Business Ad ministration

Vrije Universiteit
Faculty of Economics and Business Administration

Exam:
Finance and Financial Arithmetic I
Version B

Prof. Luc Keuleneer

llllay 26th,2009
12.00 - 14.00 am
o The duration of the exam is 2 hours;
. This exam consists of 40 multiple choice questions; 24 correct answers : 5/10
o Grades will be announced on Tuesday , Iune 23, 2009

o For questions / remarks about the results of the exam you can contact by e-mail:
Prof. Luc Keuleneer, e-mail lkeuleneer@feweb.vu.nl

o Closed book - only calculator is allowed.

Please complete the MC answer sheet

(name, student number, version of exam, ...)

If information is missing on the answer sheet, the exam will NOT be corrected
and no result will be given

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1 . The discount rate that makes the net present value of investment exactly equal to zero is
the:

A) Payback period.
@ Intlrnal rate of return.
C) Average accounting return.
D) Profitabilityindex.
E) Discounted payback period.

2. For a project with conventional cash flows, if NPV is greater than zero, then:

A) The IRR is equal to the firm's required rate of return.

B) The profitability index is greater than 1.
A The payback period is faster than the firm's required cutoff point.
\Q) The AAR exceeds the IRR.
E) The project does not pay back on a discounted payback basis.

3. If the required return is lToh, what is the discounted payback period of the following
cash flows?

Year0I2345
Cash Flow -$65,000 $25,000 $25,000 $25,000 $10,000 $10,000

A) 2years
B) 3 vears
€il 4 years
DJ 5 years
E) The project does not pay back on a discounted basis

4. Your required retum is 15Yo. Should you accept a project with the following cash
flows?

Year0123
Cash Flow -$85 $40 $40 $35

A) No, because the IRR is 139%.

B) No, because the IRR is 14.7%.
C) Yes, because the IRR is 16.2%.
o) Yes, because the IRR is 17.2%.
E) Yes, because the IRR is 19.2%.

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5. You have a choice between 2 mutually exclusive investments. If you require a 14o/o
return, which investment should you choose?

AB
Year Cash Flow Cash Flow
0 -$150,000 -$120,000
1 50,000 72,000
2 90,000 50,000
3 70,000 40,000

Project B, because it has a smaller initial investment.

qA) Project A, because it has a higher NPV.
c) Either one, because they have the same profitability indexes.
D) Project B, because it has the higher internal rate of return.
E) Project B, because it pays back faster.

6. The cash flows of a new project that come at the expense of a firm's existing projects
are:

A) Salvage value expenses.

B) Net working capital expenses.
O Sunkcosts.
D) Opportunity costs.
E) Erosion costs.

7. The cash flow from projects for a company is:

A) The net operating cash flow generated by the project, less any sunk costs and
erosion costs.
B) The sum of the incremental operating cash flow and aftertax salvage value of the
project.
The bottomline net income generated by the project, plus the annual depreciation
e expense.
D) The sum of the incremental operating cash flow, capital spending, and net
working capital expenses incurred by the project.
E) The sum of the sunk costs, opportunity costs, and erosion costs of the project.

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 to zero over its 4 year life'
8. A project costs $60,000 and will be depreciated straight-line
TheprojectgeneratesOCFof$l8,000andthefixedassetswillbesoldfor$7'000atthe
tax rate of 34%o and a required return of
termination of the pt":..J. tiln rrr* has a
l0%o, what is the NPV?

A) $ 213
H $1,133
h) $1,83e
D) $2,261
E) s2,842

in calculating a bid price you are:

9. when you set the project NPV equal to zero

Going to earn zero net income on the

project'
A)
Apptipti"rely including opportunity costs in your analysis'
B)
does bid lower, they will be bidding
c) certain to be the ro* ulaae, since, if uny firm
based on a negative NPV Project'
possible IRR'
D) Assured of eaming your firm's highest
q Finding the price at which you expect to create
zero wealth for your shareholders'

The possibility that elrors in projected cash

flows can lead to incorrect NPV estimates is
10.
called:

A) Forecasting risk.
B) Projection risk'
(C).. Scenario risk.
bt' Monte Carlo risk.
E) Accounting risk'

present value exactly equal to zero is called:

11. The sales level that results in a project net

A OPerationalbreak-even'
D Leveraged break-even'
C) Accountingbreak-even'
D) Cash break-even.
E) Financial break-even'

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12. A negative NPV project will:

I. Have a discounted payback period less than the project's life.

IL Have a sales level exceeding the accounting break-even point.
III. Have an IRR less than the required return.
IV. Have a profitability index less than one.

A) I and III only

(F) III and IV only
El II and III only
D) I, III, and IV only
E) I, II, III, and IV

13. Calculation of the weighted average cost of capital requires all of the following
EXCEPT:

The total market value of a firm's debt via the number of bonds outstanding and
the current par value per bond.
B) The market value of bonds outstanding relative to the total market value of the
firm.
C) The corporate tax rate.
D) The current market value of a firm's equity via the total number of shares and the
stock price.
E) The market value of equity outstanding relative to the total market value of the
firm.

14. Which of the following is generally true about a firm's cost of debt?

s
B)
It is equal to the yield to maturity on the firm's outstanding bonds.
It is greater than the cost of equity.
c) It normally cannot be observed, directly or indirectly, in the marketplace.
D) It is greater than the average coupon payments on outstanding debt.
E) It is equal to the coupon rate on the firm's outstanding bonds.

15. Suppose that two firms, A and B, are considering the same project which has the same
risk as firm B's overall operations. The project has an IRR of 14.0%. Firm A has a beta
of I .4, while firm B's beta is 1 . I . If the risk-free rate is 5.25% and the market risk
premium is7.0%o, which firm(s) should take the project?

A) A only
B) B only
q Both A and B
D) Neither A nor B
E) Carurot be determined without additional information

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16. Rattle me Bones, Inc.'s common stock is currently selling for $66.25 per share. You
expect the next dividend to be $5.30 per share. If the firm has a dividend growth rate of
4oh that is expected to remain constant indefinitely, what is the firm's cost of equity?

n n.o%
Btt ns%
c) t3j%
D) t3.9%
E) 14.1%

17. RMB,Inc. sold a2}-year bond at par 12 years ago. The bond pays an 8Yo annual
coupon, has a $1,000 face value, and currently sells for $893.30. What is the firm's cost
ofdebt?

A) 8.0%
B) 9.2%
c) e5%
O
E)
tol%
r}j%
18. The market value of DRK Inc.'s debt is $200 million and the total market value of the
firm is $600 million. The cost of equity is 1 5o/o, the cost of debt is \Yo, and the tax rate
is34%. What is this firm's WACC?

A) 11.14%
$ tt:6%
c) t2.2s%
D) 12.67%
E) 14.07%
t9, A proposed project lasts 3 years and has aninitial investment of $200,000. The aftertax
cash flows are estimated at $60,000 for year 1, $120,000 for year 2, and $135,000 for
year 3. The firm has a target debt/equity ratio of L2. The firm's cost of equity is 14yo
and its cost of debtis9Yo. The tax rate is 34%.What is the NPV of this project?

A) -$r2,370
B) $ 13,687
c) 8 37,723
D) $ 46,120
@ $ 57,185

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20. All else the same, the financial leverage of a firm will

A) decrease as the debt/equity ratio increases

@t decrease as the firm's retained earnings account grows
Ul increase by the amount of equity it issues in a given year
D) decrease if the firm has negative net income
E) decrease as the firm uses debt to fund expansion projects

21. You need $2,000 to buy a new stereo for your car. If you have $800 to invest at 5%o
compounded annually, how long will you have to wait to buy the stereo?

A) 6.58 years
B) 8.42 years
C) 14.58 years
D) 15.75 years
q 18.78 years

22. The current value of future cash flows discounted at the appropriate discount rate is
called the:

A) Principal value.
B) Future value.
@'\ Present value.
Dy Simple interest rate.
E) Compound interest rate.

23. Suppose you are trying to find the present value of two different cash flows using the
same interest rate for each. One cash flow is $1,000 ten years from now, the other $800
seven years from now. Which of the following is true about the discount factors used in
these valuations?

The discount factor for the cash flow ten years away is always less than or equal
to the discount factor for the cash flow that is received seven years from now.
B) Both discount factors are greater than one.
C) Regardless of the interest rate, the discount factors are such that the present value
of the $1,000 will always be greater than the present value of the S800.
D) Since the payments are different, no statement can be made regarding the discount
factors.
E) You should factor in the time differential and choose the payment that anives the
soonest.

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24. Granny puts $35,000 into a bank account earning 4Yo. Yol can't withdraw the money
until the balance has doubled. How long will you have to leave the money in the
account?

A) l6 years
B) I 7 years

g 18 years
I 9 years
E) 20 years

25. In 1889, Vincent Van Gogh's painting, "Sunflowers", sold for $125. One hundred years
later it sold for $36 million. Had the painting been purchased by your great-grandfather
and passed on to you, what annual return on investment would your family have earned
on the painting?

A) 9.11%
B) 10.09%
c) 11.88%
D) lt.99%
qt n.4o%

26. An account was opened with $1,000 l0 years ago. Today, the account balance is
$1,500. If the account paid interest compounded annually, how much interest on interest
was earned?

$ 86.20
B) $ e3.10
c) $ 102.39
D) $ 130.28
E) $s00.00

27. The interest rate charged per period multiplied by the number of periods per year is
called the:

qc)
A) Effective annual rate (EAR).
Annual percentage rate (APR),
Periodic interest rate.
D) Compound interest rate.
E) Daily interest rate.

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 in every way, except that
2g. You are considering two perpetuities which are identical
you two years from today
perpetuity A witf bJgin *at i"g annual paymen]s of $P to
year from today' It must be
while the first $P palment forlerpetuiiy B will occur one
true that the present value of perpetuity:

A) A is greater than that of B bY $P'

B) B is greater than that of A bY $P'
c) B is equal to that of PerPetuitY A.
B) A exceeds that ofB by the PV of$P for one year'
B exceeds that ofA by the PV of$P for one year'
e
received in two years'
29. what is the total present value of $50 received in one year, $200
and $800 receivei in six years if the discount rate
is 8%?

A) s482.72
B) $661.68

qc) 9697.2s
$72t.90
E) $852.83

discount rate if the present value is

30. Given the following cash flows, what is the implicit
s2,020?

Year I 23
Cash Flow $500 $7s0 $1000

A) 4.s%
B) 4.8%
bD) s.o%
s.4%
E) s9%

received at the beginning of

31. What is the future value in l0 years of $1,000 payments
rate of 5'625%'
each year for the next 10 years? Assume an interest

A) $12,259.63
B) $12,949.23
$13,679.45
9E)
$14,495.48
$14,782.15

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32. Deryl wishes to save money to provide for his retirement. Beginning one month from
now, he will begin depositing a fixed amount into a retirement savings account that will
earrr lTYo compounded monthly. He will make 360 such deposits. Then, one year after
making his final deposit, he will withdraw $100,000 annually for 25 years. The fund
will continue to eam 72Yo compounded monthly. How much should the monthly
deposits be for his retirement plan?

A) $189,s8
B)
g
$1e9.58

I3\I?L
V( $24e.38

33. In order to compare different investment opportunities (each with the same risk) with
interest rates reported in different manners you should:

A) Convert each interest rate to an annual nominal rate.

Convert each interest rate to a monthly nominal rate.
^B) Convert each interest rate to an effective annual rate.
O
D) Compare them by using the published annual rates.
E) Convert each interest rate to an APR.

34. The net present value (NPV) rule can be best stated as:
A) An investment should be accepted if, and only if, the NPV is exactly equal to
zero.
B) An investment should be rejected if the NPV is positive and accepted if it is
negative.
t\^
!/ An investment should be accepted if the NPV is positive and rejected if its is
negatlve.
D) An investment with greater cash inflows than cash outflows, regardless of when
the cash flows occur, will always have a positive NPV and therefore should
always be accepted.
E) Net present value must be equal to IRR.

35. A project costs $475 and has cash flows of $100 for the first three years and $75 in each
of the project's last five years. What is the payback period of the project?

A) The project never pays back

B) 4.75 years
C) 5.00 vears
@) 5.33 years
b/ 6.oo years

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36. The internal rate of return (IRR) rule can be best stated as;

A) An investment is acceptable if its IRR is exactly equal to its net present value
(NPV).
B) An investment is acceptable if its IRR is exactly equal to zero.
C) An investment is acceptable if its IRR is less than the required retum, else it
should be rejected.
@}
V
An investment is acceptable if its IRR exceeds the required return, else it should
be rejected.
E) Net present value must be equal to IRR.

37. You are evaluating two mutually exclusive projects, A and B. Project A costs $350 and
has cash flows of$250 in each ofthe next 2 years. Project B costs $300 and generates
cash flows of $300 and $ 100 for the next 2 years, respectively. What is the crossover
rate for these projects?

A) 26.38%
B) 27.47%
c) 3a.28%
CI) 6r.so%
!5 $.48%

38. What is the NPV of the following set of cash flows if the required return is l4o/o?

YearO1234
Cash Flow -$50,000 -$5,000 $50,000 $50,000 -$25,000

A) The NPV is negative

et $ 3,034
c) $ 9,525
D) $10,376
E) $41,410

39. Would you accept a project which is expected to pay $10,000 ayear for 7 years if the
initial investment is $40,000 and your required return is 15%;o?

\-
$ Yes; the NPV is $1,604
b1 Yes; the NPV is $1,446
C) Yes; the NPV is $4,238
D) No; the NPV is -$1,369
E) No; the NPV is -$2,783

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40. The length of time required for an investment's discounted cash flows to equal its initial
cost is the:

A) Net present value.

B) Internal rate of return.
c) Payback period.
D) Profitability index.
Discounted payback period.
,@
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