FINA1310_2022_D_Corporate Finance_Homework 1 (Individual Assignment)

Each student submits one typed or handwritten solution in PDF format through Moodle
Homework 1 Submission Folder by 11:59 pm on the due date 10th October (Monday).
Please make sure that you type or write your name and UID on the first page of typed or
handwritten answer sheet.

Multiple Choice Questions (15 points)

1. Which of the following individuals have unlimited liability based on their ownership
interest?
I. general partner
II. sole proprietor
III. stockholder
IV. limited partner
A. II only
B. I and II only
C. II and IV only
D. I, II, and III only
E. I, II, and IV only

2. Which of the following apply to a partnership that consists solely of general partners?
I. double taxation of partnership profits
II. limited partnership life
III. active involvement in the firm by all the partners
IV. unlimited personal liability for all partnership debts
A. II only
B. I and II only
C. II and III only
D. I, II, and IV only
E. II, III, and IV only
3. Which of the following are advantages of the corporate form of business ownership?
I. limited liability for firm debt
II. double taxation
III. ability to raise capital
IV. unlimited firm life
A. I and II only
B. III and IV only
C. I, III, and IV only
D. II, III, and IV only
E. I, II, III, and IV

4. Which one of the following statements concerning a sole proprietorship is correct?

A. A sole proprietorship is designed to protect the personal assets of the owner.
B. The profits of a sole proprietorship are subject to double taxation.
C. The owner of a sole proprietorship is personally responsible for all of the company's
debts.
D. The sole proprietorship can continue even after the death of the sole proprietor.
E. A sole proprietorship is structured the same as a limited liability company.

5. Which one of the following is an agency cost?

A. accepting an investment opportunity that will add value to the firm
B. increasing the quarterly dividend
C. investing in a new project that creates firm value
D. hiring outside accountants to audit the company's financial statements
E. closing a division of the firm that is operating at a loss

6. Which one of the following is a primary market transaction?

A. sale of currently outstanding stock by a dealer to an individual investor
B. sale of a new share of stock to an individual investor
C. stock ownership transfer from one shareholder to another shareholder
D. gift of stock from one shareholder to another shareholder
E. gift of stock by a shareholder to a family member.
7. Andy deposited $3,000 this morning into an account that pays 5 percent interest,
compounded annually. Barb also deposited $3,000 this morning into an account that pays
5 percent interest, compounded annually. Andy will withdraw his interest earnings and
spend it as soon as possible. Barb will reinvest her interest earnings into her account.
Given this, which one of the following statements is true?
A. Barb will earn more interest the first year than Andy will.
B. Andy will earn more interest in year three than Barb will.
C. Barb will earn interest on interest.
D. After five years, Andy and Barb will both have earned the same amount of interest.
E. Andy will earn compound interest.

8. Your grandmother has promised to give you $5,000 when you graduate from college. She
is expecting you to graduate two years from now. Given a positive interest rate, what
happens to the present value of this gift if you delay your graduation by one year and
graduate three years from now?
A. remains constant
B. increases
C. decreases
D. becomes negative
E. cannot be determined from the information provided

9. Sue and Neal are twins. Sue invests $5,000 at 7 percent when she is 25 years old. Neal
invests $5,000 at 7 percent when he is 30 years old. Both investments compound interest
annually. Both Sue and Neal retire at age 60. Which one of the following statements is
correct assuming that neither Sue nor Neal has withdrawn any money from their
accounts?
A. Sue will have less money when she retires than Neal.
B. Neal will earn more interest on interest than Sue.
C. Neal will earn more compound interest than Sue.
D. If both Sue and Neal wait to age 70 to retire, then they will have equal amounts of
savings.
E. Sue will have more money than Neal as long as they retire at the same time.
10. Martin invested $1,000 six years ago and expected to have $1,500 today. He has not
added or withdrawn any money from this account since his initial investment. All interest
was reinvested in the account. As it turns out, Martin only has $1,420 in his account
today. Which one of the following must be true?
A. Martin earned simple interest rather than compound interest.
B. Martin earned a lower interest rate than he expected.
C. Martin did not earn any interest on interest as he expected.
D. Martin ignored the Rule of 72 which caused his account to decrease in value.
E. The future value interest factor turned out to be higher than Martin expected.

11. What is the interest rate charged per period multiplied by the number of periods per year
called?
A. effective annual rate
B. annual percentage rate
C. periodic interest rate
D. compound interest rate
E. daily interest rate

12. Which one of the following accurately defines an annuity?

A. a limited number of equal payments paid in even time increments
B. payments of equal amounts that are paid irregularly but indefinitely
C. varying amounts that are paid at even intervals forever
D. unending equal payments paid at equal time intervals
E. unending equal payments paid at either equal or unequal time intervals
13. You are considering two projects with the following cash flows:

Which of the following statements are true concerning these two projects?
I. Both projects have the same future value at the end of year 4, given a positive rate of
return.
II. Both projects have the same future value given a zero rate of return.
III. Project X has a higher present value than Project Y, given a positive discount rate.
IV. Project Y has a higher present value than Project X, given a positive discount rate.
A. II only
B. I and III only
C. II and III only
D. II and IV only
E. I, II, and IV only

14. Which of the following statements related to interest rates are correct?
I. Annual interest rates consider the effect of interest earned on reinvested interest
payments.
II. When comparing loans, you should compare the effective annual rates.
III. Lenders are required by law to disclose the effective annual rate of a loan to
prospective borrowers.
IV. Annual and effective interest rates are equal when interest is compounded annually.
A. I and II only
B. II and III only
C. II and IV only
D. I, II, and III only
E. II, III, and IV only
15. Which one of the following compounding periods will yield the smallest present value
given a stated future value and annual percentage rate?
A. annual
B. semi-annual
C. monthly
D. daily
E. continuous
Calculation Questions-Please show the answers with steps provided (85 points)

1. Alex invested $50,000 in a fixed term deposit account that pays 4.5 percent simple
interest. How much more could he earn over a 20-year period if another bank provides
the same deposit service but with annual compounding? (3 points)

2. Silvia expects to receive $800,000 5 years from now. A bank will provide her a saving
plan at that time with 3% annual interest rate and she wants to grow this amount
to cover the 10% down payment and 5% closing cost of the borrowed amount for a
property that is expected to be value at $9,000,000 in future. How many years will it be
until this occurs from now? (7 points)

3. Metlife is offering a “ML-A” that pays out $5,000 monthly from the end of Apr 2023 to
the end of Dec 2040 with an interest rate 5.4% compounded monthly.

a. Metlife plans to charge $680,000 for any investors buying “ML-A” on Jan 1, 2023,
how much it should be worth on that day and please explain whether “ML-A”
represents a good offer to any investor buying “ML-A” on Jan 1, 2023? (15 points)

b. Now is the first day of October 2022, an investor is planning for retirement at the end
of 2027 (Dec 31) and would like to pay an amount of money equal to the value of
“ML-A” at that time (“ML-A” only pays $5,000 monthly after 2027 to the investor).
He is deciding to save a lump-sum amount today in order to exactly cover the amount
paid at the end of 2027 for “ML-A”, how much he needs to save today with an
interest rate 3.6% compounded monthly? (15 points)

c. An investor buys “ML-A” on Apr 30, 2023 and every time he receives the periodic
payment from it, he will immediately deposit 55% of each periodic payment received
into a saving account offered by DBS with a 4.8% interest rate compounded monthly.
How much will his saving account become at the end of Jan 31, 2041? (10 points)

d. Due to the increase of investors’ awareness of early retirement planning, sales of

“ML-A” is gaining momentum. Metlife is planning to launch another product, “ML-
B”, that starts to pay out every quarter from Mar 2023 to Dec 2040 (e.g. the last day
of Mar, Jun, Sep…) with a rate of return 4% compounded quarterly with a price of
$1,200,000 on Jan 1, 2023. How much should “ML-B” pay out per year? (15 points)
4. There are several investment opportunities available from the following banks:
Bank 1: 1-year term deposit with interest rate 5.08% compounded continuously.
Bank 2: a money market fund invests in short-term money market securities that can pay
5.1% compounded every 2 months.
Bank 3: a saving account with interest rate ties to LIBOR (London Interbank Offered
Rate). LIBORs are 4.8%, 5.2%, 5%, 5.4% compounded quarterly over the past 4
quarters. It is expected that the coming 4 quarters LIBORs will be the same as
the past 4 quarters’ LIBORs.

If the initial investment amount is $100 at the beginning of the years, what will be the
amounts of the above 3 investment opportunities from the 3 different banks become at the
end of the year? What are the EARs of the above investment opportunities? Which one
will you pick based on information available? (10 points)

5. LOX Insurance Co. is selling an insurance policy that pays $3,000 every month forever
with the first payment starting 15 months later from now. The interest rate is 4.8%
compounded monthly. What is value of the insurance policy 2 months later from today?
(10 points)