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Engineering Fundamentals: An Introduction to Engineering
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Chapter 20 / Exercise 20.19
Engineering Fundamentals: An Introduction to Engineering
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Unformatted text preview: Introduction to Managerial Finance, FINE 2000 Sample Final Exam Part 1: Multiple choices (40 points). Circle the correct answer. There is no partial credit for Part 1. 1. A manager's compensation plan that offers financial incentives for increases in quarterly profitability may create agency problems in that: A) B) C) D) The managers are not motivated by personal gain. The board of directors may claim the credit. Short-term, not long-term profits become the focus. Investors desire stable profits. 2. What APR is being earned on a deposit of $5,000 made ten years ago today if the deposit is worth $9,948.94 today? The deposit pays interest semi-annually. A) B) C) D) 3.56% 6.76% 7.00% 7.12% 3. How much would an investor lose if she purchased a 30-year zero-coupon bond with a $1,000 par value and 10% yield to maturity, only to see the yield to maturity increases to 12% one year later? (Hint: How much would the price change from a year earlier?) A) $19.93 Find"PV"of"1000"at"10%"(P"=" B) $20.00 1000/1.1^30)"and"Qind"PV"of"1000" C) $23.93 at"12%"(1"year"later)"(PV"=" D) $25.66 1000/1.12^29)"and"then"difference 4. If its yield to maturity is less than its coupon rate, a bond will sell at a _____, and increases in market interest rates will _____. A) B) C) D) Discount, decrease this discount. Discount, increase this discount. Premium, decrease this premium. Premium, increase this premium. YTM"<"C""#"coupon"rate"is" what"you"get"and"since"its" higher"then"YTM"(market" rate);"you"are"paying"higher" payments,"therefore"sell"at" Premium) 5. According to the dividend discount model, how much should you pay for a share of stock that offers a constant dividend growth rate of 10%, requires a 16% rate of return, and is expected to sell for $50 one year from now (as usual, here $50 is the price after the year-one dividend is paid) ? A) $42.00 P1=D2/r#g D1"="3/"1.1""""(bc"it"grows"at"10%"per"yr) B) $45.00 D2="P1*"(r#g) P0="2.73/0.06"="45.45 C) $45.45 ="50"*"(16%#10%) OR"P0="(2.63"+"50)/1.16"="45.45 D) $47.00 ="$3 6. If the pro forma balance sheet shows that total assets must increase by $400,000 while retaining a debt-equity ratio of .75 then (here, “debt” means “total debt”): A) B) C) D) Debt must increase by $300,000. Equity must increase by the full $400,000. Debt must increase by $171,429. Equity must increase by $100,000. D/E"="0.75" TA="D"+"E E"="D/0.75 TA"=D"+"D/0.75 change"in"TA"="1.75/0.75"D change"in"TA"="400 change"in"D"="0.75/1.75"*"400"="171429 7. Which of the following can be deduced about a three- year investment project that has a two-year payback period? A) B) C) D) The NPV is positive. The IRR is greater than the cost of capital. Both 'a' and 'b' can be deduced. Neither 'a' nor 'b' can be deduced. #"can"recover"money"in"2" years"(Payback"period) 8. Which mutually exclusive project would you select, if both require an initial outlay of $1,000 and your discount rate is 15%; Project A with three annual cash flows of $1,000, or Project B, with three years of zero cash flow followed by three years of $1,500 annually? A) B) C) D) Project A. Project B. You are indifferent since the NPVs are equal. Neither project should be selected. A"#"pays"in"yr"1,2,3 B"#"pays"in"4,5,6 NPVA"="1283">"NPVB"="1251.8 9. How much could NPV be affected by a worst-case scenario of 25% reduction from the $3 million in expected annual cash flows on a five-year project with 10% cost of capital? A) B) C) D) $2,843,090 $3,750,000 $4,578,825 $6,155,274 10. What real rate of return is earned by a one-year investor in a bond that was purchased for $1,000, has an 8% annual coupon, and was sold for $960 when the inflation rate was 6%? A) B) C) D) -1.89% 1.92% 5.66% 11.47% 11. What is the after-tax cost of preferred stock that sells for $10 per share and offers a $1.20 dividend when the tax rate is 35%? A) B) C) D) 4.20% 7.80% 8.33% 12.00% 12. The problem of using the overall firm's beta in discounting projects of different risk is: A) B) C) D) the firm would accept too many high-risk projects. the firm would reject too many low risk projects. the firm would reject too many high-risk projects. both a and b could be correct. 13. According to the efficient market hypothesis, which of the following situations is most likely to occur today for a stock that went down in price yesterday? A) B) C) D) The stock will increase in price. The stock will decrease in price. The stock has a 30% chance of decreasing in price. The stock has no predictable price-change pattern. 14. Which of the following statements about preferred stock is true? A) Unlike dividends paid on common stock, dividends paid on preferred stock are a tax-deductible expense. B) Unpaid dividends on preferred stock are a debt of the corporation. C) There is no difference in the voting rights of preferred and common stockholders. D) None of the above. 15. When securities are issued under a rights issue A) existing shareholders have the opportunity to buy more shares at a discount. B) shares are offered to the public at a discount. C) the existing shares will increase in price. D) current shareholders have the right to resell their stock to the issuer. 16. Your neighbor is complaining that not only is the market interest rate on his bond dropping but so is the coupon rate. You know he must own A. B. C. D. a zero coupon bond a convertible bond a callable bond a floating rate bond 17. Which of the following is not considered a direct flotation cost? A. underwriter’s spread B. underpricing C. Filing fees D. legal fees 18. Which of the following parties will likely benefit the most from the overpricing of a new, IPO common stock issue handled on a firm-commitment basis? A) B) C) D) The underwriter New shareholders who purchase stock during the aftermarket The issuing firm New shareholders who purchase stock from the underwriting syndicate 19. A firm that uses its WACC as a cutoff without considering project risk: I. Tends to become less risky over time. II. Tends to accept negative NPV projects over time. III. Likely will see its WACC rise over time. A) B) C) D) II only I and II only I and III only II and III only 20. Which of the following statements is true? A) B) C) D) A well-diversified portfolio has negligible systematic risk. A well-diversified portfolio has negligible unsystematic risk. An individual security has negligible systematic risk. An individual security has negligible unsystematic risk. Part 2: Problems/short answers (60 points) 1. You own a bond with the following characteristics: Face Value of Each Bond Number of bonds issued Coupon Rate Coupon Frequency Maturity Current YTM Call Provision Collateral for the Bond Protective Covenants Convertible to Common Shares $1,000 100,000 10% Annual April 21, 2025 7% None None None No How would each of the following changes affect the price of the bond, if all other features remain the same? Explain briefly what the effect of each change on bond price (that is, will the price increase or decrease or have no effect at all) in no more than 2 sentences. No calculations are needed for this question. a) The maturity is April 21, 2010. Price$would$DECREASE$as$investors$would$pay$less$for$fewer$cash$hlows$ since$the$current$YTM$is$lower$than$the$coupon$rate b) The bond is callable beginning April 21, 2015. Price$should$DECREASE$.$If$the$bond$is$called$the$investors$MIGHT$be$ deprived$of$10$years$worth$of$coupons/deprived$of$the$potential$in$price$ gains$after$the$call$date c) The bond would be convertible to common shares. Price$would$INCREASE$because$the$option$to$convert$the$shares$ would$make$the$bond$worth$more$just$than$the$face$value$plus$ coupons$if$the$share$price$increases d) The bond is secured by buildings in downtown Toronto. THe$price$should$INCREASE$because$the$bond$is$less$risky$and$ investors$will$pay$more$for$less$risky$investments 2. [4 points] Suppose your cousin invests in a stock and gets a 50% return in a single year while the market, on average, earned a return of only about 15%. Is your cousin's performance a violation of market efficiency? Support your answer with 2 explanations and restrict your answer to no more than 4 sentences. Could$be$a$stock$with$high$beta Could$be$that$she$had$insider$information One$year$is$not$enough$time$to$make$any$conclusion$about$market$efhiciency Could$be$a$stock$with$much$unsystematic$risk 3. [4 points] In a recent, closely contested lawsuit, SIM sued BIM for patent infringement. The jury came back with its decision. At that time the rate of return on SIM was rS=3.1 % and the rate of return on BIM was rB=2.5 %. There was no other news about these firms released this week. The market this week returned 3%. The Beta of SIM is 1.4 and the Beta of BIM is 0.6. The weekly risk-free rate is 0.1%. Based on the data, who lost the lawsuit? Explain briefly. R$market$=$3% R$risk$free$=$0.1% FF>$Market$Risk$premium$=$2.9% B$s$=$1.4 B$b$=$0.6 SIM$should$have$returned$(0.1$+$1.4$)*$0.029$=$0.0416 or$4.16%,$returned$3.1%$therefore$disappointed$&$lost BIM$should$have$returned$(0.1$+$0.6)$*$0.029$=$0.0184 or$1.84%$and$2.5%$(BIM)$is$better$(won) 4. [10 points] Hypo went public in 2000. The underwriters bought the stock from the company for $20.00 per share. The stock was offered to a small number of institutional investors at $22.00 per share. At the end of the first trading day the stock closed at $30. The underwriter could not return any shares that were not sold. a. [2 points] What type of underwriting was used to sell the stock? Bought$Deal$(Firm$Commitment) b. [4 points] What was the percentage of underpricing on the first day of trading? What percentage spread did the underwriters charge? %$Underpricing$=$30$F$22$/$22 =$36.4% %$Spread$=$22F20$/$20$=$10% %$Spread$=$22$F$20/$22$=$9.09%$(also$acceptable)$ c. [4 points] What can an underwriter do to decrease the underwriter’s risk of an equity offering? (Give two examples) Use$best$effort$underwriting$ From$a$syndicate$to$spread$the$underwriting$risk$ Reduce$the$offer$price 5. [14 points] YTT is a fast growing tech company specializing in new computer chip development. Analysts following YTT predict that the company faces great level of cash flow uncertainties in the next five years, and the required rate of return of its stock will be relatively high. The company will pay a constant annual dividend of $1.50 per share during this five-year period, with the next dividend to be paid in one year. Thereafter, the level of cash flow uncertainties will be reduced and the required rate of return will settle to a constant of 15%. Dividends will also increase at a constant rate of 5% forever starting from year six (so the year-six dividend is $1.575). Use the dividends discount model (DDM) of stock valuation for this problem. a. [6 points] What is the share price of YTT assuming the required rate of return for the first five years is 20%? b. [8 points] Suppose that YTT is trading at $12 per share. What is the required rate of return for the first five years the market is predicting? How would you use your answer (with respect to the required rate of return) to decide whether to buy YTT shares? A$)$1st$period:$Constant$dividend$of$1.5$for$5$year$discount$rate$=$20% 2nd$period:[email protected]$5%$for$by$6$year$discount$rate$=$15% Po$=$PV$(1st$period$dividend)$+$PV$(2nd$period$dividend) PMT$=$15 [1.575/(0.15F0.05)]$*$[1/(1+0.2)^5)] n$=$5 PV$=$6.33 r$=$20% FV$=$0 PV$=$4.49% Po$=$4.49$+$6.33$=$10.82 B)$Treat$this$part$as$a$bond$valuation$problem$with$a$terminal$(face)$value$of$15.75 FV$=$[1.575/(0.15$F$0.05)]$15.75 PMT$=$1.5$per$year$(like$coupon) PV$=$F$12 n$=$5 FF>$r$=$16.96%$required$rate$of$return$ If$you$believe$the$required$rate$of$return$is$lower$than$16.96%$then$the$fair$value$at$the$stock$is$ higher$than$$12$and$you$should$buy$the$stock 6. [20 points] Big Tree Forestry Inc BTFI has capital of the following characteristics. The company currently has two sets of bonds outstanding, both with semi-annual coupon payments. One set of bonds issued July 26, 1985 has 10 years left to maturity 8% coupons and if they were issued today at par, would have a coupon of 6%. There are 200,000 bonds each with a face value of $1,000. Another set of bonds will be called next year. The coupons are 12%, the yield to call is 3% and the call price is 102% of face value. There are $300 million in face value outstanding. The preferred shares have an annual dividend of $1.6 per share. The current market value (CMV) of all of the preferred shares is $200 million and there are 10 million preferred shares outstanding. The book value of the firm’s equity is $ 200 million and book value per share is $2. Common share annual dividends are expected to be $1.20 one year from now and the dividend is expected to grow by 3% per year. The risk free rate is 2%, the market return is 10% and the beta of the stock is 1.4. Corporate Tax Rate = 40% a. [15 points] Calculate the WACC for BTFI. b. [5 points] Suppose your firm is going to finance a new project 100% with a long term loan. The loan interest rate is 8%. Your boss wants you to use the interest costs of the loan as the discount rate for the project. Explain to your boss which discount rate should be used for this project. A)#calculate#market#value#of#each#of#the#1irm's#securities#: 10#year#bonds: n#=#2#*#10#=#20 r#=#YTM/2#=#3% PMT#=#8%/2#*#$1000#*#200,000#=#8#mill FV#=#1000*#200,000#=#200#mill KK>#PV#=#229,754,950### (market#value#of#10#year#bond) Callable#Bonds n#=#2 r#=#YTM/2#=#3%/2#=#15% PMT#=#12%/2#*#300,000=#18#mill FV#=#300,000,000#*#1.02#=#306,000,000 PV#=#332,228,397#(market#value#of#the#callable#bonds)' Preferred#shares#=#$200#mill Common#shares:#price#=#Div/#r#K#g###=#1.2/rK3% R#=#Rf#+#B#(RmKRp) ####=#2%#+#1.4#(10%#K#2%)#=#13.2% Price#=#1.2/13.2K3#=#$11.76#per#share Market#value#of#common#shares#=#market#price#*###of#shares#outstanding =#11.76#*#(200#mill/2)#=#1176.5#milliion Return#of#preferred#shares#=#div/price#=#1.6#per#share#/#(200#mill/10mill)#=#8% ...
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