Finc201_Spring10_Quiz1 Quiz 1_Solutions

New York Institute of Technology

Nanjing Campus

FINC 201 - Corporate Finance

Spring 2010

Quiz No. 1

Name: ________________________

Class: ________________________

NYIT ID #: ____________________

Section A: (20 Questions

–

40 points)

CIRCLE the letter of the one correct answer ONLY. Do NOT write any letters anywhere in

this section!

1.

A ________, is when a rich individual or organization purchases a large fraction of the

stock of a poorly performing firm and in doing so gets enough votes to replace the board

of directors and the CEO.

A.

shareholder proposal

B.

leveraged buyout

C.

shareholder action

D.

hostile takeover

2.

You own 100 shares of a

taxes. Once the corporation has paid any corporate taxes that are due, it will distribute the

rest of its earnings to its shareholders in the form of a dividend. If the corporate tax rate

is 40% and your personal tax rate on (both dividend and non-dividend) income is 30%,

then how much money is left for you after all taxes have been paid?

A.

$$210

B.

$$300

C.

$$350

D.

$$500

EPS

×

number of shares

×

(1

-

Corporate Tax Rate)

×

(1

-

Individual Tax Rate)

$$5.00 per share ×

100 shares ×

(1 - .40) x (1 - .30) = $$210

3. Which of the following statements is false?

A. In bankruptcy, management is given the opportunity to reorganize the firm and

renegotiate with debt holders.

B.

Because a corporation is a separate legal entity, when it fails to repay its debts, the people

who lent to the firm, the debt holders are entitled to seize the assets of the corporation in

compensation for the default.

C. As long as the corporation can satisfy the claims of the debt holders, ownership remains in

the hands of the equity holders

D.

If the corporation fails to satisfy debt holders' claims, debt holders may lose control

of the firm.

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4.

Which of the following is not a financial statement that every public company is required

to produce?

A.

Income Statement

B.

Statement of Sources and Uses of Cash

C.

Balance Sheet

D.

Statement of Stockholders' Equity

5.

Which of the following is not an operating expense?

A.

Interest expense

B.

Depreciation and amortization

C.

Selling, general and administrative expenses

D.

Research and development

6. Which of the following adjustments to net income is not correct if you are trying to

calculate cash flow from operating activities?

A.

Add increases in accounts payable

B.

Add back depreciation

C.

Add increases in accounts receivable

D.

Deduct increases in inventory

7.

If the risk-free rate of interest (

r

f

) is 6%, then you should be indifferent between receiving

$$250 in one year or:

A.

$$235.85 today

B.

$$250.00 today

C.

$$265.00 today

D.

$$270.00 today

Benefit = $$250.00 / ($$1.06 in one year / $$1.00 today) = $$235.85

8.

Which of the following statements regarding Net Present Value (NPV) is incorrect?

A.

The NPV represents the value of the project in terms of cash today.

B.

Good projects will have a positive NPV.

C.

The NPV of a project is the difference between the present value of its benefits and the

present value of its costs.

D.

When faced with a set of alternatives, choose the one with the lowest NPV in order

to minimize the preset value of costs.

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9.

You are offered an investment opportunity in which you will receive $$23,750 today in

exchange for paying $$25,000 in one year. Suppose the risk- free interest rate is 6% per

year. Should you take this project? The NPV for this project is closest to:

A.

Yes; NPV = $$165

B.

No; NPV = $$165

C.

Yes; NPV = -$$165

D.

No; NPV = -$$165

NPV

= 23,750 - 25,000/(1.06) = 165, since NPV > 0 accept the project

10. Which of the following statements regarding arbitrage is the most correct?

A. Any situation in which it is possible to make a profit without taking any risk is known as

an arbitrage opportunity.

B. Any situation in which it is possible to make a profit without making any investment is

known as an arbitrage opportunity.

C. We call a competitive market in which there are no arbitrage opportunities an arbitrage

market.

D.

The practice of buying and selling equivalent goods in different markets to take

advantage of a price difference is known as arbitrage.

11. Consider the following prices from a McDonald's Restaurant:

Big Mac Sandwich

Large Coke

Large Fry

$$2.99

$$1.39

$$1.09

A McDonald's Big Mac value meal consists of a Big Mac Sandwich, Large Coke, and a

Large Fry. Assuming that there is a competitive market for McDonald's food items, at

what price must a Big Mac value meal sell to insure the absence of an arbitrage

opportunity and uphold the law of one price?

A. $$4.08

B. $$4.38

C.

$$5.47

D. $$5.77

2.99 + 1.39 + 1.09 = 5.47

12. A McDonald's Big Mac value meal consists of a Big Mac Sandwich, Large Coke, and a

Large Fry. Assume that there is a competitive market for McDonald's food items and that

McDonalds sells the Big Mac value meal for $$4.79. Does an arbitrage opportunity exists

and if so how would you exploit it and how much would you make on one extra value

meal?

A.

Yes, buy extra value meal and then sell Big Mac, Coke, and Fries to make arbitrage

profit of $$0.68

B. No, no arbitrage opportunity exists

C.

Yes, buy Big Mac, Coke, and Fries then sell value meal to make arbitrage profit of $$1.09

D.

Yes, buy Big Mac, Coke, and Fries then sell value meal to make arbitrage profit of $$0.68

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Buy value meal and sell Big Mac, Coke and Fries

-4.79 + 2.99 + 1.39 + 1.09 = 0.68 (so arbitrage exists)

13.

Suppose a security with a risk-free cash flow of $$1,000 in one year trades for $$909 today.

If there are no arbitrage opportunities, then the current risk-free interest rate is closest to:

A.

8%

B.

10%

C.

11%

D.

12%

PV

=

FV

/ (1 + i) ==>>> (1 + i) =

FV

/

PV

= $$1000 / $$909 = 1.10 so i = 10%

14.

Which of the following statements is false?

A.

The process of moving a value or cash flow forward in time is known as compounding.

B.

The effect of earning interest on interest is known as compound interest.

C.

It is only possible to compare or combine values at the same point in time.

D.

A dollar in the future is worth more than a dollar today

.

15. It has long been told that the Dutch purchased Manhattan island in 1626 for the value of

60 guilders ($$24). Assuming that the Dutch invested this money into an account earning

5%, approximately how much would their investment be worth 380 years later in 2006?

A.

$$2.7 billion

B.

$$3.1 billion

C.

$$4.5 billion

D.

$$1.9 trillion

FV

= 24(1.05)

380

= 2,704,860,602 or 2.7 billion

16. You are considering investing in a security that will pay you $$80 in interest at the end of

each of the next 10 years. If this security is currently selling for $$588.81, then the IRR for

investing in this security is closest to:

A.

6.0%

B.

7.0%

C.

6.5%

D.

5.0%

PV

=

-

588.81

PMT

=

80

N

=

10

FV

=

0

Compute

I

= 5.99989

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17.

You are saving for retirement. To live comfortably, you decide that you will need $$2.5

million dollars by the time you are 65. If today is your 30th birthday, and you decide,

starting today, and on every birthday up to and including your 65th birthday, that you will

deposit the same amount into your savings account. Assuming the interest rate is 5%, the

amount that you must set aside each and every year on your birthday is closest to:

A.

$$71,430

B.

$$27,680

C.

$$26,100

D.

$$26,260

PV

(age 29)

=

2500000 / (1.05)

36

=

431643.54

PV

=

431,643.54

FV

=

0

I

=

5

N

=

36

Compute

PMT

= $$26,086

18. Your son is about to start kindergarten in a private school. Currently, the tuition is

$$12,000 per year, payable at the start of the school year. You expect annual tuition

increases to average 6% per year over the next 13 years. Assuming that you son remains

in this private school through high school and that your current interest rate is 7%, then

the present value of your son's private school education is closest to:

A.

$$332,300

B.

$$137,900

C.

$$155,800

D.

$$156,000

?

?

1

?

.06

?

1

?

1

?

< br>?

$$12,000 ×

.0 7

?

.06

?

?

1

?

.07

?

?

?

13

?

?

= $$137,893

?

?

19. If the current inflation rate is 5%, then the nominal rate necessary for you to earn an 8%

real interest rate on your investment is closest to:

A.

13.0%

B.

13.4%

C.

4.9%

D.

3.0%

nominal

= (1 +

inflation

)(1 +

real

) - 1 = (1.05)(1.08) - 1 = .134 or 13.4%

20. Consider an investment that pays $$1000 certain at the end of each of the next four years.

If the investment costs $$3,500 and has an NPV of $$74.26, then the four year risk-free

interest rate is closest to:

A.

4.5%

B.

4.58%

C.

4.55%

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D.

4.53%

NPV

=

74.26

=

-

3500

+

1000 / (1.05)

1

+

1000 / (1.048)

2

+

1000 / (1.046)

3

+

1000 / (1

+

x)

4

3574.26

-

1000 / (1.05)

1

+

1000 / (1.048)

2

+

1000 / (1.046)

3

=

1000 / (1

+

x)

4

837.60 = 1000 / (1 +

X

)

4

==>> (1 +

X

)

4

= 1000 / 837.60 ==>>

X

= .0453 or 4.53%

Bonus Question:

21.

Which of the following statements is false?

A.

If there is a fixed supply of resource available, you should rank projects by the

profitability index, selecting the project with the lowest profitability index first and

working your way down the list until the resource is consumed.

B.

Practitioners often use the profitability index to identify the optimal combination of

projects when there is a fixed supply of resources.

C.

If there is a fixed supply of resources available, so that you cannot undertake all possible

opportunities, then simply picking the highest NPV opportunity might not lead to the best

decision.

D.

The profitability index is calculated as the NPV divided by the resources consumed by

the project.

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