How to answer finance exam Q1

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1. Which of the following is/are an advantage(s) of incorporation?

A) Access to capital markets

B) Limited liability

C) Unlimited life

D) All of the above

2. Which of the following statements is false?

A) In bankruptcy, management is given the opportunity to reorganize the firm and renegotiate with debt holders.

B) Because a corporation is a separate legal entity, when it fails to repay its debts, the people who lent to the firm (the debt holders) are entitled to seize the assets of the corporation in compensation for the default.

C) As long as the corporation can satisfy the claims of the debt holders, ownership remains in the hands of the equity holders.

D) If the corporation fails to satisfy debt holders’ claims, equity holders may take control of the firm.

3. Which of the following is NOT a financial statement that every public company is required by IFRS to produce?

A) Income Statement

B) Statement of Comprehensive Income

C) Balance Sheet

D) Statement of Changes in Equity

4. The P/E ratio is not useful when the firm’s ________ are negative. In this case, it is common to look at the firm’s ________ relative to sales.

A) operating earnings; enterprise value

B) net earnings; enterprise value

C) operating earnings; market value

D) net earnings; market value

5. Consider the following oil prices:

Alaska North Slope Crude Oil (ANS)	$71.75/Bbl
West Texas Intermediate Crude Oil (WTI)	$73.06/Bbl

As an oil refiner, you are able to produce $76 worth of unleaded gasoline from one barrel of Alaska North Slope (ANS) crude oil.  Because of its lower sulfur content, you can produce $77 worth of unleaded gasoline from one barrel of West Texas Intermediate (WTI) crude.

Another oil refiner is offering to trade you 10,150 Bbls of Alaska North Slope (ANS) crude oil for 10,000 Bbls of West Texas Intermediate (WTI) crude oil. Assuming you currently have 10,000 Bbls of WTI crude, the added benefit (cost) to you if you take the trade is closest to:

A) ($1,400)

B) $1,400

C) ($3,908)

D) $3,908

6. You have an investment opportunity in Germany that requires an investment of $250,000 today and will produce a cash flow of €208,650 in one year with no risk. Suppose the risk-free rate of interest in Germany is 6% and the current competitive exchange rate is €0.78 to $1.00. What is the NPV of this project? Would you take the project?

A) NPV = 0; No

B) NPV = 2,358; No

C) NPV = 2,358; Yes

D) NPV = 13,650; Yes

7. Consider the following timeline detailing a stream of cash flows:

If the current market rate of interest is 6%, then the future value of this stream of cash flows is closest to:

A) $1,723

B) $1,500

C) $1,626

D) $1,288

8. After many years teaching finance at Capilano University, Allen wants to establish a scholarship to offer 4 $1,000 awards each year to students whose performance is excellent in finance courses. If the university can negotiate a 12.75% effective interest rate, at least how much does Allen need to endorse over to the scholarship (closest estimate)?

A) $32,000

B) $31,000

C) $31,500

D) $32,500

9. Consider the following investment alternatives:

Investment	Rate	Compounding
A	6.25%	Annual
B	6.10%	Daily
C	6.125	Quarterly
D	6.120	Monthly

The highest effective rate of return you could earn on any of these investments is closest to:

A) 6.250%

B) 6.267%

C) 6.300%

D) 6.320%

10. Which of the following statements is false?

A) The yield curve changes over time.

B) The formulas for computing present values of annuities and perpetuities cannot be used in situations in which cash flows need to be discounted at different rates.

C) We can use the term structure to compute the present and future values of a risk-free cash flow over different investment horizons.

D) The yield curve tends to be inverted as the economy comes out of a recession.

11. The Sisyphean Company has a bond outstanding with a face value of $1,000 that reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate for this bond is 8% and that the coupon payments are to be made semi-annually.

Assuming that this bond trades for $903, then the YTM for this bond is closest to:

A) 8.0%

B) 6.8%

C) 9.9%

D) 9.2%

12. Consider the following four bonds that pay annual coupons:

Bond	Years to maturity	Coupon	YTM
A	1	0%	5%
B	5	6%	7%
C	10	10%	9%
D	20	0%	8%

The percentage change in the price of the bond “A” if its yield to maturity increases from 5% to 6% is closest to:

A) -4%

B) -6%

C) -1%

D) 4%

13. You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 20% per year. If Bean’s equity cost of capital is 12%, then the price of a share of Bean’s stock is closest to:

A) $17.00

B) $10.75

C) $27.75

D) $43.50

14. Defenestration Industries plans to pay a $4.00 dividend this year and you expect that the firm’s earnings are on track to grow at 5% per year for the foreseeable future. Defenestration’s equity cost of capital is 13%.

Suppose that Defenestration decides to pay a dividend of only $2 per share this year and use the remaining $2 per share to repurchase stock. If Defenestration maintains this dividend and total payout rate, then the rate at which Defenestration’s dividends and earnings per share are expected to grow is closest to:

A) 7%

B) 13%

C) 9%

D) 5%

15. Larry the Cucumber has been offered $14 million to star in the lead role of the next three Larry Boy adventure movies. If Larry takes this offer, he will have to forgo acting in other Veggie movies that would pay him $5 million at the end of each of the next three years. Assume Larry’s personal cost of capital is 10% per year.

The NPV of Larry’s three-movie Larry Boy offer is closest to:

A) 3.5 million

B) -1.6 million

C) 1.6 million

D) -1.0 million

16. Boulderado has come up with a new composite snowboard.  Development will take Boulderado four years and cost $250,000 per year, with the first of the four equal investments payable today upon acceptance of the project.  Once in production the snowboard is expected to produce annual cash flows of $200,000 each year for 10 years.  Boulderado’s discount rate is 10%.

The IRR for Boulderado’s snowboard project is closest to:

A) 10.4%

B) 10.0%

C) 11.0%

D) 15.1%

17. The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years.  The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0. 

The cane manufacturing machine will result in sales of 2,000 canes in year 1.  Sales are estimated to grow by 10% per year each year through year three.  The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant.  The canes have a cost per unit to manufacture of $9 each.

Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts.  It is estimated that the Sisyphean Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable.  The firm is in the 35% tax bracket, and has a cost of capital of 10%.

The depreciation tax shield (assuming the half-year rule is not applied for straight-line depreciation) for the Sisyphean Corporation’s project in the first year is closest to:

A) $8,000

B) $3,500

C) $2,800

D) $5,200

18. You are considering adding a microbrewery onto one of your firm’s existing restaurants. This will entail an increase in inventory of $8,000, an increase in accounts payable of $2,500, and an increase in property, plant, and equipment of $40,000. All other accounts will remain unchanged. The change in net working capital resulting from the addition of the microbrewery is:

A) $45,500

B) $10,500

C) $6,500

D) $5,500

19. Suppose an investment is equally likely to have a 35% return or a -20% return. The standard deviation on the return for this investment is closest to:

A) 38.9%

B) 0%

C) 19.4%

D) 27.5%

20. Suppose that in the coming year, you expect Exxon-Mobil stock to have a volatility of 42% and a beta of 0.9, and Merck’s stock to have a volatility of 24% and a beta of 1.1. The risk free interest rate is 4% and the market’s expected return is 12%.

The cost of capital for a project with the same beta as Exxon Mobil’s stock is closest to:

A) 11.6%

B) 11.2%

C) 12.8%

D) 7.6%

21. Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share.

Suppose over the next year Ball has a return of 12.5%, Lowes has a return of 20%, and Abbott Labs has a return of -10%. The weight of Lowes in your portfolio after one year is closest to:

A) 20.0%

B) 34.8%

C) 30.0%

D) 36.0%

22. Consider an equally weighted portfolio that contains 100 stocks. If the average volatility of these stocks is 50% and the average correlation between the stocks is .7, then the volatility of this equally weighted portfolio is closest to:

A) .72

B) .59

C) .40

D) .50

23. Which of the following statements is false?

A) Investors may have different information regarding expected returns, correlations, and volatilities, but they correctly interpret that information and the information contained in market prices and they adjust their estimates of expected returns in a rational way.

B) Investors may learn different information through their own research and observations, but as long as they understand the differences in information and learn from other investors by observing prices, the CAPM conclusions still stand.

C) Every investor, regardless of how much information he has access to, can guarantee himself an alpha of zero by holding the market portfolio.

D) The CAPM requires making the strong assumptions of homogeneous expectations.

24. The only way it can be possible to earn a positive alpha and beat the market is if some investors are holding portfolios with ________ alphas.

A) positive

B) zero

C) negative

D) none of the above

25. Consider the following graph of the security market line:

Which of the following statements regarding portfolio “C” is/are correct?

1.  Portfolio “C” has a negative alpha.

2.  Portfolio “C” is overpriced.

3.  Portfolio “C” is less risky than the market portfolio.

4.  Portfolio “C” should not exist if the market portfolio is efficient.

A) 1 and 3

B) 2 and 4

C) 1, 3, and 4

D) 3 only

26. Uninformed individuals tend to ________ the precision of their knowledge. In finance, we call this presumptuousness the ________ hypothesis.

A) underestimate; underconfidence

B) overestimate; overconfidence

C) underestimate; overconfidence

D) overestimate; underconfidence

27. Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project’s cost of capital is 15%. The risk-free interest rate is 5%.

Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free rate and issues new equity to cover the remainder. In this situation, the cash flow that equity holders will receive in one year in a strong economy is closest to:

A) $117,000

B) $75,000

C) $50,000

D) $0

28. You are evaluating a new project and need an estimate for your project’s beta. You have identified the following information about three firms with comparable projects:

Firm Name	Equity Beta	Debt Beta	Debt to Equity Ratio
Lincoln	1.25	0	0.25
Blinkin	1.6	0.2	1
Nod	2.3	0.3	1.5

20) The unlevered beta for Nod is closest to:

A) 1.00

B) 0.90

C) 0.95

D) 1.10

29. Consider the following income statement for Kroger Inc. (all figures in $ millions):

Year	2006	2005	2004
Total Sales	60,553	56,434	53,791
Cost of goods sold	45,565	42,140	39,637
Selling, general & admin expenses	11,688	12,191	11,575
Depreciation	1,265	1,256	1,209
Operating Income	2,035	847	1,370
Other Income	0	0	0
EBIT	2,035	847	1,370
Interest expense	510	557	604
Earnings before tax	1,525	290	766
Taxes (35%)	534	102	268
Net Income	991	189	498

The interest rate tax shield for Kroger in 2006 is closest to:

A) $187 million

B) $332 million

C) $534 million

D) $179 million

30. The total amount available to pay out to all the investors in Kroger in 2006 is closest to:

A) $990 million

B) $1,525 million

C) $1,500 million

D) $2,035 million

 

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