Corporate Finance

BMS5311
Dr. Emir Hrnjić

TEST 1

han Chu
Ming
NAME _____________________________

A0289187H
STUDENT ID NUMBER_____________________

Rules and directions:

❑ Read questions carefully and answer all parts of the question to the best of your
ability.
❑ Circle only one (the best) MCQ answer.
❑ Only one person may use the restroom at a time.
❑ You may not share anything - calculators, pens, formula sheets, etc.
❑ Turn your cell phones off.

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 A. PROBLEMS:

TIME VALUE OF MONEY (12 pts)

1) You are planning to save for retirement over the next 25 years. To do this, you will
invest $300 a month in a stock account and $200 a month in a bond account. The
return of the stock account is expected to be 10 percent, and the bond account will
pay 3 percent. When you retire, you will combine your money into an account with
a 6 percent return. How much can you withdraw each month from your account
assuming a 25-year withdrawal period?

FUstock
Monthlyreturn 10 i12 0.008333

Investment 25x12 300

period

FUstock 300X
了
8 398050，02

FU Bond

Monthlyreturn 0.03个 12 0.0025

FUbond 200X
告咒 了 89201，56

FU combined FUstockt FUbond 487251158

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Withdraw

Monthly return i 0，06个12 0，005

PMT 3139.3T

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 CAPM (11 pts)

2) A stock S has a beta of 1.4 and an expected return of 14%. A risk-free asset (RF)
currently earns 2%.

a. If a portfolio of the two assets (S and RF) has a beta of 1.2, what are the portfolio
weights?
b. If a portfolio of the two assets (S and RF) has an expected return of 18%, what is its
beta?

a
βs 1.4
βPEWS'βstβrfwrf
Prfo 1 2 ⼆ W.sk4

βp 1，2 Ws 01857

Wrf 1 Ws 0.143

b ER 14

2
Rrf
Erp 18
0118 Ws 0114⼗ 1 Wsl 0102
Ws 1.33 leveraging
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βp Ws.β 1133x114 1.86

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 CAPITAL BUDGETING (12 pts)

3) Consider the following projects:

Cash Flows ($)

Project C0 C1 C2 C3 C4 C5
A -1,000 2,000 0 0 0 0
B -2,000 1,000 1,000 1,000 1,000 1,000
C -1,000 1,000 0 0 0 1,000

a. If the opportunity cost of capital is 20%, which projects have a positive NPV?
b. If you only have $3,000 to invest, which projects would you invest in?
⼭
NPVA 1000 666，67
4
NPUB
器 器 器 器 器 1 4
2000

990.61

NPV c
器 1000 235.21

2
invest
A B

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 B. MULTIPLE CHOICE:
Circle the letter in front of the best answer to each question. (5 points each)

A 1) You just inherited a trust that will pay you $100,000 per year in perpetuity. However,
the first payment will not occur for exactly four more years. Assuming a 10 percent
annual interest rate, what is the value of this trust?

A) $683,013
B) $900,000
C) $1,000,000
D) $1,100,000
E) $751,315

2) You need a 20-year, fixed-rate mortgage to buy a new home for $100,000. Your
E mortgage bank will lend you the money at a 6 percent APR for this loan and you can
afford monthly payments of up to $1,000. Your uncle has offered to help you out by
paying off the difference [between what you can afford and what you will have to pay
under the requirements of the loan repayment] at the beginning of the loan in the form
of a single payment. How large will this payment have to be?

a) $39,580
b) $0
c) $362,040.89
d) $100,000
e) Not enough information to answer the question.

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E
3) Consider the following information for three stocks, A, B, and C. The returns on the
stocks are positively but not perfectly correlated with one another, i.e., the correlation
coefficients are all between 0 and 1.

Expected Standard
Stock Return Deviation Beta
Stock A 10% 20% 1.0
Stock B 10% 20% 1.0
Stock C 12% 20% 1.4

Portfolio AB has half of its funds invested in Stock A and half invested in Stock B.
Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free
rate is 5%, and the market is in equilibrium, so required returns equal expected returns.
Which of the following statements is CORRECT?

a) Portfolio AB's coefficient of variation is greater than 2.0.

b) Portfolio ABC has a standard deviation of 20%.
c) Portfolio AB has a standard deviation of 20%.
d) Portfolio AB's required return is greater than the required return on Stock A.
e) Portfolio ABC's expected return is 10.67%.

C
4) The covariance between Amazon stock and the S&P 500 is 0.05. The standard
deviation of the stock market is 20%. What is the beta of Amazon?

A) 0.00
B) 1.00
C) 1.25
D) 1.42
E) None of the above.

5) Assume the following data for a stock: Beta = 1.5; risk-free rate = 4 percent; market

B rate of return = 12 percent; and expected rate of return on the stock = 15 percent.
Then the stock is

A) overpriced.
B) underpriced.
C) correctly priced.
D) cannot be determined.
E) All of the above.

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 6) If the standard deviation of returns on the market is 20 percent, and the beta of a well-

E diversified portfolio is 1.5, calculate the standard deviation of this portfolio.

A) 30 percent.
B) 20 percent.
C) 15 percent.
D) 10 percent.
E) None of the above.

7) The historical returns for the past three years for Stock B and the stock market
E portfolio are Stock B: 24 percent, 0 percent, 24 percent; market portfolio: 10 percent,
12 percent, 20 percent. Calculate the beta for Stock B.

A) 0.86
B) 1.00
C) 1.13
D) 1.17
E) None of the above

A
8) The market value of XYZ Corporation's common stock is $40 million and the market
value of its risk-free debt is $60 million. The beta of the company's common stock is
0.8 and the expected market risk premium is 10 percent. If the Treasury bill rate is 6
percent, what is the firm's cost of capital? (Assume no taxes.)

A) 9.2 percent
B) 14.0 percent
C) 8.1 percent
D) 10.8 percent
E) 12 percent

9) For project A in year 2, inventories increase by $12,000 and accounts payable

D increase by $2,000. Accounts receivable remain the same. Calculate the increase or
decrease in net working capital for year 2.

A) Decreases by $14,000
B) Increases by $14,000
C) Decreases by $10,000
D) Increases by $10,000
E) None of the above.

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 10) Dry-Sand Company is considering investing in a new project. The project will need
an initial investment of $1,200,000 and will generate $600,000 (after-tax) cash flows
for three years. However, at the end of the fourth year, the project will generate -
$500,000 of after-tax cash flow due to dismantling costs. Calculate the MIRR
(modified internal rate of return) for the project if the cost of capital is 15 percent.
The reinvestment rate is 12 percent.

E
A) 10.5 percent
B) 12.6 percent
C) 28.2 percent
D) 20.4 percent
E) 30.5 percent

11) A project requires an investment of $900 today. It can generate sales of $1,100 per
year forever. Costs are $600 for the first year and will increase by 20 percent per year.
(Assume all sales and costs occur at year-end [i.e., costs are $600 @ t = 1].) The
project can be terminated at any time without cost. Ignore taxes and calculate the
NPV of the project at a 12 percent discount rate.

A) $65.00
B) $57.51
C) $100.00
D) $200.00
E) It cannot be calculated as g > r.

C
12) Two machines, A and B, which perform the same functions, have the following costs
and lives.

Type PV (Costs) Life

Machine A $6,000 5
Machine B $8,000 7

Which machine would you choose? The two machines are mutually exclusive and the
cost of capital is 15 percent.

A) Machine A, because the PV is 6,000

B) Machine B, because the PV is 8,000
C) Machine B, because the EAC is $1,922.88
D) Machine B, because it has longer life
E) Machine A, because the EAC is $1,789.89

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c 13) Suppose you have the following investment opportunities, but only $25,000 available
for investment. Which projects should you take?

Project NPV Initial investment

A 10,000 10,000
B 5,000 20,000
C 7,000 35,000
D 15,000 15,000
E 2,000 12,000

A) A only
B) B and D only
C) A and D
D) A, B, and D
E) All of them.

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