Berlin School of EconomicsMBA European ManagementCorporate FinanceProf. Dr. Rainer Stachuletz

Mock Test

Final Examination

Corporate Finance (max.90 P)

DRAFT

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1. Which financial ratio measures the effectiveness of management in generating returns to common stockholders with its available assets? ( 2 P )

a. Gross profit marginb. Return on equityc. Return on assetsd. Current ratio

Answer:

2. A firm reports a current ratio of 2 and a quick ratio of 1.2. The firm has total current assets of $4,000. If the firm reports cost of goods sold at $25,000 for the given year, what is the average age of their inventory? ( 5 P )

a. 12.35 daysb. 15.63 daysc. 18.24 daysd. 23.36 days

Answer:

3. How do we calculate a company’s operating cash flow? ( 2 P )

a. EBIT - taxes + depreciationb. EBIT - taxes - depreciationc. EBIT + taxes + depreciationd. EBIT - Sales

Answer:

4. Which of the following cannot be calculated? ( 2 P )

a. Present value of an annuity.b. Future value of an annuity.c. Present value of a perpetuity.d. Future value of a perpetuity.

Answer:

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5. Which of the following statements is true? ( 2 P )

a. In an annuity due payments occur at the end of the period.b. In an ordinary annuity payments occur at the end of the period.c. A perpetuity will mature at some point in the future.d. One cannot calculate the present value of a perpetuity.

Answer:

6. How much do you have to invest today at an annual rate of 8%, if you need to have $5,000 6 years from today? ( 3 P )

a. $3,150.85b. $4,236.75c. $7,934.37d. $2,938.48

Answer:

7. You are planning your retirement and you come to the conclusion that you need to have saved $1,250,000 in 30 years. You can invest into an retirement account that guarantees you a 5% annual return. How much do you have to put into your account at the end of each year to reach your retirement goal? ( 3 P )

a. $81,314.29b. $18,814.30c. $23,346.59d. $12,382.37

Answer:

8. A bond is trading on the secondary market and will mature in 10 years. The bond has a face value of $1,000 that will be paid at maturity. Further, the bond pays an annual coupon at 9% of face value. What should the trading price be for the bond if investors seek a 12% on their investment? ( 5 P )

a. $1,192.53b. $830.49c. $827.95d. $508.52

Answer:

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9. Suppose investment A and investment B have identical cash flows. Why would an investor pay more for investment A than investment B? ( 2 P )

a. This is incorrect. You would always pay the same amount for two investments with equal future cash flows.

b. The risk in the cash flows for investment A is greater than the risk of the cash flows of investment B.

c. The risk in the cash flows for investment B is greater than the risk of the cash flows of investment A.

d. The return required for investment B is lower than the return required for investment A.

Answer:

10. You are planning your retirement and you come to the conclusion that you need to have saved $1,250,000 in 30 years. You can invest into an retirement account that guarantees you a 5% annual return. How much do you have to put into your account at the end of each year to reach your retirement goal? ( 5 P )

a. $81,314.29b. $18,814.30c. $23,346.59d. $12,382.37

Answer:

11. The Springfield Crusaders just signed their quarterback to a 10 year $50 million contract. Is this contract really worth $50 million? (assume r >0) ( 3 P )

a. Yes, because the payments over time add up to $50 million.b. No, it is worth more because he can invest the money.c. No, it would only be worth $50 million if it were all paid out today.d. Yes, because his agent told him so.

Answer:

12. WeOweEveryone, Inc. has a 12 year bond outstanding (face value $ 1,000) that has 9.5% coupon rate. If the appropriate discount rate for such a bond is 7%, what the the appropriate price for the semi-annual coupon paying bond? ( 4 P )

a. $1,200.73b. $1,198.57c. $1,000.00d. $762.77

Answer:

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13. Which of the following is not a difficulty associated with valuing common stock? ( 2 P )

a. Common stock does not have a specific expiration date.b. The required rate of return is difficult to estimate. c. Common stock does not promise a fixed cash flow stream.d. All of the above are considered difficulties associated with valuing common stock.

Answer:

14. Smith Construction, Inc. just paid a $2.78 dividend. The dividend is expected to grow by 4% each year for the next three years. After that the company will never pay another dividend ever again. If your required return on the stock investment is 10%, what should the stock sell for today? ( 5 P )

a. $7.46b. $28.91c. $46.33d. $15.63

Answer:

15. ConsGrough, Inc. has increased its annual common dividend by 3% in each of the years that the company has existed. If you believe that the company can continue to do so indefinitely, then what is the required rate of return if the price of ConsGrough is $171.67 and the dividend that it paid yesterday was $5? ( 4 P )

a. .029b. .03c. .06d. none of the above

Answer:

16. You are asked by the Chief Financial Officer of your firm to predict what the firm’s stock price will be exactly 4 years from today. If your firm is expected to grow at 3% indefinitely and the cost of capital is 10% while the expected annual dividend one year from today is $10, then what should be the price of your firm’s stock 4 years from today? ( 3 P )

a. $142.86b. $160.79c. $112.55d. none of the above

Answer:

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17. Which is TRUE concerning preferred stock? ( 2 P )

a. Preferred stock is considered debt on the company balance sheet.b. Preferred stock holders have voting rights for the company board of directors.c. Preferred stock payments are variable like common stock.d. Preferred stock is viewed as less risky than a firm’s common stock.

Answer:

18. Which of the following is an example of systematic risk? ( 2 P )

a. IBM posts lower than expected earnings.b. Intel announces record earnings.c. The national trade deficit is higher than expected.d. None of the above.

Answer:

19. What is one of the most important lessons from capital market history? ( 2 P )

a. Risk does not matter.b. There is a positive relationship between risk and return.c. You are always better off investing in stock.d. T-bills are the highest yielding investment.

Answer:

20. The value of any asset ( 2 P )

a. is based upon the benefits provided by the asset in prior years.b. is based upon the benefits that the asset will provide the owner of the asset this year.c. equals the present value of future benefits accruing to the asset’s owner.d. is not described by any of the above.

Answer:

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21. Given the data from Exhibit 2,

Year ReturnStock A Stock B Stock C

1 15% 12%    5%2 25% 14%  -6%3   8%   9% 10%4 16% 25%   1%5   5%   3% 15%

Exhibit 2: Stock Returns

what is the variance of returns for stock A? ( 5 P )

a. .00607b. .00653c. .00655d. .00506

Answer:

22. What is the standard deviation of returns for stock A? ( 2 P )

a. 8.09%b. 8.08%c. 7.79%d. 6.53%

Answer:

23. What is the expected portfolio return if you invest 30% in A and 70% in stock B. What do you expect about the portfolio risk if the correlation is at – 0.5 ( 5 P )

Answer:

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24. You have the following data on the securities of three firms:

Return last year BetaFirm A 10% 0.8Firm B 11% 1.0Firm C 12% 1.2

If the risk-free rate last year was 3%, and the return on the market was 11%, which firm had the best performance on a risk-adjusted basis? ( 4 P )

a. Firm Ab. Firm Bc. Firm Cd. There is no difference in performance on a risk-adjusted basis

Answer:

25. Security I has a beta of 1.3, the risk-free rate is 4%, and the expected market riskpremium is 11%. What is the expected return for Security I? ( 3 P )

a. 15.0%b. 18.3%c. 14.6%d. 13.1%

Answer:

26. Suppose Sarah can borrow and lend at the risk free-rate of 3%. Which of the following four risky portfolios should she hold in combination with a position in the risk-free asset? ( 3 P )

a. portfolio with a standard deviation of 15% and an expected return of 12%b. portfolio with a standard deviation of 19% and an expected return of 15%c. portfolio with a standard deviation of 25% and an expected return of 18%d. portfolio with a standard deviation of 12% and an expected return of 9%

Answer:

To determine which portfolio is the best, draw a line from the risk-free rate to each dot in the figure and choose the line with the highest slope.

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27. Suppose David can borrow and lend at the risk-free rate of 5%. Which of the following three risky portfolios should he hold in combination with a position in the risk-free asset? ( 5 P )

a. portfolio with a standard deviation of 16% and an expected return of 12%b. portfolio with a standard deviation of 20% and an expected return of 16%c. portfolio with a standard deviation of 30% and an expected return of 20%d. he should be indifferent in holding any of the three portfolios

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28. A mutual fund that adopts a passive management style is called: ( 2 P )

a. an index fund.b. a research fund.c. an active fund.d. a technology fund.

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29. If the market portfolio has an expected return of 0.12 and a standard deviation of 0.40, and the risk-free rate is 0.04, what is the slope of the security market line? ( 3 P )

a. 0.08b. 0.20c. 0.04d. 0.12

Answer:

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30. A particular asset has a beta of 1.2 and an expected return of 10%. The expected return on the market portfolio is 13% and the risk-free is 5%. Which of the following statement is correct? ( 3 P )

a. This asset lies on the security market line.b. This asset lies above the security market line.c. This asset lies below the security market line.d. Cannot tell from the given information.

Answer:

31. A stock that pays no dividends is currently priced at $40 and is expected to increase in price to $45 by year end. The expected risk premium on the market portfolio is 6% and the risk-free is 5%. If the stock has a beta of 0.6, the stock is ( 3 P )

a. overpricedb. underpricedc. appropriately pricedd. Cannot tell from the given information

Answer:

32. The stock of Alpha Company has an expected return of 18% and a beta of 1.5, and Gamma Company stock has an expected return of 15.6% and a beta of 1.2. Assume the CAPM holds. What’s the risk-free rate ? ( 5 P )

a. 8.0%b. 6.0%c. 0%d. 4.7%

Answer:

33. Everything else being equal a higher corporate tax rate... ( 3 P )

a. will increase the WACC of a firm with debt and equity in its capital structureb. will not affect the WACC of a firm with debt in its capital structure c. will decrease the WACC of a firm with some debt in its capital structure d. will decrease the WACC of a firm with only equity in its capital structure

Answer:

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34. Never-crash Airline has a capital structure that consists of 30% debt and 70% equity. The company’s cost of debt is 7%. The company has a beta of 1.9. The risk free rate equals 4.5% and the expected return on the market portfolio is 15%.Assuming no taxes, what is Never-crash Airline’s WACC? ( 4 P )

a. 7%b. 19.22%c. 24.45%d. 17.12%

ANSWER:

35. What is Never-crash Airline’s WACC, if their marginal tax rate equals 34%? ( 4 P )

a. 19.22%b. 24.45%c. 18.50%d. 4.62%

ANSWER:

36. What is the Never-crash Airline’s after tax cost of debt? ( 2 P )

a. 7.00%b. 4.62%c. 2.38%d. 4.50%

ANSWER:

37. Miller’s Dairy Products reported sales of $1.5 million in 2002 and $2.25 million in 2003. Their EBIT in 2002 was $550,000 and in 2003 the EBIT rose to $925,000. What is the company’s operating leverage? ( 3 P )

a. 2.36b. 1.36c. 1.96d. 2.86

ANSWER:

38. A firm has a capital structure containing 40 percent debt, 10 percent preferred stock, and 50 percent common stock equity. The firm’s debt has a yield to maturity of 9.50 percent. Its

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preferred stock’s annual dividend is $7.50 and the preferred stock’s current market price is $50.00 per share. The firm’s common stock has a beta of 0.90 and the risk-free rate and the market return are currently 4.0 percent and 13.5 percent, respectively. The firm is subject to a 40 percent marginal tax rate. The market value of debt is $100 million. How many shares of preferred stock should be outstanding for the capital structure to be correct ? ( 5 P )

a. 125,000 sharesb. 250,000 sharesc. 500,000 sharesd. 625,000 shares

ANSWER:

39. You are given the opportunity to play a game of high stakes gambling. The game begins by you paying an entry fee of $35,000,000 followed by a fair coin toss. If the coin toss is “heads” then you have an 80% probability of receiving a perpetuity of $10,000,000 per year and a 20% probability of receiving a perpetuity of $1,000,000 per year. Assume that the proper discount rate for the perpetual cash flow is 10%. If the coin toss is “tails”you can continue to play but you will lose $50,000,000 with certainty. Alternativley, you can make a make an opt-out payment of $10,000,000 after a “tail” to prevent you from going down such a costly path. What is the present value of playing such a game? ( 5 P )

a. $1,000,000b. -$1,000,000c. -$39,000,000d. none of the above

ANSWER:

40. You are the owner of a natural gas well that can produce exactly (at today’s prices) $1,000,000 worth of gas per year for exactly 5 years. You also know (with certainty) that the correct discount rate for these revenues is 10%. An oil and gas production firm offers you $5,000,000 today for the natural gas well. What is the implied value of the real option to not produce or not to produce natural gas? ( 5 P )

a. $0b. $604,607c. $1,209,213d. $2,418,426

ANSWER:

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41. A machine costs $3 million and has zero salvage value. Assume a discount rate of 10% and a 40% tax rate. The machine is depreciated straight-line over 3 years for tax purpose. What is the present value of depreciation tax savings associated with this machine? ( 3 P )

a. $1,200,000b. $994,741c. $1,090,900d. $400,000

ANSWER:

42. Georgia Food is exploring the possibility of bringing a new frozen pasta to the market. Which of the following items are not relevant for the project’s analysis? ( 2 P )

a. Cost of increasing shelf space at grocery storesb. Lost revenue from its frozen pizza sales since some customers will switch to

purchase the new frozen pastac. Cost of advertising the new productd. Market research funds the company has spent on testing the viability of the new

product

ANSWER:

43. A project requires an initial investment in equipment and machinery of $10 million. The equipment is expected to have a 5-year lifetime with no salvage value and will be depreciated on a straight-line basis. The project is expected to generate revenues of $5.1 million each year for the 5 years and have operating expenses (not including depreciation) amounting to 1/3 of revenues.Refer to 43: The tax rate is 40%. What is the net cash flow in year 1? ( 4 P )

a. 2.84mb. 3.40mc. 0.84md. 2.04m

ANSWER:

Refer to 43.: Assume the tax rate is 40%, and the cost of capital is 10%. What is the present value of cash inflows from year 1 to year 5? What percentage of this present value is attributed to the tax benefits accruing from depreciation ? (6 P)

a. $12.89m; 24%b. $10.77m; 28%c. 3.18m; 95%d. 7.73m; 39%e. $10.77m; 24%

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ANSWER:

44. The figure below shows the NPV profile for two investment projects. Explain the NPV, the IRR and describe possible problems. ( 8 P )

ANSWER:

44. As the discount rate increases, the IRR of a project: ( 2 P )

a. increases.b. decreases.c. is unaffected.d. cannot be determined with out knowing the discount rate.

ANSWER:

45. Which of the following is a problem with the Internal Rate of Return ? ( 2 P )

a. appropriate adjustment for the time value of moneyb. focus on cash flows

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c. multiple IRRsd. all of the above are problems with the Internal Rate of Return

ANSWER:

46. A firm has 10 million shares outstanding with a current market price of $20 per share. There is one investment project available to the firm. The initial investment of the project is $20 million, and the NPV of the project is $10 million. What will be the firm’s stock price if capital markets fully reflect the value of undertaking the project ? ( 3 P )

a. $19b. $20c. $21d. $22

ANSWER:

47. If we are able to eliminate all of the unsystematic risk in a portfolio then, what is the result ( 1 P )

a. a risk-free portfoliob. a portfolio that contains only systematic riskc. a portfolio that has an expected return of zerod. such a portfolio cannot be constructed since there will always be unsystematic risk in any

portfolio

ANSWER:

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