1. A bank is paying interest at a 5% annual rate on deposits. If you invest 10,000 and the bank compounds interest daily (i.e., 365
1. A bank is paying interest at a 5% annual rate on deposits. If you invest 10,000 and the bank compounds interest daily (i.e., 365 times per year), which of the following shows how much you will have in your account after two years?
(a) 10,000 x (1.05)2
(b) 10,000 x (1 + .05/365)365x2
(c) 10,000 x [1/.05 - 1/(.05(1.052)]
(d) 10,000 x (1 + .05/(365x2))2
Name_________________________________ Student Number___________________________________ FINAL MGF 301 Corporation Finance Fall 2013 PRACTISE (TEST 1) Please sign name in box Please tear off the answer sheet and answer all of the following questions on the answer sheet. (Note: Total Points = 100; Multiple Choice = 4 points each unless otherwise indicated) 1. A bank is paying interest at a 5% annual rate on deposits. If you invest 10,000 and the bank compounds interest daily (i.e., 365 times per year), which of the following shows how much you will have in your account after two years? (a) 10,000 x (1.05)2 (b) 10,000 x (1 + .05/365)365x2 (c) 10,000 x [1/.05 - 1/(.05(1.052)] (d) 10,000 x (1 + .05/(365x2))2 2. An investment is expected to pay the following: C1 = $2,300, C2 = $2,600, C3 = $2,900, and then for time period 4 and continuing forever thereafter the payment will increase 5% over the previous year. If the discount rate is 10%, how would you calculate a fair price for this investment? Setup the problem and be as specific as you can (Note: you do not have to solve it) (7 points) 3. The common stock of ABC corporation increased in price by 10% yesterday in trading on the New York Stock Exchange. Which of the following is true about ABC? (a) the book value of equity increased by 10% when the stock price went up (b) the market value of the assets increased by 10% when the stock price went up (c) the increase in the stock price increased the amount of cash that ABC has (d) none of the above is true. 4. You are offered the choice of receiving (a) $100,000 in time 10 or (b) 5 annual payments of $20,000 beginning in time 1 and continuing through time 5. Can you determine without doing any calculations which choice has the higher present value? Explain. (6 points) 5. If you pay 11% interest compounded semi-annually (i.e., 2 times per year), what is the effective annual rate? (a) 5.5% (b) 11% (c) 11.30% (d) 11.55% Name_________________________________ Student Number___________________________________ 6. Ben is selling his car to his friend Jason for $10,000. If Jason wants to make equal monthly payments over three years for the car, how should Ben and Jason determine the appropriate payment if the annual interest rate is agreed on at 8%? Describe the answer or set up a calculation being as specific as possible. (Note: you do not have to solve it) (7 points) 7. Which of the following is not true about a 10 year 8% bond with a face value of 1,000 that is selling for 1,100? (a) the bond will pay $80 each year as interest (b) if the yield to maturity remains constant over the next year, the price will be lower next year (c) the yield to maturity is less than 8% (d) all of the above are true 8. Exactly ten years ago, in 1997, WXZ corp. issued a 9% bond with face value of $1,000 and a 30 year maturity. The bond was issued with a price of $990 and was rated BB by Standard & Poors. Without doing any calculations, approximately what was the yield to maturity in 1997 when the bond was first issued? (a) a little above 9% (b) a little below 9% (c) exactly 9% (d) cannot be determined 9. Assume the bond from question 8 is now priced at priced at $800 in 2007. Describe two possible explanations for how a bond price could decrease so much over the 10 year period. (6 points) 10. Generic Products Inc. issued 200,000 shares of stock with par value $.01/share. The stock was issued for $20/share. If the stock price is now $30 per share and the company has retained earnings of $1,000,000, calculate (a) the par value, (b) the capital in excess of par and (c) the overall book value of equity. Show your calculations. (6 points) Name_________________________________ Student Number___________________________________ 11. Baby Products Inc. has 1,000,000 shares of stock issued and outstanding. The expected earnings of the company are $2 million next year. The discount rate is 13%. (a) If Baby Products pays out 60% of its earnings as dividends and has a return on equity of 14%, calculate the growth rate of dividends. (6 points) (b) If the dividend paid by Baby Products is expected to grow at the rate in (a) above, calculate the price of Baby Products stock. (6 points) (c) Calculate the present value of growth options (PVGO) for this stock. (6 points) 12. If the stock in question 11 does not pay a dividend, which of the following is true? (a) All the theoretical models we discussed in class require a dividend to calculate stock prices, so there is no way to estimate this stock price (b) It is still possible to estimate the stock price by discounting another measure of firm value such as cash flows (c) If the stock does not pay dividends, we can estimate the stock price by calculating the bond price (d) None of the above are true 13. Jason is planning for retirement and is putting aside $10,000 at the end of each year for the next 5 years. Which of the following calculations shows how much his investment will be worth 20 years from today? (6 points). (a) 10,000 x 5 x (1+r)20 (b) 10,000 x 20 year annuity factor (c) 10,000/r - 10,000/r(1+r)20 (d) None of the above is correct 14. Your aunt left you $50,000 in her will. If you have a choice of the following methods of receiving the money, which of the following has the highest present value? (a) receiving ten annual payments of $5,000 beginning in year 1 (b) receiving five payments of $10,000 over the next ten years payable every other year. (i.e., payments of $10,000 are receiving in time periods 2,4,6,8 and10) (c) receiving 1 payment of 50,000 in time period 10 (d) all of the above have the same present value Name_________________________________ Student Number___________________________________ 15. Mark each of the following as True (T) or False (F). (2 points each) ____ i. The book value of equity increases when the publicly traded stock price increases ____ii. Investors are willing to pay more for a bond that is callable than a similar bond that is not callable because the call feature adds value for the investors ____iii. Using book value of equity to estimate a firm's stock price will not work as well as using estimated future cash flows 16. If a firm wants to issue bonds in the financial markets, which of the following is true? (a) the bonds can be issued in either the primary market or the secondary market (b) the bonds can be issued in the secondary market only because the primary market is for trading already issued bonds (c) bonds cannot be issued in financial markets. (d) None of the above is true. 17. If the expected inflation rate is 6%, what nominal return must an investor earn to achieve a real return of 3%? (a) approximately 3% (b) approximately 8% (c) approximately 6% (d) approximately 9% 18. What is the effect on yield to maturity (YTM) and price if the rating agency changes the bond rating from AA to BB on the bond of ABC Company? (a) the YTM will go up and the price will go down (b) the YTM will go up and the price will go up (c) the YTM will go down and the price will go down (d) the YTM will go down and the price will go up 1. If you are earning interest at a 3% annual rate on deposits, which of the following will have the highest value after 10 years? (a) a bank account that uses simple interest without compounding (b) a bank account that compounds interest quarterly (i.e., 4 times per year) (c) a bank account that compounds interest daily (i.e., 365 times per year) (d) cannot be determined 2. ABC corp. reported no news yesterday, but its price decreased yesterday by 10% in trading on the New York Stock Exchange. Which of the following is true about ABC yesterday? (a) the market value of the equity stayed the same (b) the book value of equity decreased by 10% (c) the decrease in the stock price decreased the amount of cash that ABC has (d) none of the above is true. Name_________________________________ Student Number___________________________________ 3. If you pay interest compounded semi-annually that has an annual percentage rate (APR) of 6%, what is the equivalent annual rate (EAR)? Show your calculation. (6 points) 4. A 10 year bond with a coupon rate of 8% was issued 6 six years ago. It has a $1,000 face value and pays a semi-annual coupon. If the yield to maturity is 6%, how would you calculate the bond price? Set up your calculation in detail but do not solve it. (6 points) 5. Julia is planning for retirement and wants to have $500,000 forty years from now (in time 40). Which formula will calculate how much she needs to save today (time 0) to reach her goal? (a) PV = [500,000 x (1+r)40]/ (1+r)40 (b) PV = [500,000 x 40] / (1+r)40 (c) PV = 500,000 / (1+r)40 (d) FV40 = 500,000 x (1+r)40 6. Your retirement plan will begin making fixed monthly payments of $1,000 to you 30 years from today. These payments will continue forever in perpetuity (and will go to your beneficiaries after you die). Set up a formula using monthly compounding to calculate the present value of this retirement plan. Note: you do not need to solve your formula. ( 6 points) 7. The lottery is currently paying a prize that pays $15,000 five years from today (in time 5). If you invest the prize immediately in time 5 and you earn 7% interest, how much will your investment be worth in time 7? Write both your formula and your answer on the answer sheet. (6 points) Name_________________________________ Student Number___________________________________ 8. Ben is buying a car for $15,000. If Ben wants to make four annual payments and the interest rate is 7%, which of the following is most consistent with time value of money principles if interest is compounded monthly? (a) The annual payment can be calculated using a four year annuity and the EAR with monthly compounding (b) The annual payment equals $15,000 divided by 4 (c) The annual payment can be calculated by applying the annuity formula to find forty eight equal monthly payments and then multiplying this payment times 12 (d) None of the above is consistent 9. Jason has a choice of receiving $15,000 next year (time 1) or $17,000 in two years (time 2). If the discount rate is 6%, which choice has a higher present value? Write your solution method along with your answer on the answer sheet. (6 points) 10. Mark each of the following as True (T) or False (F). (2 points each) ___i. In the primary market, the company issues stocks and/or bonds to investors ___ii. If a company does not pay a dividend, there is no way to estimate the stock price ___iii.Market value of equity is always higher than book value of equity 11. Which of the following is false about a 10 year 8% bond with a face value of 1,000 that is selling for 950? (a) the bond will pay $80 each year as interest (b) if the yield to maturity remains constant over the next year, the price will be higher next year (c) the yield to maturity is less than 8% (d) none of the above 12. Today, WXZ issued a bond paying interest of X, with face value of $1,000 and a 30 year maturity. The bond was issued with a price of $1,010 and was rated A by Standard & Poors. Without doing any calculations, which of the following is false? (a) the yield to maturity for this bond is fixed when issued and will not change over the 30 year life (b) the bond currently pays more interest than investors require given the risk (c) the bond's rating may change over the life of a bond (d) none of the above Name_________________________________ Student Number___________________________________ 13. For the bond in question 10, assume that two changes happen over the next 5 years: (a) overall interest rates in the economy fall by two percent and (b) WXZ struggles financially and its rating falls to B. What will be the effect of these two changes on the bond price? Explain your answer in the space on the answer sheet. (6 points) 14. You have won $100,000 in a contest. You are given two choices: (A) receive 10,000 today (time 0) and 10,000 each year from time 1 through time 9; (B) receive 20,000 at the end of each year for time periods 1 through 5. Which of the following is true if r>0? (a) option A has a higher present value (b) option B has a higher present value (c) option A and option B have the same present value because you receive $100,000 in total in each option (d) none of the above is true 15. Julia is taking out a 6 year loan of $20,000 to buy a car. If the annual interest rate is 6% and she will make equal monthly payments, which calculation correctly finds her payment? (a) = 20,000/6 year annuity factor (b)= 20,000/72 (c) = 20,000/72 month annuity factor (d) = 20,000 x (1.06)6 16. BCD Corp. has come out with a popular new product that will be very successful for the company in the next few years. Analysts believe that BCS earnings will double in two years. Which of the following is the effect of this news on the BCD stock price? (a) the price will increase only when dividends paid by BCD increase (b) the price is set by the stock exchange and will not change because of the new product (c) the price will increase only when the higher earnings are realized in two years (d) none of the above 17. If the nominal return is 7%, approximately what is the inflation rate if there is a real return of 3%? (a) 10% (b) 7% (c) 3% (d) 4% Name_________________________________ Student Number___________________________________ 18. BP Inc. has 3,000,000 shares of stock issued and outstanding. The expected earnings of the company are $6 million in time 1. The discount rate is 11%. (a) If Baby Products pays out 60% of its earnings as dividends and has a return on equity of 13%, calculate the growth rate of dividends. Show your work. (6 points) (b) If the dividend paid by Baby Products is expected to grow at the rate in (a) above in perpetuity, calculate the expected stock price. Show your work. (6 points) (c) Calculate the present value of growth options (PVGO) for its stock. Show your work. (6 points) 1. Which of the following statements about the constant growth stock pricing model is false? (a) a higher discount rate will result in a lower estimated stock price (b) a higher growth rate will result in a lower estimated stock price (c) the stock price of a company can be estimated even if the company does not pay a dividend (d) none of the above 2. You have won an accident settlement in court and can choose between the following choices of payment plans: A: $10,000 immediately and $10,000 at the end of each year for 7 years B: $60,000 immediately C: $20,000 immediately and $20,000 at the end of each year for 3 years Mark each of the following as true (T) or false (F): (2 points each) ___ a. For every r > 0, plan B will always have the highest present value ___ b. If the discount rate is very low, plan A will have the highest present value ___ c. For every r > 0, plan C will always have a higher present value than plan A Name_________________________________ Student Number___________________________________ 3. A company has introduced a new type of bond that pays interest that increases each year. It is a 5 year bond with a $1,000 face value that pays 3% interest the first year, 4% the second year, 5% interest the third year, 6% the fourth year, and 7% the fifth year. (a) Set up an equation to find the price of this bond if the yield to maturity is 5%. Show as much detail as possible (you do not need to solve for an exact answer) (6 points) (b) When, if ever, would this bond sell for a discount? Explain. (6 points) 4. Which of the following gives the EAR of a 10% annual rate compounded daily? (a) .10 x 365 (b) (1+.10)365 - 1 (c) (1+.10/12)12 - 1 (d) none of the above 5. Your plan is to save $10,000 at the end of each year for the next 30 years. If you earn 4% interest, how much will you have after 30 years (in time 30)? Setup a solution to the problem in as much detail as possible (note: you do not have to solve the equation). (6 points) 6. You have decided to buy a car from a relative for $15,000 and pay equal amounts every week (i.e, 52 payments per year) for the next four years at an annual rate of 5.2%. Using either the annuity formula or the PMT formula from excel (=PMT(r,t,pv)), set up the calculation you would do to solve for the weekly payment. (Note: you do not have to solve your formula). (6 points) Name_________________________________ Student Number___________________________________ 7. BP Inc. is expected to have earnings per share (EPS) of $3 in time 1, $4 in time 2 and EPS that grows at 6% for every period after that. The company has a policy of paying 50% of its EPS as a dividend and the discount rate is 9%. (a) For years 3 and beyond, which of the following is the Return on Equity (ROE)? (i) 6% (ii) 9% (iii) 10% (iv) 12% (b) Set up your calculation of the expected stock price in detail. (Note: you do not need to solve for the price) (6 points) (c) Which of the following is false about the present value of growth opportunities(PVGO)? (i) BP has low PVGO because the growth rate is below the discount rate (ii) a non-growth perpetuity will be required as part of the calculation of PVGO (iii) PVGO can be calculated for BP if you assume that year 3 and after are the same as year 2 (iv) none of the above 8. Mark each of the following as True (T) or False (F). (2 points each) ___(a) The company receives cash when its stocks and/or bonds are bought in the primary market by investors ___(b) A bond price will not change over the life of the bond unless the YTM of the bond changes ___(c) All public companies are required to pay dividends so their stock prices can be estimated 9. Which of the following is true about a 10 year 8% bond with a face value of $1,000 that is selling for $1,050? (a) if the yield to maturity remains constant over the next year, the price will be lower next year (b) the yield to maturity is greater than 8% (c) the bond sells at a premium so it must pay more than $80 each year as interest (d) none of the above Name_________________________________ Student Number___________________________________ 10. Ten years ago, WXZ issued a bond paying interest of 6.75%, with face value of $1,000 and a 30 year maturity. The bond was issued with a price of $990 and was rated A by Standard & Poors. Without doing any calculations, which of the following is false? (a) today, the bond will be priced as if it were a 20 year bond because there are only 20 years remaining (b) the bond's rating may change over the life of a bond (c) if the yield to maturity goes down, the price of the bond will go up (d) none of the above 11. For the bond in question 10, assume that two changes have happened over the last 10 years: (a) overall interest rates in the economy increased by two percent and (b) WXZ's rating changed to AAA. What will be the effect of these two changes on the bond price? Explain your answer in the space on the answer sheet. (6 points) 12. A company has a 10 year 8% bond that pays interest quarterly, has a face value of $1,000 and has YTM = 6%. Which of the following is the correct method for finding the price? (a) Price = 20/(1.06) + 20/(1.062) + ... + 20/(1.0610) + 1000/(1.0610) (b) Price = 15/(1.02) + 15/(1.022) + ... + 15/(1.0240) + 1000/(1.0240) (c) Price = 20/(1.015) + 20/(1.0152) + ... + 20/(1.01540) + 1000/(1.01540) (d) Price = 15/(1.02) + 15/(1.022) + ... + 15/(1.0210) + 1000/(1.0210) 13. Julia will receive $10,000 in five years (time 5) when she turns 21. If she invests the money immediately at a 4% interest rate, how much will her investment be worth nine years later (in time 14)? (a) value = [10,000 x 9] / (1.04)30 (b) value = 10,000 / (1.04)14 (c) value = [10,000 / (1.04)5] x (1.04)14 (d) value = 10,000 x (1.04)14 14. BCD Corp. has just announced a recall on their most important product because the product was causing serious injuries to some users. Which of the following is true about the effect of this news? (a) the BCD stock price will not be immediately affected because it will take some time before the cost of the recall and lost sales affect accounting earnings. (b) if there is a decrease in the stock price, this will reduce the cash the company has on hand (c) investors in the stock will not be concerned about this information because they care primarily about the past success of the company (d) none of the above Name_________________________________ Student Number___________________________________ 15. Xtra Corp. issued its $.005 par value stock in two separate financing transactions. First, ten years ago, the founder of the company purchased 800,000 shares of stock for $50,000. Second, a venture capitalist bought 400,000 shares of stock for $1,750,000 last year. Use this information to fill in the following: (6 points) (Show your calculations as well as the final result on your answer sheet): 16. Which of the following is true? (a) If a company has a gain, this increases the book value of equity (b) Most companies have a lower market value of equity than book value of equity (c) The book value of equity calculation is adjusted for the time value of money (d) None of the above 17. Your aunt has a mortgage loan on her house with monthly payments at an annual 7% rate. If she refinances the loan, she can get a loan with the same terms except it will have an interest rate of 4%. Her savings from refinancing will be $200 per month over the 20 years remaining on the loan and it will cost $4,000 in fees to refinance her loan. The loan officer tells your aunt she will recover the cost of the refinancing in 20 months because 4,000/200 = 20. Based on principles we discussed in class, is this the correct calculation of how long until your aunt will recover the cost of refinancing? Explain. (6 points). 1. If you are paying interest at a 5% annual rate on a loan, which of the following would you have the lowest cost? (a) a loan that uses simple interest without compounding (b) a loan that compounds interest quarterly (i.e., 4 times per year) (c) a loan that compounds interest daily (i.e., 365 times per year) (d) cannot be determined 2. ABC corp. reported no news yesterday, but its price decreased yesterday by 10% in trading on the New York Stock Exchange. Which of the following is true about ABC yesterday? (a) the book value of the equity stayed the same (b) we need to know the number of shares to know if the market value of equity went down (c) the decrease in the stock price decreased the amount of cash that ABC has (d) none of the above Name_________________________________ Student Number___________________________________ 3. If you make payments on a monthly basis and the interest is compounded daily, how would you calculate the effective monthly interest rate with daily compounding? Set up a calculation using r as the annual interest rate. (6 points) 4. A 6 year bond with a coupon rate of 7% was issued two years ago. It has a $1,000 face value and pays a semi-annual coupon. If the yield to maturity is 6%, how would you calculate the bond price? Set up your calculation in detail but do not solve it. (6 points) 5. Julia is planning for retirement and wants to have $500,000 forty years from now (in time 40). Which formula will calculate how much she needs to save today (time 0) to reach her goal? (a) PV = [500,000 x (1+r)40]/ (1+r)40 (b) PV = [500,000 x 40] / (1+r)40 (c) PV = 500,000 / (1+r)40 (d) FV40 = 500,000 x (1+r)40 7. You have won the lottery's $1,000 a week for life contest. If you expect to live for 60 more years, set up a formula to calculate the present value of the prize if the appropriate discount rate is 5% on an annual basis. (Note: you do not need to solve your calculation). (6 points) 8. Using the lottery payout from question 7, mark each of the following as (T)rue or (F)alse: ___(a) If the discount rate goes up, the present value of your prize will go up ___(b) If the payment stream was a perpetuity instead of limited to 60 years, the present value of the prize would be an infinite amount of money ___(c) The present value of the payments will be greater than earning $4,000 each month over the next 60 years Name_________________________________ Student Number___________________________________ 9. Jason has a choice of receiving $25,000 next year (time 1) or $30,000 in two years (time 2). If the discount rate is 10%, which choice has a higher present value? Write your solution method along with your answer on the answer sheet. (6 points) 10. Mark each of the following as True (T) or False (F). (2 points each) ___ a. In the secondary market, the company issues stocks and/or bonds to investors ___ b. If a company does not pay a dividend, there is no way to estimate the stock price ___ c. Book value of equity is usually lower than market value of equity 11. Which of the following is false about a 10 year 8% bond with a face value of 1,000 that is selling for 1050? (a) the bond will pay $80 each year as interest (b) if the yield to maturity remains constant over the next year, the price will be higher next year (c) the yield to maturity is less than 8% (d) none of the above 12. Today, WXZ issued a bond paying interest of X, with face value of $1,000 and a 30 year maturity. The bond was issued with a price of $1,010 and was rated A by Standard & Poors. Without doing any calculations, which of the following is false? (a) the yield to maturity for this bond is fixed when issued and will not change over the 30 year life (b) the bond currently pays more interest than investors require given the risk (c) the bond's rating may change over the life of a bond (d) none of the above 13. For the bond in question 12, assume that two changes happen over the next 5 years: (a) overall interest rates in the economy fall by two percent and (b) WXZ struggles financially and its rating changes to B. What will be the effect of these two changes on the bond price? Explain your answer in the space on the answer sheet. (6 points) Name_________________________________ Student Number___________________________________ 14. You have won $100,000 in a contest. You are given two choices: (A) receive 10 payments (10,000 today (time 0) and 10,000 each year from time 1 through time 9); (B) receive 5 payments (20,000 each year for time periods 0 through 4). Which statement is true if r>0? (a) option A has a higher present value (b) option B has a higher present value (c) option A and option B have the same present value because you receive $100,000 in total in each option (d) none of the above is true 15. Julia is taking out a 6 year loan of $20,000 to buy a car. If the annual interest rate is 6% and she will make equal monthly payments, which calculation correctly finds her payment? (a) = 20,000/6 year annuity factor at 6% (b)= 20,000/72 (c) = 20,000/72 month annuity factor at .5% (d) = 20,000 x (1.06)6 16. Common Products has issued its $.001 par value stock in the following financing transactions: (i) ten years ago, the founder of the company purchased 1,000,000 shares of stock for $100,000 and her father purchased 500,000 shares for $200,000; (ii) last year the company went public by issuing 9,000,000 shares of stock to the public for $20 million. Which of the following is true? (a) The amount in the par value account is 10,500,000 x $.001 (b) The capital paid in excess of par account includes the total of all cash paid for stock (c) The book value of equity will be adjusted for the time value of money with respect to the transactions that occurred nine years apart (d) None of the above 17. If the real return is 3% and the inflation rate is 7%, approximately what is the nominal rate? (a) 10% (b) 7% (c) 3% (d) 4% 18. BP Inc. made $3 per share in earnings last year. If earnings are expected to increase at a 6% growth rate for this year (time 1) and for all years in the future, and the discount rate is 9%, answer the following questions: (a) If BP pays out 40% of its earnings as dividends, calculate the return on equity. Show your work. (6 points) (b) If the dividend paid by BP is 40% of its earnings each year, calculate the PVGO. Show your work. (6 points) Name_________________________________ Student Number___________________________________ 19. You have forecast that stock A will pay a dividend of $1 in time 1 and stock B will pay a dividend of $2 in time 1. If the two stocks have the same number of shares outstanding, which of the following is true? (a) it is possible for stock A to have a higher price than stock B (b) B will always have a higher price A because B's dividend is higher (c) the stock prices will be the same because the number of shares are the same (d) none of the above 1. Which of the following statements about yield to maturity is false? (a) if you invest in a bond, hold if for a year before selling it, and yield to maturity stays constant during the year, you will earn the yield to maturity on your investment (b) yield to maturity is the discount rate used to discount the cash flows from a bond (c) yield to maturity is the rate used to determine how much cash the bond pays each period (d) none of the above 2. Ten years ago, ABC company issued a 7% bond paying a fixed rate of interest semi-annually (every six months). If there are three years remaining on the bond and the yield to maturity is 6%, set up an equation to find the price of this bond. Show as much detail as possible (you do not need to solve for an exact answer) (6 points) 3. Considering the bond in question 2 above, which of the following is true? (a) if the company's rating is lowered, the yield to maturity will also fall (b) even if interest rates in the economy change, the company will not sell for a discount over the next three years because the payments are all fixed and cannot be changed (c) if interest rates in the economy go up, the bond may sell for a discount at some point in the next three years (d) none of the above 4. Mark each of the following as True (T) or False (F). (2 points each) __ (a) If you are calculating the present value of an annuity with equal annual payments using daily compounding, you can use the standard annuity formula if you use the EAR for the discount rate __(b) If a company announces bad news about future earnings, the stock price of the company will not react until the bad news shows up in retained earnings __(c) If you are calculating the present value of money received in the future, increasing the discount rate reduces the present value Name_________________________________ Student Number___________________________________ 5. Julia is planning for retirement and wants to have $500,000 forty years from now (in time 40). Which formula will calculate how much she needs to save today (time 0) to reach her goal? (a) PV = [500,000 x (1+r)40]/ (1+r)40 (b) PV = [500,000 x 40] / (1+r)40 (c) PV = 500,000 / (1+r)40 (d) FV40 = 500,000 x (1+r)40 6. Megan will receive an unusual inheritance. Four years from today (in month 48), she will begin to receive $100 per month forever (in perpetuity) and the payments will continue after her death to her heirs. If the annual interest rate is 4% and you compound monthly, calculate the value of this inheritance in time 48. Show your calculation. (6 points) 7. Mark each of the following as True (T) or False (F). (2 points each) __(a) The book value of a company goes up when the company's stocks and/or bonds are bought in the primary market by investors ___(b) If the yield to maturity increases for a bond, the price of that bond will also increase ___(c) There is no way to find the present value of a stream of dividend payments that goes on forever 8. Investors paid $1,000,000 for 100,000 shares of the $.005 par value stock of Xtra Corp. The first year of operations, Xtra had retained earnings of -500,000. The second year of operations, Xtra had retained earnings of $2,000,000. What is the balance in the book value of equity account after the second year of operations? Show your calculation. (6 points) 9. You have looked up three stock prices: AA = $59; BB = $103; CC = $21 Which of the following is true? (a) Company BB has the highest market value of equity because it has the highest stock price (b) Company CC could have the highest market value of equity (c) Company AA has a lower book value of equity than company BB because book value of equity is determined based on stock price alone (d) None of the above Name_________________________________ Student Number___________________________________ 10. The lottery is currently paying a prize of $25,000 ten years from today (in time 10). If you invest the prize immediately in time 10 and you earn 4% interest, how much will your investment be worth in time 12? Write both your formula and your answer on the answer sheet. (6 points) 11. You have won $100,000 in a contest. You are given three choices: (A) receive 10,000 today (time 0) and 10,000 each year from time 1 through time 9 (B) receive 20,000 in each year from time 1 through 5 (C) receive 50,000 in time 2 and 50,000 in time 4 If r >0, mark the following as (T)rue or (F)alse: ___ (a) Option A will have a higher present value than option B ___ (b) Option C will always have the highest present value of the three choices 12. Julia is taking out a 6 year loan for $20,000 to buy a car. The annual interest rate is 6% and she will make equal monthly payments. Set up the calculation using the annuity formula or an excel formula to find her monthly payment (Note: show as much detail as you can, but you do not need to solve for the payment) (6 points) 13. If the real return is 4% and the inflation rate is 3%, approximately what is the nominal rate of return? (a) 10% (b) 7% (c) 3% (d) 4% 14. Your friend has rented some furniture under a rent-to-own plan where she pays $30 each week and can own the furniture after two years (104 weeks) of payments. She has calculated that, assuming there are 52 weeks in a year, her total cost will be $30 x 104 = $3,120 for the furniture. Based on principles we discussed in class, which of the following is true? (a) the present value of her payments is more than $3,120 if you consider the time value of money (b) if she invested $3,120 at the risk-free rate today, she would have money left over two years from now after making the 104 weekly payments (c) present value can only be calculated for annual or monthly payments, not for weekly (d) none of the above Name_________________________________ Student Number___________________________________ 15. Ben is buying a car for $15,000. If Ben wants to make four annual payments and the interest rate is 7%, which of the following is most consistent with time value of money principles if interest is compounded monthly? (a) The annual payment can be calculated using a four year annuity and the EAR with monthly compounding (b) The annual payment equals $15,000 divided by 4 (c) The annual payment can be calculated by applying the annuity formula to find forty eight equal monthly payments and then multiplying this payment times 12 (d) None of the above is consistent 16. BP Inc. has 4,000,000 shares of stock issued and outstanding. The expected earnings of the company are $12 million in time 1. The discount rate is 9%. (a) If Baby Products pays out 40% of its earnings as dividends and has a return on equity of 12%, calculate the growth rate of dividends. Show your work. (6 points) (b) If the dividend paid by Baby Products is expected to grow at the rate in (a) above in perpetuity, calculate the expected stock price using the constant growth model. Show your work. (6 points) (c) Calculate the present value of growth options (PVGO) for its stock. Show your work. (6 points) 17. If you are earning interest at a 3% annual rate on deposits, which of the following will have the highest value after 10 years? (a) a bank account that uses simple interest without compounding (b) a bank account that compounds interest quarterly (i.e., 4 times per year) (c) a bank account that compounds interest daily (i.e., 365 times per year) (d) cannot be determined 18. Which of the following is true about a 10 year 8% fixed rate bond with a face value of $1,000 that is selling for $950? (a) the interest the bond pays will change depending on the economy (b) if the yield to maturity remains constant over the next year, the price will be higher next year (c) the yield to maturity is less than 8% (d) none of the above Name_________________________________ Student Number___________________________________ 1. Bond A has a 5% coupon and Bond B has a 8% coupon. If both bonds are 5 year bonds, both have the same yield to maturity and you buy both bonds today and hold them until maturity, on which bond will you earn the higher return? (a) Bond A (b) Bond B (c) The return will be the same (d) It depends on what happens in the market over the next few years 2. Which of the following gives the formula for calculating the EAR with daily compounding of an 8% APR? (a) EAR = (1+.08)365 - 1 (b) EAR = (1+.08/12)12 - 1 (c) EAR = (1+.08/52)52 - 1 (d) None of the above 3. ABC announced this morning that they have developed a drug that will cure a major medical condition. Within minutes of the announcement, the stock price of ABC doubled. Mark each of the following as (T)rue or (F)alse: __ (a) The book value of ABC stayed the same when the stock price went up __ (b) The market value of ABC's equity doubled when the stock price doubled __ (c) ABC's cash position increased this morning due to the higher stock price 4. The lottery is offering two payout choices: Choice 1 pays $10,000 each year starting today (time 0) and Choice 2 pays $5,000 each year starting today (time 0). Payments increase each year by 3% in Choice 1 and by 5% in Choice 2. If the discount rate is 6%, calculate the PV of each choice. Show your work and solve for an exact answer. (8 points) 5. As an analyst, you are trying to estimate a fair price for stock XYZ. You tried the constant growth dividend discount model but this did not work because the company does not pay a dividend. Which of the following is true? (a) XYZ should be paying a dividend because all publicly traded stocks are required to pay a dividend (b) XYZ stock can still be estimated by substituting expected free cash flow for dividends in the model (c) The best estimate of stock price for companies that do not pay a dividend is the book value of equity (d) None of the above Name_________________________________ Student Number___________________________________ 6. You have taken out a car loan with unusual terms: It is a five year loan with payments of $200 each month for 60 months and an annual bonus payment of $500 at the end of each year. Set up a calculation using monthly compounding to calculate the present value of this retirement plan. Note: you do not need to solve your formula. (6 points) 7. You are evaluating two stocks: stock A has a price of $40 per share and stock B has a price of $100 per share. You want to buy the stock in the company with lower market value of equity because these stocks tend to have higher returns than larger stocks. Which stock has the smaller market value of equity? Explain. (6 points) 8. A 10 year bond with a coupon rate of 8% was issued 4 years ago. It has a $1,000 face value and pays a quarterly coupon. If the yield to maturity is 6%, which of the following gives the bond price? (a) 20/(1.015) + 20/(1.015)2 + ... + 1020/(1.015)24 (b) 15/(1.02) + 15/(1.02)2 + ... + 1015/(1.02)12 (c) 80/(1.06) + 80/(1.06)2 + ... + 1080/(1.06)10 (d) 15/(1.06) + 15/(1.06)2 + ... + 1015/(1.06)6 9. Your bank has informed you that it will pay interest on your savings account using daily compounding instead of monthly compounding. Which is correct? (a) This change benefits the bank because they will be charging you a higher effective interest rate (b) The decrease in compounding interval increases the effective return on the account (c) There will be no change in the effective return due to the change in compounding (d) None of the above 10. Under a special promotion by the dealer, you have three choices for a \"no-interest\" 5 year car loan of $10,000: (i) 10,000/5 =$2,000 annual payment for 5 years (ii) 10,000/60 = $166.67 monthly payment for 5x12= 60 months (iii) 10,000/260=$38.46 weekly payments for 5x52 = 260 weeks All loan payments are made at the end of the period. Mark the following answers as (T)rue or (F)alse (assuming the discount rate is greater than 0): (2 points each) ___(a) The annual loan has the highest present value ___(b) The weekly loan has a higher present value than the monthly loan ___(c) All three choices have the same present value Name_________________________________ Student Number___________________________________ 11. BC Inc. has 5,000,000 shares of stock outstanding. The expected earnings of the company are $2 million next year. The discount rate is 9%. (a) If BC retains 30% of its earnings (i.e., BC pays out 70% as dividends) and has a return on equity of 13%, calculate the growth rate of dividends. Show your work along with the answer (4 points) (b) If the dividend paid by BC is expected to grow at the rate in (a) above, calculate the price of its stock using the constant growth model? (6 points) Show your work along with the answer 12. Today, WXZ issued a bond paying interest of X, with face value of $1,000 and a 30 year maturity. The bond was issued with a price of $990 and was rated A by Standard & Poors. Without doing any calculations, which of the following is true? (a) the yield to maturity for this bond is determined when issued and will not change over the 30 year life (b) the bond pays less interest than investors currently require given the risk (c) the bond sells at a premium (d) none of the above 13. For the bond in question 12, assume that two changes happen over the next 5 years: (a) overall interest rates in the economy increase by two percent and (b) WXZ struggles financially and its rating changes to B. What will be the effect of these two changes on the bond price? Explain your answer in the space on the answer sheet. (6 points) Name_________________________________ Student Number___________________________________ 14. A company is offering a perpetuity you can purchase for retirement. If the perpetuity starts 40 years from today and pays $50,000 per year, which formula correctly gives the PV if r = 4%? (a) PV = 50,000 x [(1/.04) - (1/(.04 x 1.0440))] x(1.0440) (b) PV = 50,000/(1.0440) (c) PV = 50,000/.04/(1.0439) (d) none of the above 15. A bond has an 8% coupon and a yield to maturity of 8%. If the bond is held for one year and the yield to maturity does not change, the bond price will be: (a) The same (b) Higher (c) Lower (d) More information is required to answer 16. If the nominal return is 9%, approximately what is the inflation rate if the real return is 3%? (a) 11% (b) 6% (c) 3% (d) 5% 17. Xtra Corp. issued its $.001 par value stock in two separate financing transactions. First, ten years ago, the founder of the company purchased shares. Then a venture capitalist purchased 400,000 shares of stock for $2,000,000 last year. If the equity account is as shown below, how many shares did the founder purchase and what price did she pay? (6 points) 18. The expected dividend in time 1 is $.50 per share. For years 2 and 3, the dividend is expected to grow 20% over the previous year's dividend. For years 4 and after (in perpetuity), the dividend will grow by 6% over the previous year's dividend. If the discount rate is 8%, set up a formula to calculate the stock price as the discounted future dividends. (Note: you do not need to solve the formula). (6 points) Name_________________________________ Student Number___________________________________ FORMULAS EAR = [1+(r/m)]m -1 PV = CT/(1+r)T or PV = FVT/(1+r)T FVT = C0 x (1+r)T or FVT = PV x (1+r)T Perpetuity: PV = C1/r Growing Perpetuity: PV = C1/(r - g) Annuity: PV = C[1/r - 1/r(1+r)T] (1 + real interest rate) = (1 + nominal interest rate) / (1 + inflation rate) Bond rate of return = (coupon income + price change) / investment Expected return on stock = r = (DIV1 + P1 - P0)/ P0 Dividend Discount Model: P0 = DIV1/(1+r)1 + DIV2/(1+r)2 + .... + (DIVH + PH)/(1+r)H No Growth Dividend Discount Model: P0 = DIV1 / r or P0 = EPS1 / r Constant Growth Dividend Model: P0 = DIV1 / (r - g) Expected rate of return: r = DIV1 / P0 + g g = sustainable growth rate = return on equity x plowback ratio PVGO = PV of firm with growth options- PV of firm without growth options Excel formulas: =PV(r,t,c) =PMT(r,t,pv)