University of San Carlos School of Business and Economics - Accountancy Department

AC 513 MANAGERIAL FINANCE MID-TERM DEPARTMENTAL REVIEW MATERIAL August 14, 2010 Saturday, 130pm-3pm
80 Numbers: 1.5 Hours; n x 2; Number of Pages: 13
Mid-Term Topics/Chapters Covered:

ALL MULTIPLE-CHOICE ENTRIES

Risk and Rates of Return (Chapter 5); Time Value of Money (Chapter 6); Valuation of Bonds (Chapter 7); Stocks and Their Valuation (Chapter 8); and, Cost of Capital (Chapter 9)
May the Greatest Force Be With Yougo!

A. RISK AND RATES OF RETURN 1. Consider the following information of two possible investments:
The first investment is a Treasury bill, a government security that matures in 90 days and promises to pay an annual return of 8 percent. The second investment involves the purchase of the stock of a local publishing company. Looking at the past returns of the firms stock, we have made the following estimate of the annual returns from the investment: Chance of Occurrence 1 2 4 2 1 chance in 10 (10%) chances in 10 (20%) chances in 10 (40%) chances in 10 (20%) chance in 10 (10%) Rate of Return on Investment 0% 5% 15% 25% 30%

From the above, the following statements are given: I. Investing in the publishing company could conceivably provide a return as high as 30 percent if all goes well or no return (zero percent) if everything goes against the firm. II. In the future years, we could expect a 15 percent return on average. III. In the future years, we could expect a 25 percent return on average. IV. Comparing the T-bill investment with the publishing company investment, we see that the T-bills offer an expected 8 percent rate of return of 15 percent. However, our investment in the publishing company firm is clearly more risky that is, there is greater variation or dispersion of possible returns, implying greater risk. V. Comparing the T-bill investment with the publishing company investment, we see that the T-bills offer an expected 8 percent rate of return of 25 percent. However, our investment in the publishing company firm is clearly less risky that is, there is lesser variation or dispersion of possible returns, implying low risk. From among the statements given, choose from below your best answer: a. Only I and II are correct statements. c. Only I and III are correct statements. b. Only I, II, and III are correct statements. d. Only I, II, and IV are correct statements. e. Only III and V are correct statements. 2. From #1, for the publishing company, the standard deviation is: a. 8.89% c. 9.22% b. 8.67% d. 9.58% e. 10.15% Based from #1 and #2, the actual returns for the publishing company, can reasonably be anticipated to fall between: a. 15.78% and 33.89% (k + ) c. 5.78% and 24.22% (k + ) b. 16.33% and 33.67% (k + ) d. 5.42% and 24.58% (k + ) e. 14.85% and 35.15% (k + )

3.

(The following data apply to number 4:) You are given the following information:

AC 513 MANAGERIAL FINANCE Mid-Term Departmental Examination/USC-Accountancy Department, August 8, 2012

Year Stock N Market 1 -5% 10% 2 -8% 15% 3 7 -10 The risk-free rate is equal to 7 percent, and the market required return is equal to 10 percent. 4. Stock Ns beta coefficient and required rate of return are:? a. 1.00; 5.90% respectively b.-0.60; 5.20% respectively c. 0.60; 6.40% respectively d. -0.75; 8.80% respectively e. -0.50; 6.40% respectively

5. Stock Y, Stock Z, and the Market had the following rates of return during the last 4 years:
Y Z Market 2006 10.0% 10.0% 10.0% 2007 16.0 11.5 13.5 2008 -7.50 1.0 -4.0 2009 0.0 6.0 5.5 The expected future return on the market is 15 percent, the real risk-free rate is 3.75 percent, and the expected inflation rate is a constant 5 percent. If the market risk premium rises by 3 percentage points, what will be the change in the required rate of return of the riskier stock? Per regression analysis, by =1.3374 and bz =0.6161. a. b. 4.01% 3.67% c. 4.88% d. 3.23% e. 4.66%

6. Listed firm, Aquaculture security has an expected return of 5.5 percent, a standard deviation of expected

returns of 32.89 percent, a correlation coefficient with the market of -0.3, and a beta coefficient of -0.5. Another listed telecom, Benpres security has an expected return of 9.15 percent, a standard deviation of returns of 9 percent, a correlation with the market of 0.7, and a beta coefficient of 1.0. Based on these information, one of the following statements is most rationalized:
a. Aquaculture is less risky if held in a diversified portfolio because of its negative correlation with other stocks. In a single-asset portfolio, Aquaculture Security would be more risky because Agri > Bayan and CVAgri > CVBayan. c. Aquaculture is less risky if held in isolation because of its negative correlation with other stocks. In a diversified portfolio, Aquaculture Security would be more risky because Agri > Bayan and CVAgri > CVBayan. Aquaculture is less risky if held in a diversified portfolio because of its negative correlation with other stocks. In a single-asset portfolio, Aquaculture Security would be more risky because Agri > Bayan and CVAgri > CVBayan. Aquaculture is less risky if held in a diversified portfolio because of its negative correlation with other stocks. In a single-asset portfolio, Aquaculture Security would be more risky because Agri > Bayan and CVAgri > CVBayan.

b. Aquaculture is more risky if held as a single security because of its negative correlation with other stocks. However, in a diversified portfolio, Aquaculture Security would likewise be significantly risky because Agri > Bayan and CVAgri > CVBayan.

d.

e.

7.

The expected return can equate with the risk-free rate, in a situation where the portfolio of stocks is constructed, if:
a. and when, the portfolios beta is negative. Given that the portfolio is constructed, part of the expected return is being negated by the negative beta effect to equate with the risk-free rate. b. the portfolios beta is equal to zero. It may be impossible to find individual stocks that have a nonpositive beta, and so it would also be impossible to have a stock portfolio with a zero beta. c. the portfolios beta is nonpositive. Given that the portfolio is constructed, part of the expected return is being held constant by the nonpositive beta effect to equate with the risk-free rate.

d. and when, the portfolios beta is generally constant. In this case, equating the RF returns with the expected return is just possible in a situation where the portfolio is constructed.

Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

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e. answer not given

8. A security had a 14 percent return last year, of which same period, the overall stock market declined in value.
Does this mean that the stock has a negative beta? a. Yes. For a stock to have a negative beta, its returns would have to logically be expected to go down in the future in correlation with the falling of other stocks returns. Yes. For a stock to have a negative beta, its returns would have to logically be expected to go down in the future. c. No. However, the negation of the beta is generally dependent on the overall inclination of the portfolio.

b.

d. No. For a stock to have a negative beta, its returns would have to logically be expected to go up in the future when other stocks returns were falling. A stock in a given year may move counter to the overall market, even though the stocks beta is positive. e. Answer not given.

9. The investors required rate of return can be defined as the minimum rate of return necessary to attract an
investor to purchase or hold a security. I. II. III. IV. V. The above definition considers the investors opportunity cost of making an investment; that is, if an investment is made, the investor must forego the return available from the next best investment. The investment will be made only if the purchase price is high enough relative to expected future cash flows to provide a rate of return greater than or equal to the required rate of return. The foregone return, basing from the opening statement, is an opportunity cost of undertaking the investment and consequently is the investors required rate of return. The opening statement, means that we invest with the intention of achieving a rate of return sufficient to warrant making the investment. The risk-free rate of return embedded in the required rate of return does not consider rewards for deferring consumption, but only assumes the risk; that is, the risk-free return reflects the basic fact that we invest today with no regard as to our consumption later. c. Only Statements II and V are false or incorrect. d. All statements, except statement V, are true and correct. e. Only statement II is incorrect and false.

a. Statements I, II and IV are correct. b. Statements II, III, IV, and V are true.

Here are returns and standard deviations for four investments (for Questions 10 and 11): Return Standard Deviation Treasury bills 6% 0% Stock P 10% 14% Stock Q 14.5% 28% Stock R 21.0% 26% 10. Based on the above information, calculate the standard deviations of the following portfolios: a. 50 percent in Treasury bills, 50 percent in stock P. b. 50 percent each in Q and R, assuming the shares have perfect positive correlation Perfect negative correlation No correlation Respectively, the standard deviations (questions a and b) are: a. a=7%; b=27% b. a=9%; b=30% c. a=7%; b=30% d. a=9%; b=27% e. a=9%; b=31%

11. Under same given information (in number 10 above), at 50 percent each in Q and R, (i) assuming the shares
have perfect negative correlation, and, (ii) assuming the shares have no correlation, the standard deviations, respectively are: a. 2.01% with perfect negative correlation; 21.83% with no correlation

c. 1% with perfect negative correlation; 21.83% with no correlation Page 3 of 13

Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

AC 513 MANAGERIAL FINANCE Mid-Term Departmental Examination/USC-Accountancy Department, August 8, 2012

b. 2.01% with perfect negative correlation; 19.1% with no correlation

d. 1.55% with perfect negative correlation; 19.1% with no correlation e. 1.0% with perfect negative correlation; 19.1% with no correlation

12. For each of the following pairs of investments, state which would always be preferred by a rational investor (assuming that these are the only investments available to the investor):
a. Portfolio A Portfolio B b. Portfolio C Portfolio D c. Portfolio E Portfolio F k k k k k k = = = = = = 18 14 15 13 14 14 percent percent percent percent percent percent = = = = = = 20 percent 20 percent 18 percent 8 percent 16 percent 10 percent

Respectively, (a, b and c), the rational investor would prefer the following portfolios, assuming these are the only investments available to this investor: a. a=Portfolio A; b = cannot say; and c = c. a=Portfolio A; b = cannot say; and c = Portfolio F Portfolio F b. a=Portfolio A; b = cannot say; and c = d. a=Portfolio A; b = cannot say; and c = Portfolio F Portfolio F e. answer not given The following beta table is reference for the next two questions: Stock Beta (b) Amazon.com Dell Microsoft Ford GE Reebok ExxonMobil Pfizer Coca-Cola Heinz 2.22 1.77 1.70 1.35 1.08 .46 .40 .38 .28 .28

Expected Return [kRF + b (kM- kRF)] 16.5% 13.4% 12.9% 10.5% 8.6% 4.2% 3.8% 3.7% 3.0% 3.0%

(Note: These estimates of the returns expected by investors in March 2008 were based on the capital asset pricing model or CAPM. We assumed 1 percent for the interest rate, and 7 percent for the expected risk premium, kMkRF.)

Suppose that the Treasury bill rate is 4 percent and the expected return on the market is 10percent. Use the betas in the given beta table. 13. The expected return from Microsoft is: a. 14.92% b. 13.74% c. 13.05% d. 14.20% e. 15%

14. From the same given Beta table above, the highest and lowest expected returns that are offered by one of these
stocks are, respectively: a. Dell @ 18.5%; Coca-Cola @ 5.3% b. Dell @ 17.94%; Heinz @ 5.7% c. Amazon @ 17.3%; Heinz @ 5.7% d. Amazon @ 17.3%; Coca-Cola @ 5.3% e. answer not given

For numbers 16, 17 and 18: Solar Designs is considering an investment in an expanded product line. Two possible types of expansion are being considered. After investigating the possible outcomes, the company made the estimates shown in the following table:i Expansion A $12,000 16% 20% 24% Expansion B $12,000 10% 20% 30% Page 4 of 13

Initial Investment Annual rate of return Pessimistic Most likely Optimistic

Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

AC 513 MANAGERIAL FINANCE Mid-Term Departmental Examination/USC-Accountancy Department, August 8, 2012

15. From the above given information of Solar, determine the range of rates of return for each of the two projects. a. Expansion A: 20%; Expansion B: 20% b. Expansion A: 8%; Expansion B: 20% c. Expansion A: 4%; Expansion B: 10% d. Expansion A: 14%; Expansion B: 20% e. Expansion A: 24%; Expansion B: 30%

16. Which project is less risky? Why? a. Project B is less risky @ pessismistic condition. b. Project A is less risky @ optimistic condition. c. Project B is less risky based on the range of outcomes. d. Project A is less risky based on the range of outcomes. e. Cannot be determined

17. If you were making the investment decision, which one would you choose? Why? a. Expansion A, because the weighted average of the range of returns is higher than Expansion B. b. Expansion B, because the weighted average of the range of returns is higher than Expansion B. c. Expansion B, because the returns at riskiest situation is the highest at 30%. d. Any of projects A and B is a rational decision because both has the same average returns of 20% on the average. e. Since the most likely return for both projects is 20% and the initial investments are equal, the answer depends on your risk preference.

18. Inflation, recession, and high interest rates are economic events that are characterized as a. Company-specific risk that can be diversified away. b. Market risk. c. Systematic risk that can be diversified away. d. Diversifiable risk. e. Unsystematic risk that can be diversified away.

19. Historical rates of return for the market and for Stock A are given below: Year 1 2 3 4 Market 6.0% -8.0 -8.0 18.0 Stock A 8.0% 3.0 -2.0 12.0

If the required return on the market is 11 percent and the risk-free rate is 6 percent, what is the required return on Stock A, according to CAPM/SML theory? a. 6.00% b. 6.57% c. 7.25% d. 7.79% e. 8.27%

20. Currently, the risk-free rate, kRF, is 5 percent and the required return on the market, kM, is 11 percent. Your portfolio has a required rate of return of 9 percent. Your sister has a portfolio with a beta that is twice the beta of your portfolio. What is the required rate of return on your sisters portfolio? a. 12.0% b. 12.5% c. 13.0% d. 17.0% e. 18.0%

21. Here are the expected returns on two stocks: Probability 0.1 0.8 0.1 Returns X Y -20% 10% 20 15 40 20

Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

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AC 513 MANAGERIAL FINANCE Mid-Term Departmental Examination/USC-Accountancy Department, August 8, 2012

If you form a 50-50 portfolio of the two stocks, what is the portfolios standard deviation? a. 8.1% b. 10.5% c. 13.4% d. 16.5% e. 20.0%

22. .An analyst has estimated how a particular stocks return will vary depending on what will happen to the economy: Stocks Expected Probability of State Occurring 0.10 0.20 0.40 0.20 0.10

State of the Economy Recession Below average Average Above average Boom

Return if this State Occurs -60% -10 15 40 90

What is the coefficient of variation on the companys stock? a. 2.121 c. 2.472 b. 2.201 d. 3.334 e. 3.727

B. TIME VALUE OF MONEY

23. An investment pays $100 every six months (semiannually) over the next 2.5 years. Interest, however, is compounded quarterly, at a nominal rate of 8 percent. What is the future value of the investment after 2.5 years? a. $520.61 c. $542.07 d. $541.63 d. $543.98 e. $547.49 24. Today is your 21st birthday, and you are opening up an investment account. Your plan is to contribute $2,000 per year on your birthday and the first contribution will be made today. Your 45 th, and final, contribution will be made on your 65th birthday. If you earn 10 percent a year on your investments, how much money will you have in the account on your 65th birthday, immediately after making your final contribution? a. $1,581,590.64 b. $1,739,749.71 a. d. e. $1,579,590.64 $1,387,809.67 $1,437,809.67

25. Foster Industries has a project that has the following cash flows: Year 0 1 2 3 4 Cash Flow -$300.00 100.00 125.43 90.12 ?

What cash flow will the project have to generate in the fourth year in order for the project to have a 15 percent rate of return? a. $15.55 c. $100.25 b. $58.95 d. $103.10 e. $150.75 26. If you buy a factory for $250,000 and the terms are 20 percent down, the balance to be paid off over 30 years at a 12 percent rate of interest on the unpaid balance, what are the 30 equal annual payments? a. $20,593 b. $31,036 c. $24,829 d. $50,212 e. $ 6,667

Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

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AC 513 MANAGERIAL FINANCE Mid-Term Departmental Examination/USC-Accountancy Department, August 8, 2012

27. An investment pays you $5,000 at the end of each of the next five years. Your plan is to invest the money in an account that pays 8 percent interest, compounded monthly. How much will you have in the account after receiving the final $5,000 payment in 5 years (60 months)? a. $ 25,335.56 b. $ 29,508.98 c. $367,384.28 d. $304,969.90 e. $ 25,348.23

28. Madonna has currently P500,000 in her account and she plans to contribute additional P150,000 to the account at the end of every year. The account has an expected annual return of 10 percent. If Madonnas goal is to accumulate P5 Million in the account, how many years will it take for Madonna to reach her goal? For an investment to grow eightfold in nine year, at what rate would it have to grow? a. 22.87 or 23 years b. 24.06 or 24 years c. 23.75 or 24 years d. 25.91 or 26 yrs e. answer not given

29. To what amount will the following investments accumulate? a. $5,000 invested for 10 years at 10 percent compounded annually; and, b. $775 invested for 12 years at 12 percent at 12 percent compounded annually a. a=10,320; b=1,449.29 b. a=11,087; b=1,929.15 c. a=12,970; b=3,019.40 d. a=13,568; b=3,683.75 e. answer not given

30. In future value or present value problems, unless stated otherwise, cash flows are assumed to be a. at the end of a time period b. at the beginning of a time period c. in the middle of a time period d. spread out evenly over a time period e. answer not given

31. When the amount earned on a deposit has become part of the principal at the end of a specified time period the concept is called a. discount interest b. compound interest c. primary interest d. future value e. answer not given

32. True or False: Everything else being equal, the longer the period of time, the lower the present value. a. False b. True c. it depends d. not sure e. am lost

33. True or False: In general, with an amortized loan, the payment amount remains constant over the life of the loan, the principal portion of each payment grows over the life of the loan, and the interest portion of each payment declines over the life of the loan. a. False c. it depends b. True d. not sure e. am lost again 34. True or False: In general, with an amortized loan, the payment amount remains constant over the life of the loan, the principal portion of each payment declines over the life of the loan, and the interest portion declines over the life of the loan. a. False b. True c. it depends d. not sure e. need help this time

35. If the interest rate is zero, the future value interest factor equals_________. a. -1.0 b. 0.0 c. 1.0 d. 2.0 e. 1.0 or -1.0 Page 7 of 13

Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

AC 513 MANAGERIAL FINANCE Mid-Term Departmental Examination/USC-Accountancy Department, August 8, 2012

36. The rate of interest actually paid or earned, also called the annual percentage rate (APR), is the _________ interest rate. a. effective b. nominal c. discounted d. continuous e. answer not given

C. BONDS AND THEIR VALUATION

37. A Treasury bond has an 8 percent annual coupon and a yield to maturity equal to 7.5 percent. Which of the following statements is most correct? a. The bond has a current yield greater than 8 c. If the yield to maturity remains constant, the price percent. of the bond is expected to fall over time. b. The bond sells at a price above par. d. Statements b and c are correct. e. All of the statements above are correct. 38. Which of the following statements is most correct? a. If a bond sells for less than par, then its yield to maturity is less than its coupon rate.

c. Assuming that both bonds are held to maturity and are of equal risk, a bond selling for more than par with 10 years to maturity will have a lower current yield and higher capital gain relative to a bond that sells at par. d. Statements a and c are correct. e. None of the statements above is correct.

b. If a bond sells at par, then its current yield will be less than its yield to maturity.

39. Delta Corporation has a bond issue outstanding with an annual coupon rate of 7 percent and 4 years remaining until maturity. The par value of the bond is $1,000. Determine the current value of the bond if present market conditions justify a 14 percent required rate of return. The bond pays interest annually. a. $1,126.42 c. $796.04 b. $1,000.00 d. $791.00 e. $536.38 40. Refer to question 39. Suppose the bond had a semiannual coupon. Now what would be its current value? a. $1,126.42 c. $796.06 b. $1,000.00 d. $791.00 e. $536.38 41. Refer to Question 39. Assume an annual coupon but 20 years remaining to maturity. What is the current value under these conditions? a. $1,126.42 c. $796.06 b. $1,000.00 d. $791.00 e. $536.38 42. Refer to Question 39. What is the bonds current yield? a. 8.8% c. 7% b. 13.05% d. 11.82% e. answer not given 43. A 10-year bond with a 9 percent annual coupon has a yield to maturity of 8 percent. Which of the following statements is most correct? a. The bond is selling at a discount. b. The bonds current yield is greater than 9 percent. c. If the yield to maturity remains constant, the bonds price one year from now will be lower than its current price. 44. Which of the following statements is most correct? a. The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A must have a higher yield to maturity than Bond B. b. If a bond is selling at a discount, the yield to call is a d. Statements a and b are correct. e. Statements b and c are correct. Page 8 of 13 d. Statements a and b are correct. e. None of the statements above are correct.

Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

AC 513 MANAGERIAL FINANCE Mid-Term Departmental Examination/USC-Accountancy Department, August 8, 2012

better measure of return than the yield to maturity. c. If a coupon bond is selling at par, its current yield equals its yield to maturity. 45. A 20-year bond with a par value of $1,000 has a 9 percent annual coupon. The bond currently sells for $925. If the bonds yield to maturity remains at its current rate, what will be the price of the bond 5 years from now? a. $966.79 c. $1,090.00 b. $831.35 d. $933.09 e. $925.00 46. Consider a $1,000 par value bond with a 7 percent annual coupon. The bond pays interest annually. There are 9 years remaining until maturity. What is the current yield on the bond assuming that the required return on the bond is 10 percent? a. 10.00% c. 7.00% b. 8.46% d. 8.52% e. 8.37% 47. A bond with a face value of $1,000 matures in 12 years and has a 9 percent semiannual coupon. (That is, the bond pays a $45 coupon every six months.) The bond has a nominal yield to maturity of 7.5 percent, and it can be called in 4 years at a call pric e of $1,045. What is the bonds nominal yield to call? a. 6.61% c. 3.31% b. 11.36% d. 9.98% e. 5.68%

D. STOCKS AND THEIR VALUATION

48. Stability Inc. has maintained a dividend rate of $4 per share for many years. The same rate is expected to be paid in future years. If investors require a 12% rate of return on similar investments, determine the present value of the companys stock. a. $15.00 c. $33.33 b. $30.00 d. $35.00 e. $40.00 49. Your associate, a stockholder at Invest Inc., is trying to sell you a stock with a current market price of $25. The stocks last dividend (D0) was $2.00, and earnings and dividends are expected to increase at a constant rate of 10%. Your required return on this stock is 20%. From a strict valuation standpoint, you should: a. Buy the stock: it is fairly valued. c. Buy the stock; it is undervalued by $2.00 b. Buy the stock; it is undervalued by d. Not buy the stock; it is overvalued by $3.00 $2.00 e. Not buy the stock; it is overvalued by $3.00 50. Prime Care Labs last dividend was $1.50. Its current equilibrium stock price is $15.75, and its expected growth rate is a constant 5%. If the stockholders required rate of return is 15%, what is the expected dividend yield and expected capital gains yield for the coming year? a. 0%; 15% c. 10%; 5% b. 5%; 10% d. 15%; 0% e. 15%; 15% 51. The Canning Company has been hard hit by increased competition. Analysts predict that earnings (and dividend) will decline at a rate of 5% annually into foreseeable future. If Cannings last dividend (D0) was $2.00, and investors required rate of return is 15%, what will be Cannings stock price in 3 years? a. $8.15 c. $10.00 b. $9.50 d. $10.42 e. $10.96 52. Johnson Corporations stock is currently selling at $45.83 per share. The last dividend paid was $2.50. Johnson is a constant growth firm. If investors require a return of 16% on Johnsons stock, what do they think Johnsons growth rate will be? a. 6% c. 8% b. 7% d. 9%
Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

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AC 513 MANAGERIAL FINANCE Mid-Term Departmental Examination/USC-Accountancy Department, August 8, 2012

e. 10% 53. Vogue Magazine is expected to pay a $0.45 per share dividend at the end of the year. The dividend is expected to grow at a constant rate of 5 percent a year. The required rate of return on the stock, ks, is 12 percent. What is the value per share of the companys stock? a. 6.43 b. 3.75 c. 9.00 d. 7.15 e. answer not given

Questions 54 and 55 pertain to the following information: Dora Films recently paid a dividend, Do, of $1.50. The company expects to have supernormal growth of 15 percent for 3 years before the dividend is expected to grow at a constant rate of 7 percent. The firms cost of equity is 10 percent. 54. From the given data, the terminal or horizon date and corresponding horizon or terminal value are: a. before the 3rd year; w/ terminal value of 75.61 b. before the 3rd year; w/ terminal value of 70.62 c. end of 3 years; with terminal value of 70.62 d. end of 3 years; with terminal value of 75.61 e. answer not given

55. The firms intrinsic value is: (to the nearest decimal) a. 60.02 c. 66.05 b. 80.41 d. 78.82 e. answer not given Tamara Jeans Corp. presented the companys expected financial highlights: After-tax EBIT for 2010 is expected to be P30 M Depreciation expense for 2010 is expected to be P7.5 M Capital expenditures for 2010 is expected to be P9.0 M Net operating working capital will remain the same. The companys FCF is expected to grow at a constant rate of 5 percent per year. The companys cost of equity is 14 percent. WACC is 10 percent Market value of companys debt is P126.67M The company has 10 M shares outstanding 56. Using the FCF approach, what should be the companys stock price today? to the nearest decimal a. 40/share c. 44.33/share b. 18/share d. 19.25/share e. answer not given 57. Because of the global recession, sales are decreasing in value, while costs are depleting the scarce resources of Franks Geo Corp. The companys earnings and dividends are declining at a constant rate of 3 percent per year. Do=$7 and ks=12%, what is the value of Franks Geos stock? a. 45.27 c. 80.11 b. 75.44 d. 48.07 e. answer not given 58. A share of preferred stock pays a quarterly dividend of $2.50. If the price of this preferred stock is currently $50, what is the nominal annual rate of return? a. 12% c. 20% b. 18% d. 23% e. 28% 59. The last dividend paid by Klein Company was $1.00. Kleins growth rate is expected to be a constant 5 percent for 2 years, after which dividends are expected to grow at a rate of 10 percent forever. Kleins required rate of return on equity (ks) is 12 percent. What is the current price of Kleins common stock? a. $21.00 c. $42.25 b. $33.33 d. $50.16 e. $58.75

Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

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AC 513 MANAGERIAL FINANCE Mid-Term Departmental Examination/USC-Accountancy Department, August 8, 2012

60. An analyst estimating the intrinsic value of the Rein Corporation stock estimates that its free cash flow at the end of the year (t = 1) will be $300 million. The analyst estimates that the firms free cash flow will grow at a constant rate of 7 percent a year, and that the companys weighted average cost of capital is 11 percent. The company currently has debt and preferred stock totaling $500 million. There are 150 million outstanding shares of common stock. What is the intrinsic value (per share) of the companys stock? a. $16.67 b. $25.00 c. $33.33 d. $46.67 e. $50.00

61. A share of stock has a dividend of D0 = $5. The dividend is expected to grow at a 20 percent annual rate for the next 10 years, then at a 15 percent rate for 10 more years, and then at a long-run normal growth rate of 10 percent forever. If investors require a 10 percent return on this stock, what is its current price? a. $100.00 c. $195.50 b. $ 82.35 d. $212.62 e. answer not given 62. A stock is expected to pay a $0.45 dividend at the end of the year (D1 = 0.45). The dividend is expected to grow at a constant rate of 4 percent a year, and the stocks required rate of return is 11 percent. What is the expected price of the stock 10 years from today? a. $18.25 c. $ 9.15 b. $9.52 d. $ 6.02 e. $12.65 63. A stock expects to pay a year-end dividend of $2.00 a share (D1 = $2.00). The dividend is expected to fall 5 percent a year, forever (g = -5%). The companys expected and required rate of return is 15 percent. Which of the following statements is most correct? a. The companys stock price is $10. c. The companys stock price 5 years from now is expected to be $7.74. b. The companys expected dividend yield 5 years d. Statements b and c are correct from now will be 20 percent. e. All of the statements above are correct. 64. Which of the following statements is most correct? a. If a market is strong-form efficient this implies that the returns on bonds and stocks should be identical. b. If a market is weak-form efficient this implies that all public information is rapidly incorporated into market prices. If your uncle earns a return higher than the overall stock market, this means the stock market is inefficient. d. Statements a and b are correct. e. None of the above statements is correct. c.

E. COST OF CAPITAL
65. Given: a.) Internally-generated common, ks, totaling $4.8 million. The price of the common stock is $75 per share, and the dividends per share were $9.80 last year. These dividends are not expected to increase; and, b.) New common stock, ke, where the most recent dividend was $2.80. The companys dividends per share should continue to increase at an 8 percent growth rate into the definite future. The market price of the stock is currently $53; however, flotation costs of $6 per share are expected if the new stock is issued. Calculate the individual costs of capital of the above financing plan. a. ks = 12.82%; ke = 14.43% c. ks = 13.07%; ke = 15.91% b. ks = 13.07%; ke = 16.57% d. ks = 13.07%; ke = 14.43% e. ks = 12.82%; ke = 13.84% 66. Jolie Company has the following capital structure mix: Debt 30% Preferred stock 15% Common stock 55% 100%

Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

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AC 513 MANAGERIAL FINANCE Mid-Term Departmental Examination/USC-Accountancy Department, August 8, 2012

Assuming that management intends to maintain the above financial structure, what amount of total investments may be financed if the firm uses: (a) $100,000 of debt, (b) $150,000 of debt, (c) $40,000 of preferred stock, (d) $90,000 of preferred stock, (e) $200,000 of internally-generated common equity, (f) $200,000 of internallygenerated common equity plus $300,000 in new common stock? a. a=333,333.33; b=500,000.00; c=266,6666.67; d=600,000.00; e=363,636.36; f=909,090.91 b. a=333,333.33; b=500,000.00; c=266,6666.67; d=600,000.00; e=363,636.36; f= 363,636.36 c. a=333,333.33; b=500,000.00; c=266,6666.67; d=600,000.00; e=363,636.36; f=909,090.91 d. a=333,333.33; b=500,000.00; c=266,6666.67; d=600,000.00; e=363,636.36; f=909,090.91 e. none of the above

67. Compute the cost of capital of the following financing costs: a.) A bond that has a $1,000 par value (face value) and a contract or coupon interest rate of 11 percent. A new issue would have a flotation cost of 5 percent of the $1,125 market value. The bonds mature in 10 years. The firms average tax rate is 30 percent and its margin al tax rate is 34 percent; b.) A new common stock issue paid a $1.80 dividend last year. The par value of the stock is $15, and earnings per share have grown at a rate of 7 percent per year. This growth rate is expected to continue into the foreseeable future. The company maintains a constant dividend/earnings ratio of 30 percent. The price of this stock is now $27.50, but 5 percent flotation costs are anticipated. a. a=kd = 6.53%; b = ke = 14.37% c. a= kd = 5.31%; b = ke = 14.37% b. a= kd = 6.53%; b = ke = 13.89% d. a= kd = 7.09%; b = ke = 14.37% e. answer not given 68. Campbell Co. is trying to estimate its weighted average cost of capital (WACC). Which of the following statements is most correct? a. The after-tax cost of debt is generally cheaper than c. If the companys beta increases, this will increase the the after-tax cost of preferred stock. cost of equity financing, even if the company is able to rely on only retained earnings for its equity financing. b. Since retained earnings are readily available, the cost d. Statements a and b are correct. of retained earnings is generally lower than the cost of debt. e. Statements a and c are correct. 69. Wyden Brothers has no retained earnings. The company uses the CAPM to calculate the cost of equity capital. The companys capital structure consists of common stock, preferred stock, and debt. Which of the following events will reduce the companys WACC? a. A reduction in the market risk premium. c. An increase in the companys beta. b. An increase in the flotation costs associated with d. An increase in expected inflation. issuing new common stock. e. An increase in the flotation costs associated with issuing preferred stock. 70. Which of the following actions will increase the retained earnings break point? a. An increase in the dividend payout ratio. c. An increase in the capital budget. b. An increase in the debt ratio. d. An increase in flotation costs. e. All of the statements above are correct.

71. Billick Brothers is estimating its WACC. The company has collected the following information: Its capital structure consists of 40 percent debt and 60 percent common equity. The company has 20-year bonds outstanding with a 9 percent annual coupon that are trading at par. The companys tax rate is 40 percent. The risk-free rate is 5.5 percent. The market risk premium is 5 percent. The stocks beta is 1.4. What is the companys WACC? a. 9.71% c. 8.31% b. 9.66% d. 11.18% e. 11.10%

72. The common stock of Anthony Steel has a beta of 1.20. The risk-free rate is 5 percent and the market risk premium (kM kRF) is 6 percent. Assume the firm will be able to use retained earnings to fund the equity portion of its capital budget. What is the companys cost of retained earnings, ks?
Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

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AC 513 MANAGERIAL FINANCE Mid-Term Departmental Examination/USC-Accountancy Department, August 8, 2012

a. 7.0% b. 7.2%

c. 11.0% d. 12.2% e. 12.4%

73. A company just paid a $2.00 per share dividend on its common stock (D0 = $2.00). The dividend is expected to grow at a constant rate of 7 percent per year. The stock currently sells for $42 a share. If the company issues additional stock, it must pay its investment banker a flotation cost of $1.00 per share. What is the cost of external equity, ke? a. 11.76% c. 11.98% b. 11.88% d. 12.22% e. 12.30% 74. Johnson Industries finances its projects with 40 percent debt, 10 percent preferred stock, and 50 percent common stock. The company can issue bonds at a yield to maturity of 8.4 percent. The cost of preferred stock is 9 percent. The risk-free rate is 6.57 percent. The market risk premium is 5 percent. Johnson Industries beta is equal to 1.3. Assume that the firm will be able to use retained earnings to fund the equity portion of its capital budget. The companys tax rate is 30 percent.

What is the companys weighted average cost of capital (WACC)? a. 8.33% c. 9.79% b. 8.95% d. 10.92% e. 13.15% 75. If a corporation has an average tax rate of 40 percent, the approximate annual, after-tax cost of debt for a 10year, 8 percent, $1,000 par value bond selling at $1,150 is a. 3.6% b. 4.8% c. 6% d. 8% e. answer not given

76. Using the capital asset pricing model, the cost of common stock equity is the return required by investors as compensation for a. The specific risk of the firm b. The firms diversifiable risk c. pricew volatility of the stock. d. the firms nondiversifiable risk e. answer not given

77. The cost of capital can be thought of as the rate of return required by the market suppliers of capital in order to attract their funds to the firm. a. TRUE b. FALSE c. it depends d. not sure e. need help!

78. Holding risk constant, the implementation of projects with a rate of return above the cost of capital will decrease the value of the firm, and vice versa. a. TRUE c. it depends b. FALSE d. not sure e. need help! 79. In general, floatation costs include two components, underwriting costs and administrative costs. a. TRUE c. it depends b. FALSE d. not sure e. need help! 80. CONGRATULATIONS!!!! - answer is a

The End!
Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

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AC 513 MANAGERIAL FINANCE Mid-Term Departmental Examination/USC-Accountancy Department, August 8, 2012

Examiner: GraceSocorroLarcea-Yomo-Accountancy Dept/USC/MT Departmental Examination/Aug. 14-2010

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