Exam 2 Sample Questions FINAN303 Principles of Finance McBrayer Spring 2018

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1 Sample Multiple Choice Questions 1. A bond is priced at $ The bond pays $11 every 3 months (quarterly). If it matures in 14 years, what is the bond s effective yield to maturity? a. 1.29% b. 1.47% c. 5.16% d. 5.89% e. Not enough information 2. If the stock price for GreatCo is $25 and the next dividend to be paid is $2.50 (one year from now), what is the required rate of return for the stock if the assumed growth rate is 5.9%? a. 2.1% b. 8.0% c. 13.9% d. 15.9% e. 25.0% 3. What is the present value of $1,000 to be received in 13 years, if the discount rate is 5.5% per year? a. $ b. $ c. $ d. $ e. $ What is the effective annual rate (EAR) for a credit card that charges 16.99% per year, compounded daily? Assume 365 days in a year. a % b % c % d % e % 5. What is the price of a stock if the required return is 12% and the most recent dividend amount (which is paid annually) is $2.60? a. $20.00 b. $21.67 c. $22.33 d. $24.00 e. Not enough information 6. A company s stock, and its dividend stream, is expected to have the following characteristics: D 1 = $2.00, g = 5%, and r s = 15%. If the company s price currently equals its intrinsic value, which of the following statements is correct? a. The company s expected stock price at the beginning of next year is $ b. The company s current stock price is $ c. The company s return on common stock exceeds its return on preferred stock. d. None of the above Page 1

2 7. Suppose your wealthy relative deposited $50,000 in an account for you the day you were born. If you are now 20 years old and that investment grew by 11.5% per year over that period of time, what is your account worth today (round to the nearest dollar)? a. $110,912 b. $279,047 c. $376,163 d. $441,029 e. $576, If a year s tuition at Boise State costs $7,500 in 2016, how much would a year at BSU cost my child if they attended Boise State 10 years from now and the cost of tuition increased at a rate of 4.5% per year (round to the nearest dollar)? a. $11,647 b. $11,942 c. $12,126 d. $12,405 e. $12, If you buy a car for $15,000 with a five-year loan and an interest rate of 7.5% annually, what are your required monthly payments? a. $ b. $ c. $ d. $ e. $ What is the price of a $500 par bond if the nominal yield to maturity is 6.65%, the coupon rate is 8% paid quarterly, and it matures in 11 years? a. $ b. $ c. $ d. $ e. Not enough information 11. A bond s coupon rate is equal to the annual interest paid divided by which of the following? a. Call price b. Par Value c. Current Price d. Settlement Price e. Clean Price 12. What is the most you are willing to pay for a share of GreatCo if the company just paid a $0.70 annual dividend, the dividends increase by 2.5% annually, and you require a 10% rate of return? a. $9.29 b. $9.33 c. $9.47 d. $9.57 e. $9.69 Page 2

3 13. An increase in which of the following will increase the current value of a stock according to the dividend growth model? I. Dividend Amount II. Number of Future Dividends (provided the current number is less than infinite) III. Discount Rate IV. Dividend Growth Rate a. I and II only b. III and IV only c. I, II, and III only d. I, II, and IV only e. I, II, III, and IV 14. I m starting out with $40,000 today and want to have $2,000,000 in 30 years when I retire. Assuming that I can earn 8% per year, how much must I deposit at the end of every year to reach my goal (round to the nearest dollar)? a. $13,902 b. $14,102 c. $14,457 d. $14,803 e. $15, Same question as above, but I can only afford to deposit $10,000 per year. How long until I can retire while still reaching my goal of $2,000,000? a years b years c years d years e years 16. You estimate the following free-cash flow data for GreatCo (in millions). The firm s long-term growth will be 4% per year after year three and the firm s required return on equity is 11%. GreatCo has $5 million in total debt and preferred stock and 10 million shares outstanding. Using the corporate valuation model, what is the intrinsic price of one share of GreatCo? (Round at the end) Year Free Cash flows $3 $12 $20 a. $20.17 b. $20.44 c. $21.65 d. $22.41 e. $ Assume an investment pays $10,000 in year one, $12,000 in year two, and $14,000 in year three. If an investor wanted to earn 8% on their money, what is the most they would be willing to pay for the security (round to the nearest dollar)? a. $30,925 b. $33,113 c. $28,757 d. $30,661 e. $31,513 Page 3

4 18. You have a balance of $1,000 in your investment account. How many years before it triples in value assuming that you can earn 9% compounded daily (assume 365 days in a year)? a years b years c years d years e. 4, years 19. An annuity due offers to pay you $300 every six months for 10 years. Assuming you d be willing to purchase the annuity as long as it returns 5%, what is the most you d be willing to pay (round to the nearest dollar)? a. $4,677 b. $4,794 c. $4,833 d. $4,917 e. $5, Last year Granger Telecommunication Inc. s sales were $225 million. If sales are expected to grow 6% per year, what will sales be (in millions) after 5 years of growth? a. $ b. $ c. $ d. $ Tattersall Clothiers plans to issue 6-year bonds with a par value of $1000 and an 8% coupon paid quarterly. Based on current market conditions, they expect that these bonds will sell for $1070. Given this information, what is the effective yield on Tattersall s bonds? a. 4.60% b. 5.60% c. 6.74% d. 8.00% 22. Suppose you are thinking about purchasing a new car costing $22,000. A bank has agreed to lend you the needed funds to purchase the car but requires 20% down and will loan you the remainder on a 5- year note with monthly payments. They plan to charge 8% annually. What will be your monthly payment? a. $ b. $ c. $ d. $ A 15-year, zero-coupon bond with $1000 par value is currently selling for $615. What is the bond s effective yield to maturity? a. 2.89% b. 3.29% c. 3.68% d. 3.91% Page 4

5 24. What is the effective annual rate when a bank advertises that it pays 11% compounded monthly? a % b % c % d % 25. What is the present value of $9,500 payable 17 months from now assuming a bank pays 9% compounded quarterly? a. $8, b. $8, c. $8, d. $8, Which of the following best describes the relationship between the present value of an annuity and the discount rate? a. As the discount rate rises, the present value rises b. As the discount rate rises, the present value falls c. As the discount rate rises, the present value will remain unchanged d. It depends on the annuity in question 27. What is the most you would be willing to pay for an ordinary annuity that offers $300 per year for 10- years assuming you wanted at least a 9% return on your investment. a. $1, b. $2, c. $2, d. $2, What is the most you would be willing to pay for the same annuity as above if it were an annuity due? a. $1, b. $2, c. $2, d. $2, What is the future value of the annuity at the end of its life assuming, still, that it is an annuity due and that you would want to (be able to) earn 9% on your investment? a. $4, b. $4, c. $4, d. $5, Your friend is planning on taking a 6-week backpacking trip through Europe to celebrate her 30 th birthday (in 10 years) and would like to take you with her (all expenses paid). Based on her estimation, she is going to need about $12,000 for the trip. Assuming she can invest to earn 5% annually, how much will she need to save each year starting at the end of year1? a. $ b. $ c. $ d. $1, Page 5

6 31. Same problem as above, however, your friend can only afford $700 per year. What interest rate will she need to earn to still have her $12,000 in 10-years? a. 9.83% b % c % d % 32. Same problem, however, we now know that the maximum that you friend can earn on her investment is, in fact, 5% annually. Assuming that she can still only afford to save $700 per year, how old will she be when she finally has the funds necessary for the trip? a. 30 b c d You observe a 10-year, $1,000 par value bond trading for $ Further, you know that the nominal yield to maturity on the issue is 9.25%. Given this information, what is the bond s annual coupon payment? a. $66.58 b. $67.32 c. $67.91 d. $ If market interest rates fall from 8 percent to 7 percent, which of the following bonds will have the largest percentage increase in its value? a. A 10-year zero-coupon bond. b. A 10-year bond with a 10 percent coupon. c. A 10-year bond with a 12 percent annual coupon. d. A 5-year zero-coupon bond. 35. A recent advertisement in the financial section of a magazine carried the following claim: "Invest your money with us at 11%, compounded quarterly, and we guarantee to double your money sooner than you imagine." Ignoring taxes, how many years would it take to double your money at a simple rate of 11%, compounded quarterly? a b c d Which of the following best describes the concept of time value of money? a. The value of a sum of money received over a period of time is greater than the value of that sum of money today. b. A dollar received today is worth more than a dollar to be received in the future. c. Inflation increases the value of money to be received in the future. d. Risk increases the value of money to be received in the future. Page 6

7 37. Suppose someone offered you the choice of two equally risky annuities, each paying $10,000 per year for five years. One is an ordinary annuity, the other is an annuity due. Which of the following statements is most correct? a. The present value of the ordinary annuity must exceed the present value of the annuity due, but the future value of an ordinary annuity may be less than the future value of the annuity due. b. The present value of the annuity due exceeds the present value of the ordinary annuity, while the future value of the annuity due is less than the future value of the ordinary annuity. c. The present value of the annuity due exceeds the present value of the ordinary annuity, and the future value of the annuity due also exceeds the future value of the ordinary annuity. d. If interest rates increase, the difference between the present value of the ordinary annuity and the present value of the annuity due remains the same. 38. The value of bonds is equal to a. the present value of the principal b. the present value of the interest c. the present value of the principal minus the present value of the interest d. the present value of the principal plus the present value of the interest In-Class Assignment/Quiz Problems Price the following: 39. A company s stock, and its dividend stream, is expected to have the following characteristics: D_0=$2.00, g=5%, and r_s=12%. What is the company's expected stock price 1-year from now? a. $28.57 b. $30.00 c. $31.50 d. Cannot tell from the information given 40. What is the most you are willing to pay for a share of stock if the company just paid a $1.10 annual dividend, the dividends increase by 3% annually, and you require an 11% rate of return? e. $13.75 f. $14.16 g. $15.11 h. $ The preferred stock for a company pays a $4.00 dividend every year. If one share trades for $50.00, what is the implied required return on the preferred stock? i. 8% j. 9% k. 10% l. 11% 42. There are diversification gains to holding individual assets together in a portfolio diversification so long as the assets are perfectly positively correlated. m. True n. False Page 7

8 43. Using DDM, what is the implied growth rate on dividends if a company expects to pay a dividend of $2.00, has a current stock price of $20.00 and a required return of 12%? o. 2% p. 6% q. 10% r. 12% 44. A bond whose price is less than its par value is called a bond. s. Par t. Discount u. Premium v. Floating Rate 45. Which of the following bond provisions is least preferable to bondholders? w. Putable provision x. Callable provision y. Convertible provision z. Dividend discount provision 46. What is the yield to maturity on a 5-year, $1,000 par bond that pays 4% semi-annually if it is currently trading for $960? aa. 2.46% bb. 3.83% cc. 4.00% dd. 4.91% 47. What is the price of a 5-year, $1,000 par bond that pays 4% annually if it is currently trading to yield 3.75? ee. $ ff. $ gg. $1, hh. $1, What is the price of a 10-year, zero coupon, $500 par bond that is currently trading to yield 6%? ii. $ jj. $ kk. $ ll. Cannot tell from the information given Computational Problems Price the following: year, $1000 par value, 6% semi-annual coupon bond whose current nominal yield-to-maturity (YTM) is 8% year, $1000 par value, 8% quarterly coupon bond whose current nominal YTM is 7% year, $1000 par value, zero-coupon bond whose current nominal YTM is 9.5% year, $1000 par value, 8% monthly coupon bond whose current nominal YTM is 10% year, $500 par value, 8% semi-annual coupon bond whose current nominal YTM is 8.25%. Page 8

9 Calculate the effective yield-to-maturity on the following bonds: year, $1000 par value, 6% semi-annual coupon bond that is currently being offered for $ year, $1000 par value, 8% quarterly coupon bond that is currently being offered for $ year, $1000 par value, zero-coupon bond that is currently being offered for $ year, $1000 par value, 8% monthly coupon bond that is currently being offered for $ year, $500 par value, 8% semi-annual coupon bond that is currently being offered for $465. Using DDM, price the following equity securities: 59. D 0=$2.00, g=5%, r s=11% 60. D 0=$3.00, g=-4%, r s=8% 61. D 1=$1.00, g=6%, r s=13% 62. D 1=$5.00, g=-5%, r s=12% 63. D 1=$2.00, g=8%, r s=6% Using DDM, calculate the implied return on equity: 64. D 0=$2.00, g=6%, P 0=$ D 0=$8.00, g=-5%, P 0=$ D 1=$1.00, g=4%, P 0=$ D 1=$5.00, g=-6%, P 0=$ D 1=$2.00, g=0%, P 0=$20 Gigantic Pain in the Neck Problem: 69. Suppose we have a non-constant growth stock that plans to pay the following dividend structure: D 0=$3.00 the dividends will grow by 30% for two years, 20% for the next two years, 10% for the next three years, before settling to a constant 5% after that. If markets require an 11% return on equity for holding this security, what would the price of this stock? Page 9

10 ANSWER KEY: Sample Multiple Choice Questions 1. E 2. D 3. B 4. E 5. B 6. A 7. D 8. A 9. D 10. C 11. B 12. D 13. D 14. B 15. C 16. E 17. D 18. A 19. B 20. C 21. C 22. B 23. B 24. A 25. C 26. B 27. A 28. B 29. C 30. B 31. D 32. B 33. A 34. A 35. C 36. B 37. C 38. D In-Class Assignment/Quiz Problems 39. C 40. B 41. A 42. B 43. A 44. B 45. B 46. D 47. D 48. A Computational Problems 49. $ $ $ $ $ % % % % % 59. $ $ $ $ Violates DDM % % % % % 69. $ Page 10

MULTIPLE-CHOICE QUESTIONS Circle the correct answers on this test paper and record them on the computer answer sheet.

MULTIPLE-CHOICE QUESTIONS Circle the correct answers on this test paper and record them on the computer answer sheet. #18: /10 #19: /15 Total: /25 VERSION 1 M I M E 3 1 0 E N G I N E E R I N G E C O N O M Y Class Test #1 Wednesday, 13 February, 2008 90 minutes PRINT your family name / initial and record your student ID