MT 1 solution - MGCR 341: Finance 1 Summer 2010 Vadim di...

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MGCR 341: Finance 1 Summer 2010 Vadim di Pietro Sample Midterm Student Name:____________________________________ Student Number:__________________________________ Time: Do not turn past this page until the exam has begun. The exam will be 120 minutes in length. Show your work: In order to receive credit for your answers, you must show your work. Correct answers with no work shown will not receive any credit. Incorrect answers with partial correct work may receive partial credit. The exception to this rule is the True or False section, where no explanations are required. Answer questions directly on the exam sheet. If you need more space, use the back side of the pages. Formula sheet: The exam is closed book, and you may not bring any notes into class. A formula sheet is provided on the last page of this exam. You may detach the formula sheet if you like. You do not need to hand in the formula sheet at the end of the exam. Calculator: You are allowed a non-programmable calculator with nothing stored in memory. This exam has a total of 7 pages, including the cover page and formula sheet. The exam is worth a total of 100 points. GOOD LUCK! 1) (5 points, 5 mins) Would you rather invest your money for one year at an APR of 12% with monthly compounding, or at an APR of 12.1% with annual compounding?
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For 12% APR, monthly compounding: 1+ EAR = (1+ APR/12) 12 = 1.1268 For 12.1% APR, annual compounding: 1+ EAR = (1+ APR) 12 = 1.121 Thus you prefer the 12% APR, monthly compounding option. 2) (5 points, 5 mins) If the risk free rate is 8%, and the inflation rate is 3%, by how much does the purchasing power of an investment in the risk free asset grow each year? [(1 + 0.08) / (1 + 0.03)] -1 = 4.85% 3) (10 points, 20 mins) You are considering starting a business that sells novelty t-shirts. There is an initial startup cost of $X at t = 0. Your first cash inflow will be $10M at t = 4 (on sales of 1M t-shirts, priced at $10 each; ignore the cost of producing the t- shirts). Subsequently, each year forever, you will increase the sale price of a t-shirt by the inflation rate of 2%, and each year you will sell 1% more t-shirts. If the project is risk free and the risk free rate is 5%, what is the most you would be willing to pay in startup costs, X, for this business? You can solve this using either the nominal or real approach. Nominal approach: The revenues are a forward starting growing perpetuity, where g = (1.02)(1.01) - 1= 0.0302 PV (revenues) = 10M/(0.05 – 0.0302) / (1.05^3) = $436.28M. The most you would be willing to pay is $436.28M as a startup cost for this business.
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MT 1 solution - MGCR 341: Finance 1 Summer 2010 Vadim di...

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