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2021 Corporate Finance M1 Final Exam Correction For Students Final Version
2021 Corporate Finance M1 Final Exam Correction For Students Final Version
2021 Corporate Finance M1 Final Exam Correction For Students Final Version
STUDENT N°:
21_M1_LI_BM_CCO_FIN_644
CORPORATE FINANCE
CORRECTION
DURATION: 2H
INSTRUCTIONS:
DOCUMENT NOT ALLOWED
NON-PROGRAMMABLE CALCULATOR ALLOWED
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Note: The exam has been checked several times so as to avoid any errors or ambiguity. If in doubt, do
not disturb the invigilators. Please wait to see the solution that will be made available on Blackboard
after the exam. If any problem appears, it will be taken into account in the grading process.
Circle the correct answer. 1 answer only is correct for each question. Good answer = 0.5 point ; bad
answer = -0.25 point ; no answer = 0 point.
1) You are considering investing in a retirement fund that requires you to deposit $5,000 per year, and
you want to know how much the fund will be worth when you retire. What financial technique should
you use to calculate this value?
a. Future value of a single payment
b. Future value of an annuity
c. Future Value of a growing annuity
d. Present Value of an annuity
e. Present value of a growing annuity
2) As CFO of your corporation, you would prefer (all else equal) to see the price of your corporation's
bonds:
a. Decrease, indicating that bond investors view your firm as less risky
b. Increase, indicating that bond investors view your firm as more willing to take risks
c. Increase, indicating that bond investors view your firm as less risky
d. Decrease, indicating that bond investors view your firm as more willing to take risks
e. None of the previous answers is correct
a. The rate which the business has to pay to shareholders for the resources they granted.
b. The rate at which a set of cash flows should be discounted to have a zero net present value.
c. The return required by the corporation managers.
d. The rate at which a set of cash flows should be discounted to ensure a positive net present
value.
e. The normal rate of return of a project
4) Assume that you are using the dividend growth model to value stocks. If you expect the market rate
of return to increase across the board on all equity securities, then you should also expect the:
a. market values of all stocks to decrease, all else constant.
b. market values of all stocks to increase, all else constant.
c. dividend growth rates to increase to offset this change.
d. market values of all stocks to remain constant as the dividend growth will offset the increase
in the market rate.
e. None of the previous answers is correct
5) The risk premium in the U.S capital market is computed by ______ the average return for the
investment.
a. subtracting the inflation rate from
b. adding the average return on the U.S. Treasury bill to
c. subtracting the average return on the U.S. Treasury bill from
d. subtracting the average return on long-term government bonds from
e. None of the previous answers is correct
6) You intend to save over the next 5 years the following stream of cash flow?
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Year 1: 100
Year 2: 108
Year 3: 116.64
Year 4: 125.97
Year 5: 136.05
What is the future value of your saving in year 7? The discount rate is 10%.
a. 800.15
b. 834.14
c. 854.15
d. 912.2
e. none of the previous answers
Note: Always give the details of your answers and computations in the dedicated space. Answers with
no proper explanations or computations will not be taken into account.
1) A project conducted by EDHEC corporation will produce cash inflows of $1,750 a year for the next
four years. The project initially costs $10,600 to get started. In year five, the project will be closed and
as a result should produce a cash inflow of $8,500.
a) What is the net present value of this project if the required rate of return is 13.75%?
b) Is the Internal Rate of Return of this project positive? (circle the correct answer)
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a) Compute the profitability index (PI) of the following project assuming a discount rate equal to 8%.
b) Using the Profitability Index rule, should this project be accepted? (circle the correct answer)
3) The proportion of debt in the capital (D/D+E) of EDHEC company is 40%. The cost of equity is 11%.
The debt that has a β of 0.5 is traded in the market with the prevailing risk-free rate of 2% and market
risk premium is 10%. After internal debate between the CEO and EFO, EDHEC company changes its
capital structure so that the new return on equity is now 12%. What is the new debt-equity ratio? We
assume that the new D/E does not influence the beta on debt.
First, the value of debt return is calculated using CAPM. And we have
RD= 2% + 0.5 * 10% = 7%
Then rA = WACC = 0.6(11%) + 0.4(7%) = 9.4%
Since the WACC is unchanged following the change in D/E, the new D/E ratio must satisfy:
𝐷
𝑛𝑒𝑤 𝑟̅𝐸 = 𝑟̅𝐴 + (𝑟̅𝐴 − 𝑟̅𝐷 ) (𝑛𝑒𝑤 )
𝐸
𝐷 12% − 9.4%
⇒ (𝑛𝑒𝑤 ) = = 1.0833
𝐸 9.4% − 2%
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4) Consider two assets A and B and the market portfolio. The standard deviations (σ) of their returns
are respectively σA= 0.02, σB= 0.03 and σM= 0.06. The coefficient of correlation CORR of their returns
are respectively CORR (A,B) = 0.1 CORR(A,M)=0.3 and CORR (B,M)= 0.5. The expected return of asset
B is 10% and the riskless rate is 3%. What is the expected return of the market portfolio?
cov( B, M ) 0.0009
2 = = = 0.25
var ( M ) 0.062
10% - 3%
rm satisfies rB = rf + B (rm − 3%) + 3% = rm = 0.31
10% 0.25
0.25
3%
5. A project has an Internal Rate of Return of 12%. The initial investment is €24,901 and made now.
The cash flows are the following:
Year 1 = €10,000
Year 2 = unknown
Year 3 = €9,000
6. Your parents save a yearly amount of €15,000. They start this saving at your birth until your age of
18. When you are 12 years old, they get for you a winning ticket for a "Win-for-life" lottery which will
give you a never-ending yearly amount of €5,000. What is the PV of this saving at your birth, assuming
that the discount rate is constant over years and equal to 4%? (Round the final sum to the whole
integer).
A B
A 0.49 0.084
B 0.084 0.2025
Solving this system of two equations by substituting wA = 1- wB from (1) in (2), one finds easily:
The variance of our portfolio is obtained by considering the following table that is built based on the
covariance matrix :
The sum of the elements of the table gives the variance of the portfolio i.e. 0.19162 thus the
standard deviation of the return on portfolio is: √0.19162 = 𝟒𝟑. 𝟕𝟕%
8. The beta of an all-equity firm is 1.2. Following a change in its capital structure, the new beta of equity
is 2.2. We know that Debt is equal to 300,000 and that the beta on Debt is 0.2. What is the value of
Equity? (Assume no taxes.)
D
E = A + ( A − D )
E
D
2.2 = 1.2 + (1.2 − 0.2) D = 300,000
300, 000
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9. EDHEC is considering buying super printer to accommodate its students and faculty needs
while at the same time keeping it “green” and efficient as possibly. Two choices are offered.
Printer A costs initially €7,500, has life span of 6 years and has annual maintenance of € 2,500.
At the same time printer B costs € 6,000, has a life span of 4 years and annual maintenance of
€3,000. Consider a discount rate equal to 6%. Compute the equivalent annual cost of each
project and indicate which printer is better to buy.
Your answer:
We have:
NPVA= cost of the first printer =€ 19,793.31
NPVB= cost of the second printer =€ 16,395.32
Then
𝟏𝟗, 𝟕𝟗𝟑. 𝟑𝟏 ∗ 𝟔%
𝑬𝑨𝑪A = = 𝟒, 𝟎𝟐𝟓
𝟏
𝟏−
(𝟏 + 𝟔%)𝟔
𝟏𝟔,𝟑𝟗𝟓.𝟑𝟐 ∗𝟔%
E𝑨𝑪B = 𝟏 = 𝟒, 𝟕𝟑𝟏
𝟏−
(𝟏+𝟔%)𝟒
10) A company intends to start a project which should offer a 9.5% internal rate of return. It has already
issued 4,000,000 shares and it intends to issue bonds for €100,000,000. The current market value of a
share is €80. At this price, a share offers a 12% expected return. Assume that the corporate tax rate is
35%. What is the maximum interest rate paid on bonds for this project to be acceptable?
Your answer (1 point): maximum interest rate paid on bonds = ______________ 2.3077%
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11) A corporation is initially financed solely by stocks which offer a 12% expected return. There is no
tax. It decides to issue debts and to repurchase stocks so that its D/E ratio is 0.2. Investors note the
extra risk and raise their required rate of return on the stocks to 14%. If the debt is risk-free and the
beta of the equity after the refinancing is 1.2, what is the expected return of the market portfolio?
Your answer (2 points): Expected return of the market portfolio = ______________ 12%
So Rf is equal to 2%.
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