Mock Test Solutions

1. Diaz Wizard Store has the following data:

Net Income: $90,000
Sales: $1,500,000
Total Assets: $1,000,000
Total Debt Ratio: 40%
TIE Ratio: 2.0x
Current Ratio: 1.2x

If Diaz could streamline operations, cut expenses and raise net income to $105,000, without
affecting sales or the balance sheet (additional profits will be paid out as dividends), by how much
would its ROE increase?
A. 2 percentage points
B. 2.5 percentage points
C. 3 percentage points
D. 3.5 percentage points
E. 4 percentage points.

SOLUTION:
Total Debt Ratio = 40%
Total Assets = $1,000,000 à Equity = $600,000
ROE = NI/Equity
Current ROE = 90,000/600,000 = 15%
New ROE = $105,000/$600,000 = 17.5%
Change = 17.5% – 15% = 2.5%

2. Sander Inc. and Bruce Corp. each have Total Assets of $500,000 and ROE of 12.5%.
Sander Inc. has half as much Debt but twice as much Sales relative to Bruce Corp.
Sander Inc’s Net Income equals $50,000 and its Total Asset Turnover equals 2x.
What is Bruce Corp’s profit margin?
A. 2.50%
B. 5.00%
C. 7.50%
D. 10.00%
E. 12.50%

SOLUTION:
S’s NI = $50,000
S’s ROE = 12.5% à S’s Equity = $50,000/12.5% = $400,000
à S’s Debt = $500,000 – $400,000 = $100,000
à B’s Debt = $200,000
à B’s Equity = $500,000 – $200,000 = $300,000
S’s Total Asset Turnover (TAT) = 2x
à S’s Sales = $500,000 x 2 = $1,000,000
à B’s Sales = $500,000
B’s NI = $300,000*12.5% = $37,500
à B’s Profit Margin = $37,500/$500,000 = 7.5%
 Camara Company
2021 and 2020 Balance Sheets (in $’000)

2021 2020 2021 2020

Cash 200 150 Accounts Payable 190 170
Accounts Receivable 180 220 Notes Payable 170 180
Inventory 70 60
Total Current Assets 450 430 Total Current 360 350
Liabilities
Long-term Debt 100 90

Common Stock 150 130

Net Fixed Assets 420 390 Retained Earnings 260 250
Total Assets 870 820 Total Liabilities & 870 820
Owners’ Equity

Camara Company
2021 Income Statement (in $’000)

Net Sales 950

Cost of Goods Sold 700
Depreciation Expense 60
EBIT 190
Interest Expense 20
Taxable Income 170
Less: Taxes (40%) 68
Net Income 102

3. What is the Cash Flow From Assets (CFFA) ignoring financing effects for Camara Company in 2021?
A. $144,000
B. $74,000
C. $80,000
D. $84,000
E. $92,000

SOLUTION:

OCF = 𝐸𝐵𝐼𝑇 × (1 − 𝑡! ) + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = $190,000 × (1 − 40%) + $60,000 = $174,000

NCS = 𝐸𝑛𝑑𝑖𝑛𝑔 𝑁𝐹𝐴 − 𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑁𝐹𝐴 + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = $420,000 − $390,000 + $60,000 = $90,000
∆𝑁𝑂𝑊𝐶 = ($450,000 − $190,000) − ($430,000 − $170,000) = $0

CFFA = 𝑂𝐶𝐹 − 𝑁𝐶𝑆 − ∆𝑁𝑂𝑊𝐶 = $174,000 − $90,000 − $0 = $84,000

Check:
Cashflow to Creditors = $20,000 − [($170,000 + $100,000) − ($180,000 + $90,000)] = $20,000
Dividends = $102,000 − ($260,000 − $250,000) = $92,000
Cashflow to Shareholders = $92,000 − ($150,000 − $130,000) = $72,000
Interest Tax Shield = $20,000 × 40% = $8,000

CFFA = $20,000 + $72,000 − $8,000 = $84,000

4. You are given the following cash flow information.
Year Amount
1 to 3 $25,000
4 to 7 $20,000
The appropriate discount rate is 6% for years 1 to 3 and 8% for years 4 to 7.
All payments are received at the end of the year.
How much would you be willing to pay today to receive this cash flow stream?

A. $122,444
B. $133,068
C. $119,411
D. $122,983
E. $119,296

SOLUTION:
Step 1: Find PV3 of 4-year annuity of $20,000 discounted at 8%.
Inputs:
N: 4; I/Y: 8%; PMT: $20,000; cpt PV ➔ $66,242.54

Step 2: Find PV0 of 3-year annuity of $25,000 and a lumpsum of $66,242.54 at Yr 3 @ 6%

Inputs:
N: 3; I/Y: 6%; PMT: –$25,000, FV: –$66,242.54; cpt PV ➔ $122,443.81 ~ $122,444

5. You just took out a $1.5 million mortgage from Bank Sy. This equal monthly instalment amortized
loan will be repaid over 20 years. The interest rate quoted for the loan is 3.6%. How much interest
would you pay in the third month?

A. $8,776.67
B. $4,500.00
C. $4,474.30
D. $4,276.67
E. $13,461.47

SOLUTION:
Step 1: Find the Instalment Amount
Inputs:
PV = 1,500,000; I/Y = 3.6%/12 = 0.3%; N = 20*12 =240; cpt PMT ➔ 8,776.67

Step 2: Use the Amortization Function in Calculator

Inputs:
<2nd> <PV>
P1 = 3 <ENTER> â; P2 = 3 <ENTER> â; INT = -$4,474.30
Alternatively, create the Amortization Table:
Time Starting PMT Interest Paid Principal Ending Principal
Principal Paid
Mth 1 $1,500,000 $8,776.67 = 0.3% x $1,500,000 $4,276.67 = $1,500,000 –
= $4,500 $4,276.67
= $1,495,723.33
Mth 2 $1,495,723.33 $8,776.67 = 0.3% x $1,495,723.33 $4,289.50 = $1,495,723.33 –
= $4,487.17 $4,289.50
= $1,491,433.83
Mth 3 $1,491,433.83 $8,776.67 = 0.3% x $1,491,433.83 …. ….
= $4,474.30

6. At an inflation rate of 3%, the purchasing power of $10 will be cut in half in about 23.45 years. How
long would it take for the purchasing power of $10 to be cut in half if the inflation rate rises to 5%?

A. About 14.21 years

B. About 14.07 years
C. About 39.08 years
D. About 18.67 years
E. About 20.54 years

SOLUTION:
Inputs:
I/Y: 5%; PV: -$10; FV: $20, cpt N ➔ 14.21 years

Alternatively,
10(1 + 0.05)n = 20
n x Ln (1.05) = Ln (2)
à n = Ln (2)/Ln (1.05) = 0.6931/0.0488 = 14.2057 ~ 14.21 years
7. Investment A pays you 8% APR compounded semiannually.
Investment B, of similar risk, compounds monthly.
What quoted rate (APR) would you have to receive from Investment B to make you indifferent
between the two investments?

A. 7.95%
B. 8.09%
C. 8.16%
D. 7.72%
E. 7.87%

SOLUTIONS:
Inputs:
Use the ICONV function in calculator: <2nd> <2>
Find EAR of Investment A:
NOM: 8 â; C/Y: 2 â; EFF cpt ➔ 8.16

Clear the ICONV function: <2nd> <2> <2nd> <CE/C>

Find NOM of Investment B:
EFF: 8.16 â; C/Y: 12 â; NOM cpt ➔ 7.87

Alternatively,
"."$ %
EAR of 1st investment = O1 + P − 1 = 8.16%
%

&'( )%
For 2nd investment, O1 + )%
P − 1 = 8.16%
!
&'(
à1+ )%
= 1.0816!" = 1.006558 à 𝐴𝑃𝑅 = 12 × 0.006558 = 7.87%

8. Kenny is saving towards retirement. His goal is to have $1 million when he retires on 31 Dec 2050.
He started saving on 1 Jan 2019. He saves $1,500 at the beginning of each month into a savings
account that earns 3% APR.
On 15 Dec 2021 (he has already made 36 payments by now), as he was reviewing his finances,
Kenny realized that he did not have enough income to continue saving. He would have to stop
saving temporarily. He will skip making payments from 1 Jan 2022 to 1 Dec 2023 (24 payments).
He believes he can restart his saving on 1 Jan 2024.

How much must Kenny save each month from 1 Jan 2024 (324 payments until 1 Dec 2050) in order
for him to meet his goal?

A. About $1,732
B. About $1,594
C. About $1,683
D. About $1,606
E. About $1,973
SOLUTION:

Change calculator to BEG mode: <2nd> <PMT> <2nd> <ENTER>

Step 1: Find the FV of annuity due for first 36 payments (1 Jan 2019 to 1 Dec 2021)

Inputs:
N: 36; I/Y: 3%/12 = 0.25%; PMT: $1,500, cpt FV ➔ $56,571.92 (as at 31 Dec 2021)

Step 2: Move this cashflow to 31 Dec 2023 (24 periods)

Inputs:
N: 24; I/Y: 3%/12 = 0.25%; PV: $56,571.92, cpt FV ➔ $60,065.63 (as at 31 Dec 2023)

Step 3: Find the required PMT amount (from 1 Jan 2024 to 1 Dec 2050 ➔ 27x12 = 324 payments)

Inputs:
N: 324; I/Y: 3%/12 = 0.25%; PV: –$60,065.63, FV: $1,000,000, cpt PMT ➔ –$1,731.96 ~ –$1,732

9. Which of the following statements below is most correct?

A. Given the same amount for each payment, the same number of payments and the same quoted
interest rate, the present value of an annuity is higher than the present value of an annuity due.
B. Given the same amount for each payment, the same number of payments and the same quoted
interest rate, the future value of an annuity is higher than the future value of an annuity due.
C. Given compounding within the year, the Effective Annual Rate will be higher than the
Annual Percentage Rate.
D. We calculate the monthly Period Rate by dividing the Effective Annual Rate by 12.
E. Receiving $10,000 today is better than receiving $1,000 every end of month for 12 months
given a discount rate of 24% APR.

SOLUTION:
Choice A & B: PV and FV of annuity due is higher than for annuity ➔ incorrect
Choice C: correct
Choice D: We calculate monthly Period Rate by dividing the APR by 12, not the EAR ➔ incorrect
Choice E:
Inputs:
N: 12; I/Y: 24%/12 = 2%; PMT: $1,000; cpt PV ➔ $10,575.34 > $10,000 ➔ incorrect
10. Which of the following statements is most correct?
A. Peter just executed his first purchase of 10 SIA stocks using the Broker App. This is considered a
primary market transaction.
B. Historically, large company stocks have provided the highest returns over the long term.
C. Total Dollar Return is found by subtracting Dividend received from the Capital Gains/Loss.
D. When we combine stocks together into a portfolio, the amount of risk that remains
depends upon the degree to which the stocks included share common risk.
E. The Geometric Average Return is as great or greater than the Arithmetic Average Return.

SOLUTION:
Choice A: Primary market transaction is when a private company first issues stocks to the public.
Choice B: Historically, small company stocks have provided the highest returns over the long term.
Choice C: Total Dollar Return = Dividend + Capital Gains/Loss
Choice D: correct
Choice E: Geometric Average Return is as small or smaller than the Arithmetic Average Return.

11. You have been provided the following information regarding the expected state of the economy and
the respective returns of Barnes stock.
State of Economy Probability Return of Barnes stock
Recession 40% 32%
Normal 30% 14%
Boom 30% –20%
What is the standard deviation of returns for Barnes stock?

A. 4.7%
B. 21.6%
C. 11.0%
D. 15.8%
E. 26.9%

SOLUTION:
Step 1: Find the Expected Return
𝑟̂ = 40% × 32% + 30% × 14% + 30% × −20% = 11%

Step 2: Find the squared deviation from mean

State of Economy Probability Return of Barnes stock Squared Deviation from Mean
Recession 40% 32% = (32% − 11%)% = 0.0441
Normal 30% 14% = (14% − 11%)% = 0.0009
Boom 30% –20% = (−20% − 11%)% = 0.0961

Step 3: Find Standard Deviation using formula

𝜎 = VW 𝑃* (𝑟 − 𝑟̂ )% = X(40% × 0.0441) + (30% × 0.0009) + (30% × 0.0961) = 0.2162 = 21.6%

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12. The Expected Return of Portfolio X is 15% and the Standard Deviation of returns is 25%. Assuming
returns are normally distributed, which of the following statements below is correct?
A. The probability of obtaining a return that is greater than 65% is only 2.5%.
B. The probability of obtaining a return that is less than –35% is only 0.5%.
C. The probability of obtaining a return between –10% and 40% is 95%.
D. The probability of losing half my investment is more than 2.5%.
E. None of the above statements are correct.

SOLUTION:

2.5% 2.5%

0.5% 0.5%

–60% –35% –10% 15% 40% 65% 90%

13. Ms. Chan bought an investment at the end of 2018 and held it for 3 years. The following table shows
the end-of-year stock prices and dividends paid.
End of Year Price Dividends
2018 $100
2019 $110 $6.00
2020 $98 $1.00
2021 $85 $0.75
What is the Geometric Average Return for Ms. Chan’s investment?

A. –2.17%
B. –8.65%
C. 4.33%
D. –2.97%
E. 3.24%

SOLUTION:
End of Year Price Dividends Annual Return
2018 $100
[($110 − $100) + $6]
2019 $110 $6.00 = = 0.16
$100
[($98 − $110) + $1]
2020 $98 $1.00 = = −0.10
$110
[($85 − $98) + $0.75]
2021 $85 $0.75 = = −0.125
$98
)
𝑟. = [(1 + 0.16)(1 − 0.10)(1 − 0.125)]+ − 1 = −2.97%
14. Which of the following statements is most correct?
A. The slope of the Security Market Line decreases when investors become more risk averse.
B. If the risk-free rate increases, the market risk premium will remain the same.
C. When the beta of a stock doubles, its required return will also double.
D. The Capital Market Line shows the required return of all assets and portfolios.
E. A portfolio that provides the greatest standard deviation of return for a given level of expected
return is called an efficient portfolio.

SOLUTION:
Choice A – the slope of the SML increases when investors become more risk-averse
Choice B – correct. When risk-free rate increases, the slope of the SML remains the same. The SML translates
upwards.
Choice C – required return is 𝑟! = 𝑟" + 𝛽(𝑟# − 𝑟" ). When beta doubles, the required return does not double.
Choice D – The CML shows combinations of the risk-free asset and the market portfolio. It does not show
“all” assets and portfolios.
Choice E – the efficient portfolio is the one that provides the greatest expected return for a given level of
standard deviation of returns.

15. The Crouch Fund consists of 4 stocks with the breakdown as follows:
Purchase Market
Stock Number of shares Price Price Beta
A 2,000 $45 $50 1.5
B 2,000 $110 $100 1.2
C 4,000 $60 $75 0.7
D 5,000 $90 $80 0.9
The risk-free rate of return is 1% and the Market risk premium is 11%.
What is the required return for the Crouch Fund?
A. 10.60%
B. 11.56%
C. 12.83%
D. 11.75%
E. 11.69%

SOLUTION:
Step 1: Find the weights of the stocks in the fund

Stock Number of shares Market Price Market Value Weights

A 2,000 $50 $100,000 $100,000
= = 0.1
$1,000,000
B 2,000 $100 $200,000 $200,000
= = 0.2
$1,000,000
C 4,000 $75 $300,000 $300,000
= = 0.3
$1,000,000
D 5,000 $80 $400,000 $400,000
= = 0.4
$1,000,000
TOTAL $1,000,000
Step 2: Find the Beta for Crouch Fund
𝛽/ = 0.1 × 1.5 + 0.2 × 1.2 + 0.3 × 0.7 + 0.4 × 0.9 = 0.96

Step 3: Calculate the Required Return using CAPM

𝑟! = 1% + 0.96 × 11% = 11.56%

16. Stock A and Stock B both have an expected return of 10% and a standard deviation of returns of
25%. Stock A has a beta of 1.3 and Stock B has a beta of 1.9.
Portfolio P is a portfolio with 50% invested in Stock A and 50% invested in Stock B.
Portfolio P has a standard deviation of returns of 21%.
Which of the following statement/s is correct?
I. Portfolio P has a coefficient of variation of 0.84.
II. The correlation coefficient of returns between Stock A and Stock B is less than 1.
III. Both Stocks A and B are in equilibrium.
IV. Portfolio P has a beta of 1.6.

A. I and II only.
B. II and III only.
C. II and IV only.
D. II, III and IV only.
E. I, II and IV only.

SOLUTION:
0 %)%
Statement I – the CV of Portfolio P is 𝐶𝑉 = 1̂ = )"% = 2.1
Statement II – since the standard deviation of returns of Portfolio P is less than the individual
components, Stock A and B, this must mean that 𝜌 < 1
Statement III – Insufficient information to know if the stocks are in equilibrium
Statement IV – Portfolio beta is 𝑤& 𝛽& + 𝑤4 𝛽4 = 0.5(1.3) + 0.5(1.9) = 1.6

17. Which of the following is the best example of a systematic risk factor?
A. Employment taxes are increased for high-earning foreign workers.
B. A flood washes away a company’ warehouse.
C. A pharmaceutical company recalls it’s top-selling drug due to contamination.
D. Companies that use Delivery firm XYZ are faced with supply backlog as Delivery firm XYZ faces
financial distress.
E. A new variant of the Covid-19 virus that is resistant to all current vaccines is discovered.

SOLUTION:
Choice A – only companies that employ high-earning foreign workers are impacted
Choice B – only the company is impacted
Choice C – only the pharmaceutical company is impacted
Choice D – only companies that use Delivery firm XYZ are impacted
Choice E – everyone and all companies are affected in some way
18. Which of the following is not an example of Agency Costs?
A. Offering the CEO a basic salary that is above the market average.
B. Provision of additional perks such as transport allowances, children’s education reimbursement
and free gym memberships.
C. Paying a Big-4 auditor to perform annual reviews
D. Management’s unwillingness to embark on a project that would have added value to the firm in
the long run because of the increased workload.
E. None of the above, i.e. all of the above are examples of Agency Costs.

19. You have collected the following sample historical returns of Alonso Corp and Maxi Inc.
Year Return on Alonso Corp. Return on Maxi Inc.
2019 16% 27%
2020 –10% –15%
2021 24% 30%
What is the covariance of returns for Alonso Corp. and Maxi Inc.?

A. 0.0324
B. 0.0441
C. 0.0265
D. 0.0613
E. 0.0576

SOLUTION:

Step 1: Calculate the expected returns for Alonso Corp. and Maxi Inc.
0.16 − 0.1 + 0.24
𝐸(𝑟5 ) = = 0.1
3
0.27 − 0.15 + 0.3
𝐸(𝑟6 ) = = 0.14
3

Step 2: Calculate the Covariance

(0.16 − 0.1)(0.27 − 0.14) + (−0.1 − 0.1)(−0.15 − 0.14) + (0.24 − 0.1)(0.3 − 0.14)
𝜎56 = = 0.0441
2

20. Managing the amount of inventory in the warehouse is an example of:

A. Capital Budgeting decisions

B. Capital Structure decisions
C. Net Working Capital Management decisions
D. Agency Problems
E. Agency Costs