Tentamen November 2013

EXAM CME2300 FINANCIAL ENGINEERING
WEDNESDAY NOVEMBER 6TH 2013

14:00-17:00 HOURS Delft University of Technology
Faculty of Civil Engineering and Geosciences
NAME:
Page 1 of 10
STUDENT NUMBER:
GENERAL REMARKS:
• This exam contains 40 questions.
• Questions are valued at 1 point
• Put a circle on the right answer, only one answer is right
• Fill in the Four Choice Response Form FA1
• The use of a calculator is allowed, but no mobile phones or tablets / iPads.
• You may use the Tables (see Appendices at the end of the Exam Form).
• Please name and student number on all pages on Exam-form AND Response Form
• Hand in both forms: Exam Form AND Response Form

NAME:
Page 2 of 10
STUDENT NUMBER:
1. A firm's investment decision is also called the:
A. Financing decision
B. Liquidity decision
C. Capital budgeting decision
D. None of the above
2. Mr. Dell has $100 income this year and zero income next year. The market interest rate is 10%
per year. Mr. Dell also has an investment opportunity in which he can invest $50 this year and
receive $80 next year. Suppose Mr. Dell consumes $50 this year and invests in the project. What is
the NPV of the investment opportunity?
A. $5
B. $22.73
C. $0 (zero)
D. None of the above.
3. An initial investment of $500 produces a cash flow $550 one year from today. Calculate the rate
of return on the project
A. 10%
B. 15%
C. 25%
D. none of the above
4. What is the present value of $10,000 per year perpetuity at an interest rate of 10%?
A. $10,000
B. $100,000
C. $200,000
5. After retirement, you expect to live for 25 years. You would like to have $75,000 income each
year. How much should you have saved in the retirement to receive this income, if the interest is
9% per year (assume that the payments start on the day of retirement)?
A. $736,693.47
B. $802,995.88
C. $2,043,750
NAME:
Page 3 of 10
STUDENT NUMBER:
6. Which of the following statements about the relationship between interest rates and bond prices
is true?
I) There is an inverse relationship between bond prices and interest rates.

II) There is a direct relationship between bond prices and interest rates.
III) The price of short-term bonds fluctuates more than the price of long-term bonds for a given
change in interest rates. (Assuming that coupon rate is the same for both)
IV) The price of long-term bonds fluctuates more than the price of short-term bonds for a given
change in interest rates. (Assuming that the coupon rate is the same for both)
A. I and IV only
B. I and III only
C. II and III only
D. None of the given statements are true
7. What forward rate is embedded in a two year zero coupon bonds with a yield to maturity of 6%
and a three year zero coupon bond and a yield to maturity of 6.5%? Assume both bonds are
currently priced at par.
A. 5.50%
B. 6.00%
C. 6.50%
D. 7.50%
8. Super Computer Company's stock is selling for $100 per share today. It is expected that this
stock will pay a dividend of 6 dollars per share, and then be sold for $114 per share at the end of
one year. Calculate the expected rate of return for the shareholders.
A. 20%
B. 15%
C. 10%
D. 25
9. The expected rate of return or the cost of equity capital is estimated as follows:
A. Dividend yield - expected rate of growth in dividends

B. Dividend yield + expected rate of growth in dividends
C. Dividend yield/expected rate of growth in dividends
D. (Dividend yield) * (expected rate of growth in dividends)
NAME:
Page 4 of 10
STUDENT NUMBER:
10. If the net present value (NPV) of project A is + $100, and that of project B is + $60, then the
net present value of the combined project is:
A. +$100
B. +$60
C. +$160
11. Music Company is considering investing in a new project. The project will need an initial
investment of $2,400,000 and will generate $1,200,000 (after-tax) cash flows for three years.
Calculate the NPV for the project if the cost of capital is 15%.
A. $169, 935
B. $1,200,000
C. $339,870
D. $125,846
12. When a firm has the opportunity to add a project that will utilize excess factory capacity (that is
currently not being used), which costs should be used to determine if the added project should be
undertaken?
A. Opportunity cost
B. Sunk cost
C. Incremental costs
13. If the discount rate is stated in nominal terms, then in order to calculate the NPV in a consistent
manner requires that project:
I) cash flows be estimated in nominal terms

II) cash flows be estimated in real terms
III) accounting income be used
A. I only
B. II only
C. III only
NAME:
Page 5 of 10
STUDENT NUMBER:
14. Capital equipment costing $250,000 today has 50,000 salvage value at the end of 5 years. If the
straight line depreciation method is used, what is the book value of the equipment at the end of two
years?
A. $200,000
B. $170,000
C. $140,000
D. $50,000
15. Using the technique of equivalent annual cash flows and a discount rate of 7%, what is the value
of the following project?
A. 3.06
B. 3.61
C. 10.25
D. 12.23
16. For a two-stock portfolio, the maximum reduction in risk occurs when the correlation coefficient
between the two stocks is:
A. +1
B. -0.5
C. -1
D. 0
17. What is the beta of a security where the expected return is double that of the stock market,
there is no correlation coefficient relative to the US stock market and the standard deviation of the
stock market is .18?
A. 0.00
B. 1.00
C. 1.25
D. 2.00
18. Portfolio Theory was first developed by:
A. Merton Miller
B. Richard Brealey
C. Franco Modigliani
D. Harry Markowitz
NAME:
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STUDENT NUMBER:
19. 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%
20. Suppose you invest equal amounts in a portfolio with an expected return of 16% and a standard
deviation of returns of 20% and a risk-free asset with an interest rate of 4%; calculate the standard
deviation of the returns on the resulting portfolio:
A. 8%
B. 10%
C. 20%
21. If a stock is under priced it would plot:
A. Above the security market line

B. Below the security market line
C. On the security market line
D. On the Y-axis
22. The market value of Cable Company's equity is $60 million, and the market value of its risk-free
debt is $40 million. If the required rate of return on the equity is 15% and that on the debt is 5%,
calculate the company's cost of capital. (Assume no taxes.)
A. 15%
B. 10%
C. 11%
23. The market value of Charcoal Corporation's common stock is $20 million, and the market value
of its risk-free debt is $5 million. The beta of the company's common stock is 1.25, and the market
risk premium is 8%. If the Treasury bill rate is 5%, what is the company's cost of capital? (Assume
no taxes.)
A. 15%
B. 14.6%
C. 13%
NAME:
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STUDENT NUMBER:
24. The beta of the computer company is 1.7 and the standard error of the estimate is 0.3. What is
the range of values for beta, that has 95% chance of being right?
A. 1.1 - 2.3
B. 1.4 - 2.0
C. 1.5 - 2.0
25. Calculator Company proposes to invest $5 million in a new calculator making plant. Fixed costs
are $2 million a year. A calculator costs $5/unit to manufacture and can be sold for $20/unit. If the
plant lasts for 3 years and the cost of capital is12%, what is the approximate break-even level (i.e.
NPV = 0) of annual sales? (Assume no taxes.)(approximately)
A. $133,333 units
B. $272,117 units
C. $227,533 units
26. Taj Mahal Tour Company proposes to invest $3 million in a new tour package project. Fixed
costs are $1 million per year. The tour package costs $500 and can be sold at $1500 per package to
tourists. This tour package is expected to be attractive for the next five years. If the cost of capital
is 20%, what is the NPV break-even number of tourists per year? (Ignore taxes, give an
approximate answer)
A. 1000
B. 2000
C. 15000
27. Firms can repurchase shares in the following ways:
I) Open market repurchase

II) Through a tender offer
III) Through a Dutch auction process
IV) Through direct negotiation with a major shareholder
A. I only
B. II only
C. III only
D. I, II, III, and IV
NAME:
Page 8 of 10
STUDENT NUMBER:
28. Company X has 100 shares outstanding. It earns $1,000 per year and expects to pay all of it as
dividends. If the firm expects to maintain this dividend forever, Calculate the stock price after the
dividend payment. (The required rate of return is 10%)
A. $110
B. $90
C. $100
29. Capital structure is irrelevant if:
A. the capital markets are perfect

B. each investor holds a fully diversified portfolio
C. each investor holds the same proportion of debt and equity of the firm
D. all of the above
30. Health and Wealth Company is financed entirely by common stock that is priced to offer a 15%
expected return. If the company repurchases 25% of the common stock and substitutes an equal
value of debt yielding 6%, what is the expected return on the common stock after refinancing?
(Ignore taxes.)
A. 18%
B. 21%
C. 15%
31. In order to calculate the tax shield effect of interest payment for a corporation, always use the:
I) average corporate tax rate

II) marginal corporate tax rate
III) state mandated tax rate
A. I only
B. II only
C. III only
D. I and III only
32. Given the following data for Golf Corporation:

market price/share = $12; Book value/share = $10; Number of shares outstanding = 100 million;
market price/bond = $800; Face value/bond = $1,000; Number of bonds outstanding = 1 million;
Calculate the proportions of debt (D/V) and equity (E/V) for the firm that you would use for
estimating the weighted average cost of capital (WACC):
A. 40% debt and 60% equity

B. 50% debt and 50% equity
C. 45.5% debt and 54.5% equity
D. none of the given values
NAME:
Page 9 of 10
STUDENT NUMBER:
33. Figure-2 depicts the:
A. position diagram for the buyer of a call option

B. profit diagram for the buyer of a call option
C. position diagram for the buyer of a put option
D. profit diagram for the buyer of a put option
34. Buying a call option, investing the present value of the exercise price in T-bills, and short selling
the underlying share is the same as:
A. Buying a call and a put

B. Buying a put and a share
C. Buying a put
D. Selling a call
35. A call option has an exercise price of $100. At the final exercise date, the stock price could be
either $50 or $150. Which investment would combine to give the same payoff as the stock?
A. Lend PV of $50 and buy two calls

B. Lend PV of $50 and sell two calls
C. Borrow $50 and buy two calls
D. Borrow $50 and sell two calls
36. Suppose Caroll's stock price is currently $20. In the each next six month periods it will either fall
by 50% or rise by 100%. What is the current value of a one-year call option with an exercise price
of $15? The six-month risk-free interest rate (periodic rate) is 5%. [Use the two stage binomial
method]
A. $8.73
B. $10.03
C. $16.88
D. $13.33
NAME:
Page 10 of 10
STUDENT NUMBER:
37. The opportunity to invest in a project can be thought of as a three-year real option that is worth
$500 million with an exercise price of $800 million. Calculate the value of the option given that,
N(d1) = 0. 3 and N(d2) = 0.15. Assume that the interest is 6% per year.
A. $150 million
B. $49.25 million
C. Zero
38. Which of the following conditions might lead a financial manager to decide to expedite a positive
Net Present Value investment project that previously he/she had decided to delay?
A. The risk-free interest rate increases.

B. Uncertainty about future project value increases.
C. The cash inflows generated by the project is lower than previously thought.
D. Investment required for the project is expected to increase in the near future.
39. Generally, you can insure corporate bonds through:
A. an arrangement with the Treasury department

B. an arrangement with the state government
C. credit default swap
40. A 5% debenture (face value = $1000) pays interest on June 30 and December 31. It is callable
at a price of 105% together with accrued interest. Suppose the company decides to call the bonds
on September 30. What price must it pay for each bond?
A. $1000.00
B. $1037.50
C. $1062.50
D. $1050.00

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EXAM CME2300 FINANCIAL ENGINEERING

WEDNESDAY NOVEMBER 6TH 2013

• This exam contains 40 questions.

• Questions are valued at 1 point

• Put a circle on the right answer, only one answer is right

• Fill in the Four Choice Response Form FA1

• The use of a calculator is allowed, but no mobile phones or tablets / iPads.

• Hand in both forms: Exam Form AND Response Form

1. A firm's investment decision is also called the:

I) There is an inverse relationship between bond prices and interest rates.

A. Dividend yield - expected rate of growth in dividends

I) cash flows be estimated in nominal terms

18. Portfolio Theory was first developed by:

21. If a stock is under priced it would plot:

A. Above the security market line

27. Firms can repurchase shares in the following ways:

I) Open market repurchase

29. Capital structure is irrelevant if:

A. the capital markets are perfect

I) average corporate tax rate

32. Given the following data for Golf Corporation:

A. 40% debt and 60% equity

33. Figure-2 depicts the:

A. position diagram for the buyer of a call option

A. Buying a call and a put

A. Lend PV of $50 and buy two calls

A. The risk-free interest rate increases.

39. Generally, you can insure corporate bonds through:

A. an arrangement with the Treasury department

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