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Corporate Financial Management Practice Mid-Semester Examination (Answers at back)

Disclaimer: This practice exam covers a selection of the types of questions that may be asked in the mid-semester exam, however it should not be taken as being exhaustive as to the topics that could be included in the exam. Students should therefore not be surprised if other types of questions appear in the exam. 1. $200 invested today and earning 8 per cent per annum compounded semi-annually will grow to what amount at the end of three years? (A) (B) (C) (D) 2. $158.80 $251.94 $380.75 $253.06

Bill plans to fund his individual retirement account with the maximum contribution of $2,000 at the end of each year for the next 20 years. If Bill can earn an effective return of 12 per cent per annum on his contributions, how much will he have accumulated at the end of twenty years, rounded to the nearest dollar? (A) (B) (C) (D) $14,938 $19,292 $144,105 $40,000

3.

The present value of $100 to be received 10 years from today, assuming an effective annual return of 9 per cent, is (A) (B) (C) (D) $75.64 $42.24 $699.13 $236.10

4.

Given an effective annual interest rate of 14 per cent, the present value of a perpetuity consisting of yearly payments of $25,000 starting immediately is, rounded to the nearest dollar (A) (B) (C) (D) $232,071 $203,571 $178,571 $156,641

5.

If the present value of a perpetual income stream is increasing, the discount rate must be (A) (B) (C) (D) increasing decreasing increasing proportionally changing unpredictably

6.

Janice would like to send her parents on a cruise for their 25th wedding anniversary. She has priced the cruise at $15,000 and she has 5 years to accumulate this money. To the nearest dollar, how much must Janice deposit annually in an account paying interest of 10 per cent per annum compounded annually in order to have enough money to send her parents on the cruise, assuming the first deposit is to be made one year from now? (A) (B) (C) (D) $2,457 $3,000 $2,234 $1,862

7.

Marla borrows $4,500 and repays the loan with four equal quarterly installments, with the first installment made 3 months after the loan is made. If interest is charged at a rate of 12 per cent per annum compounded quarterly, the quarterly installment is (A) (B) (C) (D) $1,107.89 $1,075.62 $1,210.62 $1,246.94

8.

A ski chalet in Aspen now costs $25,000. Inflation is expected to cause this price to increase at 5 per cent per year over the next 10 years before Barbara and Phil retire from successful investment banking careers. If they are to accumulate the money to buy the ski chalet upon retirement by making 10 equal annual deposits into an account paying an effective annual interest rate of 13 per cent, with the first deposit to be made immediately, each deposit should be? (A) (B) (C) (D) $2,210.80 $6,641.33 $1,956.46 $1,357.24

9.

Perfectly __________ correlated returns move exactly together and have a correlation coefficient of __________, while perfectly __________ correlated returns move in exactly opposite directions and have a correlation coefficient of __________. (A) (B) (C) (D) positively; +1; negatively; -1 negatively; +1; positively; -1 positively; -1; negatively; +1 negatively; -1; positively; +1

10.

The portion of an asset's risk that is attributable to firm-specific, random causes is called (A) (B) (C) (D) systematic risk unsystematic or non-systematic risk economic risk non-diversifiable risk

11.

The higher an asset's beta (A) (B) (C) (D) the higher the expected return will be in a down market. the more responsive the assets return is to changing market returns. the lower the expected return will be in an up market. the less responsive the assets return is to changing market returns.

12.

Asset P has a beta of 0.9. The risk-free rate of return is 8 per cent, while the expected return on the market portfolio of assets is 14 per cent. According to the capital asset pricing model, the asset's required rate of return is (A) (B) (C) (D) 5.4 per cent 6 per cent 10 per cent 13.4 per cent

13.

In the capital asset pricing model, an increase in inflationary expectations will be reflected by (A) (B) (C) (D) an increase in the slope of the security market line. a parallel shift downward in the security market line. a decrease in the slope of the security market line. a parallel shift upward in the security market line.

14.

The market price of outstanding bond issues often varies from par because (A) (B) (C) (D) the coupon rate has changed. the market rate of interest has changed. the maturity date has changed. old bonds sells for less than new bonds.

15.

A firm has an expected dividend next year of $1.20 per share, a zero growth rate of dividends, and a required return of 10 per cent per annum. The value of each of the firm's shares is (A) (B) (C) (D) $10 $12 $120 $100

16.

In the Gordon model, the value of ordinary shares is the (A) (B) present value of a constant, growing dividend stream. actual amount each ordinary shareholder would expect to receive if the firm's assets are sold, creditors and preference shareholders are repaid, and any remaining money is divided among the ordinary shareholders. present value of a non-growing dividend stream. net value of all assets which are liquidated for their exact accounting value.

(C) (D)

17.

A constant annual rate of dividend growth of 9 per cent is expected on a particular firms ordinary shares for an indefinite period into the future. The next annual dividend in one years time is expected to be $2.70. If the firm can earn 12 per cent per annum on similar risk investments to the firm itself, the value of the firm's ordinary shares is (A) (B) (C) (D) $90 per share $9 per share $22.50 per share $30 per share

18.

A conventional cash flow pattern associated with capital investment projects consists of (A) (B) (C) (D) an initial outflow followed by a series of inflows. an initial inflow followed by a series of outflows. an initial inflow followed by a broken cash flow series. an initial outflow followed by a broken cash flow series.

19.

The basic variables that must be considered in determining the initial investment associated with a capital expenditure are all of the following EXCEPT (A) (B) (C) (D) proceeds from the sale of the existing asset. the cost of the new asset. incremental annual savings produced by the new asset. taxes on the sale of an existing asset.

20.

A corporation is evaluating the relevant cash flows for a capital budgeting project involving expansion of the firms activities and must estimate the terminal cash flow for the project. The project will involve purchasing a machine for $120,000. The machine has a usable life of 6 years but would be disposed of after 5 years at an estimated sale price of $10,000. The machine will be depreciated under the prime cost (straight-line) method supposing a 6-year life. Net working capital is expected to decline by $6,000 at the end of the 5 years of the project. The firm has a 40 per cent tax rate on ordinary income and long-term capital gains. The terminal cash flow is (A) (B) (C) (D) $20,000 $8,000 $12,000 $0

21.

When the net present value is negative, the internal rate of return is __________ the cost of capital. (A) (B) (C) (D) equal to greater than or equal to less than greater than

22.

The monthly repayment on a loan is $593.89 with the first payment to be made one month from now. If the loan term is 30 years and interest is charged at a rate of 7.8% per annum compounded monthly, how much was borrowed (to the nearest dollar)? (A) (B) (C) (D) $75,000 $82,500 $85,000 $87,500

23.

Portfolio diversification works because I unsystematic (or non-systematic) risk exists II forming a portfolio with numerous stocks guarantees a positive real return on investment III market risk can be dramatically reduced if not eliminated (A) (B) (C) (D) I only II only II and III only I, II and III

24.

If the interest rate is 6 per cent per annum compounded monthly, the effective annual rate of interest is (correct to two decimal places) (A) (B) (C) (D) 6.09% 6.20% 6.17% 6.14%

Answer: (C) 25. A loan is being repaid by equal monthly payments of $608.62 over the next 50 months. The effective monthly rate of interest charged is 0.8%. What is the principal outstanding at the beginning of the 11th month (immediately after the 10 payment is made)? (A) (B) (C) (D) $19,874.95 $20,763.51 $21,202.51 $20,321.00

(The list of formulae and financial tables appearing in the unit outline will be provided at the back of the exam question paper)

ANSWERS

1.

Answer: (D) FV = 200 (1.04) 6 = $253.06 Answer: (C) 2,000 [(1.12) 20 1] FVA = = $144,104.88 0.12 Answer: (B) PV = 100 (1.09) 10 = $42.24 Answer: (B) 25,000 PVA = (1.14) = $203,571.42 0.14

2.

3.

4.

5. 6.

Answer: (B) Answer: (A) 15,000 (0.1) PMT = = $2,456.96 (1.1) 5 1


Answer: (C) 4,500 (0.03) PMT = = $1,210.62 1 (1.03) 4 Answer: (C) Amount required in 10 years = 25,000 (1.05)10 = $40,722.37 40,722.37 (0.13) PMT = = $1,956.46 [(1.13)10 1] (1.13)

7.

8.

9. 10. 11. 12.

Answer: (A) Answer: (B) Answer: (B) Answer: (D) k = 8 + 0.9 (14 8) = 13.4%
Answer: (D) Answer: (B)

13. 14.

15.

Answer: (B) 1.20 P0 = = $12 0.1


Answer: (A) Answer: (A) 2.70 P0 = = $90 0.12 0.09 Answer: (A) Answer: (C) Answer: (A) Book value at end of 5 years = 120,000 5 (20,000) = $20,000 Loss on book value upon sale of asset = 20,000 10,000 = $10,000 Terminal cash flow = 10,000 + 0.4 (10,000) + 6,000 = $20,000 Answer: (C) Answer: (B) i = 0.078 12 = 0.0065
PVA =

16. 17.

18. 19. 20.

21. 22.

593.89 1 (1.0065) 360 $82,500 0.0065

23. 24.

Answer (A) Answer: (C)


i 0.06 EAR = 1 + 1 = 1 + 1 = 0.06167 (6.17%) 12 m
m 12

25.

Answer: (B) Principal outstanding at the beginning of the 11th month 608.62 1 (1.008) 40 = = 20,763.51 0.008

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