finance practice exam 1

8/11/2019 Finance Practice Exam 1

1/22


2/22

First three letters ofyour last name

Finance DepartmentWharton School A.Craig MacKinlayCorporate Finance (100) Fall Term 2009

Midterm Examination I (90 Minutes)

October 12, 2009

1. (2 points) Circle the correct answer.

All investors will agree that it is optimal for the firm to use the NPV rule to select investments if:

(i) Investors preferences are such that they want their income flows at the same time.

(ii) Investors can use the capital markets to shift their income flows by borrowing orlending at a fair interest rate.

(iii) Managers of companies cannot pay themselves large bonuses.

(iv) Investors will never agree with the firm using the NPV rule.

2. (3 points) Circle the correct answer.

Which flow has the highest future value at time 5?

(i) $2500 invested for five years at an annual rate of 29% compounded quarterly.

(ii) Starting in six months, 10 deposits of $500 every six months in an account that has anannual yield of 30%.

(iii) $9500 to be paid at time 5.


3/22

3. (5 points; 1-2-2) You are investigating the costs of borrowing $1,000,000 for a term of 10years. A bank has offered you a loan with a ten year term at an annual interest rate of 8.4%compounded monthly. The loan is to have equal monthly payments.

(a) What is the annual yield for this loan rate?

(b) What would the monthly payment be for this loan?

(c) If you decided to pay off the loan immediately after making the 48thmonthly payment, howmuch would you owe?

4. (6 points; 3-1-2) Below you are given information concerning the current price and year-endcash flows for three bonds, A, B, and C.

BOND Current Time 1 Time 2 Time 3 Time 4

Price cash flow cash flow cash flow cash flow

A 780. 35 0 0 0 1000

B 981. 75 50 1050 0 0

C 1073. 50 100 1100 0 0

(a) What is the total present value of three payments: $1700 at time 1, $400 at time 2, and $2000at time 4? (The risk of these payments is the same as the risk of the flows of the bonds.)

(b) Given bonds A, B, and C, what would you expect to be the yield to maturity of a bond whichhas two years to maturity, a coupon rate of 6%, a face value of $100, and pays interest annually?State the yield to maturity as an annual yield (annual rate compounded annually).

(c) What is the interest rate you can lock in now for 1 year in the future with a term of 3 years(i.e. the forward rate f3,1)? State your answer as an annual yield (annual rate compoundedannually).


4/22

5. (5 points; 4-1) WAW is an established company operating in a rapidly growing market. Itsearnings per share this year (at time 1) are expected to be $1.90. These earnings are currentlygrowing at 15% per year. After this year, this growth rate of earnings is expected to continue forfour more years (years 2, 3, 4, and 5). To support the earnings growth, the firm will retain muchof its earnings. At time 1 and time 2, the firm expects to payout 10% of its earnings as

dividends. Then, beginning at time 3, the payout ratio will increase to 20% of earnings andremain at this level through time 5. Beginning at time 6, it is expected that the payout ratio ofthe company will be 0.50. This payout ratio is expected to remain constant forever. The time 6earnings are expected to be 8% higher than the earnings at time 5. WAW expects this 8%growth rate of earnings to continue forever. Given its risk, the required rate of return for thiscompany is 13% per year.

(a) What is the current value of a share of WAW stock?

(b) What fraction of the current value of WAW can be attributed to net present value of growthopportunities (NPVGO)?

6. (4 points) Company AAB has an unusual dividend policy. The company pays shareholdersdividends every two years. It was one year ago that the last dividend was paid. Thus, the nextdividend is expected at time 1. Then dividends are expected to be paid every two years (at time3, time 5, etc.). You expect the dividend at time 1 to be $3.00 per share. The company is verystable. In the future, you expect dividend growth to be constant at a rate of 12% every two years.(This is a two-year growth rate not an annual rate. You expect the dividend at time 3 to be $3.36per share.) Given this dividend growth forecast, what is the value of a share? The requiredreturn for companies with the risk of AAB stated as an annual yield is 10%.


5/22

First three letters of

your last name

Finance Department

Wharton School A.Craig MacKinlay

Corporate Finance (100) Fall Term 2008

Midterm Examination I

October 6, 2008

Instructions

1. This exam is administered under the Universitys rules of academic integrity.

2. Answers cannot win full credit unless you show correct supporting workincluding any necessary assumptions.

3. The exam is closed book, but you may use a calculator and one 8.5 inch x 5.5

inch sheet of notes. No other notes, books, or aids are allowed. Answer all

questions for a possible 25points. You have 1 hours.

4. Regrade requests must be submitted within one week of the date of the return ofthe exam. Only written regrade requests submitted with a completely unaltered

exam paper can be considered.

Good Luck!

Your Name:

Please PRINTclearly

Please circle the section

you are registered in:

1

10:30 AM

2

12:00 PM

3

1:30 PM


6/22

1. ( 6 poi nt s) Ci r cl e t he cor r ect answer . No expl anat i on r equi r ed.

( a) The st ock pr i ce of LWA f el l by 10% l ast mont h. Ther ef or e, t he netpr esent val ue of i t s growt h oppor t uni t i es ( NPVGO) must have decl i ned.

TRUE FALSE

( b) You have bor r owed $100, 000 at an annual r at e of 8% compoundedsemi - annual l y and have agr eed t o repay t he l oan i n t en equal annualpayment s. The f i r st payment i s due si x mont hs f r om t oday and t hen t hepayment s ar e due ever y 12 mont hs ( at 18 mont hs, 30 mont hs, et c. ) unt i lt en payment s have been made. To t he nearest dol l ar , each payment wi l lbe:

( i ) $13344

( i i ) $14351

( i i i ) $14433

( i v) $14925

( c) I f t he annual yi el d i s 7. 50% t hen t he annual r at e cont i nuousl ycompounded i s:

( i ) 7. 23%

( i i ) 7. 31%( i i i ) 7. 50%( i v) 7. 79%

2. ( 3 poi nt s) ABC has i ssued a bond wi t h 10 years t o matur i t y and acoupon r at e of 8%. The bond pays i nterest semi annual l y and has a f aceval ue of $1, 000. I f t he yi el d t o mat ur i t y of t he bond i s 14. 49%( st at ed as an annual yi el d) , what i s t he pr i ce of t he bond?


7/22

3. ( 3 poi nt s) You are gi ven t he choi ce of t hr ee i ncome st r eams. Thest r eams are:

( i ) annual payment s f or 5 year s begi nni ng i n one year ( at t i me 1) t he f i r st payment i s $5000 and the payment s wi l l gr ow at 5% per year ;

( i i ) $26000 t o be pai d i n t wo equal payment s t he f i r st payment of

$13000 i s t o be made i mmedi at el y ( at t i me 0) and the second payment of$13000 t o be pai d i n 5 years ( at t i me 5) ; and

( i i i ) a payment of $98 per mont h t hat cont i nues f or ever .

Assumi ng per f ect capi t al mar ket s, i f t he r equi r ed r at e of r et ur n oni nvest ment s i s 5% compounded annual l y, whi ch st r eam woul d you choose?

4. ( 6 poi nt s; 3- 2- 1) Bel ow you ar e gi ven i nf or mat i on concer ni ng t hecur r ent pr i ce and year - end cash f l ows f or f our bonds, A, B, C, and D.

BOND Current Year 1 Year 2 Year 3 Year 4Price cash flow cash flow cash flow cash flow

A 825. 52 0 0 1000 0

B 1019. 44 70 70 70 1070

C 87. 67 0 100 0 0

D 780. 25 0 0 0 1000

( a) What i s t he pr esent val ue of f our $900 payment s t o be recei ved att he end of years 1, 2, 3, and 4?

( b) Gi ven bonds A, B, C, and D, what woul d you expect t o be t he yi el d

t o mat ur i t y of a f i f t h pur e di scount bond whi ch has one year t omat ur i t y and wi l l pay $10000 at mat ur i t y? St at e t he yi el d to mat ur i t yas an annual yi el d ( annual r ate compounded annual l y) .

( c) What i s t he i nt er est r at e you can l ock i n now f or 1 year i n t hef ut ur e wi t h a t er m of 3 year s ( i . e. t he f or war d r at e f3, 1) ? St at e youranswer as an annual yi el d (annual r ate compounded annual l y) .


8/22

5. ( 5 poi nt s) Bi g Bi r d, a f ast f ood r est aur ant , cur r ent l y does notpay any di vi dends. I t expects t o have earni ngs per shar e of $25. 00over t he next year ( EPS1) . For year 2, year 3, and year 4, ear ni ngsare expected t o gr ow at 20% per year . At t i me 4, Bi g Bi r d expects t ost ar t payi ng di vi dends and f or t he di vi dend at t i me 4 ( DI V4) wi l l havea payout r at i o of 0. 30. For year 5, year 6, and year 7, di vi dends ar eexpect ed t o gr ow at 15% per year and f or t hose same year s, ear ni ngsare expect ed t o gr ow at 12% per year . Begi nni ng at t he end of year 7t he f i r m i s expect ed t o begi n a l ong r un st abl e phase wi t h ear ni ngsper shar e gr owi ng at 5% per pet ual l y and wi t h t he pl owback rat i oconst ant at 0. 45. The r equi r ed r at e of r et ur n f or t hi s company i s 16%per year . What i s t he cur r ent val ue of a shar e of st ock?

6. ( 2 poi nt s) You ar e ent i t l ed t o a per pet ual st r eam of payment s. Youwi l l r ecei ve a payment of $20 i n one year . Al l f ut ur e payment s wi l li ncr ease by $10 per year. ( You wi l l r ecei ve $30 at t i me 2, $40 att i me 3, $50 at t i me 4, etc. ) The payment s i ncr easi ng at $10 per yearwi l l cont i nue f or ever . I f t he appr opr i at e r equi r ed r et ur n t o val uet hese payment s i s 9% st at ed as an annual r at e compounded annual l y,t hen what i s t he pr esent val ue of t hi s payment st r eam?


9/22


10/22


11/22


12/22


13/22


14/22


15/22


16/22


17/22


18/22


19/22


20/22


21/22


22/22

finance practice exam 1

Documents