Corporate Finance Quiz

Topics: Depreciation, Investment, Net present value Pages: 6 (714 words) Published: April 25, 2014
IMBA -FIN 6425 – Quiz 1 Corporate Finance - Solution– Nimalendran

This is an individual quiz and you should submit the answers on-line by the scheduled date. You are allowed to use any resources EXCEPT help from any other person. You are allowed to use EXCEL for the calculations.

1. Barkley Credit Union sets a low annual percentage rate (5%) for all its credit card customers instead of basing the interest rates on the customers’ credit scores. Consequently Barkley is exposed to ______________.?

a. Moral Hazard
b. Screening
c. Adverse Selection
d. Signaling

Answe C

2. Bob, an environmental economist, has struggled for a year to write a paper that will be read by 50 people at most to show that, in case he must search for a job, he has remained intellectually active. Which term best describes Bob’s activity?

a. Moral Hazard
b. Screening
c. Adverse Selection
d. Signaling

Answer D

3. A three-year bond has 8.0% coupon rate and face value of $1000. If the yield to maturity on the bond is 10%, calculate the price of the bond assuming that the bond makes semi-annual coupon interest payments. (Chapter 2)

a. $857.96
b. $949.24
c. $1057.54
d. $1000.00

Response: PV = (40/1.05) + (40/(1.05^2)) +. . . + (1040/(1.05^6)) = $949.24 Answer B

4. Cisco will pay a dividend of $5 per share next year, and the dividends payout ratio is 50%. Dividends are expected to grow at a constant rate of 8% forever and the required rate of return on the stock is 13%. Calculate the present value of the growth opportunity. (Chapter 4)

a. $100
b. $76.92
c. $23.08
d. None of the above

Response: EPS= (5/0.5)=$10; No Growth Value = 10/0.13 = 76.92; Dividends next year = 0.5
Growth Value = 5/(0.13-0.08) = 100; PVGO = 100 -76.92 = 23.08 Answer C

5. Driscoll Company is considering investing in a new project. The project will need an initial investment of $2,400,000 and will generate $1,200,000 (after-tax) cash flows for three years. Calculate the NPV for the project if the cost of capital is 15%. (Chapter 5)

a. $169, 935
b. $1,200,000
c. $339,870
d. $125,846

Response: NPV = -2,400,000 + [(1,200,000)/(1.15)] + [(1,200,000/(1.15)^2] + [1,200,000/(1.15)^3] = 339,870 Answer C

6. A capital equipment costing $300,000 today has no (zero) salvage value at the end of 5 years. If straight-line depreciation is used, what is the book value of the equipment at the end of three years? (Chapter 6)

a. $120,000
b. $80,000
c. $60,000
d. $40,000

Annual depreciation = $300,000/5 = 60,000
Depreciation for 3 years = 180,000
Book value = 300,000 - 180,000 = 120,000
Answer A

7. The market value of Charcoal Corporation's common stock is $20 million, and the market value of its risk-free debt is $5 million. The beta of the company's common stock is 1.25, and the market risk premium is 8%. If the Treasury bill rate is 5%, what is the company's cost of capital? Ignore taxes. (CAPM, Chapter 8)

a. 15%
b. 14.6%
c. 13%
d. None of the above

Response: rE = 5 + 1.25(8) = 15 ; rD = 5%; Company Cost of capital = 5 (5/25) + 15(20/25) = 1 + 12 = 13% Answer C

Use this information to answer questions 8 and 9:
AmTrade is a full service broker that is considering expanding into internet brokerage business. The project is expected to last 5 years. The firm has market capitalization (market value of assets) of $1billion and it has a market value of Debt/Equity ratio of 0.5. ETrade is a pure internet brokerage Company and it has an equity beta of 1.2 and a debt beta of 0.2. ETrade has 60% debt and 40% equity in market value terms. The 5-year Treasury (risk free) rate is 5% per year and the risk premium on the market is 5%. What is your estimate of the cost of capital for AmTrade’s investment in the internet brokerage business? Ignore taxes. ( Based on Ameritrade Case Concepts)

8. What is the unlevered beta of equity for ETrade?
a. 0.5
b. 0.1
c. 0.8
d. 0.6...
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