FINC600 Corporate Finance Midterm
Exam Answers
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FINC600 Corporate Finance
Mid Term
Question 1 of 25
The concept of compound interest is
most appropriately described as:
A.Interest earned on an investment
B.The total amount of interest
earned over the life of an investment
C.Interest earned on interest
- None of the above
Question 2 of 25
Which of the following investment
rules does not use the time value of the money concept?
A.Net present value
B.Internal rate of return
C.The payback period
D.All of the above use the time
value concept
Question 3 of 25
The unique risk is also called the:
A.Unsystematic risk
B.Diversifiable risk
C.Firm specific risk
D.All of the above
Question 4 of 25
What are some of the important
points to remember while estimating the cash flows of a project?
The most important points are
1) They are estimates. So there can
be deviations
2) Some huge loss may completely
change the return from product.
3) Other risks like market risks,
reinvestment risk etc. may affect the cash flow pattern
Feedback: • Estimate after-tax cash
flows on an incremental basis.
- Include all incidental effects.
- Include working capital requirements.
- Include opportunity costs.
- Do not include sunk costs.
- Take inflation into consideration in a consistent
manner.
Comment: Missing some important
items in your answer
Question 5 of 25
A bond with duration of 10 years has
yield to maturity of 10%. This bond’s volatility is:
Correct A.9.09%
B.6.8%
C.14.6%
D.6.0%
Feedback: Volatility (%) =
Duration/(1 + yield) = 10/1.1 = 9.09%
Major disadvantages of the
Sarbanes-Oxley Act of 2002 (SOX) are the following except:
A.good investor protection
B.increase in compliance costs
C.that it constrains managers’
ability to run the firm
D.that it may discourage development
of human capital in the firm
Question 7 of 25
According to the net present value
rule, an investment in a project should be made if the:
A.Net present value is greater than
the cost of investment
B.Net present value is greater than
the present value of cash flows
C.Net present value is positive
D.Net present value is negative
Question 8 of 25
If the Wall Street Journal Quotation
for a company has the following values close: 55.14; Net chg: = + 1.04; then
the closing price for the stock for the previous trading day was?
A.$56.18
B.$54.10
C.$55.66
D.None of the above.
Feedback: Previous closing = today’s
closing net chg. = 55.14 – 1.04 = $54.10
Question 9 of 25
4.0/ 4.0 Points
For example, in the case of an
electric car project, which of the following cash flows should be treated as
incremental flows when deciding whether to go ahead with the project?
A.The cost of research and
development undertaken for developing the electric car in the past three years
B.The annual depreciation charge
C.Tax savings resulting from the depreciation
charges
- Dividend payments
Question 10 of 25
The following are some of the
actions shareholders can take if the corporation is not performing well:
A.Replace the board of directors in
an election.
B.Force the board of directors to
change the management team.
C.Sell their shares of stock in the
corporation.
- Any of the above
Question 11 of 25
The mixture of debt and equity, used
to finance a corporation is also known as:
A.Capital budgeting
B.Capital structure
C.Investing
D.Treasury
Question 12 of 25
Discuss the general principle in the
valuation of a common stock.
The value of a common stock is the
present value of all the dividends received by owning the stock discounted at
the market capitalization rate. This is called the discounted cash flow (DCF)
method.
Feedback: The value of a common
stock is the present value of all the dividends received by owning the stock
discounted at the market capitalization rate or the cost of equity. This is
called the discounted cash flow (DCF) method.
Comment: reference required
Question 13 of 25
The managers of a firm can maximize
stockholder wealth by:
A.Taking all projects with positive
NPVs
B.Taking all projects with NPVs
greater than the cost of investment
C.Taking all projects with NPVs
greater than present value of cash flow
D.All of the above
Question 14 of 25
Florida Company (FC) and Minnesota
Company (MC) are both service companies. Their historical return for the past
three years are: FC: – 5%, 15%, 20%; MC: 8%, 8%, 20%. If FC and MC are combined
in a portfolio with 50% of the funds invested in each, calculate the expected
return on the portfolio.
A.12%
B.10%
C.11%
- None of the above.
Feedback: Rp = (10)(0.5) + (12)(0.5)
= 11%
Question 15 of 25
The market value of XYZ
Corporation’s common stock is 40 million and the market value of the risk-free
debt is 60 million. The beta of the company’s common stock is 0.8, and the
expected market risk premium is 10%. If the Treasury bill rate is 6%, what is
the firm’s cost of capital? (Assume no taxes.)
A.9.2%
B.14%
C.8.1%
D.None of the above
Feedback: rE = 6 + 0.8(10) = 14%; rD
= 5%; Cost of capital = (0.6)(6) + (0.4) (14) = 9.2%
Question 16 of 25
The following are important
functions of financial markets: I) Source of financing; II) Provide liquidity;
III) Reduce risk; IV) Source of information
A.I only
B.I and II only
C.I, II, III, and IV
- IV only
Question 17 of 25
Which of the following portfolios
have the least risk?
A.A portfolio of Treasury bills
B.A portfolio of long-term United
States Government bonds
C.Portfolio of U.S. common stocks of
small firms
D.None of the above
Question 18 of 25
Present Value of $100,000 that is,
expected, to be received at the end of one year at a discount rate of 25% per
year is:
A.$80,000
B.$125,000
C.$100,000
- None of the above
Feedback: PV = (100,000)/(1 + 0.25)
= 80,000
Question 19 of 25
Discuss some of the disadvantages of
the payback rule.
The disadvantages are that it does
not take the time value of money into account and also does not use all the
cash flow. It has limited applications such as small projects
Feedback: The disadvantages are that
it does not take the time value of money into account and also does not use all
the cash flow. It has limited applications such as small projects.
Question 20 of 25
What is the relationship between
interest rates and bond prices?
It’s important to understand that
bonds and interest rates have an inverse relationship, meaning that when
interest rates go up, existing bond prices go down, and when interest rates are
low, bond prices are high. To demonstrate the reason behind the inverse
relationship, you’ll need to understand the concept of yield.
Feedback: Interest rates and bond
prices are inversely related. High interest rates cause bond prices to fall and
vice-versa. For a given change in interest rates, prices of long-term bonds
fluctuate more than for short-term bonds. Similarly, for a given change in
interest rates low coupon bond prices fluctuate more than for high coupon
bonds.
Question 21 of 25
Spill Oil Company’s stocks had -8%,
11% and 24% rates of return during the last three years respectively; calculate
the average rate of return for the stock.
A.8% per year
B.9% per year
C.11% per year
D.None of the above
Feedback: Average rate of return =
(-8 + 11 + 24)/3 = 9%
Question 22 of 25
Which of the following statements
regarding the discounted payback period rule is true?
A.The discounted payback rule uses
the time value of money concept.
B.The discounted payback rule is
better than the NPV rule.
C.The discounted payback rule
considers all cash flows.
D.The discounted payback rule
exhibits the value additive property.
Question 23 of 25
The NPV value obtained by
discounting nominal cash flows using the nominal discount rate is the: I) same
as the NPV value obtained by discounting real cash flows using the real
discount rate II) same as the NPV value obtained by discounting real cash flows
using the nominal discount rate III) same as the NPV value obtained by
discounting nominal cash flows using the real discount rate
A.I only
B.II only
C.III only
D.II and III only
Question 24 of 25
Market risk is also called: I)
systematic risk, II) undiversifiable risk, III) firm specific risk.
A.I only
B.II only
C.III only
- I and II only
Question 25 of 25
The cost of a resource that may be relevant
to an investment decision even when no cash changes hand is called a (an):
A.Sunk cost
B.Opportunity cost
C.Working capital
D.None of the above
