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Unformatted text preview: Print Last Name: Print First Name: ID Number ) ) ) COURSE NUMBER SECTIONS: (9 Circle your section)
FINANCE COMM 308/4 CC, DD, F, G, H, I EXAMINATION DATE # OF PAGES 16
Final Exam April 24, 2010 including cover VERSION 1
INSTRUCTOR' DIVISION ('9 Underline your instructor's name) John Nelson School of Business
A. Ahmad Concordia University P. Ellison
D. Newton
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“We REMINDERr Put your Name and D on (1) this exam; (2) computer answer sheet and (3) A
Your Crib Sheet. Hand in this exam, computer sheet and your Crib Sheet. Version: I I Page 1 of 16 FOR INSTRUCTOR USE ONLY: —— Version: I _ Page 2 of 16 Multiple Choice: answer on the computer answer sheet Part I: Multiple Choice Questions [24 Questions, 70 Points Total):  This part consists of 1 identifying question (worth 1 mark) and 23 questions worth 3 marks each.  Only answers on the computer answer sheet will be graded.  Use a pencil to mark your answers.  Select only one answer per question, blank or multiple answers will not receive credit.
~ You are encouraged to also circle your answer on the exam sheet as a back up. A. Identiﬁcation guestion (1 Question: 1.0'Point) 1. Please add the following numbers: 2 + l. The total is closest to:
A) 3
B) 4
C) 5
D) 6
E) 7 B. Concept and calculation guestions [23 Questions, 3 Points Each! 2. Which of the following statements about the correlation coefﬁcient is correct? .
A) Positive correlation coefﬁcients imply that the returns on Security A tend to move in the
opposite direction as those on security B.  .
B) Negative correlation coefﬁcients imply that the returns on Security A tend to move in the same direction to those on security B. _ _
C) The closer the absolute value of the correlation coefﬁcient is to one, the stronger the relationship between the returns on the two securities.
D) All of the above statements are correct ‘
E) None of the above statements are correct 3. Which of the following is NOT a true statement:
A) Common shareholders are the true owners of the corporation .
B) Common shareholders are entitled to the assets before any other claims have been paid
C) Common shareholders have the right to vote on major issues such as takeovers. ‘
ID) Dividends to common shares are not a legal obligation of the firm until declared by the board
of directors.
B) All of the above are true statements  Version: I _ Page 3 of 16 _ l Multiple Choice: answer on the computer answer sheet 4. On January 15, 2007 the XYZ Company issued a 25 year bond. The bond has a coupon rate of 7%,
coupons are paid once a year and the face'value of the bond is $1,000. Today (April 24, 2010) the
bond trades at a price of $1,005.69. The yield on the bond today must be: A) 7% B) Greater than 7% C) Less than 7% D) Cannot be determined. 5. If you invested $500 in asset l and $750 in asset2; then which of the following statements are true:
I. the return on the portfolio can never be less than the smallest return on the two assets
II. the return on the portfolio might be less than the smallest return on the two assets
III. the variance of the portfolio can never be less than the smallest variance on the two assets
IV. the variance of the portfolio might be less than the smallest variance on the two assets A) I and III only
B) I and IV only
C) II and IV only D) II and III only
E) None of the statements are true 6. Winifred, a junior analyst in your ﬁrm, is very excited. She tells you that she has been analyzing
different ﬁrms and has found that ﬁrms with high levels of long term debt tend to generate higher
returns for their Stock holders. Should you follow Winifred’s advice and buy companies with high
levels of long term debt? Select the best answer. A) Yes, Winifred’s analysis IS likely an indication of short—term market inefﬁciency and if you act
quickly on the information, you can make an abnormal proﬁt. B) Yes, by modifying Winifred’s strategy to hold a diversiﬁed portfolio of ﬁrms with high long
term debts, a high rate of return can be earned while reducing the financial leverage risk. C) No, Winifred has just rediscovered the effects of ﬁnancial leverage. The extra return is to
compensate shareholders for the increased risk of ﬁnancial distress. There is no abnormal return.
D) No, ﬁrms with high levels of long term debt are likely to beCOme bankrupt. One should never invest in firms with high levels of long term debt. Version: I Page 4 of 16 Multiple Choice: answer on the computer answer sheet 7. Consider the following two statements:
I. A ﬁrm’s sustainable growth rate decreases with higher proﬁt margins, higher asset turnover, and higher debt.
II. A ﬁrm’s sustainable growth rate can be estimated by multiplying the earnings retention ratio by the return on equity. A) I. is correct, II is incorrect
B) I is correct, II is correct C) I is incorrect, His incorrect
D) I is incorrect, II is correct 8. Which of the following statements are true:
I. If the cost of equity is 10% and the return on equity (ROE) is 10%, then changing the
retention ratio would not affectthe share price. '
II. If the cost of equity is 10% and the ROE is 14%, then a higher retention ratio would result in
a higher share price.
III. If the cost of equity is 10% and the ROE 1s 8%, then a higher retention ratio would result 1n a higher share price A) Ionly
B) II only
C) III only
D) I and II
E) I and III 9. Which of the following statements are true:
 I. The value of a call option increases with an increase in the strike price but the value of a put option will decrease. . II. As the interest rate goes up, the value of a call option goes up but the value of a put option
goes down. III. The values of both call and put options increase with an increase in the volatility of the underlying stock price. A) III only B) I and II only
C) I and III only
D) II and III only
E) I, II, and III Version: I Page 5 of 16 10. 11. 12. Multiple Choice: answer on the computer answer sheet SuppOSe the Canadian Space Agency has two mutually exclusive projects: landing a woman on
Mars and landing a man on Venus. Project Mars has an IR of 15 percent and project Venus has an
IR of 12 percent. The crossover rate is 9 percent. The project’s appropriate discount rate is 8
percent. The Canadian Space Agency should: A) Accept project Mars. B) Accept project Venus. C) Accept both projects. D) Accept neither project. E) Can’t answer without the cash ﬂows You observe the following:
I. You use a simple trading rule: buy every stock that has gone up three days in a row, hold the 
stock for 2 days and then sell. On average, you make an unusual proﬁt using this strategy. .
II. On average, the CEO of XYZ Corporation does not make unusual proﬁts trading the stock of XYZ Corporation.
Which of the following statements is most correct? A) 1 is not consistent with weakform market efﬁciency while II is consistent with strong form efﬁciency
B) I is not consistent with weakform market efﬁciency while 11 is not consistent with strong form efﬁciency
C) I is consistent with weak— form market efﬁciency While II is consistent with strong form efﬁciency 1)) I is consistent with weakform market efﬁciency while 11 is not consistent with strong form efﬁciency The Willy Wonker Toy Company has two divisions — stuffed toys and ﬁreworks. The stuffed toy division’s cash ﬂows are very low risk while the ﬁreworks division is very risky. The required rate of return for the stuffed toy projects is 3% while the rate for the ﬁreworks projects is 15%. The overall weighted average cost of capital (WACC) for Willy Wonker is 10%. If Willy Wonker uses the ﬁrm WACC to evaluate sniffed toy and ﬁreworks projects then: ' A) Value of the ﬁrm will decrease because the ﬁrm will reject low risk stuffed toy projects and
accept high risk ﬁreworks projects . B) Value of the ﬁrm will increase because the ﬁrm will reject low risk stuffed toy projects and
accept high risk ﬁreworks projects C) Value of the ﬁrm will decrease because the ﬁrm will accept low risk stuffed toy projects and
reject high risk ﬁreworks projects D) Value of the ﬁrm will increase because the ﬁrm will accept low risk stuffed toy projects and
reject high risk ﬁreworks projects E) Value of the ﬁrm will increase because projects will only be accepted if they promise a return
that is higher than the ﬁrm’s WACC ' Version: I Page 6 of 16 Multiple Choice: answer on the computer answer sheet 13. The price of a 10 year semiannual pay bond with a face value of $1 ,000 and a 6.8% annual coupon
and yield to maturity of 5.8% is closest to:
A) $928.29
B) $929.11
, C) $1,074.30
D) $1,075.08
E) $1,672.05 14. Hui Tan has borrowed $25,000 from his local bank. The loan will cost him 12% per year for the
ﬁrst 7 years and 4% per year for the next 15 years. The interest is compounded annually. At the
end of the 22 years, the amount he will have to repay is closest to: A) $50,145.31
B) $99,532.81
C) $100,290.62
D) $135,913.51
E) $302,507.75 15. Your sister has given you $25,000 which you have invested. If you earn 6% compounded annually,
then the value of the gift in 10 years will be'ciosest to:
' A) $13,960 ‘
B) $26,500
C) $40,000
D) $44,771 Version: I I Page 7 of 16 Multiple Choice: answer on the computer answer sheet 16. Abdul has invested $12,000 in a security that pays 3% annual simple interest. How much interest
does he earn in the 4th year of the investment? Choose the closest answer.
A) $360.00
B)_ $381.92
C) $393.38
D) $405.18 17. An interest rate of 15% compounded monthly is equivalent to arate of compounded
quarterly. '
A) 15.19%
B) 15.87%
C) 16.08%
D) 20.38% 18. Ten years ago you purchased a house for $150,000. You have just sold the house for $115,000. The
annual rate of return you have earned on this property is closest to:
A) 2.62%
B) 2.33%
C) 2.33%
D) 2.69%
.E) 76.87% Version: 1 Page 8 of 16 19. 20. 21. Multiple Choice: answer on the computer answer sheet The HiTop Company is expected to pay a dividend of $1.50 next year. The current stock price is
$25 per share. You believe that the dividends of HiTop will grow at a rate of 5% per year forever. If the required rate of return for HiTop is 11.25%, then:
A) You should buy the stock because you believe that the value of the stock will rise to: $25.20
B) You should not buy the stock because you believe that the value of the stock will rise to: $25.20 .
C) You should buy the stock because you believe that the value of the stock will fall to: $24.00 D) You should not buy the stock because you believe that the value of the stock will fall to: $24.00 Ten years ago, The HighTop Co issued $15 million in preferred shares with a par value of $50 each
and an annual dividend rate of 5.5%. If the market value of these preferred shares today is $25
million, then the required rate of return is closest to: A) 2.75% B) 3.30% C) 5.24% D) 5.50% E) 9.17% The UK Company has just paid a dividend of $5. The dividends are expected to grow at a rate of
20% for the next three years. After the third year, dividends are expected to decline at a rate of 3%
per year forever. The required rate of return for UJK is 12%. The current price of UJK is closest to:
A) $73.12 B) $66.45 C) $61.17 D) $59.33 B) $57.02 Version: I Page 9 of 16 . Multiple Choice: answer on the Computer answer Sheet 22. Franklin wishes to have $10 million in his retirement savings plan in 25 years. His bank is offering
him an investment that promises a return of 8% compounded monthly. Franklin wishes to deposit
money every six months and plans to make his ﬁrst deposit immediately. Franklin’s semiannual
deposit is closest to: A) $61,643
B) $62,983
C) $64,151
D) $65,502 23. The stock of XYZ Corporation has a beta of 0.8 and the current stock price is $15. The ﬁrm pays
no dividends. If the one year risk free rate is 3% and the expected return on the market for the next
year is 15%, then the expected stock price in one year is closest to: A) $15.45
B) $16.80
C) $16.89
B) $17.25
B) $17 .79 24. You have observed the following information about the two stocks you hold in your portfolio: __—
 Standard deviation of 8% 5% returns
The correlation between XXS and Yyk is 0.40 (negative .40). The standard deviation of your portfolio
is closest to:
A) 3.36%
B) 3.83%
C) 4.24%
D) 4.97%
E) 5.18% Version: I Page 10 of 16 Problems: Answer on the exam in the space provided Problem 1. (8 marks) The BrandyWine Falls Beverage Company is considering two mutually
exclusive projects code named Lily and Frog. The projects have the following characteristics: Lily
requires an initial investment of $75,000 and will generate cash ﬂows of $15,000 per year for 8
years. At the end of the 8 years, the machinery will have a value of zero. Project Frog requires an
initial investment of $166,000 and will earn cash ﬂows of $25,000 per year for the next 17 years.
At the end of year 17, the machinery will have a value of zero. All projects can be replicated
indeﬁnitely. The BrandyWine Falls Beverage Company pays no taxes. The beta of Project Lily is .80 and the beta of Project Frog is 1.3. The risk free rate is 3% and
the expected return on the market is 10%  both rates are expected to be constant forever. A) Determine the required rate of return for each project: B) Which project should the company undertake? Why? Show your work. Version: I  p Page 11 of 16 Problems: Answer on the exam in the space provided Recommendation: Version: 1 Page 12 of 16 Problems: Answer on the exam in the space provided Problem 2. (10 marks) The Silicone Bathing Suit Company is considering investing in a project to
develop a self cooling bathing suit. The marketing department feels that there is a demand from
people who wish to sit by the pool and keep 0001 without having to get wet. The management of
Silicone have developed the following estimates: Annual sales of self cooling bathing suits: $85,000 Annual production costs: $25,000 Annual loss of sales of PAC (personal air conditioning units): $15,000 Reduction in production costs of PACs: $10,000 Research and development costs incurred over the last four years: $50,000 Chief Executive Officer’s salary: $150,000 peryear Cost of machinery required to produce self cooling bathing suits: $250,000 CCA class 23  rate: 15%, tax rate: 45% ' Assume life of project is 10 years, at which point the machinery has zero salvage value.
Assume that the company has many assets in the class and that the class will remain open (no recapture etc).
Silicone believes that the appropriate discount rate for projects of this risk is 9%. Do you recommend that Silicone enter the SelfCooling bathing suit business? Why or why not. Show your work. Version: 1 Page 13 0f16 Problems: Answer on the exam in the Space provided Recommendation: Version: 1 Page 14 of 16 Problem 3. Problems: Answer on the exam in the space provided (4 marks) liang Min has obtained the following information on the Velocity Bicycle Company: book values: assets = $350,000; common equity = $125,000; preferred stock 3 $150,000
and debt = $75,000. Coupons on debt are paid Once a year. number of shares outstanding: 10,000 common and 20,000 preferred market prices per share: common stock $25, preferred $15 preferred dividend $1.20 per share; coupon rate on debt is 4%; Velocity does not pay
dividends on its common stock beta of the stock is 1.15 market value of the debt equals the book value of the debt tax rate is 35%, risk free rate is 2%, expected return on the market is 15%. Calculate the weighted average cost of capital (WACC) or the Velocity Bicycle Company. Show your
work clearly. If the answer cannot be determined using the available information, explain what information is missing and how you would use it.
Version: I WACC= Page 15 of 16 Problems: Answer on the exam in the space provided Problem 4 and Problem 5 are based on the following situation: Your Grandfather is very confused — he has invested $100,000 in a long term Government of Canada
bond and $100,000 in a shortterm Government of Canada bond. Neither bond pays any coupons. He
expected that the value of his investment would never decline. After all, the Government will always
pay its debts! However, when he went to the broker to seil his bonds, he found that the long term bond
was only worth $65,000 while the short term bond was worth $95,000. He is very confused. Problem 4. (4 marks) Explain to your Grandfather how it is possible for the Vaiue of the bonds to fall
despite the fact that the Government will always pay its debts. Problem 5. (4 marks) Explain to your Grandfather why the long term bond fell so much more (in %
terms) than the short term bond. HAVE YOU:
— Put your Name and ID on the exam, computer answer sheet and “crib” sheet?  Make sure you hand in the exam, the computer answer sheet and “crib” sheet.  Enjoy your summer and see you next year  Version: I Page 16 of 16 ...
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