EXAM CME2300 FINANCIAL ENGINEERING

WEDNESDAY NOVEMBER 5TH 2014

14:00-17:00 HOURS Delft University of Technology
Faculty of Civil Engineering and Geosciences
NAME:
Page 1 of 10
STUDENT NUMBER:

GENERAL REMARKS:

• This exam contains 40 questions.

• Questions are valued at 1 point

• Put a circle on the right answer, only one answer is right

• Fill in the Four Choice Response Form FA1

• The use of a calculator is allowed, but no mobile phones or tablets / iPads.

• You may use the Tables (see Appendices at the end of the Exam Form).

• Please put your name and student number on all pages on Exam-form AND Response Form

• Hand in both forms: Exam Form AND Response Form

 EXAM CME2300 FINANCIAL ENGINEERING
WEDNESDAY NOVEMBER 5TH 2014
14:00-17:00 HOURS Delft University of Technology
Faculty of Civil Engineering and Geosciences
NAME:
Page 2 of 10
STUDENT NUMBER:

1. The following are examples of tangible assets except:

A. Machinery
B. Factories
C. Trademarks
D. Offices

2. The following are important functions of financial markets:

I) Source of financing; II) Provide liquidity; III) Reduce risk; IV) Source of information

A. I only
B. I and II only
C. I, II, III, and IV
D. IV only

3. The following statements regarding the NPV rule and the rate of return rule are true except:

A. Accept a project if its NPV > 0

B. Reject a project if the NPV < 0
C. Accept a project if its rate of return > 0
D. Accept a project if its rate of return > opportunity cost of capital

4. A 5-year bond with 10% coupon rate and $1000 face value is selling for $1123. Calculate the
yield to maturity on the bond assuming annual interest payments.

A. 10.0%
B. 8.9%
C. 7.0%
D. None of the above

5. If the 5-year spot rate is 10% and the 4-year spot rate is 9%, what is the one-year forward rate
of interest four years from now?

A. 14.1%
B. 9.5%
C. 1.0%
D. 11.0%
 EXAM CME2300 FINANCIAL ENGINEERING
WEDNESDAY NOVEMBER 5TH 2014
14:00-17:00 HOURS Delft University of Technology
Faculty of Civil Engineering and Geosciences
NAME:
Page 3 of 10
STUDENT NUMBER:

6. The constant dividend growth formula P0 = Div1/(r - g) assumes:

I) the dividends are growing at a constant rate g forever.

II) r > g
III) g is never negative.

A. I only
B. II only
C. I and II only
D. III only

7. Otobai Motor Company is currently paying a dividend of $1.40 per year. The dividends are
expected to grow at a rate of 18% for the next three years and then a constant rate of 5%
thereafter. What is the expected dividend per share in year 5?

A. $2.35
B. $2.54
C. $2.91
D. $1.50

8. Which of the following investment rules may not use all possible cash flows in its calculations?

A. NPV
B. Payback period
C. IRR
D. All of the above

9. Investment in net working capital is not depreciated because:

A. It is not a cash flow

B. It is recovered during or at the end of the project and is not a depreciating asset
C. It is a sunk cost
D. All of the above

10. A firm owns a building with a book value of $150,000 and a market value of $250,000. If the
building is utilized for a project, then the opportunity cost ignoring taxes is:

A. $100,000
B. $150,000
C. $250,000
D. None of the above
 EXAM CME2300 FINANCIAL ENGINEERING
WEDNESDAY NOVEMBER 5TH 2014
14:00-17:00 HOURS Delft University of Technology
Faculty of Civil Engineering and Geosciences
NAME:
Page 4 of 10
STUDENT NUMBER:

11. A firm has a general-purpose machine, which has a book value of $300,000 and is sold for
$500,000 in the market. If the tax rate is 35%, what is the opportunity cost of using the machine in
a project?

A. $500,000
B. $430,000
C. $300,000
D. None of the above

12. Which of the following countries had the highest spread?

A. Germany
B. Denmark
C. Italy
D. None of the above

13. The annual return for three years for stock B comes out to be 0%, 10% and 26%. Annual
returns for three years for the market portfolios are +6%, 18%, 24%.
Calculate the beta for the stock.

A. 0.74
B. 1.36
C. 1.0
D. None of the above

14. The distribution of returns, measured over a short interval of time, like daily returns, can be
approximated by:

A. Normal distribution
B. Lognormal distribution
C. Binomial distribution
D. none of the above

15. Florida Company (FC) and Minnesota Company (MC) are both service companies. Their historical
return for the past three years are: FC: - 5%, 15%, 20%; MC: 8%, 8%, 20%. The correlation
coefficient is equal to zero.
Calculate the mean of returns for each company.

A. FC: 12%, MC: 6%

B. FC: 10%, MC: 12%
C. FC: 20%, MC: 32%
D. None of the above
 EXAM CME2300 FINANCIAL ENGINEERING
WEDNESDAY NOVEMBER 5TH 2014
14:00-17:00 HOURS Delft University of Technology
Faculty of Civil Engineering and Geosciences
NAME:
Page 5 of 10
STUDENT NUMBER:

16. Suppose you borrow at the risk-free rate an amount equal to your initial wealth and invest in a
portfolio with an expected return of 20% and a standard deviation of returns of 16%. The risk-free
asset has an interest rate of 4%; calculate standard deviation of the resulting portfolio:

A. 28%
B. 40%
C. 32%
D. none of the above

17. The market value of Cable Company's equity is $60 million, and the market value of its risk-free
debt is $40 million. If the required rate of return on the equity is 15% and that on the debt is 5%,
calculate the company's cost of capital. (Assume no taxes.)

A. 15%
B. 10%
C. 11%
D. None of the above

18. Cost of equity can be estimated using:

A. Discounted cash flow (DCF) approach

B. Capital Asset Pricing Model (CAPM)
C. Arbitrage Pricing theory (APT)
D. All of the above

19. The historical returns data for the past three years for Stock B and the stock market portfolio
are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%.
If the risk-free rate is 4%, calculate the market risk premium.

A. 18.1%
B. 14%
C. 10%
D. None of the above

20. Which of the following statements is true ?

A. The technical lifetime is always longer than the economic lifetime.

B. It is economically seen wise that the economic life is longer than the technical life.
C. Build a new structure when Integral cost of the new structure is lower than the total cost of the
old structure.
D. Build a new structure when Integral cost of the new structure is lower than the variable cost of
the old structure.
 EXAM CME2300 FINANCIAL ENGINEERING
WEDNESDAY NOVEMBER 5TH 2014
14:00-17:00 HOURS Delft University of Technology
Faculty of Civil Engineering and Geosciences
NAME:
Page 6 of 10
STUDENT NUMBER:

21. The beta of the computer company is 1.7 and the standard error of the estimate is 0.3. What is
the range of values for beta, that has 95% chance of being right?

A. 1.1 - 2.3
B. 1.4 - 2.0
C. 1.5 - 2.0
D. None of the above

22. The following data for year-1 are given. Revenue = $46; Total costs = $30; Depreciation = $6;
Tax rate = 30%. Calculate the operating cash flow for the project for year-1.

A. $7
B. $10
C. $13
D. None of the above

23. Tool Company Ltd. proposes to invest $6 million in a new type of hammer-making equipment.
The fixed costs are $0.5 million per year. The equipment is expected to last for five years. The
manufacturing cost per hammer is $1and the selling price per hammer is $6. The cost of capital is
20%. Calculate the break-even (i.e. NPV = 0) sales per year. (Ignore taxes, round to the nearest
1,000.)

A. 500,000 units
B. 600,000 units
C. 100,000 units
D. None of the above

24. Company X has 100 shares outstanding. It earns $1,000 per year and expects repurchase its
shares in the open market instead of paying dividends. Calculate the number of shares outstanding
at the end of year-1, if the required rate of return is 10%.

A. 110
B. 90
C. 100
D. None of the above

25. If both dividends and capital gains are taxed at the same ordinary income tax rate, the effect of
tax is different because:

A. Capital gains are actually taxed, while dividends are taxed on paper only
B. Dividends are taxed when distributed while capital gains are deferred until the stock is sold
C. Both dividends and capital gains are taxed every year
D. Both A and C
 EXAM CME2300 FINANCIAL ENGINEERING
WEDNESDAY NOVEMBER 5TH 2014
14:00-17:00 HOURS Delft University of Technology
Faculty of Civil Engineering and Geosciences
NAME:
Page 7 of 10
STUDENT NUMBER:

26. If firm U is unlevered and firm L is levered, then which of the following is true:

I) VU = EU
II) VL = EL + DL
III) VL = EU + DL

A. I only
B. I and II only
C. I, II, and III
D. III only

27. For a levered firm,

A. As earnings before interest and taxes (EBIT) increases, the earnings per share (EPS) increases by
the same percent
B. As EBIT increases, the EPS increases by a larger percent
C. As EBIT increases, the EPS decreases
D. None of the above

28. Learn and Earn Company is financed entirely by common stock that is priced to offer a 20%
expected rate of return. The stock price is $60 and the earnings per share are $12. If the company
repurchases 50% of the stock and substitutes an equal value of debt yielding 8%, what is the
expected earnings per share value after refinancing?

A. $12.00
B. $19.20
C. $24.00
D. None of the above

29. The relative tax advantage of debt with personal and corporate taxes is: Where: TC = (Corporate
tax rate) = 35%; TpE = Personal tax rate on equity income = 30%; and Tp = Personal tax rate on
interest income = 20%: (approximately)

A. 1.76
B. 1.16
C. 1.35
D. None of the given ones

30. The costs of financial distress depend on the:

I) probability of financial distress

II) corporate and personal tax rates
III) the magnitude of costs encountered if financial distress occurs

A. I only
B. I and II only
C. I, II and III
D. I and III only
 EXAM CME2300 FINANCIAL ENGINEERING
WEDNESDAY NOVEMBER 5TH 2014
14:00-17:00 HOURS Delft University of Technology
Faculty of Civil Engineering and Geosciences
NAME:
Page 8 of 10
STUDENT NUMBER:

31. The trade-off theory of capital structure predicts that:

A. Unprofitable firms should borrow more than profitable ones

B. Safe firms should borrow more than risky ones
C. Rapidly growing firms should borrow more than mature firms
D. Increasing leverage increases firm value

32. What signal is sent to the market when a firm decides to issue new stock to raise capital?

A. Bond markets are overpriced

B. Bond markets are underpriced
C. Stock price is too low
D. Stock price is too high

33. Given the following data for Vinyard Corporation:

Calculate the proportions of debt (D/V) and equity (E/V) for the firm that you would use for
estimating the weighted average cost of capital (WACC):

A. 40% debt and 60% equity

B. 50% debt and 50% equity
C. 25% debt and 75% equity
D. none of the given values
 EXAM CME2300 FINANCIAL ENGINEERING
WEDNESDAY NOVEMBER 5TH 2014
14:00-17:00 HOURS Delft University of Technology
Faculty of Civil Engineering and Geosciences
NAME:
Page 9 of 10
STUDENT NUMBER:

34. A firm is financed with 30% debt, 60% common equity and 10% preferred equity. The before-
tax cost of debt is 5%, the firm's cost of common equity is 15%, and that of preferred equity is
10%. The marginal tax rate is 30%. What is the firm's weighted average cost of capital?

A. 10.05%
B. 11.05%
C. 12.5%
D. None of the above

35. The Position diagram for a put with the same exercise price and premium as the call on the
same underlying asset with the same maturity is (like):

A. the inverse of the call diagram along the put price

B. unrelated to the call diagram no matter what the exercise price
C. the mirror image of the call diagram around the exercise price
D. exactly the same as the call diagram for the given exercise price

36. Figure-3 depicts the:

A. position diagram for the writer of a call option

B. profit diagram for the writer of a call option
C. position diagram for the seller of a put option
D. profit diagram for the seller of a put option

37. The following data are given:

The expiration = 6 months; Stock price = $80; exercise price = $75;

call option price = $12; risk-free rate = 5% per year.

Calculate the price of an equivalent put option using put-call parity:

A. $3.07
B. $5.19
C. $11.43
D. none of the above
 EXAM CME2300 FINANCIAL ENGINEERING
WEDNESDAY NOVEMBER 5TH 2014
14:00-17:00 HOURS Delft University of Technology
Faculty of Civil Engineering and Geosciences
NAME:
Page 10 of 10
STUDENT NUMBER:

38. Suppose VS's stock price is currently $20. Six-month call option on the stock with an exercise
price of $15 has a value of $7.14. Calculate the price of an equivalent put option if the six-month
risk-free interest rate is 5% (periodic rate).

A. $1.43
B. $9.43
C. $8.00
D. $12.00

39. If the volatility (variance) of the underlying stock increases then the: [Assume everything else
remaining the same]

A. Value of the put option increases and that of the call option decreases
B. Value of the put option decreases and that of the call option increases
C. Value of both the put option and the call option increases
D. Value of both the put option and the call option decreases

40. The call policy that maximizes shareholder wealth is to call a bond issue when:

A. The bond's price is above par

B. The bond's price is above par, but below the call price
C. The bond's price exceeds the call premium
D. The bond's price equals or exceeds the call price