Final exam

Name _______________________
Multiple Choices (40*2.2=88)
1.

A bond sells for $850 with a 15 year maturity. Pick the correct answer.
a. coupon rate > current yield.
b. current year > yield to maturity
c. yield to maturity > coupon rate
d. current yield = coupon rate

2.

Pick the correct answer.

a. A discount bond, its yield to maturity must be lower than coupon
rate.
b. A discount bond, its yield to maturity = coupon rate.
c. A premium bond, its yield to maturity = coupon rate.
d. Bond is selling at par. So its current yield = yield to maturity.

3.

There are three bonds with ten year maturity, noncallable. All three
bonds YTM are the same because they have the same amount of risk. One
bond A has 8% coupon rate, the other B has 10% and the last one C has
12% coupon rate. Bond B sells at par. Imagine that the interest rate
will be stable in the next ten years, pick the correct answer
a. Bond As current yield tend to escalate annually.
b. Since the bonds have the same YTM, they should all have the same
price, and since interest rates are not expected to change, their
prices should all remain at their current levels until maturity.
c. Bond C sells at a premium, meaning price > par, and price will
escalate annually.
d. Bond A sells at a discount, meaning price<par, and its price will
escalate annually.
Answer: Note that Bond 10 sells at par, so the required return on all these bonds is 10%. 10's price
will remain constant; 8 will sell initially at a discount and will rise, and 12 will sell initially at a
premium and will decline. Note too that since it has larger cash flows from its higher coupons, Bond
12 would be less sensitive to interest rate changes, i.e., it has less price risk. It has more default risk.

4.

Pick the correct answer

a. When Fed increases interest rate unexpected, then bond price tends
to increase.
b. Bond price is approaching par when maturity date approaches, if
bondsYTM remains constant.
c. Bonds are riskier than stocks in general, because bonds are more
unpredictable.
d. Bond investors never suffer any losses.

5.

AAA firm bonds will mature in eight years, and coupon is $65. YTM is
8.2%. Bonds market value?

a.
b.
c.
d.

$903.04
$925.12
$1,048.43
$912.58

N
I/YR
PMT
FV
PV

6.

AAA firms bonds market value is $1,120, with 15 years maturity and
coupon of $85. What is YTM?
a. 6.84%
b. 7.15%
c. 7.17%
d. 7.81%
N
PV
PMT
FV
I/YR

7.

15
$1,120
$85
$1,000
7.17%

AAA firm bonds market value is $1,050, with six years to maturity and
coupon of $75. Current yield?
a. 7.14%
b. 6.50%
c. 6.88%
d. 7.27%
e. 7.68%
PV
PMT
Current yield =

8.

8
8.2%
$65
$1,000
$903.04

$1,050
$75
7.14%

AAA firms semiannual bond has 12 years maturity and coupon rate of
8.75% semiannually. The firm also sells annual bonds with all the same
condition except the coupon is paid annually (means ytm is the same).
What is the price of this annual coupon bond?(hint: the two bonds should
offer the same annual effective rate, not semi-rate * 2) (hard one)
a. $ 1037.56
b. $ 981.60
c. $ 986.25
d. $1,005.91
These two bonds should provide the same EFF%. Therefore, we can find the EFF% for the semiannual
bond and then use it as the YTM for the annual payment bond. At the calculated price, the two bonds will
have YTMs with the same EFF%. Note too that the semiannual payment bond must have a higher price

than the annual bond because then it receives the same cash flow, but faster. Therefore, the annual bond
must sell at a price below the $1,000 par value at which the semiannual bond sells.
Semiannual bond:
Par value
Coupon rate=Nominal rate
Payment per period
Years to maturity
Periods/year
Total periods
EFF% = (1+Nom rate/2) 2 1 =
Price

$1,000
8.75%
$43.75
12
2
24
8.941%
$1,000.00

Annual bond:
Par value
Coupon rate
Pmt/Period
Yrs to maturity
Periods/year
Total periods
EFF% = YTM
Price

$1,000
8.75%
$87.50
12
1
12
8.941%
$986.25

9.

You observed the following information:

Stock list
Standard-deviation

Stock A
20.00%
0.5900
Stock B
10.00%
0.6100
Stock C
12.00%
1.2900
You are a rational investor. You should choose Stock ____ if you have
only one stock and Stock ____ if you have a well diversified portfolio.
a. A. B.
b. A. A.
c. B. A.
d. C. A.

10.

Beta of stock A is 1.5. Pick the correct answer and assume beta of stock
B is 0.5.
a. Stock As return > Stock Bs return
b. Stock Bs return < stock As return
c. Stock As is always more risky than that of B, either hold in
isolation or hold in a well diversified portfolio
d. Stock B is always a better choice than stock A to any investor

11.

With the information given as follows, pick the correct answer (hint:
remember the project Is beta calculation?)
Years
1
2
3
4
5

Market r
3%
-5%
1%
-10%
6%

a. bA is positive and bB equal to 1.

b. bA > 1 and bB equal to 0.

Stock A
16%
20%
18%
25%
14%

Stock B
5%
5%
5%
5%
5%

c. bA equal to 0 and bB equal to -1.

d. bA is negative and bB equal to 0.
First, note that B's beta must be zero, so either b or d must be correct. Second, note that A's returns are
highest when the market's returns are negative and lowest when the market's returns are positive. This
indicates that A's beta is negative. Thus, d must be correct.

12.

What is the general common character of the following besides they are
economic events: high inflation, start of recession, and high interest
rates
a.
b.
c.
d.

13.

all of the three are systematic risks that can be eliminated.

firm specific risks that can be eliminated
all of the three are responsible for market risk.
all of the risks are beyond the control of investors and thus should
not be considered

Beta of stock A is 1.0 and that of stock B is 2. Risk free rate 6%;
market risk premium > 0. Pick correct answer.
a. risk free rate escalate but market risk premium unchanged Stock
B's increases of required return > that of stock A.
b. Stock B's return = two times of that of Stock A.
c. If Stock A's return = 11%, the market risk premium should be
estimated to be 5%.
d. Stock B's return = 11%, then the market risk premium is estimated to
be 5%.

14.

Pick correct answer.

a. The slope of SML = market risk premium.
b. Returns should decreases with beta.
c. Beta shows diversifiable risk.
d. The intercept of SML = market return

15.

Beta of stock A = 1.2 and = 20%. Beta of stock B = 0.8 and = 25%.
You have a total investment of $200,000, among which 50% invest in stock
A and the rest in B. Imagine your total investment including this
portfolio is well diversified. Pick the correct answer.
a.
b.
c.
d.

16.

Stock A is safer than Stock B.

Stock Bs return > stock As return
Your portfolios beta = 1
Cannot determine

Pick the correct answer with the following information. Risk free rate
is constant, however, market risk premium tends to be reducing.
a. market portfolios return is unchanged.

b. slope of SML tends to be decreasing

c. slope of SML tends to be increasing
d. market portfolios return tend to increase

17.

Stock A has an expected return of 10% and a standard deviation of 20%.

Stock B has an expected return of 13% and a standard deviation of 30%.
The risk-free rate is 5% and the market risk premium, rM rRF, is 6%.
Assume that the market is in equilibrium. Portfolio AB has 50% invested
in Stock A and 50% invested in Stock B. The returns of Stock A and
Stock B are independent of one another, i.e., the correlation
coefficient between them is zero. Which of the following statements is
CORRECT? (hard one)
a. beta of stock A = 0.8333.
b. Portfolio of AB is riskless, because the two stocks are not
correlated.
c. Stock B's beta = 1.
d. Portfolio AB's return = 11.00%.
a is correct. Stock A's required return is 10% = 5% + b(6%), so b = 5%/6% = 0.83333.

18.

AAA firms stock has a 0.25 possibility to make 30.00% return, a 0.50
chance to make 12% return, and a 0.25 possibility to make -18% return.
Calculate expected rate of return
a. 0.0772
b. 0.0812
c. 0.0855
d. 0.0900
Prob.
Conditions
Prob.
Return
Return
Good
0.25
30.0%
7.50%
Average
0.50
12.0%
6.00%
Poor
0.25
-18.0%
-4.50%
1.00
9.00% = Expected return

19.

If investors anticipate a 7.0% risk-free rate, the market risk premium =

5.0%, beta = 1, Find the return.
a.
b.
c.
d.

10.29%
10.83%
11.40%
12.00%

Real rate (r*):

IP:
RPM:
Beta:
Required return = r RF + b(RPM) = r* + IP + b(RPM) =

3.00%
4.00%
5.00%
1.00
12.00%

20.AAA firm has a portfolio with a value of $200,000 with the following
four stocks. Calculate the beta of this portfolio
Stock
A
B
C
D
Total
a.
b.
c.
d.

Investment
$50,000
$50,000
$50,000
$50,000
$200,000

Percentage
25.00%
25.00%
25.00%
25.00%
100.00%

Beta
0.95
0.80
1.00
1.20

Product
0.238
0.200
0.250
0.300
0.988 = Portfolio Beta

With the following information, find (Hint: use stdev function in

excel)
Year
Return
2012
21.00%
2011
-12.50%
2010
25.00%
a. 20.18%
b. 20.59%
c. 20.11%
d. 20.64%

Year
2012
2011
2010
Expected return
SQRT = = 20.59%

22.

0.9500
0.8000
1.0000
1.2000

0.948
0.988
1.017
1.091

Stock
A
B
C
D
Total

21.

value
$ 50,000.00
50,000.00
50,000.00
50,000.00
$200,000.00

Return
21.00%
-12.50%
25.00%
11.17%

Deviation
from Mean
9.83%
-23.67%
13.83%

Squared
Deviation
0.97%
5.60%
1.91%
8.48%
4.24%

Sum sqd deviations

Sum/(N 1)

20.59% with Excel

A portfolio with a value of $40,000,000 has a beta = 1. Risk free rate =

4.25%, market risk premium = 6.00%. An additional $60,000,000 will be
included in the portfolio. After that, the expected return should be
13%. Find the average beta of the new stocks to achieve the goal
a. 1.78
b. 1.76
c. 1.81

d. 1.84

23.

Old funds (millions)

New funds (millions)
Total new funds

$40.00
$60.00
$100.00

Beta on existing portfolio

Risk-free rate
Market risk premium
Desired required return
Required new portfolio beta
Required beta on new stocks

1.00
4.25%
6.00%
13.00%
1.4583
1.76

D1 = $0.75, rs = 10.5%, g = 6.4%.

a.
b.
c.
d.

D1
a.
b.
c.
d.

D0
a.
b.
c.
d.

Calculate stock price.

$0.75
10.5%
6.4%
$18.29

= $1.25, g = 4.7%, P0 = $26, find dividend yield for the next year
5.12%
5.34%
4.77%
4.81%

D1
g
P0
Dividend yield = D1/P0 =

25.

13% = r RF + b(RPM); b = (13% r RF)/RPM

beta = (return risk-free)/RPM
Req b = (old$/total$) old b + (new$/total$) new b

$18.39
$18.84
$18.29
$17.75

D1
rs
g
P0 = D1/(rs g)

24.

40.00%
60.00%
100.00%

$1.25
4.7%
$26.00
4.81%

= $1.75, g = 3.6%, P0 = $32, find the stock return

9.27%
9.59%
9.18%
9.13%

D0
g
P0
D1 = D0(1 + g) =
Total return = r s = D1/P0 + g

$1.75
3.6%
$32.00
$1.81
9.27%

26.

D1 = $1.25, g = 6.00%, = 1.15, market risk premium = 5.5%, and risk

free rate = 4 %. Find stock price
a.
b.
c.
d.

$28.90
$28.62
$29.36
$30.12

D1
b
rRF
RPM
g
rs = rRF + b(RPM) =
P0 = D1/(rs g)
27.

$1.25
1.15
4.00%
5.50%
6.00%
10.33%
$28.90

Firm AAA was set up ten years ago. The dividend payout is as follows and
then to grow at a constant rate of 8% forever. Imagine required return =
11%, find stock price
Year
g
Dividend
a.
b.
c.
d.

0
NA
$0

year1
NA
$0

year2
NA
$0

year3
NA
$0.25

year4
50%
$0.375

year5
25%
$0.469

year6
8%
$0.506

$10.94
$11.19
$10.45
$10.72

Required return = 11%

Year

Dividend
$0.000
Horizon value = P5 = D6/(rs g6) =
Total CFs
PV of CFs

$0.000

$0.000

$0.250

4
50.00%
$0.375

$0.000
$0.000

$0.000
$0.000

$0.250
$0.183

$0.375
$0.247

5
25.00%
$0.469
16.875
$17.344
$10.293

6
8.00%
$0.506

Price = $10.72
28.

AAA firms required return = 12.00%, the price of the stock = $40 per
share. D0 = $1. Dividend will grow by 30% for the next four years. After
the fourth year, the dividend will grow at the rate of g forever. Find
g. (hint: D4 = $1.00(1.30)4. And then you can pick a number and try)
(very hard)
a. 5.17%
b. 6.34%
c. 5.72%
d. 6.02%
Stock price
Paid dividend (D0)
Short-run growth rate
Required return
Forecasted LR growth rate, X

$40.00
$1.00
30.0%
12.0%
6.34% Arbitrarily set at 5% initially.

Year

Dividend
$1.0000
Horizon value = P4 = D5/(rs g5):
Total CFs
PV of CFs

1
30.0%
$1.3000

2
30.0%
$1.6900

3
30.0%
$2.1970

$1.3000
$1.1607

$1.6900
$1.3473

$2.1970
$1.5638

4
30.0%
$2.8561
53.6777
$56.5338
$35.9282

5
6.34%
$3.0372

Stock price = $40.00 Must equal $40. Change the forecasted growth rate till reach $40.
We must solve for the long-run growth rate. We can forecast the dividends in Years 1-4, so they are
inserted in the time line. We need a growth rate to find D 5 and the HV. We begin with a guess of say
5.0%, which we insert in the forecast cell. We then find the PV of the forecasted CFs and sum them. If
the sum equals the given price, then our growth rate would be correct. If not, we need to substitute in
different g's until we find the one that works. We used Excel's Goal Seek function to simplify the
process, but one could use trial and error.

29.

Pick the correct answer.

a. NPV = 0, then IRR = 0
b. NPV decreases with WACC
c. NPV < 0, then IRR < WACC
d. NPV >0, then IRR < 0

30.

Calculate NPV.
WACC (required rate of return, or discount rate):
Year
year0
year1
year2
year3
Cash flows
-$1000.00 $500.00 $500.00 $500.00
a. $265.65
b. $268.93
c. $262.88
d. $277.52
WACC: 9.00%
Year
Cash flows

0
-$1,000

1
$500

2
$500

3
$500

NPV = $265.65

31.

Find IRR
Year
Cash flows
a.
b.
c.
d.

year0
-$1000.00

year1
year2
year3
$425.00 $425.00 $425.00

13.85%
13.21%
12.87%
13.56%

Year
Cash flows
IRR = 13.21%

0
-$1,000

1
$425

2
$425

3
$425

9%

32.

Find payback period

Year
year0
CF
-$1150
a.
b.
c.
d.

1.86
2.17
2.30
2.03

year1
$500

year2
$500

year3
$500

1
$500
-$650
-

2
$500
-$150
-

3
$500
$350
2.30

years
years
years
years

Year
Cash flows
Cumulative CF
Payback = 2.30

0
-$1,150
-$1,150
-

Payback = last year before cum CF turns positive + abs. val. last neg. cum CF/CF in payback year.
33.

Find the changes in NPV due to increase in WACC

Old WACC: 10.00%
New WACC: 11.25%
Year
0
1
2
3
Cash flows
-$1,000
$410
$410
$410
a.
b.
c.
d.

-21.89
-22.88
-21.93
-22.03

dollars
dollars
dollars
dollars

Old WACC: 10.00%

Year
0
Cash flows
-$1,000

New WACC: 11.25%

1
2
$410
$410

3
$410

Old NPV = $19.61

New NPV = -$2.42
Change = -$22.03
34.

Find MIRR
WACC: 10%
Year
CF
a.
b.
c.
d.

year0
-$1000

year1
$450.00

year2
$450.00

year3
$450.00

1
$450
$544.50

2
$450
$495.00

3
$450
$450.00

12.32%
14.20%
15.50%
13.78%

WACC: 10.00%
Year
0
Cash flows
-$1,000
Compounded values, FVs

TV = Sum of compounded inflows: $1,489.50

MIRR = 14.20% Found as discount rate that equates PV of TV to cost, discounted back 3 years @ WACC
MIRR = 14.20% Alternative calculation, using Excel's MIRR function

35.

Find discounted payback period

WACC: 10%
Year
year0
year1
cf
-$900
$500
a.
b.
c.
d.

1.98
2.09
2.19
2.32

year3
$500

years
years
years
years

WACC: 10.00%
Year
Cash flows
PV of CFs
Cumulative CF
Payback = 2.09
36.

year2
$500

0
-$900
-$900
-$900
-

1
$500
$455
-$445
-

2
$500
$413
-$32
-

3
$500
$376
$343
2.09

Find the crossover rate with the following information

WACC: 10.25%
Year
year0
year1
year2
year3
year4
CFS
-$2,050
$750
$760
$770
$780
CFL
-$4,300
$1,500
$1,518
$1,536
$1,554
a. 14.79%
b. 14.18%
c. 13.27%
d. 16.29%
WACC: 10.25%

13.275% = crossover

Year
0
1
CFS
-$2,050
$750
CFL
-$4,300
$1,500
CFs-CFl
And then use IRR to get crossover rate

2
$760
$1,518

3
$770
$1,536

4
$780
$1,554

37.

Imagine yield curve is downward sloping. Then, compare ten year T-bond
YTM with that of one year T-bill
a. YTM of ten year bond < YTM of one year T-bill
b. YTM of ten year bond > YTM of one year T-bill
c. YTM of ten year bond = YTM of one year T-bill
d. Cannot be determined

38.

The CFO of Lenox Industries hired you as a consultant to help estimate

its cost of capital. You have obtained the following data: (1) rd =
yield on the firms bonds = 7.00% and the risk premium over its own debt
cost = 4.00% (like said, the cost of equity = 7%+4%=11%). (2) rRF =

5.00%, RPM = 6.00%, and b = 1.25. (3) D1 = $1.20, P0 = $35.00, and g =

8.00% (constant). You were asked to estimate the cost of equity based
on the three most commonly used methods and then to indicate the
difference between the highest and lowest of these estimates. What is
that difference? (hard one)
a.
b.
c.
d.
e.

39.

1.13%
1.50%
1.88%
2.34%
2.58%

Bond yield
Risk premium
rs

7.00%
4.00%
11.00%

rRF
RPM
b
rs

5.00%
6.00%
1.25
12.50%

D1
P0
g
rs

$1.20
$35.00
8.00%
11.43%

Max
Min
Difference

12.50%
11.00%
1.50%

Wall Inc. forecasts that it will have the free cash flows (in millions)
shown below. If the weighted average cost of capital is 14% and the
free cash flows are expected to continue growing at the same rate after
Year 3 as from Year 2 to Year 3, what is the firms total corporate
value, in millions? (hard)
Year
Free cash flow
a.
b.
c.
d.
e.

1
-$20.00

2
$48.00

2
$48.00

3
$54.00

3
$54.00

$2,650.00
$2,789.47
$2,928.95
$3,075.39
$3,229.16

Year
Free cash flow
WACC = 14.00%

1
-$20.00

First, find the growth rate:

g = FCF3/FCF2 1 = 12.500%
Second, find the horizon, or continuing, value, at Year 2:
HV2 = FCF3/(WACC g) = $3,600.00
Now find the PV of the FCFs and the horizon value:
Total corporate value = FCF1/(1.14) + (FCF2 + HV2)/(1.14)2 = $2,789.47

40.

The before-tax cost of debt, which is lower than the after-tax cost, is
used as the component cost of debt for purposes of developing the firm's
WACC.
a. True
b. False

Short Answers (total 12 points)

Use the following information to answer the questions.
Assets
CA
Net plant, property, & equipment
TA

$ 38,000,000
101,000,000
$139,000,000

Liabilities and Equity

AP
Accruals
Current liabilities
Long-term debt (40,000 bond)
TL
Equity (10 million shares)
Retained earnings
Total shareholders' equity
Total liabilities and shareholders' equity

$ 10,000,000
9,000,000
$ 19,000,000
40,000,000
$ 59,000,000
30,000,000
50,000,000
80,000,000
$139,000,000

The stock price is $15.25 per share. Price of bond with a par value of $1,000
is $875, 20-year maturity, 7.25% coupon rate, semiannual. Beta = 1.25, risk
free rate of six months Treasury bill = 3.50%. Yield of 20 year Treasury bond
= 5.50%. Stock require = 11.50% and market return = 14.50%. Tax rate = 40%.
1. Find after tax cost of debt

2. Find cost of equity

3. What is weight of debt?

4. What is weight of equity?

5. What is WACC?

Extra Credit ( 5 points CFA question)

Marc Juneau, equity analyst, has just been assigned the task of valuing Avalon Games, Inc.
The company is expected to grow at 30 percent for the next two years. Beginning in the year 4,
the growth rate is expected to reach seven percent and stabilize. The required return for this
type of company in the non-electronic games sector is estimated at 13 percent. The dividend in
year 1 is estimated at $3.00. Which of the following is closest to the value Juneau should
calculate for the stock of Avalon Games?
A) $71.88.

B) $64.68.
C) $73.01.
D) $45.41.
Answer:
D1=3
D2=3*(1+30%) = 3.9
D3= 3*(1+30%)2 = 5.07
D4 = 3*(1+30%)2*(1+7%) = 5.4249
P3= D4/(r-g) = 3*(1+30%)2*(1+7%) /(13%-7%) = 90.415
Price = npv(13%, 3, 3.9, 5.07+90.415) = 71.89
Or price = npv(13%, 3, 3*1.03, 3*1.3^2 + 3*1.3^2*1.07/(13%-7%)) = 71.89