Midterm-W10-MSci 261-Solutions

# Midterm-W10-MSci 261-Solutions - SOLUTIONS TO WINTER 2010...

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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 cash-flow 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/(i-g) (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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2 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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Midterm-W10-MSci 261-Solutions - SOLUTIONS TO WINTER 2010...

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