Business Finance Page 133

Sample Mid-term questions

[Mid-term: 20 Multiple Choice Questions from Topic 1 - 4]
August 7, 2012 @ 14:15

Question 1
Which of the following is false?
a. Present value is the amount which must be set aside today in order to have a specified future amount
b. Present value is higher with more frequent compounding
c. For an ordinary annuity it is assumed that the payments are received at the end of each period
d. All are true

Question 2
Diep plans to go traveling in eight years time. To pay for her trip, she has decided to save $1,000 per month for the next eight
years in a bank account paying 2% p.a. fixed interest, compounded monthly. How much money will Diep have in six years
time?


Question 3
Which of the following statements are not true?
a. An ordinary annuity is an equal payment paid or received at the end of each period
b. An annuity due is a payment paid or received at the beginning of each period that decreases by an equal amount each
period
c. An ordinary annuity is an equal payment paid or received at the end of each period
d. All are untrue

Question 4
Trang has a 30-year, $100,000 mortgage with a nominal interest rate of 10 percent p.a. and monthly compounding. Which of
the following statements regarding his mortgage is most incorrect?
a. The monthly payments will decline over time.
b. The proportion of the monthly payment which represents interest will be lower for the last payment than for the first
payment on the loan.
c. The total dollar amount of principal being paid off each month gets larger as the loan approaches maturity.
d. None of the above

Question 5
The present value of a payment of $1,000 to be received one year from now will be greatest at which rate of interest?

a. 6% b. 7% c. 8% d. Compounding frequency is more important than the rate
of interest. Fewer compounding periods, the higher the PV


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Question 6
Using daily compounding, a 3 year zero coupon bond that has a face value of $1,000 and a required return of 18% p.a. would
be priced at

Question 7
What semi-annual payment is necessary to accumulate $10 million over 5 years if the annual interest rate is 7.5% compounded
semi-annually? Assume payments are made at the end of each period.

Question 8
Given the following information about Mai Inc, what is the growth rate of its ordinary shareholders?
The expected rate of return is 12.0 percent p.a., the current market price of its ordinary shares is $50.00 and the last dividend
paid to the firms ordinary shareholders was $1.75.

Question 9
When a bond is selling at a discount:
a. It is an unattractive investment
b. Its coupon rate is equal to the market yield
c. Its price is more than the face value
d. All of these
e. b & c only
f. None of the above

Question 10
Which of the following statements is most correct?
a. If annual compounding is used, the effective annual rate equals the nominal rate.
b. If annual compounding is used, the effective annual rate equals the interest rate per period.
c. If a loan has a 12 percent p.a. nominal rate with semi-annual compounding, its effective annual rate is equal to 11.66
percent.
d. Answers a and b are correct.

Question 11
When evaluating the cash flows for a capital budgeting evaluation, which of the following statements is most correct?
a. The rate of depreciation is not cash flow therefore ignored.
b. Inflation is considered a sunk cost and therefore included when making investment decisions.
c. Tax shields are considered incremental income and therefore included in making decisions.
d. None of these are correct dilemma

Question 12
What is the payback period if the initial investment is $810 and the cash flows are:
Year 1 $200,000 Year 2 $250,000 Year 3 $300,000 Year 4 $100,000 Year 5 $-50,000

Business Finance Page 135

Question 13

Xuan must choose between two alternative investments. Each asset is expected to provide cash flows over a three-year period
described below:

Asset Year 1 Year 2 Year 3
A $15,000 $20,000 $27,000
B $27,000 $20,000 $15,000

Based on these cash flows and assuming the required rate of return for A is 12% p.a. and the required rate of return for B is
10% p.a., Xuan would choose

Question 14

Which of the following statements is least correct?

a. In an amortized loan with monthly payments, the proportion of the payment that goes toward repayment of principal
falls increases over time
b. The future value of a five year ordinary annuity will be greater than the future value of a five year annuity due,
assuming that both annuities consist of a $100 payments.
c. If an investment is compounded semi-annually, its nominal rate must higher than its effective rate.
d. All are incorrect

Question 15

An investment is accepted if the Payback period is:

a. Equal to the expected rate of return
b. Equal to the real rate of return
c. Below the nominal rate of return
d. None of the above

Question 16

Which of the following would decrease the IRR of a project (all other things held constant)?

a. An increase in the initial cost of the project.
b. An increase in the required rate of return on the project.
c. An increase in the incremental revenues generated by the project.
d. An increase in the operating costs associated with the project.

Question 17

You buy a six year bond which pays interest of 8% p.a. At the end of year six, you purchase a one year bond that pays interest
of 12% p.a. According to the expectations theory of interest rates, you could have purchased a seven year bond today that
paid interest each year of:


Question 18

Minh Inc. issued a fix-rate perpetual preferred stock three years ago. The stock was issued at $25 per share with
a dividend of $1.75. If the company were to issue preferred stock today, the yield would be 6.5%. The stocks
current value is:

a. $25.00 b. $26.92 c. $37.31

Question 19

The likelihood that managers may place personal goals ahead of corporate goals is called:

a. Agency problem b. Opportunity cost c. Poison pill d. Fidelity conflict


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Question 20

What quarterly payment is necessary to accumulate $1.5 million over 15 years if the annual interest rate is 6.75% compounded
quarterly? Assume payments are made at the end of each quarter.

a. $10,703 b. $14,637 c. $18,534 d. $24,748


Question 21

Given the following information about Flinstone Ltd., what is the required rate return of its ordinary shareholders? The
expected growth rate of dividends is 4.5 percent p.a., the current market price of its ordinary shares is $43.67 and the last
dividend paid to the firms ordinary shareholders was $1.75.

a. 4.5 % b. 8.51% c. 8.69% d. 9.51%


Question 22

You are considering acquiring a share and selling it at the end of one year. You expect to receive both $1.50 in dividends and
$26 from the sale of the share at the end of the year. What is the maximum price you would pay for the share today if you
wanted to earn a 15% p.a. return?

a. $23.91 b. $24.11 c. $27.30 d. $27.50

Question 23

If a bond is selling at a premium:

a. It is an attractive investment
b. Its coupon rate is below the market yield
c. Its price is less than the face value
d. Its yield to maturity is lower than its coupon rate

Question 24

An investment is accepted if the IRR exceeds the:

a. Expected rate of return
b. Real rate of return
c. Nominal rate of return
d. Required rate of return
Question 25

The coupon rate of a bond is the:

a. annual income that a bond investor receives expressed as a percent of the bonds par value.
b. annual rate earned including the capital gain or loss.
c. rate earned giving consideration to coupon reinvestment
d. promised yield to maturity.


Question 26

Which of the following statements about NPV and IRR is false?

a. for an independent project the NPV will be positive if the IRR is less than the firms cost of capital
b. any independent project acceptable by the NPV method will also be acceptable by the IRR method (if the multiple
IRR problem does not exist)
c. when IRR equals the firms cost of capital, NPV = 0
d. when considering mutually exclusive projects, it is preferable to use NPV rather than IRR


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Question 27

Which of the following would increase the NPV of a project (all other things held constant)?

a. An increase in the initial cost of the project.
b. An increase in the required rate of return on the project.
c. An increase in the incremental revenues generated by the project.
d. An increase in the operating costs associated with the project.

Question 28

Using semi-annual compounding, a 15 year zero coupon bond that has a face value of $1,000 and a required return of 8% p.a.
would be priced at:

a. $308 b. $315 c. $464 d. $555

Question 29

When evaluating the cash flows for a capital budgeting evaluation, which of the following statements is most correct?

a. The rate of depreciation will affect operating cash flows, even though depreciation is not a cash expense.
b. Corporations should fully account for sunk costs when making investment decisions.
c. Corporations should fully account for opportunity costs when making investment decisions.
d. Answers a and c are correct.

Question 30

The payback period rule:

a. Discounts cash flows
b. Determines a cut-off point so that all projects accepted by the NPV rule will be accepted by the payback period rule
c. Varies the cut-off point with the interest rate
d. Requires an arbitrary choice of a cut-off point

Question 31

What is the present value at a 10 percent p.a. discount rate of depreciation tax shield which occurs in the fifth year for a firm in
the 35 percent tax bracket that purchases a $10,000 asset being depreciated straight line over five years to zero salvage value?

a. $434.64 b. $636.36 c. $1,241.84 d.$2,000.00
Question 32

You buy a six year bond which pays interest of 8% p.a. At the end of year six, you purchase a one year bond that pays interest
of 12% p.a. According to the expectations theory of interest rates, you could have purchased a seven year bond today that
paid interest each year of:

Question 33

The director of capital budgeting for KLM Ltd has identified a project with the following expected net
cash flows. This project has a 10% p.a. cost of capital. What is the projects NPV?

Year Expected Net Cash Flows
0 ($100)
1 70
2 50
3 20

Question 34

If a $50,000 loan is repaid over 10 years with an $8,137 annual payment, how much is the principal portion of the 4th
payment?
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Question 35

Which of the following statements is most correct?

a. In an amortized loan with monthly payments, the proportion of the payment that goes toward repayment of
principal falls steadily over time.
b. The present value of a five year ordinary annuity will be greater than the present value of a five year annuity
due, assuming that both annuities consist of a $100 payment.
c. If an investment is compounded annually, its nominal rate must always equal its effective rate.
d. Both B and C are correct.

Question 36

You are considering acquiring a share and selling it at the end of one year. You expect to receive both $4.50 in dividends and
$226 from the sale of the share at the end of the year. What is the maximum price you would pay for the share today if you
wanted to earn a 15% p.a. return?


Question 37

In finance, the wealth of the owners of a firm is represented by:

a. Profits b. EPS c. Share price d. Cash flow

Question 38

With continuous compounding, holding periods cannot be measured, thus at 10 percent compounded continuously for 30
years, the future value of an initial investment of $2,000 is closest to

a. $34,898 b. $40,171 c. $164,500 d. $328,282


Question 39

If two year interest rates are 6% and three year interest rates are 7%, what is the one year rate, one year from now?

Question 40
Using the constant growth model, a decrease in the required rate of return from 15 to 13 precent combined with an increase in
the growth rate from 5 to 6 precent would cause the price of a share to

a. Rise by more than 50% b. Rise less than 50% c. Remain constant d. Fall more than 50%

Question 41
When comparing simple and compound rates of interest, it is always a true statement when calculating an equivalent simple
interest rate that:
a. For all positive rates of interest with greater than one compounding period, simple rates are always greater than
compound rates
b. For all positive rates of interest, simple rates are always greater than compound rates
c. For all positive rates of interest, simple rates are equal to compound rates
d. For all positive rates of interest, simple rates are unrelated to compound rates
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Question 42
If an investment in HAGL Co. Ltd shares returned an unrealized return of 8.0% over one year, if continuously compounded, it
would be the equivalent to ______ ?
a. Ln 8 b. ln 1.08 c. e
1.08
d. e
8


Question 43
Which of the following statements about IRR is correct?
a. IRR is the discount rate which maximizes the NPV of a project
b. IRR will always give the same ranking of projects as the NPV criterion
c. IRR is the discount rate which sets NPV equal to zero
d. IRR is another term for the firms required rate of return
Question 44
The director of capital budgeting for KLM Ltd has identified a project with the following expected net cash flows:
Year Expected Net Cash Flows
0. ($130)
1. $90
2. $70
3. 3 $80
This project has a 8% p.a. cost of capital. What is the projects NPV?
a. $19.98 b. $74.10 c. $30.00 d. $76.85
Question 45
Which one of the following statements is NOT true about amortization?
a. Amortization refers to the way the borrowed amount (principal) is paid down over the life of the loan
b. With an amortized loan, each loan payment contains some payment of principal and an interest payment
c. With an amortized loan, a smaller portion of each months payment goes toward interest in the early periods
d. A loan amortization schedule is just a table that shows the loan balance at the beginning and end of end of each
period, the payment made during that period, and how much of that payment represents interests and how much
represents repayment of principal
Question 46
If todays one-year yield is 10% p.a and three-year yield is 8% p.a, then the two-year yield expected one year from today is:
a. 9% b. 8% c. 7% d. 6%

Question 47
Nguyen Pty Ltds last dividend, D0 was $0.25 and the company expects to experience growth in dividends in the next four years
of 4% p.a. Beginning in the fifth year Nguyen Ptys dividends should attain a 5% p.a. growth rate which will continue
thereafter. Nguyen Pty Ltds shareholders have a required rate of return of 9% p.a. The value of Nguyen Pty Ltd share today
would be:
d. $6.33 b. $6.59 c. $6.11 d. $6.82
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Question 48
Using the constant growth model, a decrease in the required rate of return from 15 to 13 percent combined with an increase in
the growth rate from 5 to 6 percent would cause the price of a share to

a. Rise more than 50%
b. Ride less than 50%
c. Remain constant
d. Fall more than 50%

Question 49
A cash strapped young professional offers to buy your car with four, equal annual payments of $3,000, beginning two years
from today. Assuming youre indifferent to cash versus credit, that you can invest at 10%, and that you want to receive $9,000
for the car, should you accept?

a. Yes, Present value is $9,510
b. Yes, Present value is $11,372
c. No, Present value is $8,645
d. No, Present value is $7,461


Question 50
What would the future value of T16 of a yearly annuity of $350 for 16 years if the appropriate interest rate is 9.0% p.a. and the
first payment arrives today?

a. $12,591 b. $11,551 c. $2,909 d. $3,171


Question 51
A security is currently selling for $8,000 and promises to pay $1,000 annually for the next 9 years, and $1500 annually in the 3
years thereafter with all payments occurring at the end of each year. If your required rate of return is 7% p.a, should you buy
this security?

a. Yes, because the return is greater than 7%
b. Yes, because the return is less than 7%
c. Yes, because the present value at 7% is less than $8,000
d. No, because the return is less than 7%

Question 52
For a project to have only one IRR, it must be the case that:

a. All cash flows after the initial cost of the project are positive
b. ARR is positive
c. All cash flows after the initial cost of the project are both positive and negative
d. NPV is positive

Question 53
When measuring continuous compounding financial returns of a financial asset, it is a true statement that:

a. Holding periods are so large they cannot be measured, with frequency of compounding so large it goes to infinity
b. Holding periods are so small they cannot be measured, with frequency of compounding so small it goes to zero
c. Holding periods are so small they cannot be measured, with frequency of compounding so large it goes to infinity
d. Holding periods are so small they cannot be measured, with frequency of compounding that equals the constant
2.718

Business Finance Page 141


Question 54
Regarding loan amortization, which of the following is TRUE? The amount of
a. Principal in subsequent payments decrease
b. Each payment is equal
c. Interest paid in subsequent payment increases
d. Interest equals the amount of principal in each payment
Question 55
A security is currently selling for $8,000 and promises to pay $1,000 annualy for the next 9 years, and $1,500 annualy in the 3
years thereafter with all payments occurring at the end of each year. If your required rate of return is 7% p.a., should you buy
this security?
a. Yes, because the return is greater than 7%
b. Yes, because the return is 7%
c. Yes, because the present value at 7% is less than $8,000
d. No, because the return is less than 7%
Question 56
What would be the future value of T
16
of a yearly annuity of $350 for 16 years if the appropriate interest rate is 9.0% p.a. and
the first payment arrives today?
a. $12,591 b. $11,551 c. $2,909 d. $3,171
Question 57
Over a one-year period, the difference between the future value of $500 invested at 15% p.a. simple interest and $500
invested at 15% p.a annually compounded interest will be:
a. Nothing b. $15.00 c. $1.50 d. $150.00
Question 58
Use the following information and the dividend discount model to find the value of GoFlower Incs common stock.
Shareholders have a required rate of return of 10%
Current dividend was $3.10 per share. The growth rate in dividends is estimated to be 11% for years 1-3,, 5% for years 4-5,
and for year 6 to forever is 3%
a. $92.50 b. $66.75 c. $61.22 d. $68.78

Question 59
Which of the following capital budgeting decision rules does not use the cost of capital, r, in its calculation:
a. IRR b. NPV c. Payback Period d. Both a & c

Question 60
Using the constant growth rate dividend discount model to value a firm whose growth rate is greater than its required rate of
return on equity would result in a value that is:
a. Negative b. Infinite c. Zero d. Finite but unknown
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Question 61
Truong Nguyen is considering investing in a new printing machine. The machine costs $150,000 and is projected to generate
$25,200 cash inflows at the end of each year for a period of 10 years. Truong Nguyen estimates the appropriate discount rate
to be 7% p.a. What is the NPV of the new printing machine?
a. -$14,189.91 b. -$27,315.85 c. $4,843.09 d. $26,994.25

Question 62
Truong Nguyens outstanding bond are traded at the following market yields:
Year 1: 10% Year 3: 9.0% Year 4: 7.0% Year 5: 5.0% Year 10: 3.0%
The yield curve of the term structure of interest rates can be best described as:
a. Flat b. Inverted c. Normal d. Humped