NOTE WELL: ONLY THE ANSWER KEY WILL BE GRADED!!!

4.

You may use a financial calculator. No notes, formula sheets, scratch paper (use back
pages of exam if necessary), or stored formulae allowed.
The exam consists of 25 questions each worth 4.0 points. Choose the BEST ANSWER
for each question. Your score will be computed as:
[100 - (number missed x 4.0)].
You will have 120 minutes to complete the exam. Do not leave any answers blank - an
unanswered question will be graded as a wrong answer. Good Luck!

DIRECTIONS: Circle the letter corresponding to the best answer for each multiple choice
question and then transfer that letter answer to the attached ANSWER SHEET. Be sure
to carefully record your answers to the ANSWER SHEET. Only the ANSWER SHEET
will be graded.
1. You are considering two perpetuities which are identical in every way except for the when the
perpetuity payments will begin. Perpetuity A will begin making annual payments of a fixed amount,
with the first payment being made two years from today. Perpetuity B pays the same fixed annual
payment, but will make the first payment one year from today. Which of the following statements is
most correct?

a. The PV of perpetuity A is greater than the PV of perpetuity B by the amount of the fixed
payment.
b. The PV of perpetuity B is greater than the PV of perpetuity A by the amount of the fixed
payment.
c. The PV of perpetuity A is equal to the PV of perpetuity B.
d. The PV of perpetuity A is greater than the PV of perpetuity B by the present value of the amount
of the fixed payment.
e. The PV of perpetuity B is greater than the PV of perpetuity A by the present value of the amount
of the fixed payment.

Stocks and Bonds Questions

2. Which of the following statements is correct?
a.
b.
c.
d.
e.

A zero coupon bond is a promise to pay a single lump sum at some point in the future.
The price of a bond moves in the opposite direction to changes in market interest rates.
A bond that has a yield to maturity that is greater than its coupon rate will sell at a premium.
(a), (b), and (c) are all correct.
(a) and (b) are both correct.

3. Assume that investors lower their required rates of return. Assuming all other factors remain
constant, which of the following scenarios is most likely?

a.
b.
c.
d.
e.

The prices of stocks will increase and the prices of bonds will decrease.
The prices of stocks will decrease and the prices of bonds will increase.
The prices of stocks and bonds will both increase.
The prices of stocks and bonds will both decrease.
It is impossible to tell without more information.

4. Do It Yourself Dental Surgery Inc. just paid a $20 dividend at the end of the current year (i.e., D 0 =
$20). After the dividend is paid, the companys dividends are expected to grow at a 50% annual rate
for each of the following two years, and then settle down to a steady state growth rate of 5% annually.
If investors required rate of return is 15% on this stock, what should a share sell for today?
a.
b.
c.
d.

$472.50
$350.75
$380.34
$417.39

e. none of the above answers is within $10 of the correct answer

5. What is the price on a 20-year, 8% annual coupon bond, assuming that the market rate is 12%.
a.
b.
c.
d.
e.

$1,000
$701.22
$750
$890.50
$642.43

6. Bobby Inc.s most recent dividend was $10 per share. Dividends are expected to grow at an 8%
annual rate into the foreseeable future. If your required rate of return is 12% annually, how much
should you pay for a share of ABC Corp?
a.
b.
c.
d.
e.

$270
$250
$130
$83.33
$415

7. A 25-year bond with a $1,000 face value and a 6% coupon rate (with semi-annual payments) is
currently selling for $634.88. What is the annual yield to maturity on this bond?
a.
b.
c.
d.
e.

10%
10.03%
5%
10.25%
6%

Capital Budgeting Questions

8. A five-year project, if undertaken, will require an initial investment of $95,000. The expected end-ofyear cash flows are:
Year 1:
$12,000
Year 2:
$39,000
Year 3:
$39,000
Year 4:
$30,000
Year 5:
$18,000
If the appropriate discount rate for this project is 15%, which of the following is a correct statement?
a.
b.
c.
d.
e.

Reject the project because its IRR is 13.56%

Accept the project because its NPV is $6,500
Accept the project because the IRR is 17.3%
Reject the project because its NPV is -3330.70
Both a and d are correct

9. The following table lists the capital budgeting analysis of four different independent projects with an
equal life:
Project
A
B
C
D

NPV
$4,500
-$3,600
$7,100
$75

IRR
15%
17%
8%
23%

Discount Rate
13%
18%
6%
22.5%

Which project(s) would you choose?

a.
b.
c.
d.
e.

A only
C only
A and C
A, C, and D
A, B, C, and D

10. Which of the following statements is most correct concerning a project with normal cash flows (i.e., a
cash outflow in Year 0 followed by cash inflows in all subsequent years)?
a. If the NPV of a project is positive then the payback period rule will always accept the project
b. If the NPV of a project is negative, then the profitability index of the project will always be
greater than one.
c. If the PI of a project is greater than one, then the IRR will always be less than the projects cost of
capital
d. If the NPV of a project is zero, then the IRR of the project will be equal to the discount rate for
the project.
e. If the discount rate of a project is zero, then the project will always be accepted.
11. MECCS Inc. is considering the purchase of VICX Inc. The managers of VICX estimate that the assets
of VICX will generate $14 million in cash flows next year and that these cash flows will grow at a
constant rate of 6 percent per year forever. The appropriate discount rate is 13 percent per year and
the purchase price is $180 million. Compute the NPV of this investment.
a.
b.
c.
d.
e.

$10 million
$20 million
$30 million
$40 million
$50 million

Use the following information to answer questions 23 through 25.

Truman Electronics manufactures a variety of household appliances. The company is considering
introducing a new microwave oven. The unique feature of this oven is that it is capable of cooking food
items 80 percent faster than conventional microwave ovens. The company's CFO has collected the
following information about the proposed product.

The project has an anticipated economic life of 5 years.

The company will have to purchase a new production facility to produce the ovens which will
require an immediate outlay of $16 million.
The production facility will be depreciated on a straight-line basis over 5 years to a $6 million
salvage value. Truman Electronics plans to sell the production facility to a competitor for $6
million at the end of the 5-year period.
If the company goes ahead with the proposed project, it will require an immediate increase in net
working capital of $200,000. The net working capital will be recovered after the project is
completed.
The new ovens are expected to generate sales revenue of $40 million per year for each of the next
5 years.
Operating costs, excluding management salaries, are expected to be $32 million per year.
Last year, a market research study for the new product cost $15 million. The company has
capitalized these costs and is recording them on the income statement at $3 million per year over
the next 5 years.
Allocated management salaries will be $2 million per year, although no new managers will be
hired for this project. If the project is not undertaken then these managers will work on the
companys other projects instead of this one.
The company's interest expense each year will be $3.5 million.
The company's cost of capital (i.e., the required rate of return on this project) is 12 percent.
The company's tax rate is 30 percent.

Record your final numerical answer to each of the following questions on the answer sheet. Show your
work on the back of the answer sheet for possible partial credit.
12. What is the initial investment for the project?
13. What is the second year expected incremental operating cash flow?
14. What is the 5th year incremental non-operating cash flow?

Answer Key for EXAM NUMBER Version of FI 3300

Final Exam
Spring 2002
1. E
2. D
3. B
4. C
5. E
6. A
7. C
8. C
9. D
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.

B
B
E
E
C
D
B
A
A
E
D
D
B
(16,200,000)
6,200,000
6,200,000