EBF 401 EBF401 Midterm 1 with Answers (Penn State University)

EBF 401 EBF401 Midterm 1 Answers (Penn State University)

Multiple-choice questions (2 points each)

1. Free cash flow is:

a. Net income plus taxes;

b. Net income minus taxes;

c. An increase in net working capital;

d. Cash that the firm is free to distribute to creditors and stockholders;

e. Unlevered net income plus depreciation minus capital expenditures.

2. A firm has $450 in inventory, $700 in fixed assets, $210 in accounts receivable, $50 in accounts payable, and $60 in cash. What is the amount of the current assets?

a. $270;

b. $510;

c. $720;

d. $960;

e. $1410.

3. The interest rate charged per period multiplied by the number of periods per year is called the _____ rate:

a. Effective annual;

b. Annual percentage;

c. Periodic interest;

d. Compound interest;

e. Daily interest.

4. If you have a choice to earn simple interest on $10,000 for three years at 8% or annual compounded interest at 7.5% for three years, which one will pay more and by how much?

a. Simple interest by $50;

b. Compound interest by $22.97;

c. Compound interest by $150;

d. Compound interest by $150.75;

e. None of these.

5. Today you earn a salary of $28,500. What will be your annual salary fifteen years from now, if you earn annual raises of 3.5%?

a. $47,035.35;

b. $47,522.89;

c. $47,747.44;

d. $48,091.91;

e. $48,201.60.

6. Which one of the following statements is correct concerning the payback period?

a. An investment is acceptable if its calculated payback period is less than some pre-specified period of time;

b. An investment should be accepted if the payback is positive and rejected if it is negative;

c. An investment should be rejected if the payback is positive and accepted if it is negative;

d. An investment is acceptable if its calculated payback period is greater than some pre-specified period of time;

e. An investment should be accepted any time the payback period is less than the discounted payback period, given a positive discount rate.

7. You are trying to determine whether to accept project A or project B. These projects are mutually exclusive. As part of your analysis, you should compute the incremental IRR by determining:

a. The internal rate of return for the cash flows of each project;

b. The net present value of each project using the internal rate of return as the discount rate;

c. The discount rate that equates the discounted payback periods for each project;

d. The discount rate that makes the net present value of each project equal to zero;

e. The internal rate of return for the differences in the cash flows of the two projects.

8. The potential decision to abandon a project has option value because:

I. Abandonment can occur at any future point in time;

II. A project may be worth more dead than alive;

III. Management is not locked into a negative outcome.

a. I and II only;

b. I and III only;

c. II and III only;

d. All of these;

e. None of these.

9. A bond with a 6% coupon that pays interest semi-annually and is priced at par will have a market price of ____ and interest payments in the amount of ____ each:  

a. $1,006; $60;

b. $1,060; $30;

c. $1,060; $60;

d. $1,000; $30;

e. $1,000; $60.

10. Next year’s annual dividend divided by the current stock price is called the:  

a. Yield to maturity;

b. Total yield;

c. Dividend yield;

d. Capital gain;

e. Capital gain rate.

Key

1. D

2. C [$450+$210+$60=$720]

3. B

4. B  

Simple Interest = $10,000 (.08)(3) = $2,400;
Compound Interest = $10,000((1.075)³ - 1) = $2,422.97;
Difference = $2,422.97 - $2,400 = $22.97

5. C

Future value = $28,500 × (1 + .035)¹⁵ = $47,747.44

6. A

7. E

8. D

9. D

10. C

Short questions

11. In most large corporations, ownership and management are separated. What are the main implications of this separation?

Short questions

11. In most large corporations, ownership and management are separated. What are the main implications of this separation?

12. What are the differences between stocks and bonds? Explain.

13. Explain what leverage means.

14. Explain the difference between book value of equity and market value of equity (or market capitalization).

15. What is the present value of a perpetuity paying $5 each month, beginning this month (in 1 second), if the monthly interest rate is a constant 0.5% per month and the cash flows will grow at a rate of 0.1% per month?

16. Mario Brothers, a game manufacturer, has a new idea for an adventure game. It can market the game either as a traditional board game or as an interactive DVD, but not both. Considering the following cash flows of the two mutually exclusive projects for Mario Brothers. Assume the discount rate is 10%.

17. Suppose that a firm issues a $1,000 face value, eight-year zero coupon bond. What is the yield to maturity on the bond, if the bond is offered at $627? Assume annual compounding.

18. Suppose an investor is considering the purchase of a share of the Utah Mining Company. The stock will pay a $3 dividend a year from today. The dividend is expected to grow at 10% per year for the foreseeable future. The investor thinks that the required return on this stock is 15%, given her assessment of the company’s risk.

a. What is the price of a share of Utah Mining Company’s stock?

b. What happens to the stock price if the dividend growth rate increases by 25%?

(10 points)