FIN 331 Final Exam Practice Questions Spring 2024 PDF

FIN 331 PRACTICE QUESTION SET - SPRING 2024 Chapter 5 1. If an investment pays the same amount at the beginning of each year for a 10-year period, the cash ﬂow stream is called: a. Perpetuity b. Growing Perpetuity. c. Ordinary Annuity d. Annuity Due e. Variable Annuity 2. You want to save for making a down payment on a house 3 years from now, and you plan to save $5,000 per year, beginning one year from today. You will deposit your savings in a fund that pays 5% annual interest. How much will you have for the down payment just after you make the 3rd deposit, 3 years from now? a. $15,762.50 b. $12,603.50 c. $13,267.50 d. $13,930.50 e. $14,626.50 3. Your friend just won the Florida lottery. She has the choice of $15,000,000 today or a 20- year annuity of $1,050,000, with the ﬁrst payment coming one year from today. What rate of return is built into the annuity? a. 3.44% b. 3.79% c. 4.17% d. 4.58% e. 5.04% 4. Jasmine is saving up to buy a car in one year. When she’s comparing options to invest her money for the next year, she sees two options, Option A: a stated interest rate of 5%, compounding monthly; and Option B: a stated interest rate of 5% interest rate compounding daily. Which option should she choose, and why? a. Option A: The edective annual rate is higher because months are longer than days b. Option B: The edective annual rate is higher because interest compounds more often c. Option B: The edective annual rate is lower because months are longer than days d. It doesn’t matter, they both will result in the same future value at the end of the year because they have the same nominal interest rate e. Option A: The edective annual rate is lower, resulting in a higher future value at the end of one year Chapter 6 1. Suppose that a 3% rate of inﬂation is expected for the next 2 years, after which inﬂation is expected to increase to 5%, and there is a positive maturity risk premium that increases with years to maturity. Assume that the real risk-free rate remains constant (yield curve is upward sloping). Which of the following statements is CORRECT? a. The yield on a 10-year T-bond must exceed that of a 5-year T-bond due to higher maturity risk and inﬂation. b. The yield on a 10-year corporate bond must exceed that of a 10-year T-bond due to higher maturity risk associated with corporate bonds. c. The yield on a 10-year corporate bond must exceed that of a 10-year T-bond due to higher inﬂation risk associated with corporate bonds. d. The yield on a 10-year T-bond must exceed that of a 30-year T-bond due to higher maturity risk and inﬂation. e. The yield on a 10-year T-bond must exceed that of a 10-year corporate bond due to higher default risk associated with T-bonds. 2. You compare yields on two 20-year bonds to invest in: T-bond = 6.00% and AAA corporate bond= 7.50%. Assume that the liquidity risk premium on the corporate bond is 0.50%. Which of the following statements on default risk premium is CORRECT? a. The default risk premium on the T-bond is 1.00%. b. The default risk premium on the corporate bond is 1.00%. c. The default risk premium on the T-bond is 2.00%. d. The default risk premium on the corporate bond is 2.00%. e. You need more information on inﬂation rates and maturity risk premium to estimate the default risk premium. 3. Tigers Inc's 10-year bonds yield 7.50% and 10-year T-bonds yield 5.50%. The default risk premium is 1.00% and the liquidity premium on Tiger's bonds is 1.00%. Assume that the real risk-free rate is 2.0%, and the inﬂation premium for 10-year bond is 2.5%. Which of the following statements on maturity risk premium is CORRECT? a. The maturity risk premium on 10-year corporate bonds is 2.00%. b. The maturity risk premium on 10-year corporate bonds is 3.00%. c. The maturity risk premium on 10-year corporate bonds is 2.00%, while the maturity risk premium on 10-year T-bonds is 1%. d. The maturity risk premium on 10-year corporate bonds is 3.00%, while the maturity risk premium on 10-year T-bonds is 0%. e. The maturity risk premium is 1.00% for both 10-year corporate and T-bonds. 4. The current yield to maturity on Smiles Corp’s corporate bond is 8%, while the YTM on James Corp’s corporate bond is 6%. Both bonds mature in 10 years and have a 1% liquidity premium. Which below statement has to be correct based on the above information? a. Smiles Corp has a higher risk of default which is why buyers of the bond demand a higher YTM. b. James Corp has a higher risk of default which is why the holder of the bond demands a higher coupon payment. c. James Corp has a higher risk of default, so they pay a lower coupon payment to avoid going bankrupt. d. Smiles Corp has a higher risk of default which is why the price of their bond is higher. e. All bonds have the same risk of default, if they didn’t investors would not know how to choose what to invest in. Chapter 7 1. GiantTiger Inc. has two bonds available for sale. Bond A pays a $75 annual coupon, matures in 10 years, and sells for $1040. Bond B pays a $55 annual coupon, matures in 8 years, and currently sells for $850. Which Bond would you want to buy and why? a. Bond A because it has the higher coupon. b. Bond A because it provides a greater return. c. Bond B because it is selling at a discount. d. Bond B because it provides a greater return. e. Neither Bond A nor Bond B 2. Bakery Corp is odering investors a bond priced at $985.23. The bond pays 5% semiannual coupons and matures in eight years. Current bonds in the market are yielding 6%. Should investors buy the bonds at the odered price? (Round to the nearest dollar.) a. Yes, the bond is worth more at $1,065. b. No, the bond is only worth $937. c. Yes, the bond is worth more at $1,441. d. No, the bond is only worth $938. e. Yes, the bond the bond is fairly priced at $985.23. 3. Callan Inc. is o#ering a 6-year bond at a price of $985.00 (not necessarily the ‘value’). The bond has a coupon rate of 6% and pays the coupon semiannually. Similar bonds in the market oders a yield of 7% today. Should you buy the bonds at the odered price? (Round to the nearest dollar.) a. Yes, the bond is worth $1000. b. No, the bond is only worth $952. c. Yes, the bond is worth more than $985. d. No, the bond is only worth $910. e. Yes, the bond is a premium bond since the rates went up since issue. 4. The $1,000 face value bonds of Briley Enterprises have coupon of 6.5 percent and pay interest semiannually. Currently, the bonds are quoted at $1,250.00 and mature in 12 years; but can be called in 10 years with a call premium of $40 (total value paid at call date should include call premium). What is the yield to call (annual reference)? a. 3.80 percent; b. 3.03 percent c. 7.32 percent d. 7.44 percent e. 5.73 percent Chapter 8 1. Generally, when investing in the market, what are the implications of risk and rates of return? And, what should investor select? a. The higher a security’s risk, the higher its required return. Select the greatest return that is aligned with the investors risk appetite. b. The higher a security’s risk, the lower its required return. Select the greatest return that is aligned with the investors risk appetite. c. The lower a security’s risk, the higher its required return. Select the average return that is aligned with the investors risk appetite. d. The lower a security’s risk, the higher its required return. Select the greatest return that is aligned with the investors risk appetite. e. The higher a security’s risk, the higher its required return. Select the lowest return that is aligned with the investors risk appetite. 2. You are interested in Stark Inc’s stock and ask your investment consultant for advice. Your consultant tells you that in her opinion, the stock’s expected return (after you complete an analysis of returns forecasted for various economic scenarios with probabilities for each scenario) is lower than its required return (using CAPM and the risk free and market rates, and betas) this suggests that your consultant thinks… a. the stock is experiencing fast growth. b. the stock should be purchased. c. the stock is not worth buying. d. management is probably trying to maximize the price per share. e. dividends are likely to be declared. 3. You are considering adding one stock from ﬁve candidate stocks to your investment portfolio. You already hold a well-diversiﬁed portfolio. You are using CAPM to help you select one of the following ﬁve stocks for your portfolio. Stock 1 has a beta of 2, stock 2 has a beta of 1.5, stock 3 has a beta of 1.2, stock 4 has a beta of 0.9, and stock 5 has a beta of 0.5. The market risk premium is 13%, and risk-free rate is 3%. Part 1: Which of the following statements about the required return on the ﬁve stocks is TRUE? a. Using CAPM, the required return on stock 1 is 29% b. Using CAPM, the required return on stock 2 is 18% c. Using CAPM, the required return on stock 3 is 11% d. Using CAPM, the required return on stock 4 is 13% e. Using CAPM, the required return on stock 5 is 10% Part 2: Based the required returns of the stocks from CAPM, which stock should you add to your portfolio if all the ﬁve stocks have the same expected return of 12%? a. You should add stock 1 b. You should add stock 2 c. You should add stock 3 d. You should add stock 4 e. You should add stock 5 4. Jack is reviewing stocks for inclusion in his portfolio. He will only invest in stocks with a better coedicient of variation than 0.8. He is considering following ﬁve stocks and has gathered the following data on those ﬁve stocks. Stock number Standard deviation Expected return 1 6% 15% 2 12% 16% 3 12% 14% 4 8% 12% 5 13% 17% Part 1: Which of the following statements about the coedicient of variation on the ﬁve stocks is TRUE? a. The coedicient of variation of stock 1 is 2.68 b. The coedicient of variation of stock 2 is 0.71 c. The coedicient of variation of stock 3 is 0.77 d. The coedicient of variation of stock 4 is 0.67 e. The coedicient of variation of stock 5 is 0.88 Part 2: If Jack will only invest in stocks with a better coedicient of variation than 0.8. Which stock he will NOT invest in? a. Stock 1 b. Stock 2 c. Stock 3 d. Stock 4 e. Stock 5 Chapter 9 1. As a shareholder of a company, you are __________ with the authority to vote on ____________. a. A lender to the company. Management holidays and perks. b. An owner of the company. Board of Directors. c. A partner with management. All major operating decisions. d. Not entitled to dividends. Board of Directors. e. An owner of the company. Hiring of all Executives. 2. An increase in which of the following will increase the current (intrinsic) value of a stock according to the dividend constant growth model? I. dividend amount II. discount rate III. dividend constant growth rate a. I only. b. II and III only. c. I and II only. d. I and III only. e. I, II, III. 3. Upper Crust Bakers just paid an annual dividend of $3.10 a share and is expected to increase that amount by 4 percent per year. If you are planning to buy 1,000 shares of this stock next year, how much should you expect to pay per share if the market rate of return for this type of security is 12 percent at the time of your purchase? a. $37.33 b. $38.16 c. $38.83 d. $40.30 e. $42.00 4. High Country Builders currently pays an annual dividend of $1.35 and plans on increasing that amount by 2.5 percent each year. Valley Builders currently pays an annual dividend of $1.20 and plans on increasing its dividend by 3 percent annually. Given only this information, you know for certain that the stock of High Country Builders' has a lower ______ than the stock of Valley Builders. a. market price. b. dividend yield. c. capital gains yield. d. total return. e. The answer cannot be determined based on the information provided. 5. Sonoma Inc. just paid an annual dividend of $2.00 last week and is currently selling for $25 per share (not necessarily the value). Its dividends are expected to increase by 5% annually. Based on the riskiness of Sonoma Inc’s stock, your required rate of return is 15%. What should be your trading strategy on this stock? a. Buy the stock at $25.00 if you don’t own it as it is worth $21.00 per share. b. Sell the stock if you own it at $25.00 as it is worth $21.00 per share. c. Buy the stock at $25.00 if you don’t own it as it is worth $28.00 per share. d. Sell the stock if you own it at $25.00 as it is worth $13.50 per share. e. Nothing, the stock is fairly priced at $25.00 per share. Chapter 10 1. For a company whose target capital structure calls for 30% debt and 70% common equity, which of the following statements is CORRECT? a. The rate used to calculate the WACC is the average after-tax cost of all the company's outstanding debt as shown on its balance sheet b. The WACC is calculated on a before-tax basis. c. The WACC exceeds the cost of equity. d. The cost of equity is always equal to or greater than the cost of debt. e. The cost of retained earnings typically exceeds the cost of new common stock. 2. Practice Inc. is considering four independent projects. The company’s pretax cost of debt is 6%. The Company has a tax rate of 25%. The cost of preferred equity is 10% and the cost of retained earnings is 14%. The target capital structure for debt, preferred equity, and retained earnings is 15%, 10%, and 75%, respectively. Which of the following projects should Practice Inc. accept as they exceed the ‘hurdle rate’ or WACC? Project Expected Return 1 11.0% 2 11.2% 3 12.0% 4 12.8% a. project 1, 2, and 3 only. b. project 2 and 4 only. c. project 1 only. d. project 2 only. e. project 4 only. 3. Waystar estimates that it can issue debt at a rate of 8% and its tax rate is 25%. Its preferred stock pays a constant dividend of $5.00 per year and costs today $55 per share. Waystar’s common stock current sells at $40.00 per share, the next expected dividend is $3.75 and is expected to grow at a constant rate of 5% per year. Waystar’s target capital structure is 70% common stock; 20% debt; and 10% preferred stock. What is Waystar’s weighted average cost of capital? a. 11.84% b. 12.17% c. 12.50% d. 12.57% e. 15.23% 4. Banditos Inc.’s common stock current trades at $30.00 per share. It is expected to pay an annual dividend of $1.50 per share at the end of the year and the constant growth rate is 3%. Using the dividend discount model, calculate the ﬂoatation cost adjustment to the cost of equity if the ﬂoatation costs are 10%. a. 0.56% b. 0.98% c. 1.41% d. 2.01% e. 15.21% 5. Based on its target capital structure, Georgia Inc. estimates: i. WACC of 12% for its average-risk projects; ii. WACC of 10% for its below-average risk projects; and, iii. WACC of 14% for its above-average risk projects. Georgia Inc. is choosing between three independent projects. Which of the following projects (A, B, and C) should the company accept? a. Project A only, which is of average risk and has a return of 12.5%. b. Project B only, which is of below-average risk and has a return of 9.5%. c. Project C only, which is of above-average risk and has a return of 13.5%. d. None of the projects should be accepted. e. All of the projects should be accepted. Chapter 11 The following information is relevant for questions 1-3. Project NPV IRR Payback Period A - $0.3 million 6.76% 3.6 years B $1.8 million 3.23% 4.1 years C $3.3 million 4.56% 2.2 years 1. Assuming that Capital Projects A and B and C are independent, what would be the correct decision using the payback decision rule if the payback cutoff period determined by Management is 3 years? a. Accept Capital Project A and C. b. Accept Capital Project C only. c. Accept all Capital Projects. d. Accept Capital Project B only. e. Reject all Capital Projects. 2. Assuming that Capital Projects A and B and C are independent, what would be the correct decision using IRR method only if the WACC was 5%. a. Accept Capital Project B and C. b. Accept Capital Project A. c. Accept Capital Project B. d. Accept Capital Project C. e. Accept all Capital Projects. 3. Assuming that Capital Projects A and B and C are mutually exclusive, which recommendation may be the most reasonable for a person trained in Finance who understands the best method to use when different methods give contradictory decisions? a. Accept Capital Project A because of the Net Present Value results. b. Accept Capital Project C because of the Net Present Value results. c. Accept Capital Project A because of the IRR results. d. Accept Capital Project B because of the Payback method results. e. Accept Capital Project A and C because of the IRR results. 4. When using the Net Present Value methodology to evaluated Capital Projects___________. a. one should discount the future cash flows including the project costs at the WACC rate. b. one should discount the future cash flows at the required return excluding the project costs. c. one should discount future cash flows including the project costs at the IRR rate. d. one should ignore the NPV calculation if the payback period is greater than 4 years. e. one should discount the future cash flows excluding project costs at the IRR rate. 5. Independent Capital Projects should always be accepted __________. a. if the NPV is greater than the IRR, whether negative or positive. b. if the NPV is less than $0, but the IRR is positive. c. if the NPV is greater than $0. d. if the payback period is less than 4 years. e. if the IRR is less than the WACC. ANSWER SHEET 5.1.D 5.2.A ORDINARY ANNUITY SETTING PV0. N3. PMT -5000. IY5. FV= 15,762.50 5.3 A ORDINARY ANNUITY SETTING. PMT $1,050,000. N20. PV -$15,000,000. FV0. IY=3.44% 5.4.B 6.1.A 6.2.B 6.3.E SINCE BOTH TIGERS AND T-BOND IS SAME. MATURITY 10 YEARS, THE MRP IS THE SAME. SO, T-BOND r=5.50% = r (risk free) 2.0% + IP 2.5% + DRP 0 = LP 0 + MRP. Leaving 1.00% as MRP for both. 6.4.A The risk free rate, inﬂation premium, and maturity risk premium should be the same for both as they are both 10 year bonds. The liquidity premium is the same as given, so only diderence is default risk premium. 7.1.D Compute YTM (total return) for both bonds. A Bond: PMT75. N10. PV1040. FV1000. IY=6.93%. B Bond: PMT55. N10. PV850. FV1000. IY= 7.71% 7.2.B semiannual problem FV0. IY3. PMT25. FV1000. PV=$937.19 7.3.B N=12; I/Y=3.5; PMT=30; FV=1000; PV= 952 7.4.A 20 −1,250.00 32.50 1,040.00 N I/Y PV PMT FV 1.90178 1.90178% × 2 = 3.80356% 8. 1. A 8.2.C. If the expected return is higher than the required return, the investment is undervalued. If the expected return equals the required return, the investment is fairly valued. If the expected return is lower than the required return, the investment is overvalued. 8.3.part 1. A Using CAPM, Required return = risk-free rate + beta * market risk premium Required return on stock 1 = 3% + 2 * 13% = 29% Required return on stock 2 = 3% + 1.5 *13% = 22.5% Required return on stock 3 = 3% + 1.2 * 13% = 18.6% Required return on stock 4 = 3% + 0.9*13% = 14.7% Required return on stock 5 = 3% + 0.5*13% = 9.5% 8.3. part 2. E Add the stock that has a higher expected return than the required return. 8.4.part 1.D The coedicient of variation = Standard deviation/expected return The coedicient of variation of stock 1 is 6%/15% = 0.40 The coedicient of variation of stock 2 is 12%/16% = 0.75 The coedicient of variation of stock 3 is 12%/14% = 0.86 The coe9icient of variation of stock 4 is 8%/12% = 0.67 The coedicient of variation of stock 5 is 13%/17% = 0.76 8.4.part 2. C Higher coedicient of variation means that the investment has more volatility relative to its expected return. If Jack has a threshold on coedicient of variation of 0.8, he will not invest in stock 3 which has a coedicient of variation of 0.86. 9. 1. B 9. 2. D 9. 3. D. P = 3.10 (1+.04) / (.12-.04)=n $40.30 9. 4. C 9. 5. B. P = 2.00 (1.05) / (.15 -.05) = $21.00 10. 1. D 10. 2. E WACC =.15*(0.06*(1-0.25)) + 0.10*(0.10) + 0.75*(0.14) = 12.18%; project 4 only 10. 3. B WACC = 0.2*(.08*(1-.25)) + 0.1*(5/55) +.7*[(3.75/40)+0.05] = 12.17% 10. 4. A Rre=(1.5/30)+.03=0.08; Rﬂoat=1.5/[30*(1-0.1)]+.03 = 0.0856; Adj = Rﬂoat–Rre.56% 10. 5. A 11. 1. B 11. 2. B 11. 3. B 11. 4. A 11. 5. C

FIN 331 Final Exam Practice Questions Spring 2024 PDF

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