income Statement
B) Statement of
Comprehensive Income
C) Balance Sheet
D) Statement of
Changes in Equity
4. The P/E ratio is not useful when the firm’s ________ are
negative. In this case, it is common to look at the firm’s ________ relative to
sales.
A) operating
earnings; enterprise value
B) net earnings;
enterprise value
C) operating
earnings; market value
D) net earnings;
market value
5. Consider the following oil prices:
Alaska North Slope Crude Oil (ANS) |
$71.75/Bbl |
West Texas Intermediate Crude Oil (WTI) |
$73.06/Bbl |
As an oil refiner,
you are able to produce $76 worth of unleaded gasoline from one barrel of
Alaska North Slope (ANS) crude oil.
Because of its lower sulfur content, you can produce $77 worth of
unleaded gasoline from one barrel of West Texas Intermediate (WTI) crude.
Another oil refiner
is offering to trade you 10,150 Bbls of Alaska North Slope (ANS) crude oil for
10,000 Bbls of West Texas Intermediate (WTI) crude oil. Assuming you currently
have 10,000 Bbls of WTI crude, the added benefit (cost) to you if you take the
trade is closest to:
A) ($1,400)
B) $1,400
C) ($3,908)
D) $3,908
6. You have an investment opportunity in Germany that requires an
investment of $250,000 today and will produce a cash flow of €208,650 in one
year with no risk. Suppose the risk-free rate of interest in Germany is 6% and
the current competitive exchange rate is €0.78 to $1.00. What is the NPV of
this project? Would you take the project?
A) NPV = 0; No
B) NPV = 2,358; No
C) NPV = 2,358; Yes
D) NPV = 13,650; Yes
7. Consider the following timeline detailing a stream of cash
flows:
If the current market
rate of interest is 6%, then the future value of this stream of cash flows is
closest to:
A) $1,723
B) $1,500
C) $1,626
D) $1,288
8. After many years teaching finance at Capilano University, Allen
wants to establish a scholarship to offer 4 $1,000 awards each year to students
whose performance is excellent in finance courses. If the university can
negotiate a 12.75% effective interest rate, at least how much does Allen need
to endorse over to the scholarship (closest estimate)?
A) $32,000
B) $31,000
C) $31,500
D) $32,500
9. Consider the following investment alternatives:
Investment |
Rate |
Compounding |
A |
6.25% |
Annual |
B |
6.10% |
Daily |
C |
6.125 |
Quarterly |
D |
6.120 |
Monthly |
The highest effective
rate of return you could earn on any of these investments is closest to:
A) 6.250%
B) 6.267%
C) 6.300%
D) 6.320%
10. Which of the following statements is false?
A) The yield curve
changes over time.
B) The formulas for
computing present values of annuities and perpetuities cannot be used in
situations in which cash flows need to be discounted at different rates.
C) We can use the
term structure to compute the present and future values of a risk-free cash
flow over different investment horizons.
D) The yield curve
tends to be inverted as the economy comes out of a recession.
11. The Sisyphean Company has a bond outstanding with a face value
of $1,000 that reaches maturity in 15 years. The bond certificate indicates that
the stated coupon rate for this bond is 8% and that the coupon payments are to
be made semi-annually.
Assuming that this
bond trades for $903, then the YTM for this bond is closest to:
A) 8.0%
B) 6.8%
C) 9.9%
D) 9.2%
12. Consider the following four bonds that pay annual coupons:
Bond |
Years |
Coupon |
YTM |
A |
1 |
0% |
5% |
B |
5 |
6% |
7% |
C |
10 |
10% |
9% |
D |
20 |
0% |
8% |
The percentage change
in the price of the bond “A” if its yield to maturity increases from
5% to 6% is closest to:
A) -4%
B) -6%
C) -1%
D) 4%
13. You expect that Bean Enterprises will have earnings per share
of $2 for the coming year. Bean plans to retain all of its earnings for the
next three years. For the subsequent two years, the firm plans on retaining 50%
of its earnings. It will then retain only 25% of its earnings from that point
forward. Retained earnings will be invested in projects with an expected return
of 20% per year. If Bean’s equity cost of capital is 12%, then the price of a
share of Bean’s stock is closest to:
A) $17.00
B) $10.75
C) $27.75
D) $43.50
14. Defenestration Industries plans to pay a $4.00 dividend this
year and you expect that the firm’s earnings are on track to grow at 5% per
year for the foreseeable future. Defenestration’s equity cost of capital is
13%.
Suppose that
Defenestration decides to pay a dividend of only $2 per share this year and use
the remaining $2 per share to repurchase stock. If Defenestration maintains
this dividend and total payout rate, then the rate at which Defenestration’s
dividends and earnings per share are expected to grow is closest to:
A) 7%
B) 13%
C) 9%
D) 5%
15. Larry the Cucumber has been offered $14 million to star in the
lead role of the next three Larry Boy adventure movies. If Larry takes this
offer, he will have to forgo acting in other Veggie movies that would pay him
$5 million at the end of each of the next three years. Assume Larry’s personal
cost of capital is 10% per year.
The NPV of Larry’s
three-movie Larry Boy offer is closest to:
A) 3.5 million
B) -1.6 million
C) 1.6 million
D) -1.0 million
16. Boulderado has come up with a new composite snowboard. Development will take Boulderado four years
and cost $250,000 per year, with the first of the four equal investments
payable today upon acceptance of the project.
Once in production the snowboard is expected to produce annual cash
flows of $200,000 each year for 10 years.
Boulderado’s discount rate is 10%.
The IRR for
Boulderado’s snowboard project is closest to:
A) 10.4%
B) 10.0%
C) 11.0%
D) 15.1%
17. The Sisyphean Corporation is considering investing in a new
cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the
machine will be depreciated straight line over its three-year life to a residual
value of $0.
The cane
manufacturing machine will result in sales of 2,000 canes in year 1. Sales are estimated to grow by 10% per year
each year through year three. The price
per cane that Sisyphean will charge its customers is $18 each and is to remain
constant. The canes have a cost per unit
to manufacture of $9 each.
Installation of the
machine and the resulting increase in manufacturing capacity will require an
increase in various net working capital accounts. It is estimated that the Sisyphean
Corporation needs to hold 2% of its annual sales in cash, 4% of its annual
sales in accounts receivable, 9% of its annual sales in inventory, and 5% of
its annual sales in accounts payable.
The firm is in the 35% tax bracket, and has a cost of capital of 10%.
The depreciation tax
shield (assuming the half-year rule is not applied for straight-line
depreciation) for the Sisyphean Corporation’s project in the first year is
closest to:
A) $8,000
B) $3,500
C) $2,800
D) $5,200
18. You are considering adding a microbrewery onto one of your
firm’s existing restaurants. This will entail an increase in inventory of
$8,000, an increase in accounts payable of $2,500, and an increase in property,
plant, and equipment of $40,000. All other accounts will remain unchanged. The
change in net working capital resulting from the addition of the microbrewery
is:
A) $45,500
B) $10,500
C) $6,500
D) $5,500
19. Suppose an investment is equally likely to have a 35% return
or a -20% return. The standard deviation on the return for this investment is
closest to:
A) 38.9%
B) 0%
C) 19.4%
D) 27.5%
20. Suppose that in the coming year, you expect Exxon-Mobil stock
to have a volatility of 42% and a beta of 0.9, and Merck’s stock to have a
volatility of 24% and a beta of 1.1. The risk free interest rate is 4% and the
market’s expected return is 12%.
The cost of capital
for a project with the same beta as Exxon Mobil’s stock is closest to:
A) 11.6%
B) 11.2%
C) 12.8%
D) 7.6%
21. Suppose you invest $20,000 by purchasing 200 shares of Abbott
Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and
100 shares of Ball Corporation (BLL) at $40 per share.
Suppose over the next
year Ball has a return of 12.5%, Lowes has a return of 20%, and Abbott Labs has
a return of -10%. The weight of Lowes in your portfolio after one year is
closest to:
A) 20.0%
B) 34.8%
C) 30.0%
D) 36.0%
22. Consider an equally weighted portfolio that contains 100
stocks. If the average volatility of these stocks is 50% and the average
correlation between the stocks is .7, then the volatility of this equally
weighted portfolio is closest to:
A) .72
B) .59
C) .40
D) .50
23. Which of the following statements is false?
A) Investors may have
different information regarding expected returns, correlations, and
volatilities, but they correctly interpret that information and the information
contained in market prices and they adjust their estimates of expected returns
in a rational way.
B) Investors may
learn different information through their own research and observations, but as
long as they understand the differences in information and learn from other
investors by observing prices, the CAPM conclusions still stand.
C) Every investor,
regardless of how much information he has access to, can guarantee himself an
alpha of zero by holding the market portfolio.
D) The CAPM requires
making the strong assumptions of homogeneous expectations.
24. The only way it can be possible to earn a positive alpha and
beat the market is if some investors are holding portfolios with ________
alphas.
A) positive
B) zero
C) negative
D) none of the above
25. Consider the following graph of the security market line:
Which of the
following statements regarding portfolio “C” is/are correct?
1. Portfolio “C” has a negative alpha.
2. Portfolio “C” is overpriced.
3. Portfolio “C” is less risky than
the market portfolio.
4. Portfolio “C” should not exist if
the market portfolio is efficient.
A) 1 and 3
B) 2 and 4
C) 1, 3, and 4
D) 3 only
26. Uninformed individuals tend to ________ the precision of their
knowledge. In finance, we call this presumptuousness the ________ hypothesis.
A) underestimate;
underconfidence
B) overestimate;
overconfidence
C) underestimate;
overconfidence
D) overestimate;
underconfidence
27. Consider a project with free cash flows in one year of $90,000
in a weak economy or $117,000 in a strong economy, with each outcome being
equally likely. The initial investment required for the project is $80,000, and
the project’s cost of capital is 15%. The risk-free interest rate is 5%.
Suppose that to raise
the funds for the initial investment the firm borrows $40,000 at the risk free
rate and issues new equity to cover the remainder. In this situation, the cash
flow that equity holders will receive in one year in a strong economy is
closest to:
A) $117,000
B) $75,000
C) $50,000
D) $0
28. You are evaluating a new project and need an estimate for your
project’s beta. You have identified the following information about three firms
with comparable projects:
Firm Name |
Equity |
Debt |
Debt |
Lincoln |
1.25 |
0 |
0.25 |
Blinkin |
1.6 |
0.2 |
1 |
Nod |
2.3 |
0.3 |
1.5 |
20) The unlevered
beta for Nod is closest to:
A) 1.00
B) 0.90
C) 0.95
D) 1.10
29. Consider the following income statement for Kroger Inc. (all
figures in $ millions):
Year |
2006 |
2005 |
2004 |
Total Sales |
60,553 |
56,434 |
53,791 |
Cost of goods sold |
45,565 |
42,140 |
39,637 |
Selling, general & admin expenses |
11,688 |
12,191 |
11,575 |
Depreciation |
1,265 |
1,256 |
1,209 |
Operating Income |
2,035 |
847 |
1,370 |
Other Income |
0 |
0 |
0 |
EBIT |
2,035 |
847 |
1,370 |
Interest expense |
510 |
557 |
604 |
Earnings before tax |
1,525 |
290 |
766 |
Taxes (35%) |
534 |
102 |
268 |
Net Income |
991 |
189 |
498 |
The interest rate tax
shield for Kroger in 2006 is closest to:
A) $187 million
B) $332 million
C) $534 million
D) $179 million
30. The total amount available to pay out to all the investors in
Kroger in 2006 is closest to:
A) $990 million
B) $1,525 million
C) $1,500 million
D) $2,035 million
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