Faculty of Economics and Business Academic year 2013-2014

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Exam: Financiering (6011P0122) and Finance (6011P0135)

Date and time of the exam: May, 27th

Duration of the exam: 3 hours

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Specific information on this exam: <30 multiple choice questions equally weighted with correction for

guessing, 2 open questions 5 points in total.>

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Question 1

Which of the following statements is FALSE?

A) By setting the NPV equal to zero and solving for r, we find the IRR.

B) The simplest investment rule is the NPV investment rule.

C) If you are unsure of your cost of capital estimate, it is important to determine how

sensitive your analysis is to errors in this estimate.

D) The IRR investment rule will identify the correct decision in many, but not all, situations.

Answer 1: B

Diff: 1

Skill: Conceptual

Question 2

If CY’s shares are currently trading at $24.00 and CY has 25 million shares outstanding. CY

also has 325 million of debt and its book debt to equity ratio is 2.5, then CY’s market-to-book

ratio is closest to:

A) 4

B) 0.24

C) 6

D) 30

Answer 2: A

Explanation: B) Market to Book = (MV Equity)/(BV Equity) = ($24 × 25 million)/(325

million / 2.5) = 4.62

Question 3

Do corporate decisions that increase the value of the firm's equity benefit society as a whole?

A) Yes, as long as the value of the firm's equity increases, society is better off.

B) No, any gain in the value of the firm's equity is always less than the cost to society.

C) Yes, as long as the increase in the value of the firm's equity does not come at the expense

of others.

D) No, any gains in the value of the firm's equity are perfectly offset by societal costs.

Answer 3 : C

Diff: 1

Section: 1.2 Ownership Versus Control of Corporations

Skill: Conceptual

Question 4

Consider the following two mutually exclusive projects:

Project

Year 0

Cash Flow

Year 1

Cash Flow

Year 2

Cash Flow

Year 3

Cash Flow

Year 4

Cash Flow

Discount

Rate

A -100 40 50 60 N/A .15

B -73 30 30 30 30 .15

The internal rate of return (IRR) of project A is 21.64% and that of Project B is 23.34%.

Which of the following statements is correct?

A) You should accept project A since its IRR > 15%.

B) You should reject project B since its NPV > 0.

C) You should accept project B since its IRR < 15%.

D) You should accept project B since its NPV is larger than zero and higher than that of

project A.

Answer 4: D

Explanation: A) NPVA = -100 + 40/(1.15)1 + 50/(1.15)2 + 60/(1.15)3 = 12.04

NPVB = -73+ 30/(1.15)1 + 30/(1.15)2 + 30/(1.15)3 + 30/(1.15)4 = 12.65

Diff: 2

Section: 7.2 The Internal Rate of Return Rule

Skill: Analytical

Question 5

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

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

minimize the present value of costs.

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

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

present value of its costs.

D) Good projects will have a positive NPV.

Answer 5: A

Question 6

You are considering investing $600,000 in a new automated inventory system that will

provide after-tax cost savings of $50,000 next year. These cost savings are expected to grow

at the same rate as sales. If sales are expected to grow at 5% per year forever and your cost

of capital is 10%, then what is the NPV of the automated inventory system?

A) $400,000

B) $500,000

C) -$100,000

D) $1,000,000

Answer 6: A

Explanation: A) NPV = - $600,000 = $400,000

Diff: 2

Skill: Analytical

Question 7

When you purchased your house, you took out a 25-year annual-payment mortgage with an

interest rate of 7.5% per year. The annual payment on the mortgage is $10,000. You have just

made a payment and have now decided to pay the mortgage off by repaying the outstanding

balance. You have lived in the house for 12 years.

The payoff amount is closest to?

A)$197,02

B)$81,258

C)$153,400

D)$106,232

Answer 7: B

Calculate the present value for the remaining years:

𝑃𝑉 = 𝐶 ∗1

𝑟(1 −

1

(1 + 𝑟)𝑁) = 10000 ∗

1

7.5%(1 −

1

(1 + 7.5%)(25−12)) = 81258.40

Question 8

Which of the following statements is FALSE?

A) An investor who expects the stock price to rise is not faced by an arbitrage opportunity.

B) Markets normally offer no arbitrage opportunities.

C) Because arbitrage opportunities do not require taking risk, the rate of return equals the

risk-free rate.

D) One can benefit from an arbitrage opportunity using the ‘buy low sell high’ strategy.

Answer 8: C

Question 9

Consider the following security: receive $1 in year 1, $2 in year 2 and $3 in year 3. The

interest rate for 1 year investments is 2%. When does this security have the highest price?

A) If the yield curve is upward sloping

B) If the yield curve is downward sloping

C) If the yield curve is flat

D) The price is not related to the yield curve due to the separation principle.

Answer 9: B

If yield curve is downward sloping, the discount rate is lower for 2nd and 3rd year so higher

value.

Question 10

Assume there are five default-free bonds with the following cash flows:

Bond Price today Cash Flows

Year 1 Year 2 Year 3 Year 4

A $48 $50

B $1265 $200 $1200

C $94.5 $100

D $45.5 $50

E $912 $50 $50 $50 $1050

Assume that you are financially constrained and can use up to $1300 to invest initially. The

arbitrage profit you can make by trading those bonds is the closest to:

A) $94

B) $33

C) Cannot be calculated on the basis of this information

D) $61

Answer 10: D

Since four-year zero coupon bond is not available, four-year coupon E-bond cannot be

replicated. An arbitrage strategy then would include two-year coupon B-bond and suggest

that investor sells four A-bonds and twelve C-bonds as well as buy 1 B-bonds. Zero-coupon

bonds require payment of $200 in year 1 and $1200 in year 2, whereas coupon B-bond

delivers $200 in year 1 as a coupon and $1200 in year 2 as a sum of a coupon and face value.

Buying B-bonds costs $1265 today whereas selling A and C bonds costs

48*4+94.5*12=$1326. Thus, arbitrage profit is $61.

Question 11

Assume a normal market. If a German government bond has a low yield to maturity, which

statement is most likely to be true?

A) An investor should not invest in the bond since the beta of the bond will be close to zero

B) An investor should not invest since a low yield does not compensate for inflation

C) An investor should not invest since a low yield on a government bond implies a low return

D) None of the above

Answer 11: D

Explanation: all second parts of the statements may be true, but assuming that the bond is

traded In a normal market this is all adequately priced and thus no reason not to invest.

Question 12

The percentage of a firm’s net earnings that is used to reinvest in new investment project is

called:

A) capital expenditures

B) dividend payout ratio

C) plowback ratio

D) stock split

Answer 12: C

Plowback ratio is otherwise called retention rate, the share of net earnings retained in

the company.

Question 13

Which of the following risks that a firm faces is most likely to be systematic risk?

A) The risk that the firm has to recall a large number of products due to a critical flaw in

product design.

B) The risk that the demand for the firms’ products drops because of a fall in global trade.

C) The risk that the production is interrupted because supplies of raw materials are delayed.

D) The risk the firms’ information system breaks down.

Answer 13: B

Question 14

XYZ Co.'s share is currently traded at the price $31.5. It is expected to pay $1.45 dividend at

the end of this year. Dividend is expected to grow at a constant rate. XYZ's equity cost of

capital is 8%. The dividend growth rate the market expects is closest to:

A) 3.4%

B) 3.7%

C) 4.0%

D) 4.2%

Answer 14: A

According to constant dividend growth model, share price is:

P=Div1/(r-g)

From here, the dividend growth rate is g=r-Div1/P=8%-1.45/31.5=3.4%.

Question 15

Which of the following statements is FALSE?

A) A bond will trade at a discount if its coupon rate exceeds its yield to maturity

B) Credit default spread is the difference between yields on corporate bonds and yields on

Treasury securities C) The price of the bond approaches its face value as the bond approaches maturity

D) The expected return on the corporate bond is less than the bond’s yield to maturity

Answer 15: A

A bond will trade at a discount if its yield to maturity exceeds the coupon rate

Question 16

Philips has beta equal to 1.55. Compute the expected return on its stock using CAPM if the

risk free rate is 2% and the expected return of the market portfolio is 5%.

A) 9.75%

B) 4.65%

C) 5.75%

D) 6.65%

Answer 16: D r_Philips=r_f + beta*(r_mkt – r_f) = 0.02 + 1.55*(0.05-0.02)=0.0665

Question 17

Which of the following statements is FALSE?

A) In exchange for bearing systematic risk, investors want to be compensated by earning a

higher return.

B) A key step to measuring systematic risk is finding a portfolio that contains only

unsystematic risk.

C) When evaluating the risk of an investment, an investor will care about its systematic risk,

which cannot be eliminated through diversification.

D) To measure the systematic risk of a stock, we must determine how much of the variability

of its return is due to systematic, market-wide risks versus diversifiable, firm specific risks.

Answer 17: B

Explanation: B) A key step to measuring systematic risk is finding a portfolio that contains

only systematic risk (the market portfolio).

Diff: 1

Section: 10.7 Measuring Systematic Risk

Skill: Conceptual

Question 18

Using the information below of comparable firms, find the company A's share price on the

basis of the P/E ratio.

Company Market

capitalization,

million euro

Shares

outstanding,

million

EBITDA,

million euro

Net earnings,

million euro

A N/A 10 40.5 37.0

B 515 20 92.8 82.1

C 302 13 66.2 59.8

D 109 15 32.5 28.9

A) 18.6 euro

B) 9.6 euro

C) 5.1 euro

D) 12.3 euro

Answer 18: A

Given the data available, we can compute P/E multiple (or price-to-earnings ratio) for

comparable firms B,C,D by dividing market capitalization by net earnings:

Firm B: P/E=82.1/515=6.28

Firm C: P/E=302/59.8=5.05

Firm D: P/E=109/28.9=3.77

The average P/E=5.03

As a result, we can find market capitalization of firm A:

MC=P/E * Net Earnings= 5.03 * 37=186 million euro

Then the share price of firm A is Market capitalization/Number of shares=186/10=18.6 euro.

Question 19

Consider an investment A with expected return of 6.5% and a beta of 0.85. The risk-free rate

of return is 3% and the expected return on the market portfolio is 7%. Which statement is

true?

A) Investment A lies below the Security Market Line.

B) Investment A lies on the Security Market Line.

C) Investment A lies above the Security Market Line.

D) Investment A cannot be related to the Security Market Line.

Answer 19: C

SML: r_A = 0.03+ 0.85*(0.07-0.03) =0.064 so the investment lies above the SML.

Question 20

A firm has a 50% pay-out ratio and you expect that at the end of the year will have $4

earnings per share. The expected return on all future retained earnings is 10% and the firm’s

equity beta is 0.75. The risk-free interest rate is 2% and the expected market risk premium is

8%. The value of a share of this firm is closest to:

A) $60

B) $50

C) $40

D) $30

Answer 20: A

Answer: A

Explanation: g = retention rate × return on new investment

= (1-0,5)*10% = 5%

Cost of equity = 2%+ 0.75 x (8%) = 8%

P0 = Div1/(rE - g) = 2/(0,08 - 0.05) = 66,6666

Question 21

What is a syndicated loan?

A) A loan secured by fixed assets.

B) A loan secured by marketable securities.

C) A loan provided by a credit union.

D) A loan provided by a group of banks.

Answer 21: D

Question 22

Consider a five-year lease for a €100,000 car, with a residual market value of €25,000 at the

end of the five years. Assume there is no risk that the lessee will default on the lease. The

risk-free interest rate is 6% APR with monthly compounding.

The monthly lease payments in a perfect market for a fair market value lease is closest to?

A) €1,567

B) €1,823

C) €1,545

D) €1,259

Answer 22: A

EMR=0.06/12=0.005. N=60

PV = 100000 – 25000/(1.005)^60 = 81466.

Lease payments = PV / annuity = 1567 (annuity has to be calculated with payments at the

beginning of the period see example 25.1 in the book!

Question 23

Suppose ABN AMRO just finished building their new headquarters on the Amsterdam Zuid-

As. The total construction costs of the new building was €50,000,000. The building will

depreciate in a straight-line basis in 5 years, after which it will be worthless. The alternative

is that ABN AMRO will sell the building immediately to an investor and subsequently lease

back the building. If leased, the lease payments will be €11,000,000 per year for 5 years.

Now suppose that (1) ABN AMRO’s borrowing cost is 8%, (2) its tax rate is 30%, and (3) the

lease qualifies as a true tax lease.

If ABN AMRO does not sell and lease back the headquarters, what is the amount of the

lease-equivalent loan?

A) 26.2 million

B) 30.5 million

C) 39.7 million

D) question is unanswerable

Answer 23: C

1.Cashflows when buying: t=0: -50 and t1 trough t5= (t*d=) +3M

with t being the tax rate and d being the depreciation (50M / 5). = depreciation tax shield

2.Cashflows when leasing: t0 to t4 = -11M + (t*l=) 3.3M) = -7.7M

T 5: 0

with l being the lease payments (11M) and t being the tax rate (30%).

3. Discount the difference between 1. and 2. from t=1 through t=5 against 5.6% = 39.7

million

Question 24

Bakker Bart purchases supplies of EUR 1,000 on terms of 1/10, Net 25. Rabobank has quoted

Bakker Bart an interest of 12.1% on borrowed funds. What is the effective annual cost to

Bakker Bart if it chooses not to take advantage of the trade discount offered?

A) 1.01%

B) 12.1%

C) 27.7%

D) 39.8%

Answer 24: C

The interest on the 'loan' is. 10/990 = 1.01%. The loan period is 15 days (=25-10).

The effective annual cost of the trade credit is EAR = (1.0101)^(365/15) - 1 = 27.7%.

The information regarding the Rabobank quote is excess information.

Question 25

Which of the following statements regarding net working capital and cash is incorrect?

A) The main components of net working capital are cash, inventory, receivables and

payables.

B) Net working capital is the excess capital required in the short term to run the business.

C) Some practitioners measure the cash cycle by calculating the cash conversion cycle.

D) The amount of cash a firm holds to counter the uncertainty surrounding its future cash

needs is known as a precautionary balance.

Answer 25: B

Question 26

Consider the following two statements

Statement I: Stocks with high variance have low expected returns.

Statement II: Securities with returns higher than the risk-free rate have a positive beta.

A) Both statements are true

B) Statement I is true, statement II is false

C) Statement I is false, statement II is true

D) Both statements are false

Answer 26: c

Question 27

Luther Industries currently has the following balance sheet (in Thousands of dollars):

Assets Liabilities

Cash $500 Debt $4,500

Property, Plant, and

Equipment $7,000 Equity $3,000

Total Assets $7,500 Total Debt plus Equity $7,500

Luther is about to add a new fleet of delivery trucks. The price of the fleet is $1.5 million.

If Luther acquires the new fleet of delivery trucks using a capital lease, Luther's Debt to

Equity ratio will be closest to:

A) 0.66

B) 2.0

C) 1.5

D) 0.80

Answer 27: B

Explanation: D) If the firm acquires the fleet through a capital lease it is the same as if

Luther borrowed the money and purchased the fleet directly. The fleet is must be listed as an

asset and the lease will show up as a liability. Therefore, Luther's balance sheet will look

like:

Assets Liabilities

Cash $500 Debt $6,000

Property, Plant, and Equipment $8,500 Equity $3,000

Total Assets $9,000 Total Debt plus Equity $9,000

Luther's Debt to Equity ratio therefore is equal to = 2.0

Diff: 2

Section: 25.2 Accounting, Tax, and Legal Consequences of Leasing

Skill: Analytical

Question 28

The quarterly working capital levels for Intertoys are presented in the following table (in €

millions):

Quarter 1 2 3 4

Cash 305 350 210 450

Accounts Receivable 485 654 1160 800

Inventory 300 554 600 456

Accounts Payable 528 840 905 1015

The permanent working capital of Intertoys is closest to?

A) 562

B) 1065

C) 555

D) 1090

Answer 28: A

Question 29

Which of the following statements is FALSE?

A) After a firm decides on its credit standards, it must next establish its credit terms.

B) The decision of how much credit risk to assume plays a large role in determining how

much money a firm ties up in its payables.

C) Knowledge of the payments pattern is also useful for forecasting the firm's working capital

requirements.

D) An aging schedule categorizes accounts by the number of days they have been on the

firm's books.

Answer 29: B

Explanation: B) The decision of how much credit risk to assume plays a large role in

determining how much money a firm ties up in its receivables.

Diff: 2

Section: 26.3 Receivables Management

Skill: Concept

Question 30

Suppose you observe that a two-year default-free bond with annual coupon rate of 5% and

face value of $1000 has a price today of $899.8. It is also known that the price of a one-year

zero-coupon bond of the same face value is $952.4. What is the yield to maturity of a two-

year zero-coupon bond (assume no arbitrage)?

A) 14%

B) 12.5%

C) 11%

D) 9.5%

Answer 30: C

From the price of one-year zero coupon bond, we can find one-year yield to maturity:

YTM1=FV/P=1000/952.4-1=5%. No arbitrage exists if the price of a two year coupon is

equal to the sum of its year 1 cash flow ($50 of coupon payment) discounted at one-year

YTM (5%) and its year 2 cash flow ($50 of coupon and $1000 of face value) discounted at

two-year yield to maturity, i.e

899.8= 50/1.05+1050/(1+YTM2)^2

From this equation, express two-year yield to maturity YTM2:

YTM2=[1050/(899.8-50/1.05)]^0.5-1=11%.

Thus, the yield to maturity of a two-year zero coupon bond is 11%.

Question 1 (3 points)

A) In an efficient market, what is the effect on stock prices if new public information

becomes available? (1 point)

B) If markets are efficient, one of the implications for corporate managers is that they

can avoid accounting illusions. Explain this implication. (2 points)

Answer:

A) In an efficient market, public information will be incorporated in the stock price quickly

(bad news will lower the stock price, good news will increase the stock price)

B) Accounting consequences of a decision do not directly impact the value of the firm

and should not drive decision making (see page 298).

Question 2 (2 points)

Goldsboro Industries has an average accounts payable balance of $680,000. Its annual cost

of goods sold is $4,500,000, and it receives terms of 1/10, net 40 from its suppliers.

Goldsboro chooses to forgo this discount. Is Goldsboro managing its accounts payables

well?

Answer: The firm is not managing its accounts payables well. Goldsboro's days payable

outstanding is = 55.16 days. They are over the term of 40 days offer by their

suppliers. Goldsboro is stretching the terms of the credit agreement (which reduces its

financing cost) and risks having problems with their suppliers as a result.

Formula sheet Financiering / Finance

PV (CF)

FV (CF)

NPV NPV = PV – Investment

PV perpetuity

PV growing

perpetuity 𝑃𝑉(𝐺𝑟𝑜𝑤𝑖𝑛𝑔 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦) =

𝐶1

𝑟 − 𝑔

PV annuity

PV growing

annuity

EAR

After-tax interest

rate )1()( rrr

Price of a

Coupon Bond

𝑃 = 𝑃𝑉(𝐵𝑜𝑛𝑑 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤𝑠)

=𝐶𝑃𝑁

1 + 𝑌𝑇𝑀1+

𝐶𝑃𝑁

(1 + 𝑌𝑇𝑀2)2+ ⋯ +

𝐶𝑃𝑁 + 𝐹𝑉

(1 + 𝑌𝑇𝑀𝑛)𝑛

1 1 (annuity of for periods with interest rate ) 1

(1 )

N

PV C N r Cr r

Dividend

Discount model 𝑃0 = ∑𝐷𝑖𝑣𝑛

(1 + 𝑟𝐸)𝑛

∞

𝑛=1

Dividend-

Discount model

with constant

growth (g)

Discounted Free

CF model

CAPM 𝑟𝑖 = 𝑟𝑓 + 𝛽𝑖 × (𝐸[𝑅𝑀𝑘𝑡] − 𝑟𝑓)

10

E

=-

DivP

r g

1 20 2

wacc wacc wacc wacc

1 (1 ) (1 ) (1 )

= + + + ++ + + +

N N

N N

FCF VFCF FCFV

r r r r