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# FINAL EXAM

NAME ________________________________________________________
STUDENT NUMBER ____________________________________________
CLASS DAYS/TIME ___________________

INSTRUCTOR__________________________

## READ THE FOLLOWING DIRECTIONS VERY CAREFULLY.

FAILURE TO
FOLLOW THESE DIRECTIONS WILL ALMOST CERTAINLY RESULT IN YOUR
IF THERE IS ANYTHING ABOUT THE DIRECTIONS THAT YOU DO NOT
1.

Fill in your name, student number, and the days and time of the class for which you are
registered (for example, T/Th at 5:00 p.m.) on the Answer Sheet as well as on the lines
above.

2.

In the box on the Answer Sheet titled "EXAM NUMBER" record the number that
appears in the upper right hand corner of this sheet on the line "EXAM NUMBER"
since there are multiple versions of the exam, failure to do so may result in your
exam being graded with the wrong answer key!!! DO NOT COPY FROM
SOMEONE ELSE'S EXAM - YOUR NEIGHBOR MAY HAVE A DIFFERENT
VERSION OF THE EXAM!!!

3.

Read each question very carefully. Consider all of the answer items and then select the
best correct answer - there is only one best answer per question. Circle the letter answer
on the exam and record your answers on the Answer Sheet.

1. You are considering two perpetuities which are identical in every way except for the when the
perpetuity payments will begin. Perpetuity A will begin making annual payments of a fixed amount,
with the first payment being made two years from today. Perpetuity B pays the same fixed annual
payment, but will make the first payment one year from today. Which of the following statements is
most correct?

a. The PV of perpetuity A is greater than the PV of perpetuity B by the amount of the fixed
payment.
b. The PV of perpetuity B is greater than the PV of perpetuity A by the amount of the fixed
payment.
c. The PV of perpetuity A is equal to the PV of perpetuity B.
d. The PV of perpetuity A is greater than the PV of perpetuity B by the present value of the amount
of the fixed payment.
e. The PV of perpetuity B is greater than the PV of perpetuity A by the present value of the amount
of the fixed payment.

## Stocks and Bonds Questions

2. Which of the following statements is correct?
a.
b.
c.
d.
e.

A zero coupon bond is a promise to pay a single lump sum at some point in the future.
The price of a bond moves in the opposite direction to changes in market interest rates.
A bond that has a yield to maturity that is greater than its coupon rate will sell at a premium.
(a), (b), and (c) are all correct.
(a) and (b) are both correct.

3. Assume that investors lower their required rates of return. Assuming all other factors remain
constant, which of the following scenarios is most likely?

a.
b.
c.
d.
e.

The prices of stocks will increase and the prices of bonds will decrease.
The prices of stocks will decrease and the prices of bonds will increase.
The prices of stocks and bonds will both increase.
The prices of stocks and bonds will both decrease.
It is impossible to tell without more information.

4. Do It Yourself Dental Surgery Inc. just paid a \$20 dividend at the end of the current year (i.e., D 0 =
\$20). After the dividend is paid, the companys dividends are expected to grow at a 50% annual rate
for each of the following two years, and then settle down to a steady state growth rate of 5% annually.
If investors required rate of return is 15% on this stock, what should a share sell for today?
a.
b.
c.
d.
e.

\$472.50
\$350.75
\$380.34
\$417.39
none of the above answers is within \$10 of the correct answer

5. What is the price on a 20-year, 8% annual coupon bond, assuming that the market rate is 12%.
a.
b.
c.
d.
e.

\$1,000
\$701.22
\$750
\$890.50
\$642.43

6. Bobby Inc.s most recent dividend was \$10 per share. Dividends are expected to grow at an 8%
annual rate into the foreseeable future. If your required rate of return is 12% annually, how much
should you pay for a share of ABC Corp?
a.
b.
c.
d.
e.

\$270
\$250
\$130
\$83.33
\$415

7. A 25-year bond with a \$1,000 face value and a 6% coupon rate (with semi-annual payments) is
currently selling for \$634.88. What is the annual yield to maturity on this bond?
a.
b.
c.
d.
e.

10%
10.03%
5%
10.25%
6%

## Capital Budgeting Questions

8. A five-year project, if undertaken, will require an initial investment of \$95,000. The expected end-ofyear cash flows are:
Year 1:
\$12,000
Year 2:
\$39,000
Year 3:
\$39,000
Year 4:
\$30,000
Year 5:
\$18,000
If the appropriate discount rate for this project is 15%, which of the following is a correct statement?
a.
b.
c.
d.
e.

## Reject the project because its IRR is 13.56%

Accept the project because its NPV is \$6,500
Accept the project because the IRR is 17.3%
Reject the project because its NPV is -3330.70
Both a and d are correct

9. The following table lists the capital budgeting analysis of four different independent projects with an
equal life:
Project
A
B
C
D

NPV
\$4,500
-\$3,600
\$7,100
\$75

IRR
15%
17%
8%
23%

Discount Rate
13%
18%
6%
22.5%

## Which project(s) would you choose?

a.
b.
c.
d.
e.

A only
C only
A and C
A, C, and D
A, B, C, and D

10. Which of the following statements is most correct concerning a project with normal cash flows (i.e., a
cash outflow in Year 0 followed by cash inflows in all subsequent years)?
a. If the NPV of a project is positive then the payback period rule will always accept the project
b. If the NPV of a project is negative, then the profitability index of the project will always be
greater than one.
c. If the PI of a project is greater than one, then the IRR will always be less than the projects cost of
capital
d. If the NPV of a project is zero, then the IRR of the project will be equal to the discount rate for
the project.
e. If the discount rate of a project is zero, then the project will always be accepted.
11. MECCS Inc. is considering the purchase of VICX Inc. The managers of VICX estimate that the assets
of VICX will generate \$14 million in cash flows next year and that these cash flows will grow at a
constant rate of 6 percent per year forever. The appropriate discount rate is 13 percent per year and
the purchase price is \$180 million. Compute the NPV of this investment.
a.
b.
c.
d.
e.

\$10 million
\$20 million
\$30 million
\$40 million
\$50 million

## Use the following information to answer questions 23 through 25.

Truman Electronics manufactures a variety of household appliances. The company is considering
introducing a new microwave oven. The unique feature of this oven is that it is capable of cooking food
items 80 percent faster than conventional microwave ovens. The company's CFO has collected the
following information about the proposed product.

## The project has an anticipated economic life of 5 years.

The company will have to purchase a new production facility to produce the ovens which will
require an immediate outlay of \$16 million.
The production facility will be depreciated on a straight-line basis over 5 years to a \$6 million
salvage value. Truman Electronics plans to sell the production facility to a competitor for \$6
million at the end of the 5-year period.
If the company goes ahead with the proposed project, it will require an immediate increase in net
working capital of \$200,000. The net working capital will be recovered after the project is
completed.
The new ovens are expected to generate sales revenue of \$40 million per year for each of the next
5 years.
Operating costs, excluding management salaries, are expected to be \$32 million per year.
Last year, a market research study for the new product cost \$15 million. The company has
capitalized these costs and is recording them on the income statement at \$3 million per year over
the next 5 years.
Allocated management salaries will be \$2 million per year, although no new managers will be
hired for this project. If the project is not undertaken then these managers will work on the
companys other projects instead of this one.
The company's interest expense each year will be \$3.5 million.
The company's cost of capital (i.e., the required rate of return on this project) is 12 percent.
The company's tax rate is 30 percent.

Record your final numerical answer to each of the following questions on the answer sheet. Show your
work on the back of the answer sheet for possible partial credit.
12. What is the initial investment for the project?
13. What is the second year expected incremental operating cash flow?
14. What is the 5th year incremental non-operating cash flow?

Final Exam
Spring 2002
1. E
2. D
3. B
4. C
5. E
6. A
7. C
8. C
9. D
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.

B
B
E
E
C
D
B
A
A
E
D
D
B
(16,200,000)
6,200,000
6,200,000