Midterm Exam – October 17, 2012 SOLUTIONS Instructions: 1. Read the questions carefully. 2. Answer all questions on the following pages. 3. A financial calculator and a regular calculator are permitted. 4. A one-sided 8.5” x 11” formula sheet is permitted with formulas only. 5. The midterm has 11 pages, including 2 blank pages. 6. For Part 2, show all your work. 7. Midterm duration: 75 minutes. 8. Mark allocation: Shown on exam.
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Good Luck!!! Part 1: Multiple Choice Part 2: Short Answer and Problems Question 1 Question 2 Question 3 Question 4 Total /20 /4 /5 /10 /16 /55
Part 1 [2 points each = 20 points]: Multiple Choice. Circle the BEST answer. 1. The Double Dip Co. is expecting its ice cream sales to decline due to the increased interest in healthy eating. Thus, the company has announced that it will be reducing its annual dividend by 5% a year for the next two years. After that, it will maintain a constant dividend of $1 a share. Two weeks ago, the company paid a dividend of $1.40 per share. What is this stock worth if you require a 9% rate of return? A. $10.86 B. $11.11 C. $11.64 D. $12.98 E. $14.23 2. The value of common stock today depends on: A. The expected future holding period and the discount rate. B. The expected future dividends and the capital gains. C. The expected future dividends, capital gains and the discount rate. D. The expected future holding period and capital gains. E. None of the above. 3. The tax shield on CCA is calculated by: A. The quantity (1-Tc) multiplied by CCA. B. Revenues less expenses less CCA. C. The quantity (Revenues-Expenses) multiplied by CCA. D. Revenues less expenses less taxes. E. None of the above. 4. If the project beta-IRR co-ordinates plot above the SML, the project should be: A. Accepted because it is overvalued. B. Accepted because it is undervalued. C. Rejected because it is overvalued. D. Rejected because it is undervalued. E. None of the above. 5. The opportunity set of portfolios is: A. All possible return combinations of those securities. B. All possible risk combinations of those securities. C. All possible risk-return combinations of those securities. D. The best or highest risk-return combination. E. The lowest risk-return combination. 2
The combination of the efficient set of portfolios with a riskless lending and borrowing rate results in: A. The capital market line which shows that all investors will only invest in the riskless asset. B. The capital market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio. C. The security market line which shows that all investors will invest in the riskless asset only. D. The security market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio. E. None of the above.
Stock A has an expected return of 20%, and stock B has an expected return of 4%. However, the risk of stock A as measured by its variance is 3 times that of stock B. If the two stocks are combined equally in a portfolio, what would be the portfolio's expected return? A. 20.0%. B. 4.0%. . C. 12.0%. D. Greater than 20%. E. Need more information to answer.
8. Two mutually exclusive investment opportunities require an initial investment of $8 million. Investment A then generates $1 million per year in perpetuity, while investment B pays $500,000 in the first year, with cash flows increasing by 5% per year thereafter. Determine the NPV for which an investor would regard both opportunities as being equivalent. A. −$1 million B. $0 C. $1 million D. $2 million E. $8 million 9. When comparing two projects with different lives, why do you compute an annuity with an equivalent present value (PV) to the net present value (NPV)? A. So that you can...
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