Business 2039 Finance II

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Frederick Dickerson
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1 Business 2039 Finance II Lakehead University Midterm I P. Grégoire Spring 2005 Time allowed: 2 hours. Instructions: Calculators are permitted. No cheat sheet allowed. Please answer all questions in the exam booklets provided. Please hand in the exam booklets only. The marks awarded for each question are in parentheses. Good luck! 1. An analysis of what happens to NPV estimates when we ask what-if questions is called: (a) Forecasting analysis (b) Scenario analysis. (c) Sensitivity analysis. (d) Simulation analysis. (e) Break-even analysis. 2. An analysis of what happens to NPV estimates when only one variable is changed is called: (a) Forecasting analysis. (b) Scenario analysis. (c) Sensitivity analysis. (d) Simulation analysis. (e) Break-even analysis. 3. An analysis of what happens to NPV estimates when many variables take on many different values simultaneously is called: (a) Forecasting analysis. (b) Scenario analysis. (c) Sensitivity analysis. (d) Simulation analysis. (e) Break-even analysis. 4. An analysis of the relation between sales volume and various measures of profitability is called: (a) Forecasting analysis. (b) Scenario analysis. (c) Sensitivity analysis. 1

2 (d) Simulation analysis. (e) Break-even analysis. 5. The sales level that results in a project s net income exactly equal to zero is called: (a) Operational break-even. (b) Leveraged break-even. (c) Accounting break-even. (d) Cash break-even. (e) Financial break-even. 6. The degree to which a firm or project relies on fixed production costs is called its: (a) Operating leverage. (b) Financial break-even. (c) Contribution margin. (d) Cost sensitivity. (e) None of the above. 7. Find the accounting break-even point given the following information: Price = $50 per unit; variable cost = $35 per unit; annual fixed costs = $50, 000; depreciation = $10, 000. (a) 1,160 units (b) 2,298 units (c) 3,333 units (d) 3,429 units (e) 4,000 units 8. What is the cash break-even point? Price = $100 per unit; variable cost = $24 per unit, fixed cost = $40, 000 per year; depreciation = $10, 000 per year. Assume a discount rate of 10%, project initial outlay of $100,000, project life of 10 years, and ignore taxes. (a) 527 units (b) 624 units (c) 658 units (d) 741 units (e) 1,130 units 9. What is the financial break-even point? Price = $100 per unit; variable cost = $24 per unit, fixed cost = $40, 000 per year; depreciation = $10, 000 per year. Assume a discount rate of 10%, an initial outlay of $100,000, a project life of 10 years, and ignore taxes. (a) 527 units (b) 624 units (c) 658 units (d) 740 units (e) 1,130 units 10. What is the degree of operating leverage? Sales = 100, 000 units; price = $50; variable cost = $30; fixed costs = $950, 000; depreciation = $250, 000. There are no taxes. 2

3 (a) 0.90 (b) 1.22 (c) 1.37 (d) 1.90 (e) If the DOL = 1.05 and OCF rises from $10,000 to $12,500, what is the percentage change in sales? (a) 18.6% (b) 19.2% (c) 22.3% (d) 23.8% (e) 26.2% Cost of the project: $60,000 Life of the project: 3 years Depreciation of assets: Straight-line to zero over 3 years Price per unit: $20 Variable cost per unit: $10 Fixed cost: $30,000 per year Table 1: Information for questions Use the information in Table 1 to answer this question. If you expect to sell 7,000 units per year, what is the OCF in each year assuming a required return of 15% and a tax rate of 30%? Hint: With taxes, OCF = (1 t)((p v)q FC D) + D. (1) (a) $17,000 (b) $20,000 (c) $34,000 (d) $48,000 (e) $55, Use the information in Table 1 to answer this question. If you expect to sell 7,000 units per year, compute the NPV assuming a required return of 15% and a tax rate of 30%. (a) Less than $0 (b) $8,347 (c) $14,416 (d) $17,630 (e) More than $20, Use the information in Table 1 to answer this question. The depreciation tax shield for this project is per year if the tax rate is 30%. (a) $6,000 3

4 (b) $14,000 (c) $18,000 (d) $32,000 (e) $42, Use the information in Table 1 to answer this question. For what value of Q is OCF equal to zero (use equation 1)? (a) 2,143 (b) 1,789 (c) 1,200 (d) 2,657 (e) 3, Use the information in Table 1 to answer this question. Suppose now that fixed assets have a salvage value of $12,000 after three years. Compute the NPV of the project if you expect to sell 7,000 units per year, the required rate of return is 15% and the tax rate is 30%. (a) Less than $0 (b) $11,347 (c) $14,890 (d) $18,807 (e) More than $20, Use the information in Table 1 to answer this question. Suppose now that fixed assets have a salvage value of $12,000 after three years. What is then the annual depreciation tax shield if the tax rate is 30%? (a) $2,000 (b) $3,800 (c) $4,000 (d) $4,800 (e) $6,000 Base Case Worst Case Best Case Units sold 3,000 2,750 3,250 Price/unit $14 $13 $16 Variable cost/unit $9 $8 $10 Fixed cost $9,000 $8,500 $10,000 Initial outlay $10,000 for all cases Life of the project 4 years for all cases Depreciation Straight line to zero over 4 years Discount rate 10% for all cases Tax rate 34% for all cases Note on taxes: A tax credit is received when earnings are negative Table 2: Data for questions

5 18. Use the information in Table 2 to answer this question. What is the base case NPV for the project? (a) $1,523 (b) $4,974 (c) $5,247 (d) $6,529 (e) $8, Use the information in Table 2 to answer this question. What is the worst case NPV for the project? (a) $11, 594 (b) $10, 967 (c) $4, 423 (d) $2, 327 (e) +$3, Use the information in Table 2 to answer this question. What is the best case NPV for the project? (a) $5,247 (b) $26,462 (c) $29,306 (d) $32,327 (e) $34, Use the information in Table 2 to answer this question. Suppose you want to conduct a sensitivity analysis for the possible changes in unit sales. What is the change in NPV relative to the base case when sales are 3,250 units instead of 3,000? (a) $1,475 (b) $7,890 (c) $4,744 (d) $3,679 (e) $2, Use the information in Table 2 to answer this question. Suppose you are interested in the project s sensitivity to unit price. What is the change in NPV relative to the base case when unit price is $13 instead of $14? (a) -$6,276 (b) -$1,029 (c) $105 (d) $1,868 (e) $2, Use the information in Table 2 to answer this question. What is the base case accounting break-even point? 5

6 (a) 1,083 (b) 1,500 (c) 1,800 (d) 2,300 (e) 2, Use the information in Table 2 to answer this question. What is the base case cash break-even point? Ignore taxes. (a) 1,500 (b) 1,800 (c) 1,917 (d) 2,300 (e) 2, Use the information in Table 2 to answer this question. What must OCF be each year to have a zero NPV in the base case? (a) 1,500 (b) 1,917 (c) 2,300 (d) 3,155 (e) 4, The hypothesis that market prices reflect all available information is called efficiency in the: (a) Open form. (b) Strong form. (c) Semi-strong form. (d) Weak form. (e) Stable form. 27. The hypothesis that market prices reflect all publicly-available information is called efficiency in the: (a) Open form. (b) Strong form. (c) Semi-strong form. (d) Weak form. (e) Stable form. 28. For a stock that does not pay a dividend, the total return can also be defined as the: (a) Risk premium plus the inflation rate. (b) Capital gains return. (c) Real rate of return. (d) Financial rate of return. (e) Nominal after-tax rate of return. 6

7 29. If a company insider uses all of her knowledge about the company stock and still has no advantage in the marketplace over outside investors, the market has to be: (a) Semi-strong form efficient. (b) Strong form efficient. (c) Weak form efficient. (d) Overpriced. (e) Underpriced. 30. Which of the following is generally considered to represent the risk-free return? (a) Common stocks (b) Treasury bills (c) Small stocks (d) Long bonds (e) Inflation 31. Assume that markets are semi-strong form efficient. Suppose, then, that during a trading day, important new information is released for the first time concerning a certain company. This information indicates that one of the firm s oil fields, previously thought to be very promising, just came up dry. How would you expect the price of a share of stock to react to this information? (a) The value of a share will fall over an extended period of time as investors begin to sell shares in the company. (b) The value of a share will drop immediately to a price that reflects the value of the new information. (c) The value of a share will fall below what is considered appropriate because of the decreased demand for the shares, but eventually the price will rise to the correct level. (d) The value of a share will rise over a long period of time as investors sell the stock. (e) The stock price will not change since this type of information has no impact in markets that are semi-strong form efficient. 32. You discover that you can make greater than expected returns by buying stock in firms whenever the growth rate in sales predicted by an investment survey exceeds the stock s current price-earnings ratio. Which of the following describes this event? (a) This would not be a violation of market efficiency. (b) This would be a violation of weak form efficiency. (c) This would be a violation of semi-strong form efficiency but not of weak form efficiency. (d) This would be a violation of strong form efficiency but not of semi-strong form efficiency. (e) This would be a violation of all forms of market efficiency. 33. You discover you can make above normal returns if you buy oil-company stocks just before noon on any given trading day and then sell them immediately before the market closes that same day. Which of the following describes this event? (a) This would not be a violation of market efficiency. (b) This would be a violation of weak form efficiency. (c) This would be a violation of semi-strong form efficiency. 7

8 (d) This would be a violation of strong form efficiency. (e) This would be a violation of all forms of market efficiency. 34. You have discovered from looking at charts of past stock prices that if you buy just after a stock price has declined for three consecutive days, you make money every time! This is a violation of which form of market efficiency? (a) weak form (b) semi-weak form (c) semi-strong form (d) strong form (e) TSX stock 35. While eating in an exclusive restaurant in New York City, you overhear two executives negotiating a merger. When you check the news about the two companies after lunch you find there is no public information about any merger. Thus, you buy shares of stock in both firms and make a killing when the merger is announced publicly two days later. This is a violation of which form of market efficiency? (a) weak form (b) semi-weak form (c) semi-strong form (d) strong form (e) TSX stock 36. Which of the following are included in the market prices if the market is semi-strong efficient? I. All historical information II. All insider information III. All public information IV. All information of any kind (a) I only (b) III only (c) I and III only (d) I, II, and III only (e) I, II, III, and IV 37. You purchased a five-year 6% annual coupon bond one year ago for $990. You sold the bond today when the market rate of return is 4.5%. If the inflation rate for the past year was 2.0%, what nominal rate of return did you earn on this investment? (a) 7.07% (b) 8.16% (c) 10.30% (d) 11.67% (e) 12.51% 8

9 38. Angelo purchased a 7% annual coupon bond one year ago for $987. At the time of purchase, the bond had six years to maturity. Over the past year inflation has been 3.2%. The market required return on this bond today is 8%. If Angelo sells the bond today at the market price, what real rate of return will he realize on this investment? (a) -1.16% (b) 1.13% (c) 1.17% (d) 4.33% (e) 4.36% 39. Over the past four years a stock produced annual returns of 4%, -18%, - 21%, and 48%, respectively. Based on this information, what is the standard deviation for this stock? (a) 18.03% (b) 27.58% (c) 31.85% (d) 34.62% (e) 55.16% 40. One year ago, Yokino purchased 100 shares of stock for $3,896. Since that time, he has received a total of $180 in dividends. If he sells the stock at today s market price he will realize a total return on his investment of 10.37%. Assuming he sells the stock today, what is the dollar amount of his capital gain per share of stock? (a) $1.80 (b) $2.24 (c) $3.68 (d) $4.04 (e) $ You purchased a stock for $47.00 a share one year ago. Today you sold the stock for $50.21 a share and realized an 8.51% total rate of return. What was the dividend yield on this stock for the past year? (a) 1.68% (b) 1.71% (c) 1.88% (d) 2.03% (e) 2.12% 42. Which of the following statements is/are true about the variance of the possible future returns on a financial asset where you have multiple possible states of the economy along with associated probabilities of the states occurring? I. The variance is a simple average of the squared deviations of the actual returns from the expected returns II. The greater the dispersion in the possible returns on the firm s stock, the lower the variance of the possible returns, all else equal III. The variance of the possible returns on a risk-free asset is zero 9

10 (a) I only (b) II only (c) III only (d) II and III only (e) I, II, and III 43. Which of the following is true about calculating expected portfolio returns and variances? (a) You need to calculate the weight of each asset relative to the total portfolio to calculate the portfolio return, but not to calculate the portfolio variance. (b) Portfolio return can be calculated using the expected return and portfolio weight for each asset. (c) The portfolio return is not needed to calculate the portfolio variance. (d) The portfolio return and variance are independent of the possible states of nature. (e) The portfolio variance is generally a weighted average of the variances of the individual assets in the portfolio. 44. If portfolio weights are positive: 1) Can the return on a portfolio ever be less than the smallest return on an individual security in the portfolio? 2) Can the variance of a portfolio ever be less than the smallest variance of an individual security in the portfolio? (a) 1) yes; 2) yes (b) 1) yes; 2) no (c) 1) no; 2) yes (d) 1) no; 2) no (e) 1) maybe; 2) no 45. What is the expected return for the following stock? (a) (b) (c) (d) (e) State Probability Return Average.55 20% Recession.20 10% Depression.25-20% 46. What is the variance of the following returns? (a) State Probability Return Boom.15 60% Good.50 20% Recession.25-10% Depression.10-30% 10

11 (b) (c) (d) (e) You own 40 shares of stock A, which has a price of $15 per share, and 200 shares of stock B, which has a price of $2 per share. What is the portfolio weight for stock A in your portfolio? (a) 18% (b) 25% (c) 40% (d) 60% (e) 75% State Probability Return on A Return on B Boom.6 15% 8% Bust.4 5% 20% Table 3: Information for questions Use the information in Table 3 to answer this question. What is the expected return of security B? (a) (b) (c) (d) (e) Use the information in Table 3 to answer this question. What is the standard deviation of security A? (a) (b) (c) (d) (e) Use the information in Table 3 to answer this question. What is the standard deviation of a portfolio that is 50% invested in A and 50% invested in B? (a) (b) (c) (d) (e)

Finance 300 Exam 3 Spring 1999 Joe Smolira. Multiple Choice 4 points each 80 points total Put all answers on the answer page

Finance 300 Exam 3 Spring 1999 Joe Smolira Multiple Choice 4 points each 80 points total Put all answers on the answer page 1. When a cash payment is made to shareholders as it has been at the end of each