Revision Question Final _a

1. Dividend growth rate is important to many investors. You are considering investing in a firm after
looking at the firm's dividends over a seven-year period. At the end of the year 2002, the firm paid a
dividend of $1.15. At year-end 2009, it paid a dividend of $1.84. What was the average annual growth rate
of dividends for this firm?
A) 7.25%
B) 9.86%
C) 6.94%
D) There is not enough information to answer this question.
Answer: C
Explanation: C) r = (FV/PV)1/n - 1 = ($1.84/$1.15)1/7 - 1 = 6.94%

2) Current annual dividends for Simpsons Frozen Foods Inc., are $1.35 per share. Four years ago,
dividends per share were exactly $1.00. What has been the rate of growth for Simpsons' dividends per
share?
Answer: r = (FV/PV)1/n - 1 = ($1.35/$1.00)1/4 - 1 = 7.79% per year.

3) At your birth, your grandparents put $5,000 into a college fund for you. Now you want to use the fund
to pay your first year of college costs of $23,000. To have enough money in your college fund for your
stated purpose, what annual rate of return would have to have been earned on the account over an 18-
year period?
Answer: r = (FV/PV)1/n - 1 = ($23,000/$5,000)1/18 - 1 = 8.85% per year.

4) You are saving money for a down payment on a new house. You intend to place $5,000 at the end of
each year for three years into an account earning 6% per year. At the end of the fourth year, you will
place $10,000 into this account. How much money will be in the account at the end of the fourth year?
A) $26,873.08
B) $26,518.17
C) $25,918.00
D) $25,000.00
Answer: C
FIVFA(i,n)+10,000
FVIFA(0.06,3)+10,000 = 15,918+10,000 = 25,918

In this equation I split the $10,000 final payment into two $5,000 payments so that I could use a four-year
future value of a $5,000 annuity formula to go along with the last cash flow.

5) You just won a lottery—CONGRATULATIONS! Your parents have always told you to plan for the
future, so since you already have a well-paying job you decide to invest rather than spend your lottery
winnings. The payment schedule from the lottery commission is $100,000 after taxes at the end of year
one and 19 more payments of exactly $100,000 after taxes in equal annual end-of-the-year deposits (i.e., 20
deposits of $100,000 each, the first deposit is one year from today) into your account paying 7%
compounded annually. How much money will be in your account after the last deposit is made?
A) $2,000,000.00
B) $3,637,896.48
C) $4,099,549.23
D) $4,486,517.68
Answer: C

Explanation: C) FV = PMT × = $100,000 × = $4,099,549.23.

6) The furniture store offers you no-money-down on a new set of living room furniture. Further, you may
pay for the furniture in three equal annual end-of-the-year payments of $1,000 each with the first
payment to be made one year from today. If the discount rate is 6%, what is the present value of the
furniture payments?
A) $3,183.60
B) $3,000.00
C) $2,833.39
D) $2,673.01
Answer: D
Explanation: D)

PV = PMT × = $1,000 × = $2,673.01.

7) You have an annuity of equal annual end-of-the-year cash flows of $500 that begin two years from
today and last for a total of ten cash flows. Using a discount rate of 4%, what are those cash flows worth
in today's dollars?
A) $3,899.47
B) $4,055.45
C) $4,380.24
D) $5,000.00
Answer: A
Explanation: A)

PV = PMT × all divided by (1 + r)1 = $500 × /(1.04)1 = $3,899.47

8) What is the present value of a stream of annual end-of-the-year annuity cash flows if the discount rate
is 0%, and the cash flows of $50 last for 20 years?
A) Less than $1,000
B) Exactly $1,000
C) More than $1,000
D) This question cannot be answered because we have an interest rate of 0.0%.
Answer: B
Explanation: B) Since the interest rate is 0.0%, the PV is simply the cash flow of $50 times the number of
periods, 20 = $1,000.

12) What if the company goes out of business in fifteen years and thus pays an annual dividend of $2.10
for only those fifteen years? What is the present value of a share for this company if we want a 10% return
on the stock?
A) $15.97
B) $16.97
C) $17.97
D) $18.97
Answer: A
Explanation: A) Keep in mind that the future price in 15 years is zero so that any discounted value is also
zero. Thus, we are only concerned with the present value of the annuity from the $2.10 dividend. For this
annuity, with r = 10% and n = 15, we get PVIFA = 7.60608, giving the present value of a share = P= $2.10 ×
7.60608 = $15.973 or about $15.97.

13) The next dividend (Div1) is $1.80, the growth rate (g) is 6%, and the required rate of return (r) is 12%.
What is the stock price, according to the constant growth dividend model?
A) $31.80
B) $30.80
C) $30.00
D) $15.00
Answer: C

Explanation: C) The Dividend Growth Model states that P0 = .

Inserting our values gives: P0 = = = $30.00.

14) The last dividend (Div0) is $1.80, the growth rate (g) is 6%, and the required rate of return (r) is 12%.
What is the stock price according to the constant growth dividend model?
A) $31.80
B) $30.80
C) $30.00
D) $15.00
Answer: A

Explanation: A) The Dividend Growth Model states that P0 = .

Inserting our values gives: P0 = = = = $31.80.

15) The Commuter Solutions Company just paid an annual dividend of $1.12. If you expect a constant
growth rate of 4% and have a required rate of return of 13%, what is the current stock price according to
the constant growth dividend model?
A) $12.44
B) $12.94
C) $13.46
D) There is not enough information to answer this question.
Answer: B

Explanation: B) The Dividend Growth Model states that P0 = .

Inserting our values gives: P0 = = = = $12.94.

16) Mind-The-Gap Corp. is selling for $30 a share. In looking at the stream of dividends over the past ten
years, you find out that the first dividend was $1.00 and the last dividend was $2.00. What is the firm's
growth rate of dividends? What is the firm's expected return?
Answer:

Using the formula g = - 1, where FV = $2 is the most recent dividend and PV = $1 is the initial

dividend and n = 10, we get g = -1= - 1 = 1.071773 - 1 = 0.071773, or about 7.18%. OR: One
could use the TVM keys with N = 10, PV = -$1, FV = $2, and PMT = 0 to get I/Y = 7.1773% or about 7.18%.

To get the expected return (r), we use the formula: r = + g. Inserting our values, we get: r =

+ 0.071773 = 0.143225, or about 14.32%.

17) Consider the following ten-year project. The initial after-tax outlay or after-tax cost is $1,000,000. The
future after-tax cash inflows each year for years 1 through 10 are $200,000 per year. What is the payback
period without discounting cash flows?
A) 10 years
B) 5 years
C) 2.5 years
D) 0.5 years
Answer: B
Explanation: B) $1,000,000/$200,000 per year = 5 years.

18) Consider the following four-year project. The initial outlay or cost is $180,000. The respective cash
inflows for years 1, 2, 3 and 4 are: $100,000, $80,000, $80,000 and $20,000. What is the discounted payback
period if the discount rate is 11%?
A) About 1.667 years
B) About 2.000 years
C) About 2.135 years
D) About 2.427 years
Answer: D
Explanation: D) We first discount all after-tax cash inflows, which gives us after-tax cash inflows of
$90,090.09, $64,929.79, $58,495.31, and $13,174.62. After two years, we will have paid back $155,019.88,
leaving $24,980.12 to pay back in after-tax cash flows in the third year. Since we get $58,495.31 in the third
year, the rule of thumb is to divide what is needed by the cash inflows we will get next period and add it
to the number of previous periods of cash inflows, e.g., ($24,980.12 divided by $58,495.31) + 2. Doing this
gives 2.427 years as the discounted payback period.

19) Simpson, Inc. is considering a five-year project that has an initial after-tax outlay or after-tax cost of
$80,000. The respective future cash inflows from its project for years 1, 2, 3, 4 and 5 are: $15,000, $25,000,
$35,000, $45,000 and $55,000. Simpson uses the net present value method and has a discount rate of 9%.
Will Simpson accept the project?
A) Simpson accepts the project because the NPV is $129,455.25.
B) Simpson accepts the project because the NPV is 79,455.25.
C) Simpson accepts the project because the NPV is $49,455.25.
D) Simpson accepts the project because the NPV is less than zero.
Answer: C

Explanation: C) NPV = -CF0 + + + + +

= -$80,000 + + + + +
= -$80,000 + $13,761.47 + $21,042.00 + $27,026.42 + $31,879.13 + $35,746.23
= -$80,000 + $129,455.25 = $49,455.25.
Thus, Simpson accepts the project since it has a positive NPV.
Using the NPV function in Excel yields the same answer.

20) Meyer, Inc. is considering a five-year project that has an initial after-tax outlay or after-tax cost of
$70,000. The future after-tax cash inflows from its project for years 1, 2, 3, 4 and 5 are all the same at
$35,000. Meyer uses the net present value method and has a discount rate of 10%. Will Meyer accept the
project?
A) Meyer accepts the project because the NPV is about $69,455.
B) Meyer accepts the project because the NPV is about $62,678.
C) Meyer rejects the project because the NPV is about -$13,382.
D) Meyer rejects the project because the NPV is less than -$33,021.
Answer: B
Explanation: B) The future after-tax cash inflows are an annuity. Thus, we can use:

NPV = -CF0 + (PMT × . Inserting the given values gives:

NPV = -$70,000 + = -$70,000 + ($35,000 × 3.790787)

= -$70,000 + $132,677.54 = $62,677.54. Thus, Meyer accepts the project since it has a positive NPV.
Using the NPV function in Excel yields the same answer.
Diff: 3

21) Dakota, Inc. is currently considering an eight-year project that has an initial outlay or cost of $140,000.
The cash inflows from its project for years 1 through 8 are the same at $35,000. Dakota has a discount rate
of 12%. Because there is a shortage of funds to finance all good projects, Dakota wants to compute the
profitability index (PI) for each project. That way Dakota can get an idea as to which project might be a
better choice. What is the PI for Dakota's current project?
A) About 1.24
B) About 1.21
C) About 1.19
D) About 1.09
Answer: A
Explanation: A) The PI is (NPV plus the absolute value of the costs) divided by the absolute value of the
costs. The future after-tax cash inflows are an annuity. Thus, we can use:
NPV = -CF0 + . Inserting the given values gives:

NPV = -$140,000 + = -$140,000 + ($35,000 × 4.967640)

= -$140,000 + $173,867.39 = $33,867.39. We can now compute the PI.

We have: PI = = = 1.2419, or about 1.24.

22) The following market information was gathered for the Blender Corporation. The firm has 1,000
bonds outstanding, each selling for $1,100.00 with a required rate of return of 8.00%. Blenders has 5,000
shares of preferred stock outstanding, selling for $40.00 per share and 50,000 shares of common stock
outstanding, selling for $18.00 per share. If the preferred stock has a required rate of return of 11.00% and
the common stock requires a 14.00% return, and the firm has a corporate tax rate of 30%, calculate the
firm's WACC adjusted for taxes.
Explanation: C) E = $18 × 50,000 shares = $900,000, PS = $40 × 5,000 shares = $200,000, D = $1,100 × 1,000
bonds = $1,100,000.
E/V = $900,000/$2,200,000 = 0.40909, P/V = $200,000/$2,200,000 = 0.0909, D/V = $1,100,000/$2,200,000 = 0.5.

WACC = × Rd × (1 - Tc) + × Rps + × Re = 0.5 × 8% × (1 - 0.30) + 0.0909 × 11% + 0.40909 × 14% =

9.53%.

23) Alex's Sporting Goods is the only official supplier of soccer balls for games and practices at all levels
of play in the Northwest region. It expects to sell 150,000 soccer balls this year. If carrying costs are $1.50
per soccer ball per year and ordering costs are $93 per order, what is the firm's EOQ for this product?
(Please round your answer to the nearest whole number of balls.)
A) 70 balls
B) 4,313 balls
C) 18,600 balls
D) There is not enough information to answer this question
Answer: B

Explanation: B) EOQ = = = 4,312.77 ≈ 4,313.

24) Ready Tees, an online retailer of t-shirts, orders 100,000 t-shirts per year from its manufacturer. The
carrying cost is $0.10 per shirt per year. The order cost is $500 per order. What is the optimal order
quantity for the t-shirt inventory (rounded to the nearest dollar)?
A) 1,581
B) 8,333
C) 15,841
D) 31,623
Answer: D

Explanation: D) EOQ = = = 31,622.78 ≈ 31,623.