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SOLUTIONS TO WINTER 2010 MIDTERM EXAM, MSci 261, Prof. Fuller
1
Problem 1.
Multiple Choice. For each question, select the one
correct answer by circling the letter.
1.1
[2 marks]
A company decides on proposed investments by the present worth method, with the MARR as
the weighted average cost of capital calculated as w
d
i
d
+w
e
i
e
.
A proposed investment has a present worth
PW>0.
(a) Normally, MARR < w
d
i
d
+w
e
i
e
.
(b) Normally, w
d
i
d
< PW < w
e
i
e
.
(c) Normally, i
e
< i
d
.
(d) Normally, MARR > i
e
.
(e) none of the above.
1.2
[2 marks]
3
Consider the following two cashflow diagrams. Interest is compounded once per period at
the rate i .
What is the interest factor (A*/ A, i, N) that transforms these two annuities into equivalent cash flows?
(a)
(P/A, (1+i)
2
1, N) (A/P, i, 2N)
(b)
1 / [(1 + i/2)
2
+ 1]
(c)
1 / [(1 + i/2)
2
– 1]
(d)
1/(1 +2 i)
(e)
½
1.3
[2 marks]
Annual maintenance on a new building is estimated to start at $12,000 in one year, and to
increase geometrically at 2% per year for a very large number of years thereafter.
The building’s owners want
to deposit an amount of money, X, into an account that earns interest at the rate of 4%, in order to have
enough to withdraw the money required for maintenance, for 120 years.
Indicate the best approximation of X:
(a) X
≈
[$12,000/(1+.02)]/(0.04)
(b) X
≈
[$12,000*(1+.02)]/(0.04)
(c) X
≈
the limit as i
→
0 of $12,000*(1+i)/(1+.02+.04)
(d) X
≈
$12,000/(.04  .02)
(e) X
≈
$12,000/(.04 + .02)
0
1
2
3
4
2N
A
0
1
2
3
4
2N
A*
Correct answer: (e)
Normally MARR
≥
WCC=w
d
i
d
+w
e
i
e
Hence, choice (a) to (d) are not correct
.
Correct answer: (a)
(P/A, (1+i)
2
1, N) factor will convert the cash flow series shown
above into a present worth (with the effective interest rate=(1+i)
2
1 ).
(A/P, i, 2N) factor converts this into annuities per period, which is
equivalent to the cash flow series shown below.
Correct answer: (d)
As N goes to infinity for a geometric gradient series
P=A/(ig)
(from quiz question 4.1 or 1.1 of Management section )
If N=120 (relatively large number) we can estimate
present worth by X
≈
$12,000/(.04  .02)
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Problem 2
[7 marks]
You have been asked to prepare the financial statements
for your company.
As part of
your task, you have to place several accounting items under the correct general headings. Place an “x” in the
box for the correct heading, for each of the following items.
Item
Current
Assets
Long Term
Assets
Current
Liabilities
Long Term
Liabilities
Owners’
Equity
Income
Statement
Accounts Receivable
X
Depreciation This Year
X
Retained Earnings
X
Income Tax Paid This Year
X
Accounts Payable
X
Book Value of Equipment
X
Shares
X
Note that there is only one heading for each item.
Problem 3
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 Winter '09
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