Midterm Exam for FIN 6000

Please complete the midterm exam independently.  Don't discuss it with other students in the class.  Please email me if you have any clarifying questions.

A.      Basic lEVEL Questions

Question #1 (5 points): This question is from CHAPTER 1

Discuss principal - agent problems for a corporation. Explain some of the institutional arrangements that ensure that managers work toward increasing the value of a firm.

Question #2 (5 points): This question is from CHAPTER 4

Casino Inc. is expected to pay a dividend of \$3 per share at the end of year 1 (D1) and these dividends are expected to grow at a constant rate of 6% per year forever. If the required rate of return on the stock is 18%, what is current value of the stock today?

Question 3 (5 points): This question is from CHAPTER 5

A&B Enterprises is trying to select the best investment from among three alternatives.  Each alternative involves an initial investment of \$100,000.  Their cash flows follow:

Year        A                      B                      C

1          \$10,000           \$50,000           \$25,000

2            20,000             40,000             25,000

3            30,000             30,000             25,000

4            40,000                      0             25,000

5            50,000                      0             25,000

(a). Which investment will you select using the payback method? Why?
(b). Which investment will you select using the net present value method? (Using a 10% discount rate. Be sure to compute NPV for all three projects
(c). Which investment will you select using the internal rate of return method? Please compute IRR for the above three projects.

Question #4 (5 points): This question is from CHAPTER 3

Consider a bond with a face value of \$1,000, a coupon rate of 6%, a yield to maturity of 8%, and ten years to maturity. Please calculate this bond's duration and volatility.

B.         Intermediate Level Questions

Question #5 (5 points): This question is from CHAPTER 2

Dr. Howard He is planning for his golden years.  He will retire in 20 years, at which time he plans to begin withdrawing \$50,000 annually to pay for his living expenses during retirement.  He is expected to live for 30 years following her retirement.  His financial advisor thinks he can earn 7% annually before his retirement and 10% after his retirement. How much does he need to invest at the end of each quarter to prepare for his financial needs after his retirement?

Question #6 (5 points): This question is from CHAPTER 3

A three-year bond has 8.0% coupon rate and face value of \$1000.
(A). If the yield to maturity on the bond is 10%, calculate the price of the bond assuming that the bond makes semi-annual coupon interest payments.
(B). Assuming that this bond trades for \$1,112, what is the YTM for this bond assuming that the bond makes semi-annual coupon interest payments? (Compute IRR)
{Hint: See Homework Answer key for Chapter 3}

Question #7 (5 points): This question is from CHAPTER 3

If the 4-year spot rate is 7% and the 3-year spot rate is 6%, what is the one-year forward rate of interest three years from now? (Hint: similar to homework question Q13, page 71)

Question #8 (5 Points) This question is from CHAPTER 7

Consider the following probability distribution of returns for Alpha Corporation:

 Current Stock Price (\$) Stock Price in One Year (\$) Return R Probability PR \$35 40% 25% \$25 \$25 0% 50% \$20 -20% 25%

{Hint: See lecture notes for chapter 7}
(A).      Compute the expected return for Alpha Corporation
(B).      Compute the standard deviation of the return on Alpha Corporation

Question #9 (5 points) This question is from CHAPTER 7
The U.S. market has an expected return of 12% and a standard deviation of 22%.  An index mutual fund that matches the Morgan Stanley Europe, Australia, and Far East Index (EAFE) has an expected return of 14% and a standard deviation of 30%.  The U.S. market and the EAFE fund have a correlation coefficient of 0.5.  Kramer was considering investing in a portfolio that is 58% invested in the U.S. and 42% invested in the EAFE Fund.  Calculate the expected return and standard deviation of this portfolio. {Hint: Pages 170-172}

Question #10 (5 points): This question is from CHAPTER 4

Otobai Motor Company is currently paying a dividend of \$1.40 per year. The dividends are expected to grow at a rate of 18% for the next three years and then a constant rate of 5% thereafter forever. What is the vlaue of its current stock price? Assuming that the discount rate is 10%.{Hint: pages 84-86}

Question #11 (5 points): This question is from CHAPTER 4

Summer Co. is expected to pay a dividend or \$4.00 per share out of earnings of \$7.50 per share. If the required rate of return on the stock is 15% and dividends are growing at a current rate of 10% per year, calculate the present value of the growth opportunity for the stock (PVGO). {Hint: page 89}

Question 12 (5 points): This question is from CHAPTER 4

You expect KT industries (KTI) will have earnings per share of \$3 this year and expect that they will pay out \$1.50 of these earnings to shareholders in the form of a dividend.  KTI's return on new investments is 15% and their equity cost of capital is 12%.  Please determine the value of a share of KTI's stock. {Hint: page 81-84}

Question 13 (5 points): This question is from CHAPTER 6

A firm is evaluating two mutually exclusive projects that have unequal lives.  Evaluate the projects using the equivalent annual annuity approach (EAA), recommend which project they should select.  The firm's cost of capital has been determined to be 18 percent, and the projects have the following initial investments and cash flows: {Hint: Pages 141-142}

 Project W Project Y Initial investment: (\$40,000) (\$58,000) Cash flows: 1 \$20,000 \$30,000 2 \$20,000 35,000 3 \$20,000 40,000 4 \$20,000 5 \$20,000

C.        Challenging Questions

Question #14 (5 points): This question is from CHAPTER 2

Suppose that a young couple has just had their first baby and they wish to ensure that enough money will be available to pay for their child's college education.  Currently, college tuition, books, fees, and other costs, average \$12,500 per year.  On average, tuition and other costs have historically increased at a rate of 4% per year.  Assuming that college costs continue to increase an average of 4% per year and that all her college savings are invested in an account paying 7% interest, what is the amount of money she will need to have available at age 18 to pay for all four years of her undergraduate education?   {Hint: need two steps to solve this question}

Question #15 (10 points): This is a challenging question from CHAPTER 6

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 6% of its annual sales in accounts payable.  The firm is in the 35% tax bracket, and has a cost of capital of 10%. {Hint: Pages: 132-136}

(A).      Calculate the total Free Cash Flows for each of the three years for the Sisyphean

Corporation's new project.

(B).      What is the NPV for this project?

(C).      What is the IRR for this project?

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