FIN 3113 EXAM 2 QUESTIONS AND
CORRECT ANSWERS
The common stock of Auto Deliveries sells for $28.16 a share. The stock is expected to
pay $1.35 per share next year when the annual dividend is distributed. The firm has
established a pattern of increasing its dividends by 3% annually and expects to continue
doing so. What is the required rate of return? - Answer- 7.79%
What is the IRR of a project that costs $100,000 and provides cash inflows of $40,000
annually for 6 years? - Answer- 32.7%
If a firm replaces an old machine they expect to save $5,000 per year in operating
costs. Depreciation expense will be $2,000 per year. The old machine was fully
depreciated. The firm's tax rate is 35%. The new machine costs $8,000. The new
machine is expected to last about 4 years at which time it will be worthless and have to
be replaced. The required return for these types of projects is 10%. What are the
incremental operating cash flows of this replacement project? - Answer- $3,950
Which one of the following methods determines the amount of the change a proposed
project will have on the value of a firm?
a. payback
b. internal rate of return
c. profitability index
d. discounted payback
e. net present value - Answer- e. net present value
Nonconventional cash flow patterns - Answer- Multiple internal rates of return can be
obtained if there exists:
If you paid $935 for a $1000, 30 year, 12% coupon bond paying annual interest with 10
years left to maturity, what is the yield-to-maturity for this bond? - Answer- 13.2%
Your firm is analyzing a project. A new machine must be purchased which will be sold in
5 years when the project ends. The salvage value of the machine is expected to be
$8,000 at that time. The machine costs $22,000 today and the book value in year 5 is
expected to be $10,000. What is the after-tax salvage value of the machine? Assume a
corporate tax rate of 40%. - Answer- $8,800
, A group of nerds perfect a process for converting seawater into crude oil. In order to
keep their process off the market, OPEC offers to license the process by paying the
nerds an annual royalty payment of $100,000,000 starting one year from now, and then
increasingly annually thereafter at a 4% rate forever. The nerds have figured out that
they won't live forever, and they decide to sell their royalty rights to J.G. Spentworth
Financial for a one-time lump sum payment based on a 10% discount rate their financial
advisor recommended. What price, in whole dollars, should they expect to receive if
J.G. Spentworth meets their expectations? - Answer- $1,666,666,667
Snooze Inc. projects a rate of return on equity of 20%. Management plans to pay 70%
of earnings as dividends. Earnings this year will be $3.00 per share, and investors
expect a 12% rate of return on the stock. Calculate the sustainable growth rate
assuming ending equity is relevant. - Answer- 6.4%
What price will be paid for a $1000 U.S. Treasury bond with an ask price of $135.20? -
Answer- $1,356.25
A bond maturing in 10 years pays $50 semi-annually and $1,000 upon maturity.
Assuming 10% to be the appropriate market discount rate, what is the price of the bond
(round to nearest $10)? - Answer- $1,000
Junk bond - Answer- A high-risk, high yield bond used to finance mergers, leveraged
buyouts, and troubled companies is generally called a/an...
Mutually exclusive - Answer- When acceptance of one project eliminates another
project from consideration, the projects are said to be..
EXAMPLE: bridge vs ferry
Which of the following affect an asset's value to an investor?
1. Amount of an asset's expected cash flow
2. The riskiness of the cash flows
3. Timing of an asset's cash flows
4. Investor's required rate of return - Answer- 1, 2, 4
What would you pay for a 10-year, 8% semiannual coupon bond with a $1000 face
value if the market rate of return (YTM) is 7.5%? - Answer- $1034.74
Sensitivity analysis; scenario analysis - Answer- With _______________ one variable at
a time is changed; whereas with ________________ multiple variables are changed to
determine the impact to NPV
Bond A is a 10-year Treasury bond with an 8% coupon and Bond B is an 8-year
Treasury bond with a 10% coupon. If the market rates increase by 2%, which of the
following statements is most correct? - Answer- Both bonds will decline in price, but the
10-year bond will have a greater percentage decline in price the 8-year bond.
CORRECT ANSWERS
The common stock of Auto Deliveries sells for $28.16 a share. The stock is expected to
pay $1.35 per share next year when the annual dividend is distributed. The firm has
established a pattern of increasing its dividends by 3% annually and expects to continue
doing so. What is the required rate of return? - Answer- 7.79%
What is the IRR of a project that costs $100,000 and provides cash inflows of $40,000
annually for 6 years? - Answer- 32.7%
If a firm replaces an old machine they expect to save $5,000 per year in operating
costs. Depreciation expense will be $2,000 per year. The old machine was fully
depreciated. The firm's tax rate is 35%. The new machine costs $8,000. The new
machine is expected to last about 4 years at which time it will be worthless and have to
be replaced. The required return for these types of projects is 10%. What are the
incremental operating cash flows of this replacement project? - Answer- $3,950
Which one of the following methods determines the amount of the change a proposed
project will have on the value of a firm?
a. payback
b. internal rate of return
c. profitability index
d. discounted payback
e. net present value - Answer- e. net present value
Nonconventional cash flow patterns - Answer- Multiple internal rates of return can be
obtained if there exists:
If you paid $935 for a $1000, 30 year, 12% coupon bond paying annual interest with 10
years left to maturity, what is the yield-to-maturity for this bond? - Answer- 13.2%
Your firm is analyzing a project. A new machine must be purchased which will be sold in
5 years when the project ends. The salvage value of the machine is expected to be
$8,000 at that time. The machine costs $22,000 today and the book value in year 5 is
expected to be $10,000. What is the after-tax salvage value of the machine? Assume a
corporate tax rate of 40%. - Answer- $8,800
, A group of nerds perfect a process for converting seawater into crude oil. In order to
keep their process off the market, OPEC offers to license the process by paying the
nerds an annual royalty payment of $100,000,000 starting one year from now, and then
increasingly annually thereafter at a 4% rate forever. The nerds have figured out that
they won't live forever, and they decide to sell their royalty rights to J.G. Spentworth
Financial for a one-time lump sum payment based on a 10% discount rate their financial
advisor recommended. What price, in whole dollars, should they expect to receive if
J.G. Spentworth meets their expectations? - Answer- $1,666,666,667
Snooze Inc. projects a rate of return on equity of 20%. Management plans to pay 70%
of earnings as dividends. Earnings this year will be $3.00 per share, and investors
expect a 12% rate of return on the stock. Calculate the sustainable growth rate
assuming ending equity is relevant. - Answer- 6.4%
What price will be paid for a $1000 U.S. Treasury bond with an ask price of $135.20? -
Answer- $1,356.25
A bond maturing in 10 years pays $50 semi-annually and $1,000 upon maturity.
Assuming 10% to be the appropriate market discount rate, what is the price of the bond
(round to nearest $10)? - Answer- $1,000
Junk bond - Answer- A high-risk, high yield bond used to finance mergers, leveraged
buyouts, and troubled companies is generally called a/an...
Mutually exclusive - Answer- When acceptance of one project eliminates another
project from consideration, the projects are said to be..
EXAMPLE: bridge vs ferry
Which of the following affect an asset's value to an investor?
1. Amount of an asset's expected cash flow
2. The riskiness of the cash flows
3. Timing of an asset's cash flows
4. Investor's required rate of return - Answer- 1, 2, 4
What would you pay for a 10-year, 8% semiannual coupon bond with a $1000 face
value if the market rate of return (YTM) is 7.5%? - Answer- $1034.74
Sensitivity analysis; scenario analysis - Answer- With _______________ one variable at
a time is changed; whereas with ________________ multiple variables are changed to
determine the impact to NPV
Bond A is a 10-year Treasury bond with an 8% coupon and Bond B is an 8-year
Treasury bond with a 10% coupon. If the market rates increase by 2%, which of the
following statements is most correct? - Answer- Both bonds will decline in price, but the
10-year bond will have a greater percentage decline in price the 8-year bond.
