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Date Posted: 12:44:20 02/15/01 Thu
Author: Charles Hodges
Subject: Another Sample Exam 1

Exam 1 Spring 2000 FI 4300 Your Name ______________________________

YOU HAVE 1 3/4 HOURS TO COMPLETE BOTH PARTS OF THIS EXAM
Instructions:
1) The part of the exam is closed book and closed notes. No scrap paper is allowed, use the back of the exam if necessary.
2) Read the entire exam before starting. The best strategy is generally to "cherry pick". In other words, solve the easiest (and/or most familiar) problems first. This will save time (and energy) that can be expended on the more difficult problems.
3) Partial points are based on readily observable evidence that you know at least part of the solution concept. The more evidence presented (and the clearer the evidence), the better the chance for partial points. In other words, SHOW ALL WORK!
4) If you have additional time remaining, give your work one last check.
5) True/False questions are worth 2 points. Multiple choice questions are worth 3 points. Short answer questions usually take less than three sentences and are worth 4 points. Problems are worth the number of points listed in the question.

1. According to the text, the primary goal for a firm's financial managers is to maximize shareholder's wealth.
a. True b. False

2. A major difference between debt and equity is that while payments to bondholders are a legal obligation, payments to stockholders are at the discretion of the Board of Directors.
a. True b. False

3. According to the textbook, which of the following may be a right associated with common stock ownership?
a. rights to interest payments. b. right to maturity value. c. preemptive right.
d. for Delaware corporations only, the Sulekovich right.
e. none of the above are typical rights of shareholders.

4. Which of the following is not considered a primary responsibility of the financial managers of a corporation?
a. liquidity management b. operations management c. capital budgeting
d. capital structure e. dividend policy

5. What is meant by the agency problem?





6. Briefly describe the set-of-contracts model of the corporation?







7. What is meant by the term "moral hazard"?





8. Diversification is a means of increasing return while simultaneously reducing risk (as measured by standard deviation)
a. true b. false

9. A sunk cost is an example of an incremental cost.
a. true b. false

10. Investments with NPV=$0:
a. yield no profits.
b. do not adequately compensate for risk
c. will generally have low discount rates.
d. all of the above.
e. none of the above.

11. (Short answer, 3-5 sentences) Assume I am considering starting an internet company to sell textbooks to college students. I know that the college bookstore typically runs a 33% profit on textbooks. A quick search revealed several potential competitors including effollet.com (operator of over 600 college bookstores) and varsitybooks.com (currently the largest internet textbook seller). Using Shapiro's barriers to entry or at least 3 principles of finance, discuss whether my internet company is likely to be positive, negative, or 0-NPV project?







12. ___________ markets deal in securities with maturities of one year of less; ___________ markets deal with markets in which new securities are issued.
a. money, primary b. capital, equity
c. spot, derivative d. futures, debt
e. none of the above.

13. A portfolio's standard deviation is always less than, or equal to, the standard deviation of the individual security with the highest stand-alone risk.
a. True b. False

14. A portfolio's standard deviation is always greater than, or equal to, the standard deviation of the individual security with the lowest stand-alone risk.
a. True b. False

15. Assume the risk free rate is currently 5%. Stock A has an expected return of 14% and a beta of .8. Stock B has a standard deviation of 34% and a beta of .7. What is the beta of the market portfolio?





16. List the four steps of the capital budgeting process.






17. For a long-term capital budgeting project, expensing an item rather than capitalizing an item will most likely not affect the total cash flows of a project. However, expensing the item will raise the project's calculated Net Present Value.
a. True B. False


18. (4 points) Match the Capital Budgeting method with the assumed reinvestment rate (answers may be used more than once).
a. Net Present Value ______________
b. Internal Rate of Return _____________
c. Profitability Index _________________
d. Payback Period _______________

a. Internal Rate of Return b. Cost of Capital
c. Return on Investment d. Return on Equity
e. None of the above.

19. If the corporate tax rate were 0, changes in depreciation would not affect the annual cash flows in capital budgeting analysis.
a. true b. false

20. What is a post-audit? Why is it used in the capital budgeting process?


Exam 1 Spring 2000 FI 4300 Your Name ______________________________

YOU HAVE 1 ¾ HOURS TO COMPLETE BOTH PARTS OF THIS EXAM
Instructions:
The part of the exam is open book and open notes. Show your work for partial credit.
Point values are listed with the question.


1. (8 points) Your required rate of return is 10%. If you invest $150 today you will receive the following cash flows: At the end of year 1 $90
At the end of year 2 $35
At the end of year 3 $40
What is the IRR of the project? What is the profitability index (PI) of the project?













2. Albatros, Inc., an all equity firm, is considering buying a piece of equipment (a cyclotron) from Warren Piece for $40 million. By reducing Albatros's expenses for Proton-spectroscopy, the equipment will increase the company's net income by $2.7 million per year for next 20 years. At the end of year 20, the company can sell the cyclotron's magnetic alloys for $8.0 million. The depreciable life of the cyclotron is 20 years and company can use straight-line depreciation to $0 million salvage value. Albatros, Inc. estimated for this project a discount rate of 9 percent p.a. and corporate tax rate is 40 %.
(4 points) What is the NPV of the equipment ? (4 points) What is the payback?







3. (8 points) You have information on the following stock:

State of Economy Probability of State Stock A's Return
Great .12 15
Good .26 18
OK .28 9
Bad .18 0
Terrible .16 -4

What is the expected return and standard deviation of Stock A?








4. (20 points) Parker Products manufactures a variety of household products. The company is considering introducing a new detergent. The company's CFO has collected the following information about the proposed product. (Note: You may or may not need to use all of this information, use only the information that is relevant.)

a. The project has an anticipated economic life of 4 years. To assess the demand for the new product, last year the company conducted a marketing survey that cost $60,000.
b. The company will have to purchase a new machine to produce the detergent. The machine has an up-front cost (t = 0) of $2 million. The machine will be depreciated on a straight-line basis over 4 years (that is, the company's depreciation expense will be $500,000 in each of the first four years (t = 1, 2, 3, and 4).) The company anticipates that the machine will last for four years, and that after four years, its salvage value will equal $0. However, due to environmental concerns about the machine it will cost $50,000 to dispose of the machine at the end of the project.
c. If the company goes ahead with the proposed product, it will have an effect on the company's net working capital. At the outset, t = 0, inventory will increase by $140,000 and accounts payable will increase by $40,000. At t = 4, the net working capital will be recovered after the project is completed.
d. The detergent is expected to generate sales revenue of $1 million the first year (t = 1), $2 million the second year (t = 2), $2 million the third year (t = 3), and $1 million the final year (t = 4). Each year the operating costs (not including depreciation) are expected to equal 50 percent of sales revenue.
e. The company's interest expense each year will be $100,000.
f. The new detergent is expected to reduce the after-tax cash flows of the company's existing products by $250,000 a year (t = 1, 2, 3, and 4).
g. The proposed project is riskier than the average project for Parker; the project's Cost of Capital is estimated to be 12 percent.
h. The company's tax rate is 40 percent.

What is the net present value of the proposed project?

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