Download Mid-term 1 solution

Midterm Exam 1
1. Businesses can be organized as
A) sole proprietorships
B) partnerships
C) corporations
D) any of the above
E) None of the above
Answer: D
2.Which of the following would be considered an advantage of the sole proprietorship form of
organization?
A) Wide access to capital markets
B) Unlimited liability
C) A pool of expertise
D) Profits taxed at one level
E) None of the above
D)
3.One common reason for partnerships to convert to a corporate form of organization is that the
partnership:
A) faces rapidly growing financing requirements.
B) wishes to avoid double taxation of profits.
C) has issued all of its allotted shares.
D) agreement expires after ten years of use.
E) None of the above
A)
4. A firm's investment decision is also called the:
A) Financing decision
B) Capital budgeting decision
C) Liquidity decision
D) None of the above
Answer: B
5. The goal of a financial manager is to:
A) Maximize sales
B) Maximize profits
C) Maximize the wealth of all the firm’s security holders, including debt and stock
holders
D) Maximize the wealth of the share holders
E) None of the above
Answer: D
Financial managers are to maximize the wealth of shareholders.
This is because shareholders are the owners and managers are hired by them.
6. Which of the following is the function of a financial market
A) provide liquidity
B) risk management
C) efficient allocation of money
D) provide information.
E) all of the above
Answer: E
7.
When the management of a business is conducted by individuals other than the
owners, the business is more likely to be a:
A) corporation.
B) sole proprietorship.
C) partnership.
D) general partner.
E) None of the above
A)
8. “Double taxation” refers to:
A) all partners paying equal taxes on profits.
B) corporations paying taxes on both dividends and retained earnings.
C) paying taxes on profits at the corporate level and dividends at the personal
level.
D) the fact that marginal tax rates are doubled for corporations.
E) None of the above
C)
9. A board of directors is elected as a representative of the corporation’s:
A) top management.
B) stakeholders.
C) shareholders.
D) customers.
E) bond and stock holders
Answer: C
10. Which of the following would be considered a capital budgeting decision?
A) Planning to issue common stock rather than issuing preferred stock
B) A decision to have a service division in India
C) Repurchasing shares of common stock
D) Issuing debt in the form of long-term bonds
E) None of the above
Answer: B
11. Corporations are referred to as public companies when their:
A) shareholders have no tax liability.
B) shares are held by the federal or state government.
C) stock is widely traded.
D) products or services are available to the public.
E) none of the above
Answer: C .
12. Which of the following statements best distinguishes the difference between real
and financial assets?
A) Real assets have more value than financial assets.
B) Real assets are tangible; financial assets are not.
C) Financial assets claim the cash flows produced by underlying real assets.
D) Real assets claim the cash flows that are generated by financial assets.
E) None of the above.
Answer: C
13. Corporations that do not issue more financial securities such as stock or debt
obligations:
A) will not be able to increase sales.
B) may use internal cash flows to fulfill their needs
C) cannot be profitable.
D) have insufficient funds to fulfill their needs.
E) none of the above.
Answer: B
14. The managers of a firm are supposed to
A)
B)
C)
D)
E)
take all projects with positive NPVs
take all projects with NPVs greater than the discount rate
take all projects with NPVs greater than present value of cash flow
All of the above
None of the above
Answer: A
15. What is the present value at time zero of the following cash flows at a discount rate on
10%?
t = -1
-$121,000
t=0
$100
t=1
$121,000
A) $100
B) -$23,100
C) -$23,000
D) $23,000
E) None of the above
Answer: C
16. You would like to have enough money saved to receive a perpetuity, with the first
payment of $60,000, after retirement so that you and your family can lead a good life.
How much would you need to save in your retirement fund to achieve this goal (assume
that the perpetuity payments start two years from the date of your retirement. The
interest rate is 10%)?
A) $545,454.55
B) $495,867.77
C) $600,000.00
D) None of the above
Answer: A
17.
Three yeas from now, if the economy is good, you will receive $100; if the
economy is bad, you will receive $50. If the probability for the good economy is 30% and
the economy has only two states three years from now: good and bad, what is the
present value of this expected payment if the discount rate is 0?
A) $65.00
B) $72.07
C) $59.48
D) None of the above
E) Any of the above
Answer : A
First calculate C3, which is the expected cash flows at period three.
C3 = 0.3*100+0.7*50=$65
PV= C3/(1+r)3 = 65/1 =$65
18.10 years ago in the financial market, you made an investment, which was a half of
its present value ( the present value is the value at time zero or now). If the discount rate
is the same for every year, what is the annual discount rate ?
A) 7.18%
B) 6.7%
C) -6.7%
D) -7.18%
E) none of the above
A)
19.
You have a car loan of $30,000 (which is called the principal) with the interest
rate of 6.5%. You decide to pay off this loan in next four years with equal
payment each year, what is the remaining principal before the third payment?
A) $16,445.22
B) $14,056.62
C) $15,943.38
D) $ 12,222.61
E) none of the above
First use the annuity formula to calculate the total payment in each period.
That is, 30000=C(1/r-1/(r.(1+r)4)), where r=0.065. So C=$8,757
Answer: C.
20.The annual coupon rate of a bond equals:
A) its yield to maturity.
B) a percentage of its price.
C) the maturity value.
D) the ratio of the annual coupon payment to the par value.
E) None of the above
Answer: D
21.The face value of a bond is received by the bondholder:
A) at the time of purchase.
B) annually.
C) whenever coupon payments are made.
D) at maturity.
E) none of the above
Answer: D
22.Which of the following presents the correct relationship? As the discount rate of a
bond decreases, the bond’s:
A) face value decreases.
B) price tends to increase.
C) coupon payments decrease.
D) maturity date is decreased.
E) none of the above
Answer: B
23. How much would an investor expect to pay for a $1,000 par value bond with a 9%
annual coupon that matures in 20 years if the interest rate is 9%?
A) $696.74
B) $1,075.00
C) $1,000.00
D) $1,123.01
E) None of the above
Answer: C
Questions 24-26 are based on the following information:
A 9% coupon bond matures in three years, with a face value of $1,000. The yield to
maturity (YTM) now is 9%. The market price of the bond expects to be the same next
year. Suppose you buy one share of the bond now and hold it for one year.
24.What is the market price of the bond now (or time zero)?
A) $1,000
B) $ 900
C) $1,100
D) there is no enough information
E) none of the above
Answer: A
25. What is the yield to maturity next year?
A)
10%
B)
9%
C)
11%
D)
there is no enough information
E) none of the above
Answer: B
26. What is the expected rate of return for your investment (for holding one year)?
A) 10%
B) 12%.
C) 11%
D) 9%
E) None of the above
Answer: D
27.What is the coupon rate for a bond (par value of $1,000) with three years to maturity,
a price of $1,000, and a yield to maturity of 8%?
A) 6%
B) 7%
C) 8%
D) 9%
E) None of the above
Answer: C
28.What happens to the price of a three-year bond with an 8% coupon when interest
rates change from 6% to 8%?
A) A price increase of $53.47
B) A price decrease of $51.54
C) A price decrease of $53.47
D) No change in price
E) None of the above
Answer: C
 $1,000
1
 1
PV = $80 


3 
3
.06 .06i(1 .06)  (1.06)
= $80[16.667 – 13.994] +
$1,000
1.06 3
= $213.84 + $839.63
= $1,053.47
This represents a price change of $53.47, since the bond had sold for par.
29.Which of the following bonds would be considered to be of speculative-grade?
A) A Caa-rated bond.
B) An Aaa-rated bond.
C) An AAA-rated bond.
D) A Baa-rated bond.
E) None of the above
Answer: A
Question 30 is based on the following information for the term-structure of interest rates
now:
t (Investment horizon in year)
1
2
3
4
r (spot rates)
0.5%
0.625%
0.75%
0.875%
30.Which of the following describes the shape of the yield curve.
A) Flat
B) Downward sloped
C) Upward sloped
D) cannot be decided
E) none of the above
Answer: C
31.According to the dividend discount model, the current value or price of a stock is
equal to the:
A) present value of all expected future dividends.
B) sum of all future expected dividends.
C) next expected dividend, discounted to the present.
D) discounted value of all dividends growing at a constant rate.
E) none of the above
Answer: A
32.If a stock’s P0/E0 ratio is now 13.5 when earnings are now $3 per year, what is the
stock’s current price?
A) $4.50
B) $18.00
C) $22.22
D) $40.50
E) None of the above
Answer: D
P/E = 13.5
Then P = 13.5 x $3
Price = $40.50
33. A stock paying $10 in annual dividends next year sells now for $100 and has an
expected return of 15% next year. What might investors expect to pay for the
stock one year from now?
A) $182.00
B) $186.00
C) $115.00
D) $105.00
E) None of the above
Answer: D .
Expected return
15%
=
=
Div1  P1  Po
Po
$10  P1 $100
$100
$105 = P1
34.How much should you pay for a share of stock now that offers a constant dividend
growth rate of 10%, has a discount rate of 16%, and pays a dividend of $3 per
share next year ?
A)
B)
C)
D)
E)
$50.00
$55.00
$45.45
$60.50
none of the above
Answer: A
P0=DIV1/(r-g)=3/0.06=$50
35.The price of a stock will likely increase if:
A) the investment horizon decreases.
B) the growth rate of dividends increases.
C) the discount rate increases.
D) dividends are discounted back to their present value.
E) none of the above
Answer: B
36.What should be the price for a common stock two years from now paying a constant
of $3.50 annual dividends per share every year if the discount rate is 8%?
A) $22.86
B) $28.00
C) $42.00
D) $43.75
E) None of the above
Answer: D
Div 3.50

 $43.75
P2 =
r
.08
37.What is the plowback ratio for a stock with current price of $40, earnings of $5 per
share next year, a discount rate of 15% , and a rate of return on equity of 25% ?
A) 0.2
B) 0.3
C) 0.4
D) 0.5
E) None of the above
A)
38.What is the expected constant growth rate of dividends for a stock currently priced at
$55, that is now paying a dividend of $5, and has a required return of 20%?
A) 13%
B) 12%
C) 11%
D) 10%
E) none of the above
Answer: D
By using the dividend growth model, P0 =div1/(r-g), we have
$55 = $5*(1+g)/(.2 – g).
g = 0.1=10%
39.If the (current) dividend yield (Div1/P0) is 5% and the stock price now is $25, what
will the year four dividend be if dividends grow at a constant 6%?
A) $1.33
B) $1.40
C) $1.49
D) $1.67
E) none of the above
Answer: C
Dividend yield is Div1/P0, which is 5%. So
Div1=.05 x 25 = 1.25
then, Div4 = div1*(1+g)3=1.25 x (1.06)3 = $1.49
40.What would be the price of a stock at year 3 when dividends are expected to grow at
a 25% rate for next three years (from now to year 3), then grow at a constant rate of 5%,
if the stock’s required return is 15% and the dividends per share is $4 in year one?
A) $60.63
B) $68.63
C) $62.63
D) $65.63
E) None of the above
Answer: D
P3 = Div4 / (r-g) =4*1.25*1.25*1.05/(0.15 -0.05) = $65.625