Undergraduate year 3 CORPORATE FINANCE L1085 Sample exam paper 201314 With answers This exam paper is divided

into three parts: Part A: multiple-choice questions (answer sheet on page 2) Part B: calculation questions Part C: questions requiring short written answers You are advised to spend approximately 45 minutes on Part A, 55 minutes on Part B and 80 minutes on Part C. These times are proportional to the marks available. Time allowed: 3 hours University approved calculators are permitted A formula sheet is provided

CORPORATE FINANCE Answer sheet for multiple-choice questions in Part A Student number_____________________ Question 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Answer A A A A A A A A A A A A A A A A A A A A A A A A A A Answer B B B B B B B B B B B B B B B B B B B B B B B B B B Answer C C C C C C C C C C C C C C C C C C C C C C C C C C Answer D D D D D D D D D D D D D D D D D D D D D D D D D D

Circle the answer you think is correct

Part A: Multiple-choice questions Attempt all 25 questions; one mark for each correct answer This part carries 25 marks; there are no penalty marks 1. When a corporation fails, the maximum that can be lost by an investor protected by limited liability is: A. the amount of the initial investment. B. the amount of the profit on the investment. C. the amount necessary to pay the corporation's debts. D. the amount of the investor's personal wealth. 2. Profit maximization is not a well-defined corporate objective because: A. it leaves open the question of which year's profits are to be maximised. B. higher profits do not necessarily mean a better rate of return on capital. C. profit can be changed by using different accounting rules. D. all of these. 3. How much more is a perpetuity of $1,000 worth than an annuity of the same amount for 20 years? Assume a 10% interest rate and end-period cash flows. A. $297.29 B. $1,486.44 C. $1,635.08 D. $2,000.00 4. $50,000 is borrowed, to be repaid in three equal, annual payments with 10% interest. Approximately how much principal is amortized with the first payment? A. $2,010.60 B. $5,000.00 C. $15,105.74 D. $20,105.74 5. The discount rate that makes the present value of a bond's payments equal to its price is termed the ... A. ... rate of return. B. ... yield to maturity. C. ... current yield. D. ... coupon rate. 6. How much does the $1,000 face value to be received upon a bond's maturity in 4 years time contribute to the bond's current price if the yield to maturity is 6%? A. $209.91 B. $260.00 C. $760.00 D. $792.09

7. What stock price reaction would you expect from a firm that unexpectedly raises its dividend (apparently permanently) and by a substantial amount? A. Price should rise, given dividend discount models. B. Price should decline, given discounted cash flow analysis. C. Price will remain constant, due to market efficiency. D. Price will remain constant, due to random-walk behavior. 8. What rate of return is expected from a stock that sells for $30 per share, pays $1.50 annually in dividends, and is expected to sell for $33 per share in one year? A. 5.00% B. 10.00% C. 14.09% D. 15.00% 9. What is the approximate maximum amount that a firm should consider paying for a project that will return $15,000 annually for 5 years if the opportunity cost of capital is 10%? A. $33,520 B. $56,860 C. $62,540 D. $75,000 10. The net present value (NPV) of an investment made today is $10,000. If postponed for one year, the investments NPV will increase by $1,000. Which of the following statements is correct if the opportunity cost of capital is 12%? A. Postpone the project because NPV is increasing as time passes B. Postpone the project because the growth rate of NPV exceeds the opportunity cost C. Invest in the project now because NPV does not grow at a sufficient rate D. Invest in the project now because you should always accept positive NPV projects immediately 11. When is it appropriate to include sunk costs in the evaluation of a project? A. Include sunk costs when they are relatively large. B. Include sunk costs if they improve the project's NPV. C. Include sunk costs if they are considered to be overhead costs. D. It is never appropriate to include sunk costs. 12. Which of the following statements is correct when Treasury bills yield 7.5% and the market risk premium is 9.5%? A. The S&P 500 is expected to yield about 8.50%. B. The S&P 500 is expected to yield about 9.50%. C. The S&P 500 is expected to yield about 12.68%. D. The S&P 500 is expected to yield about 17.00%.

13. The CAPM provides a model of determining expected security returns that is ... A. ... precise in its calculations of risk premiums. B. ... imprecise, but it is an acceptable guideline. C. ... excellent for high beta stocks. D. ... excellent for well-diversified companies 14. According to the pecking order theory which of the following lists presents the correct order of financing from the most preferred method of financing to the least preferred method? A. Debt issue, stock issue, internally generated funds B. Internally generated funds, debt issue, stock issue C. Stock issue, internally generated funds, debt issue D. Internally generated funds, stock issue, debt issue 15. A firm is said to be smoothing dividends if dividends ... A. ... are paid through an automatic dividend reinvestment plan. B. ... change more slowly than changes in earnings. C. ... increase by the same dollar amount each year. D. ... are paid only in even dollar amounts. 16. What is the expected return on equity for a firm with a 15% return on assets, a 10% return on debt, and a 0.75 debt-equity ratio? A. 18.75% B. 20.00% C. 23.75% D. 26.25% 17. What price would you expect to pay for a stock with 13% required rate of return, 4% rate of dividend growth, and an annual dividend of $2.50 which will be paid tomorrow? A. $27.78 B. $30.28 C. $31.10 D. $31.39 18. Which of the following changes will decrease the value of a call option? A. An increase in stock price B. An increase in strike price C. An increase in stock price volatility D. An increase in interest rates 19. What is the value of a convertible bond with a conversion ratio of 25, face value of $1,000, coupon of 10% and yield of 10%? The common stock of this firm is currently selling at $35. A. $875 B. $1,000 C. $1,125 D. $1,875

20. The main purpose of contracting to purchase foreign currency in the forward market is to ... A. ... earn a premium (interest) on the currency. B. ... lock into a price now. C. ... take advantage of future price reductions. D. ... avoid the more expensive spot rates. 21. Why might an individual or organization be willing to swap fixed-rate interest for floating-rate interest? A. They may perceive that interest rates are about to increase. B. Their cash flows may vary directly with interest rates. C. Floating rates are not lower than fixed rates. D. They may be able to postpone the payment of principal. 22. Which of the following futures contract holders is speculating? A. A wheat farmer who sells wheat futures B. A cattle farmer who buys live cattle futures C. A candy maker who buys sugar futures D. An oil-producer who sells crude oil futures 23. The seller of a pork bellies futures contract at $0.41 per pound notes that todays closing price of pork bellies is $0.44. What happens to this contract (which requires the delivery of 40,000 pork bellies at expiration)? A. A loss of $400 is posted to the account. B. A gain of $400 is posted to the account. C. A loss of $1,200 is posted to the account. D. A gain of $1,200 is posted to the account. 24. A merger is expected to produce cost savings of $50 million and the acquired firm's shareholders will receive a premium of 20% over the $150 million value of their firm. The acquirers gain from the merger is: A. $20 million. B. $30 million. C. $50 million. D. $130 million. 25. The cost of a merger may outweigh the potential gain if the ... A. ... present value of the acquired firm exceeds the price paid for it. B. ... present value of the merged firms is greater than the sum of their individual values. C. ... merger allows cost savings to occur. D. ... acquired firm's shareholders receive more than the value of their firm.

Part B: Calculation questions Attempt six questions from ten; each question carries five marks. This part carries 30 marks. Show your working. Mark allocation for each calculation question: 2 marks for each correct answer and 3 marks for working or explanation. 26. In 2010 motorists in the UK were upset because the price of unleaded petrol climbed to 1.50 per litre. Motorists looked back to 20 years earlier when they were paying just 0.88 per litre. How much did the real price of petrol change over this period, given that the consumer price index was 1.81 in 2010 compared with 100 in 1990? 27. You have two bonds: a 5-year and a 10-year bond, each with a 7% coupon. Both bonds currently sell at par. How much will the price of each bond change if interest rates increase to 8%? Explain the difference between the two price changes. 28. You can continue to use an old, inefficient machine at a cost of $8,000 annually for the next 5 years. Alternatively, you can purchase a new, more efficient machine for $12,000 plus $5,000 annual maintenance. Which machine will you use, given a cost of capital of 15%? 29. How does an increase of $25,000 in net working capital affect the NPV of a 5-year project when the firm has a 15% cost of capital? 30. An investment today of $25,000 promises to return $15,000 annually for the next 2 years. What is the real rate of return on this investment if inflation averages 6% per year during the period? 31. Calculate the risk premium on stock C given the following information: risk-free rate = 5%, market return = 13%, stock C beta = 1.3. 32. What is the weighted average cost of capital (WACC) for a firm using 55% equity with a required return of 15%, 35% debt with a required return of 8%, 10% preferred stock with a required return of 10%, and a tax rate of 35%? 33. A firm is considering a project that will generate perpetual cash flows of $50,000 per year beginning next year. The project has the same risk as the firm's overall operations. If the firm's WACC is 12.0%, and its debt-to-equity ratio is 1.33, what is the most it could pay for the project and still earn its required rate of return? 34. Calculate the company cost of capital for a firm with a 65/35 debt/equity split, an 8% cost of debt, a 15% cost of equity, and a 35% tax rate.

35. You are given the following data: expiration = 6 months; stock price = $60; exercise price = $65; call option price = $3; risk-free rate = 5% per year. Calculate the price of the put option using put-call parity. Part C: short answer questions; this part carries 45 marks Answer three questions from five; each question carries 15 marks 36. How do corporations ensure that managers' and stockholders' interests coincide? 37. How should we compare interest rates quoted over different time intervalsfor example, monthly versus annual rates? 38. How can an analyst feel comfortable in stating that the value of a stock is equal to the discounted value of all future dividends when a company may pay dividends indefinitely and it is virtually impossible to predict dividends beyond some time horizon? 39. Compare and contrast share repurchases with dividend payouts as means of returning cash to investors. 40. Why are bondholders willing to pay more for bonds with warrants attached (a warrant being a security that entitles the holder to buy the underlying stock of the issuing company at a fixed exercise price until the expiry date)?