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1 Financiering P 6011P0088/ Finance PE 6011P0109 Midterm exam 23 April 2012 Your Name: Student Number: Signature: This is a closed-book exam. You are allowed to use a non-programmable calculator and a dictionary. There is a formulae page attached to the exam. You have 1 hour for the exam. There are 15 multiple choice questions in total, equally weighted. With 9 good answers the grade is a 6. There is no penalty for the wrong choice. On the answers sheet provided you should put your name and student number and fill in only one choice for each question that you think is the best. You can only use a pencil to fill in the answer form. Version code = 1 Please fill this in at the answer sheet under Versie Code Further on the answer sheet, answer A corresponds with 1, B with 2, C with 3 and D with 4. Be kindly reminded that you should rely on your own effort; no conversation is allowed during the exam. Please sign before you start. When you finish, this FrontPage must be removed from the questions and handed in together with your answer page. Good Luck! 1

2 Q 1 Which of the following are the major duties of a financial manager? 1. to make investment decisions 2. to make financing decisions 3. to manage cash flow and working capital A) 1 only B) 1 and 2 only C) 1 and 3 only D) all of the above Answer: D Q 2 Which of the following statements is incorrect? A) In general, money today is worth more than money in one year. B) We define the risk-free interest rate, rf for a given period as the interest rate at which money can be borrowed or lent without risk over that period. C) We refer to (1 - rf) as the interest rate factor for risk-free cash flows. D) For most financial decisions, costs and benefits occur at different points in time. Answer: C Q 3 You are offered an investment opportunity in which you will receive $23,750 today in exchange for paying $25,000 in one year. Suppose the risk-free interest rate is 6% per year. Should you take this project? The NPV for this project is closest to: A) Yes; NPV = $165 B) No; NPV = $165 C) Yes; NPV = -$165 D) No; NPV = -$165 Answer: A Q 4 How does the statement of cash flows change if shareholders are paid a dividend? A) The operational cash flow decreases. B) The investment cash flow increases. C) The financial cash flow decreases. D) The statement of cash flows does not change. Answer C Q 5 Statement I: The interest coverage ratio defined as EBIT/interest expenses gives information about the credit risk of the company. Statement II: Project analysis is primarily based on the operating and investment cash flow, not the financing cash flow. A) Both statements are false B) Statement I is true, statement II is false 2

3 C) Statement I is false, statement II is true D) Both statements are true Answer D Q 6 Your firm can borrow at 12% APR with quarterly compounding. The EAR in this case is closest to: A) 2.87% B) 12.55% C) 13.80% D) 15.61% Thus, answer B! Q 7 Suppose your bank pays interest daily with the interest rate quoted as an effective annual rate (EAR) of 90%. What amount of interest will you earn each daily? A) 0.176% B) 0.186% C) 0.196% D) 0.206% SOLUTION 0,00176 Thus, answer A! Use the table for the question(s) below. Suppose the term structure of interest rates is shown below: Term 1 year 2 years 3 years 5 years 10 years 20 years Rate (EAR%) 5.00% 4.80% 4.60% 4.50% 4.25% 4.15% Q 8 What is the shape of the yield curve and what expectations are investors likely to have about future interest rates? A) Inverted; Higher B) Normal; Higher C) Inverted; Lower D) Normal; Lower Answer: C Q 9 3

4 The present value of receiving $1000 per year with certainty at the end of the next three years is closest to: A) $2,737 B) $2,723 C) $2,733 D) $2,744 Answer: A Explanation: A) = 1000 / (1.05) / (1.048) / (1.046)3 = 2737 Q 10 If the current rate of interest is 8%, then the present value of an investment that pays $1000 per year, starting two years from now, and lasts 20 years is closest to: A) $17,147 B) $11,574 C) $9,090 D) $9,818 Answer: C Explanation: C) PV(t=1) = C/r (1 - (1 + r) -N) = 1000/.08(1-(1+0.08)-20) PV(t=1) = $9,818 PV (T=0)= 9,818/1,08 = $9,090 Q 11 You are considering an investment in a clothes distributor. The distributor needs $100,000 today and expects to repay you $120,000 in a year from now. What is the IRR of this investment opportunity? Given the riskiness of the investment opportunity, your cost of capital is 20%. What does the IRR rule say about whether you should invest? A) IRR = 12%. We should invest since the cost of capital is higher than the IRR. B) IRR = 20%. We are indifferent between investing or not investing since the IRR is equal to the cost of capital. C) IRR = 12%. We should not invest since the cost of capital is higher than the IRR. D) IRR = 20%. The IRR rule cannot be used for this projects since the positive cash flows precede the negative ones. ANSWER: B Q 12 Consider the following two mutually exclusive projects: I. Project with an IRR of 10% II. Project with an IRR of 20% Which of the following answers is best: A) Project II is best, because it has the highest IRR. B) Project I is best, because it has the lowest IRR. C) You cannot say they might differ in scale. 4

5 D) You cannot say they might differ in risk and in scale. Answer D. Q 13 In September 2008, the IRS changed tax laws to allow banks to utilize the tax loss carry-forwards of banks they acquire to shield their future income from taxes (prior law restricted the ability of acquirers to use these credits). Suppose Fargo Bank acquires Covia Bank and with it acquires $74 billion in tax loss carry-forwards. If Fargo Bank is expected to generate taxable income of 10 billion per year in the future, and its tax rate is 30%, what is the present value of these acquired tax loss carry-forwards given a cost of capital of 8%? A) -$16.27 Billion B) $3.21 Billion C) $6.27 Billion D) $16.27 Billion ANSWER: D SOLUTION: We can shield $10 billion per year for the next 7 years, and $4 billion in year 8. Given a tax rate of 30%, this represents of tax savings of $3 billion in years 1 7, and $1.2 billion in year PV = 3 1 $16.27B Q 14 The controller of a firm demands that a new production facility should carry a proportional amount of the costs of the existing firm headquarters. How should the costs of the headquarters be incorporated in the capital budgeting analysis for the new production facility? 1. They should partially be taken into account because the firm needs to be profitable. 2. They should be taken into account but discounted to correctly measure the time value of money. 3. They should only be taken into account only if they actually correspond to cash flows. 4. They should not be taken into account when they are not part of incremental cash flows. Answer: D Q 15 Shepard Industries is evaluating a proposal to expand its current distribution facilities. Management has projected the project will produce the following cash flows for the first two years (in millions). Year 1 2 Revenues Operating Expense Depreciation Increase in working capital Capital expenditures Marginal corporate tax rate 30% 30% 5

6 The free cash flow from Shepard Industries project in year one is closest to: A) $240 B) $300 C) -$5 D) $390 Answer: A Explanation: A) Free Cash Flow Revenues Expenses Depreciation = EBIT Taxes (30%) Incremental Net Income Depreciation Capital expenditures Change in NWC Free Cash Flow

7 Formula sheet Financiering / Finance PV (CF) FV (CF) NPV PV perpetuity NPV = PV Investment PV growing perpetuity PV annuity 1 1 PV (annuity of C for N periods with interest rate r) C 1 r (1 r) N PV growing annuity EAR After-tax interest rate r ( r) r(1 ) 7

E-120: Principles of Engineering Economics. Midterm Exam I Feb 28, 2007

E-120: Principles of Engineering Economics Midterm Exam I Feb 28, 2007 Name: (please print) SID: Clearly state all the formula and mathematical expressions that are needed to solve the problems. No credit