AB1201 Sem1AY2022-23 Financial Management PDF

NANYANG TECHNOLOGICAL UNIVERSITY SEMESTER 1 MID-TERM QUIZ 2022-2023 AB1201 - Financial Management Date: 5 October 2022 Time Allowed: 60 minutes INSTRUCTIONS 1 This paper contains FIFTEEN(15) multi...

NANYANG TECHNOLOGICAL UNIVERSITY SEMESTER 1 MID-TERM QUIZ 2022-2023 AB1201 - Financial Management Date: 5 October 2022 Time Allowed: 60 minutes INSTRUCTIONS 1 This paper contains FIFTEEN(15) multiple choice questions (MCQs) and comprises FIVE(5) pages and ONE(1) appendix of THREE(3) pages. 2 Choose the correct answer from the alternatives given. In your SCANTRON SHEET, shade the correct answer (A), (B), (C), (D), or (E) next to the question number. 3 Use only 2B pencils and erasers. Complete the front page of the Scantron sheet as follows: (a) Write your Subject Title as Financial Management. (b) Write your Subject Code as AB1201. (c) Instead of writing your Seat Number, write down your full name as it appears in the attendance list and also your seminar class number. (d) Write and shade your MATRICULATION NUMBER in the box provided for matriculation number. Read the examples shown and ask for clarification if you have any doubt. PLEASE DO NOT TURN OVER THE QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO Students are to avoid all forms of academic dishonesty, including plagiarism, collusion, cheating, and allowing another student to copy answers during an examination/quiz. The penalties on students who are found to have violated this Policy include expulsion; suspension; zero mark/fail grade; marking down; re- doing of assignments; and verbal or written warning. - BLANK PAGE - Section A This section consists of TEN(10) multiple choice questions. Choose the correct answer from the alternatives given. In your SCANTRON SHEET, shade the correct answer (A), (B), (C), (D), or (E) next to the question number. Each multiple choice question carries ONE(1) mark. (1) Which of the following statements is most CORRECT? (A) One advantage of a partnership is that it pays lower tax than a corporation because personal tax rates are lower than corporate tax. (B) When a business generates a lot of profits, often it makes more sense to incorporate it rather than set it up as a partnership. (C) Unlimited life and unlimited liabilities are both advantages of a partnership. (D) A limited liability company is a type of organization that is a hybrid between a partnership and a corporation. (E) Since the financial goal of management is to increase stock price, management should do all actions that increase the company’s current profit eventhough it has to cut-off Research and Development expenses. (2) Which of the following statements is most CORRECT? (A) The balance sheet provides information on company’s profits and losses. (B) The stockholders’ equity in the balance sheet only reflects how much initial capital shareholders have paid-in. (C) The interest expenses for a corporation are tax deductible. (D) Dividend payments to shareholders in a financial year can subsequently reduce company’s corporation tax payments. (E) Double taxation means that the shareholders of a corporation need to pay two layers of taxes on their personal level: once upon receiving the dividends, and once at the end of the year. (3) Which of the following deposit accounts has the highest effective annual return? (A) An account that pays 12% nominal interest with monthly compounding. (B) An account that pays 12% nominal interest with quarterly compounding. (C) An account that pays 11% nominal interest with daily compounding. (D) An account that pays 11% nominal interest with monthly compounding. (E) An account that pays 12% nominal interest with daily compounding. (4) Which of the following statements regarding Initial Public Offering (IPO) is most CORRECT? (A) IPO is the process in which a company offers shares to the general public, and it may not involve listing of the shares on a stock exchange or on a dealers’ market. (B) In an IPO, if investors want to buy more of the shares than the company wants to sell, then the IPO said to be undersubscribed. (C) A company need not raise new capital in an IPO. (D) In an IPO, the company can choose to allow its shares to be traded either in the Capital Market or in the Money Market. 1 of 8  (E) A company has total discretion on whether to list or not to list its shares on a stock exchange, and it usually does not need to meet any specific criteria to qualify for an IPO on the stock exchange. (5) Which of the following statements is most CORRECT? (A) Liquidity premiums are generally higher on Treasury bonds than corporate bonds. (B) Subordinated debt has less default risk than senior debt. (C) Junk bonds typically provide a lower yield to maturity than investment-grade bonds. (D) The nominal risk-free rate in Singapore is the same as that in the U.S. (E) None of the above. (6) Suppose the inflation rate is expected to be 5% next year, 8% the following year, and 3% thereafter. Assume that the real risk-free rate, r*, will remain constant at 1% per annum and that maturity risk premiums (MRP) on Treasury securities is found with the formula MRP = (t – 1)  0.1%, where t = number of years to maturity. What is the annual nominal interest rate on a Treasury bond with 5-year maturity? (A) 4.0% (B) 4.4% (C) 6.5% (D) 5.8% (E) 5.4%. (7) Which of the following statements is most CORRECT? (A) The price of a bond should always equal to its face value (par value). (B) The expected annual return of a bond is the bond’s coupon rate. (C) Bond investors generally do not face any default risk since bonds are generally considered as risk-free investments. (D) A premium bond is generally better than a discount bond. (E) A bond pays semi-annual coupons with 8% annual coupon rate. The par value of the bond is $1000. Given that the nominal Yield To Maturity (YTM) is 9%, the bond price should be smaller than $1000. (8) Stock A has a beta of +0.8 and Stock B has a beta of -0.8. Which of the following statements is most CORRECT? (A) Stock A and Stock B are equally volatile on a standalone basis, except that they tend to move in the opposite direction. (B) Stock A and Stock B are equally risky. (C) Stock A is more risky than Stock B. (D) Stock B is more risky than Stock A. (E) Combining one share of Stock A with one share of Stock B would yield a riskless 2-stock portfolio with beta of 0. 2 of 8 (9) Which of the following statements is most CORRECT? (A) In the perspective of the company, issuing common stock is less risky compared to issuing preferred stock. (B) A stock that pays dividends will have higher intrinsic value than a similar stock that does not pay dividends. (C) The price of a company’s common stock should be higher than that of its preferred stock because common stock is more risky than preferred stock. (D) Since the common stock of a company is more risky than its preferred stock, the realized return on the common stock will be higher than that of its preferred stock. (E) If two companies pay the same dollar dividends every year, and also have the same perpetual annual dividend growth rate, the intrinsic value of their shares would be the same. (10) Which of the following statements is most CORRECT? (A) Dividends of a stock grow at a rate of 10%, and 5% in Year 1 and 2, respectively. From Year 3 onwards, its dividend grows at a constant rate of 3% indefinitely. The stock’s intrinsic value will also increase at the same rates as its dividend’s grow rate each year. (B) Dividends of a stock grow at a rate of 10%, and 5% in Year 1 and 2, respectively. From Year 3 onwards, its dividend grows at a constant rate of 3% indefinitely. The capital gains yield of this stock in Year 3 is 3%. (C) You bought a stock at $12 in January, two years ago. At the end of the year that you purchased the stock, you received $0.50 as dividends. At the end of the following year, you received a dividend of $0.80 and then you sold the stock for $13. The realised annual rate of return you received on the stock during two- years holding period was 5.25%. (D) A preferred stock with an annual dividend of $2 sells for $25. Its expected return is 12.5% (E) A constant growth model can be used only when growth rate of dividend, g is not a zero. (Total: 10 marks) Section B This section consists of FIVE(5) multiple choice questions. Choose the correct answer from the alternatives given. In your SCANTRON SHEET, shade the correct answer (A), (B), (C), (D), or (E) next to the question number. Each multiple-choice question carries TWO(2) marks. (11) Addy invests $X in an investment today. He expects that the investment will provide cash inflows of $5, $10, $15, $20 and $25 at the end of year 1, 3, 5, 7,and 9, respectively. Assume nominal annual rate of return of 12% with semi-annual compounding. What is the value of X? (A) $33.36 (B) $34.06 (C) $37.48 (D) $38.16 (E) $49.45 3 of 8 (12) John just celebrated his 20th birthday today and decided to start saving for his retirement. He will deposit $2000 quarterly into his savings account until he reaches 65th birthday, with first deposit one quarter from today and last deposit on his 65th birthday. The savings account provides a nominal interest rate of 6% per annum, compounded monthly. The amount John has in his savings account on his 65th birthday is closest to: (A) $1,828,172 (B) $1,792,249 (C) $1,701,948 (D) $1,787,348 (E) $1,855,701 (13) Bond XYZ is a 5-year, $1,000 par value bond. It pays a 6% annual coupon rate with semi-annual payments during its first year (you receive $30 every 6 months for the first year). For the remaining four years, this bond pays a 10% annual coupon rate with semi- annual payments (you receive $50 every 6 months for the remaining 4 years). The current nominal yield to maturity of bond XYZ is 6%, compounded semi-annually. What is the current price of bond XYZ? (A) $388.24 (B) $858.12 (C) $1,110.66 (D) $1,132.33 (E) $1,152.48 (14) There is now significant uncertainty over the state of the economy in the coming year and CXL’s stock performance is expected to be positively correlated with the economy. What is the Coefficient of Variation on the return of CXL's stock, given the following probability distribution for CXL’s stock returns? State of Economy Probability Stock Return Boom 10% 30.0% Normal 40% 10.0% Recession 50% -10.0% (A) 1.0 (B) 1.8 (C) 2.0 (D) 6.6 (E) 7.1 (15) A stock expects to pay annual dividend of $1 per share at the end of the first 3 years, after which the annual dividends are expected to grow at a constant perpetual rate. The stock has a beta of 2. The risk-free rate and market rate of return are 3% and 9%, respectively. If the stock’s intrinsic value today is $8, what is the annual constant perpetual growth rate for the dividends after the first 3 years? (A) 2.63% (B) 3.14% (C) 3.50% 4 of 8 (D) 4.55% (E) 5.00% (Total: 10 marks) - END OF PAPER - 5 of 8  Appendix 1 Selected Formulas Chapter 3 Stockholders' equity  Paid-in capital  Retained earnings Stockholders' equity  Total assets  Total liabilities Net operating working capital = (Current assets – Excess cash) – (Current liabilities – Notes payable) * Note on NOWC, assume Excess cash = 0 Operating income (or EBIT)  Sales revenue  Operating costs FCF = [EBIT(1-T) + Depreciation] – (Capital expenditures + ∆Net operating working capital) Chapter 5 Future value  FV N  PV (1  I) N FV N Present value  P V  (1  I) N  (1+I)N -1 FVAN =PMT(1+I)N-1 +PMT(1+I)N-2 +PMT(1+I)N-3 +...+PMT(1+I)0 = PMT    I  FVA due  FVA ordinary 1  I   1   1-  PMT PMT PMT (1+I) N PVA N = + +...+ = PMT     1 2 N (1+I) (1+I) (1+I) I   PVA due  PVA ordinary 1  I  PM T PV of a perpetuity  I N CF1 CF2 CFN CFt PV    L  1  I 1  I 1 I 1 I 1 2 N t t 1 S tated an nu al rate I P erio dic rate  I PER    N um ber o f p aym en ts p er year M Number of periods   Number of years Periods per year   N  M M  I  Effective annual rate  EFF%  1  NOM  1.0  M  6 of 8  Appendix 1 (continued) Chapter 7 Quoted interest rate (r)  r*  IP  DRP  LP  MRP  rRF  DRP  LP  MRP rT-bill  rR F  r *  IP rT-bond  rt*  IPt  MRPt rC-bond  rt*  IPt  MRPt  DRPt  LPt Chapter 8 N ˆ = P1 r1  P2 r2 ...  PN rN =  Pi ri Expected rate of return (r) i=1 N Standard deviation     (r  r)ˆ P i 1 i 2 i  Coefficient of variation  CV  r̂ N rˆp = w 1 rˆ1  w 2 rˆ2 ...  w N rˆN =  w i rˆi i=1 N b p = w 1 b1 +w 2 b 2 +...+w N b N =  w i b i i=1 RPM = rM - rRF RPi  (RPM )b i ri  rRF  (rM  rRF )b i Chapter 9 INT INT INT M Bond's value  VB    L  1  rd  1  rd  1  rd  1  rd  1 2 N N N INT M   1  rd  1  rd  t N t 1 2N INT 2 M Price of semiannual-coupon bond (VB )    1  rd 2 1 rd 2 t 2N t 1 7 of 8  Appendix 1 (continued) Chapter 10   Value of stock Pˆ0  PVof expected future dividends D1 D2 D   L  1  rs  1  rs  1  rs  1 2   Dt  1  rs  t t 1 D 0 1  g  D 0 1  g  D 0 1  g  1 2  Constant growth stock: Pˆ 0   L  1  rs  1  rs  1  rs  1 2  D 0 1  g  D1   rs  g rs  g Expected rate Expected Expected growth rate, or   of return dividend yield capital gains yield D1 r̂s  g P0 Growth rate  1 Payout ratio ROE Return on common equity (ROE) = Net Income/Common Equity Payout ratio = Dividends/ Net Income Retention ratio = 1 – Payout ratio D Z e ro g ro w th s to c k : Pˆ 0  rs D N +1 H o riz o n v a lu e  Pˆ N  rs  g D1 D2 DN D N 1 D Nonconstant growth stock : Pˆ 0   L  L 1  rs  1  rs  1  rs  1  rs  1  rs  1 2 N N 1  D1 D2 DN Pˆ N   L  1  rs  1  rs  1  rs  1  rs  1 2 N N  PV of nonconstant dividends  PV of horizon value, Pˆ N Price/Earnings (P/E) = Price per share/ Earnings per share Dp Dp Vp  r̂p  rp Vp - END OF APPENDIX - 8 of 8