BFIN3321 FINAL EXAM SUMMER I 2014- A security formalizing an agreement between two parties to exchange

| June 14, 2018

BFIN3321FINAL EXAMSUMMER I 2014MULTIPLE CHOICE1. A security formalizing an agreement between two parties to exchange a standard quantity of anasset at a predetermined price on a specified date in the future isA. liquidity assetB. trading volumeC. derivative securityD. initial public offering2. This is the ease with which an asset can be converted into cash.A. liquidityB. direct transferC. primary marketD. secondary market3. Once firms issue financial instruments in primary markets, these same stocks and bonds are thentraded in which of these?A. direct transfersB. secondary marketsC. initial public offeringsD. over-the-counter stocks4. Which of the following is NOT a capital market instrument?A. U.S. Treasury billsB. Corporate stocks and bondsC. U.S. Treasury notes and bondsD. U.S. government agency bonds5. These provide a forum in which demanders of funds raise funds by issuing new financialinstruments, such as stocks and bonds.A. money marketsB. primary marketsC. investment banksD. secondary markets6. Primary market financial instruments include stock issues from firms allowing their equity shares tobe publicly traded on stock market for the first time. We usually refer to these first-time issues aswhich of the following?A. direct transfersB. initial public offeringsC. money market transfersD. over-the-counter stocks7. This is the interest rate that is actually observed in financial markets.A. nominal interest ratesB. real interest ratesC. real risk free rateD. market premium8. According to this theory of term structure of interest rates, at any given point in time, the yieldcurve reflects the market’s current expectations of future short-term rates.A. Expectations TheoryB. Unbiased Expectations TheoryC. Future Short-term Rates TheoryD. Term Structure of Interest Rates Theory9. This theory argues that individual investors and financial institutions have specific maturitypreferences, and to encourage buyers to hold securities with maturities other than their mostpreferred requires a higher interest rate.A. Unbiased Expectations TheoryB. Liquidity Premium HypothesisC. Market Segmentation TheoryD. Supply and Demand Theory10. This is the interest rate that would exist on a default free security if no inflation were expected.A. nominal interest rateB. real risk free rateC. real interest rateD. market premium11. This is the risk that a security issuer will miss an interest or principal payment or continue to misssuch payments.A. price riskB. default riskC. liquidity riskD. maturity risk12. This is a comparison of market yields on securities, assuming all characteristics except maturityare the same.A. market riskB. liquidity riskC. maturity riskD. term structure of interest rates13. This is defined as the volatility of an investment, which includes firm specific risk as well asmarket risk.C. standard deviationA. diversifiable riskB. market riskD. total risk14. This is defined as the portion of total risk that is attributable to firm or industry factors and canbe reduced through diversification.A. modern portfolio riskB. firm specific riskC. market riskD. total risk15. This is defined as a combination of investment assets held by an investor.A. bundleB. portfolioC. market basketD. All of these16. This is the portion of total risk that is attributable to overall economic factors.A. modern portfolio riskB. firm specific riskC. market riskD. total risk17. This is the investor’s combination of securities that achieves the highest expected return for agiven risk level.A. efficient portfolioB. modern portfolioC. optimal portfolioD. total portfolio18. This is the term for portfolios with the highest return possible for each risk level.A. efficient portfoliosB. modern portfoliosC. optimal portfoliosD. total portfolios19. This is a measurement of the co-movement between two variables that ranges between -1 and+1.A. coefficient of variationB. standard deviationC. correlationD. total risk20. Dominant Portfolios Determine which one of these three portfolios dominates another. Name thedominated portfolio and the portfolio that dominates it. Portfolio Blue has an expected return of 14percent and risk of 19 percent. The expected return and risk of portfolio Yellow are 15 percent and18 percent, and for the Purple portfolio are 16 percent and 21 percent.A. Portfolio Purple dominates Portfolio BlueB. Portfolio Blue dominates Portfolio YellowC. Portfolio Yellow dominates Portfolio BlueD. Portfolio Purple dominates Portfolio YellowPortfolio Yellow dominates Portfolio Blue because it has both a higher expected return and a lower risk level.21. This is the average of the possible returns weighted by the likelihood of those returns occurring.A. market returnB. efficient returnC. required returnD. expected return22. This is typically considered the return on U.S. government bonds and bills and equals the realinterest and the expected inflation premium.A. market risk premiumB. required returnC. risk-free rateD. risk premium23. In theory, this is a combination of securities that places the portfolio on the efficient frontier andon a line tangent from the risk-free rate.A. efficient marketB. market portfolioC. stock market bubbleD. probability distribution24. The use of debt to increase an investment position.A. stock market bubbleB. behavioral financeC. financial leverageD. probability25. A measure of the sensitivity of a stock or portfolio to market risk.A. behavioral financeB. efficient marketC. hedgeD. beta26. This is the reward investors require for taking risk.A. market risk premiumB. required returnC. risk premiumD. risk-free rate27. Which of these is the measurement of risk for a collection of stocks for an investor?A. betaB. portfolio betaC. efficient marketD. expected return28. Which of the following is NOT a necessary condition for an efficient market?A. Many buyers and sellers.B. No trading or transaction costs.C. No prohibitively high barriers to entry.D. Free and readily available information available to all participants.29. The constant growth model assumes which of the following?A. That there are executive stock options available to managers.B. That there is privately held information.C. That the stock is efficiently priced.D. That there is no restricted stock.30. A theory that describes the types of information that are reflected in current stock prices.A. asset pricingB. behavioral financeC. public informationD. efficient market hypothesis31. When calculating the weighted average cost of capital, weights are based onA. book values.B. book weights.C. market values.D. market betas.32. Which of the following is a true statement regarding the appropriate tax rate to be used in theWACC?A. One would use the marginal tax rate that the firm paid the prior year.B. One would use the average tax rate that the firm paid the prior year.C. One would use the weighted average of the marginal tax rates that would have been paid on thetaxable income shielded by the interest deduction.D. One would use the marginal tax rates that would have been paid on the taxable income shieldedby the interest deduction.33. Which of these is the basic intuition behind calculating the cost of capital?A. Firms need to know what the cost of all their current sources of capital cost them.B. When firms use multiple sources of capital, they need to calculate the current expenditures in adollar amount format.C. When firms use multiple sources of capital, they need to calculate the appropriate interest rate forvaluing their firm’s cash flows as a weighted average of the capital components.D. When firms use multiple sources of capital, they need to calculate the appropriate interest rateafter taxes for estimating current cash outflows.34. These are fees paid by firms to investment bankers for issuing new securities.A. floatation costsB. interest expenseC. seller financing chargesD. user fees35. This is a principle of capital budgeting which states that the calculations of cash flows shouldremain independent of financing.A. generally accepted accounting principleB. financing principleC. separation principleD. WACC principle36. This is the process of estimating expected future cash flows of a project using only the relevantparts of the balance sheet and income statements.A. incremental cash flowsB. cash flow analysisC. pro forma analysisD. substitutionary analysis37. Concerning incremental project cash flow, this is a cost one would never count as an expense ofthe project.A. initial investmentB. taxes paidC. operating expenses of the projectD. financing costs38. This is used as a measure of the total amount of available cash flow from a project.A. free cash flowB. operating cash flowC. investment in operating capitalD. sunk cash flow39. When calculating operating cash flow for a project, one would calculate it as beingmathematically equal to which of the following?A. EBIT – Interest – Taxes + DepreciationB. EBIT – TaxesC. EBIT + DepreciationD. EBIT – Taxes + Depreciation40. A decrease in net working capital (NWC) is treated as aA. cash inflowB. cash outflowC. sunk costD. historical cost41. Accelerated depreciation allows firms toA. receive less of the dollars of depreciation earlier in the asset’s life.B. receive more of the dollars of depreciation earlier in the asset’s life.C. not pay any taxes during an asset’s life.D. receive more of the dollars of depreciation later in the asset’s life.42. Section 179 allows a business, with certain restrictions, to do which of the following?A. Offset the tax liability with the cost of the asset in the year of purchase.B. Expense the asset immediately in the year of purchase.C. Expense the asset using double declining balance depreciation during the life of the asset.D. Get a government grant to purchase the asset.43. For which situation below would one need to "smooth out" the variation in each set of cash flowsso that each become a perpetuity?A. choosing between projects with differing risksB. choosing between independent projectC. choosing between alternative assets with differing livesD. choosing between alternative assets with equal lives44. The best approach to convert an infinite series of asset purchases into a perpetuity is known astheA. Net working capital approachB. Net present value approachC. Equivalent annual cost approachD. Equivalent annual cash flow approach45. With regard to depreciation, the time value of money concept tells us thatA. delaying the depreciation expense is always better.B. taking the depreciation expense sooner is always better.C. delaying the depreciation expense is sometimes better.D. taking the depreciation expense sooner is sometimes better.46. When looking at these types of projects, one must consider any cash flows that arise fromsurrendering old equipment before the end of its useful life.A. incrementalB. replacementC. cost-cuttingD. new47. Of the capital budgeting techniques discussed, which works equally well with normal and nonnormal cash flows and with independent and mutually exclusive project?A. payback periodB. discounted payback periodC. modified internal rate of returnD. net present value48. The Net Present Value decision technique may not be the only pertinent unit of measure if thefirm is facingA. time or resource constraints.B. a labor union.C. the election of a new board of directors.D. a major investment.49. Neither payback period nor discounted payback period techniques for evaluating capital projectsaccounts forA. time value of money.B. market rates of return.C. cash flows that occur after payback.D. cash flows that occur during payback.50. Which rate-based decision statistic measures the excess return – the amount above and beyondthe cost of capital for a project, rather than the gross return?A. Internal Rate of Return, IRRB. Modified Internal Rate of Return, MIRRC. Profitability Index, PID. Net Present Value, NPV51. These are groups or pairs of projects where you can accept one but not all.A. dependentB. independentC. mutually exclusiveD. mutually dependent52. A capital budgeting technique that converts a project’s cash flows using a more consistentreinvestment rate prior to applying the Internal Rate of Return, IRR, decision rule.A. discounted paybackB. net present valueC. modified internal rate of returnD. profitability index53. Investing in stocks can be like gambling when:A. Both have a short time horizonB. Both involve riskC. Both involve an initial outflow of cashD. Both have a positive expected returnE. Both result in long-term loses.54. Which of the following is false?A. Incremental costs can be Opportunity costs.B. Opportunity costs can be Incremental cost.C. Of the three categories of Opportunity costs, only one is usually an Incremental cost.D. Opportunity costs and Incremental cost may be discounted at different rates.E. Some Opportunity costs are not Incremental costs.55. If the risk of an investment project is different than the firm’s risk then:A. you must adjust the discount rate for the project based on the firm’s risk.B. you must adjust the discount rate for the project based on the project risk.C. you must exercise risk aversion and use the market rate.D. an average rate across prior projects is acceptable because estimates contain errors.E. one must have the actual data to determine any differences in the calculations.56. Insider trading does not offer any advantages if the financial markets are:A. strong form efficient.B. semi-strong form efficient.C. semi-weak form efficient.D. weak form efficient.E. inefficient.PROBLEMS1. (4 points) A particular security’s default risk premium is 5 percent. For all securities, the inflationrisk premium is 4 percent and the real interest rate is 2 percent. The security’s liquidity risk premiumis 1 percent and maturity risk premium is 3 percent. The security has no special covenants. What isthe security’s equilibrium rate of return?2. (4 points) Suppose that the current one-year rate (one-year spot rate) and expected one-year Tbill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows_1R1= 2.0%, E(2R1) = 3.0%, E(3R1) = 13.0%, E(4R1) = 15.0%,Using the unbiased expectations theory, what is the current (long-term) rate for four-year-maturityTreasury securities (1R4)?3. (4 points) HydroTech Corp stock was $100 per share a year ago when it was purchased. Sincethen, it paid a $4 per share dividend. The stock price is currently $97. If you owned 200 shares ofMedTech, what was your percent return?4. (4 points) Portfolio Return Year-to-date, Company X had earned a -2 percent return. Duringthe same time period, Company Y earned 10 percent and Company Z earned 5 percent. If you havea portfolio made up of 60 percent Company X, 30 percent Company Y, and 10 percent Company Z,what is your portfolio return?5. (8 points) You hold the positions in the table below.COMPANYPRICE# SHARESBETAGoodmonthIcestoneBridgerock$60.00$40.00$70.002001501002.02.5– 1.5A. What is the beta of your portfolio?B. If you expect the market to earn 8 percent and the risk-free rate is 3 percent, what is therequired return of the portfolio?6. (4 points) TAB Inc. has a $1,000 (face value), 10 year bond issue selling for $1,184 that pays anannual coupon of 8.5 percent. What would be TAB’s before-tax component cost of debt?7. (4 points) Team Sports has 4 million shares of common stock outstanding, 2 million shares ofpreferred stock outstanding, and 20 thousand bonds ($1,000 par). If the common shares are sellingfor $4.50 per share, the preferred share are selling for $20 per share, and the bonds are selling for110 percent of par, what would be the weight used for equity in the computation of Team’s WACC?8. (4 points) Suppose that TipsNToes, Inc.’s capital structure features 40 percent equity, 60 percentdebt, and that its before-tax cost of debt is 9 percent, while its cost of equity is 15 percent. If theappropriate weighted average tax rate is 25 percent, what will be TipsNToes’s WACC?9. (4 points) Suppose you sell a fixed asset for $110,000 when its book value is $125,000. If yourcompany’s marginal tax rate is 39%, what will be the effect on cash flows of this sale (i.e., what willbe the after-tax cash flow of this sale)?10. (7 points) Your company has spent $500,000 on research to develop a new computer game.The firm is planning to spend $100,000 on a machine to produce the new game. Shipping andinstallation costs of the machine will be capitalized and depreciated; they total $5,000. The machinehas an expected life of 3 years, a $100,000 estimated resale value, and falls under the MACRS 5-Yearclass life. Revenue from the new game is expected to be $500,000 per year, with costs of $200,000per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 10 percent, and itexpects net working capital to increase by $100,000 at the beginning of the project. What will be thenet cash flow for year one of this project?11. (4 points) Compute the NPV for Project Y and accept or reject the project with the cash flowsshown below if the appropriate cost of capital is 12 percent.TIME:CASH FLOW:0-5001-1,00021,0003042,00052,00012. (5 points) Compute the Payback statistic for Project X and recommend whether the firm shouldaccept or reject the project with the cash flows shown below if the appropriate cost of capital is 10percent and the maximum allowable payback is 5 years.TIME:CASH FLOW:0- 751- 7520310047559013. (4 points) Compute the IRR statistic for Project X and note whether the firm should accept orreject the project with the cash flows shown below if the appropriate cost of capital is 10 percent.TIME:CASH FLOW:0- 751- 7520310047559014. (8 points) Suppose your firm is considering two mutually exclusive, required projects with thecash flows shown below. The required rate of return on projects of both of their risk class is 8percent, and that the maximum allowable payback and discounted payback statistic for the projectsare 2 and 3 years, respectively.TIME:0Project A CF: $ – 10,000Project B CF: $ – 30,0001$ 10,000$ 10,0002$ 30,000$ 20,0003$ 3,000$ 50,000Use the Profitability Index (PI) decision rule to evaluate these projects; what is the PI for eachproject, and which one(s) should it be accepted or rejected?

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