Department of Finance

FNCE10002 Principles of Finance

Semester 2, 2019
Sample Final Exam 1

This sample final exam has three parts. There are a total of 100 marks.

There is a multiple choice part where most of the questions are for the material covered from week 6.
Students should refer to the sample MST for additional multiple choice questions for the first four
weeks of the semester. The final exam will cover all material in the subject but with a greater
emphasis on material covered from week 6.

The true/false with explanations and short answer/numerical questions cover the entire subject but
with a greater emphasis on material covered since the MST.

Questions 1 through 11 are multiple choice questions and each worth 2.5 marks.

1. Stock A has an expected return of 4% and a standard deviation of returns of 20% while Stock
B has an expected return of 6% and a standard deviation of returns of 30%. If the stock
returns are perfectly negatively correlated the expected return on the minimum variance
portfolio consisting of these stocks will be closest to:

A. 4.8%.
B. 5.0%.
C. 5.2%.
D. 5.4%.
E. None of the above

2. During the past four years the annual returns on the market index were +9%, –10%, +15%
and +12%, respectively. The average annual geometric return over this period is closest to:

A. 6.0%.
B. 6.5%.
C. 26.0%.
D. 26.3%.
E. None of the above.

Sample FINAL Exam 1

 3. The shares DBY Ltd are currently selling for $20.00 per share. You have developed the
following probability distribution of the ex-dividend price and the dividend to be paid one
year from now.

State of the Probability Price Dividend

Market
Bearish 0.3 $17.00 $1.00
Normal 0.4 $19.00 $1.00
Bullish 0.3 $24.00 $2.00

The standard deviation of the rate of returns for DBY Ltd shares is closest to:

A. 2.6%.
B. 12.7%.
C. 16.3%.
D. 25.4%.
E. None of the above

4. Which of the following securities would a risk averse investor prefer?

A. Security A: E(rA) = 10%, σA = 12%.
B. Security B: E(rB) = 10%, σB = 16%.
C. Security C: E(rC) = 12%, σC = 12%.
D. A risk averse investor would require more information to make a decision.
E. None of the above

5. The standard deviation of returns on securities X and Y is 20% and 22%, respectively. If the
standard deviation of an equally-weighted portfolio of X and Y is 19.62% then the covariance
between these securities’ returns is closest to:

A. –0.0650.
B. 0.0328.
C. 0.0572.
D. 0.0720.
E. None of the above

6. You have developed the following return probability distribution for the X Co. and Y Ltd. for
next year.

State of the Probability X Co’s Return Y Ltd’s Return

Market
Excellent 0.3 -20% 20%
Normal 0.4 5% 15%
Poor 0.3 30% 10%
Expected return 5% 15%

Sample FINAL Exam 2

 Based on the above information, the correlation between the returns on securities X and Y is:

A. Negative.
B. Positive.
C. Zero.
D. Not computable without additional information.
E. None of the above.

7. Your uncle invested $50,000 at the end of 2012 and the total market value of his portfolio
over 2013-16 has been as follows:

End of Year Market Value

2013 $60,000
2014 $40,000
2015 $30,000
2016 $80,000

The average annual geometric rate of return the investment during this period is closest to:

A. 9.9% p.a.
B. 12.5% p.a.
C. 15.0% p.a.
D. 60.0% p.a.
E. None of the above

8. Which of the following statements regarding capital budgeting are true?

I. The payback method of project evaluation tends to be biased against the potential
acceptance of projects with long establishment (or development) periods where large net
cash flows occur later in their lives.
II. In capital budgeting, one advantage of the internal rate of return is that it does not require
the estimation of a cost of capital (or hurdle rate).
III. If the size of the initial outlay and future net cash flows from a project is doubled then the
net present value will also double but the internal rate of return will remain unchanged.

A. I and II only
B. I and III only
C. II and III only
D. I, II and III
E. None of the above
9. Which of the following statements regarding ``American-type’’ call options is false?

A. The higher the current share price, the greater the call price.
B. The higher the exercise price, the lower the call price.
C. The call price is greater, the longer the term to expiry.
D. The lower the risk-free interest rate, the higher the call price.
E. None of the above.

Sample FINAL Exam 3

10. Firm currently has $100 million in debt outstanding with a 10% interest rate. The terms of the
loan require the firm to repay $25 million of the debt outstanding each year. The firm’s
marginal corporate tax rate is 40% and that the interest tax shields have the same risk as the
loan. The present value of the interest tax shields from this debt is closest to:

A. $8.3 million.
B. $10.0 million.
C. $15.1 million
D. $20.8 million.
E. None of the above.

11. Which of the following statements about capital budgeting analysis are most likely to be true?
I. A necessary condition for multiple internal rates of return is that the future cash flows
change sign at least two times.
II. Financing costs such as dividends paid to shareholders should be included in the estimation
of a project’s net cash flow.
III. Financing costs such as interest on debt should not be included in the estimation of a
project’s net cash flow.

A. I and II only.
B. II and III only.
C. I and III only.
D. I, II and III.
E. III only

12. Koala Ltd is an Australian company. It has just paid a fully franked dividend of $2.80 per share.
Assuming a corporate tax rate of 30%, the franking credit attached to this dividend is closest
to:

A. $1.40
B. $1.20
C. $1.00
D. $0.80
E. None of the above

Questions 13 through 20 are True/False with explanations. They are worth 3 marks each.

13. The only difference between the capital market line (CML) and the security market line (SML) is
that in the CML risk is measured using the standard deviation of returns while in the SML risk is
measured using the beta.

14. The payback method of project evaluation discriminates against projects with long establishment
periods and large cash flows later in their lives.

15. A zero coupon bond maturing in six years with a face value of $1,000 is selling today for $500.
Since the return over this six-year period is 100%, the yield to maturity on this bond is 16.67%.

16. Investors who purchase shares after the ex-dividend date, purchase the shares cum dividend and are
entitled to receive the dividend.

17. The constant and variable dividend growth models are ideal for valuing high-growth companies.

Sample FINAL Exam 4

18. A forward contract does not require a payment on initiation so its present value must always be
positive.

19. The accounting rate of return is often used as a discount rate in discounted cash flow analysis.

20. The slopes of the Security Market Line (SML) and the Capital Market Line (CML) are the same.

Questions 21 through 25 are short answer and numerical questions.

21. You are given the following information on two stocks and the market portfolio.

Variance-
Covariance Matrix
Security Alpha Ltd Gamma Ltd Market
Alpha Ltd 0.040
Gamma Ltd 0.018 0.090
Market 0.015 0.009 0.010

Assume that you have $50,000 available to invest. You form a portfolio by investing $20,000 in
Alpha Ltd and the rest in Gamma Ltd.

(a) Compute the standard deviation of this portfolio.

(b) Compute the beta of each stock and the portfolio in (a)
(c) One of your clients, Ian Vest is considering investing in the above securities. Ian
is quite a risk averse investor. He notices that Alpha Ltd and Gamma Ltd appear
to be much more risky than the market portfolio, and he is quite concerned that
Gamma Ltd is considerably more risky than Alpha Ltd. He concludes that he
should not invest in Gamma Ltd’s shares for that reason. Is Ian correct? What
advice would you give him? Explain.

(5 + 6 + 6 = 17 marks)
22.

B
• •C
•
Rf

•A
0 σ

Sample FINAL Exam 5

Which portfolio (s) are efficient? Provide a brief explanation for your answer. ( 6 marks)

23. The following table sets out the tax rates for Australian resident individuals for the
financial year ended 30 June 2019.

Taxable Income Tax on this Income

$0 – $18,200 NIL
$18,201 – $37,000 19 cents for each $1 over $18,200
$37,001 – $87,000 $3,572 plus 32.5cents on each dollar over $37,000
$87,001 – $180,000 $20,797 plus 37 cents on each dollar over $87,000
Over $180000 $54,097 plus 45 cents on each dollar over $180000

Excluding dividends and share transactions, Ranjit’s income for the 2018-19 financial year
was $88,200. He received a fully franked dividend of 21 cents per share on his holding of
10,000 shares in National Brakes Ltd (NBL) and an unfranked dividend of 7 cents per share
on his holding of 6000 shares in Rockhampton Bank Ltd. Calculate Ranjit’s tax payable.
Show all calculations.

( 6 marks)

24.
(a) Distinguish between a hedger and a speculator for forwards contracts.
(b) Why is the price of a call option positively related to the risk-free interest rate, whereas
the price of a put option is negatively related to the risk-free interest rate?

( 5 + 6 =11 marks)

25. A company is considering two mutually exclusive projects, A and B, each requiring
an initial investment of $400,0000. The expected future net cash flows associated with
the projects (stated in nominal terms), appear in the following table. Expected annual
inflation is 5%.

Year 0 Year 1 Year 2

Project A -$400,000 $400,000 $300,000
Project B -$400,000 $200,000 $430,000

The company’s real cost of capital is 12% per annum. Calculate the net present value
of each project and advise the company of the appropriate investment decisions. Show
all calculations.

( 6 marks)

Sample FINAL Exam 6