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practicemidterm1_sol

# practicemidterm1_sol - Tepper School of Business...

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Tepper School of Business – Finance (70-391) – Fall 2008 Professor Lars-A. Kuehn Your Name: Student ID: Practice Midterm Exam I with Solutions Instructions: 1. You have 50 minutes to complete this examination. 2. You are allowed to consult the provided formula sheet only. 3. Laptops are not permitted. 4. There are 3 questions on this examination worth 100 points total. 5. Please answer the questions in the space provided. Write your full name legibly at the bottom of this page. 6. Please show all work to ensure full credit. Partial credit is extensive and a function of the work shown. 7. Please stop writing when time is called. Failure to stop writing when time is called will result in an immediate loss of 30 points. Good Luck! 1

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Formula Sheet Net present value: NPV = C 0 + T X t =1 C t (1 + r t ) t = T X t =0 C t (1 + r t ) t Discount Factor: DF t = 1 (1 + r t ) t Growing Perpetuity: PV = C r - g T -year growing annuity: PV = C r - g 1 - 1 + g 1 + r T ! Gordon growth model: r = D 1 P 0 + g g = b · ROE P = D 1 r - g = (1 - b ) E 1 r - g Bond price: P = T X t =1 C (1 + r t ) t + F (1 + r T ) T Bond yield: P = T X t =1 C (1 + y ) t + F (1 + y ) T Forward rates: f t = (1 + r t ) t (1 + r t - 1 ) t - 1 - 1 = DF t - 1 DF t - 1 Real interest rates: (1 + R t ) t = (1 + r t ) t (1 + i t ) t 2
1 Short Problems [X Points Total] You have just won the lottery. Among other things that you are now concerned with is how to choose the optimal method of payment. The state lottery agency offers the following options: A A lump sum of \$600,000 payable today B A 20-year annuity with \$72,000 annual payments C A 20-year annuity with \$38,000 semiannual payments D A 20-year annuity with \$5,000 monthly payments Assuming that your discount rate is an effective quarterly rate of 2.5%, which of these options

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