FINANCE 634
Fall 1995 Exam I
Be concise and specifically address the question that is asked.
Don't ramble. Points as marked. No partial credit.
1. Name three advantages that a corporation has over other business forms that help to
create value for the shareholders. [3]
A.
B.
C.
2. Corporations came into being to (4 items): [3]
A.
B.
C.
D.
3. Describe three ways in which the agency problem can be addressed by shareholders. [3]
A.
B.
C.
4. The three primary elements in the role of the corporate financial manager are: [3]
A.
B.
C.
5. Describe two reasons why the Total Asset figure on the balance sheet does not reflect the
true value of the company. [3]
A.
B.
6. Describe two reasons why the Net Income figure on the income statement does not reflect
the true profit of the company. [3]
A.
B.
7. Under the conceptual framework of financial accounting, how is inflation incorporated in
the portrayal of balance sheet and income statement values? [3]
8. Name and briefly describe the three main factors that compose the required rate of return
on any investment. [6]
A.
B.
C.
9. What is the Yield Curve and why is it important? What does it show concerning investors'
expectations about economic conditions in the future? Draw and label the current yield curve
(including reasonable estimates of current interest rates. [5]
10. Assuming everything else remains constant, what should happen to a stock's price when
the stock goes ex-rights? Why? [3]
11. Describe the difference between the "best efforts" and "firm commitment" methods of
handling a securities issue through an investment banker. [3]
12. What is a "shelf registration" and why would a company choose to use it? [3]
13. What type of bond has the advantage of secrecy of ownership, but has the disadvantage
that ownership is not recorded by the registrar? [2]
14. Give an example of a negative bond covenant.[2]
15. What company recently announced that it will split into three separate companies? [2]
16. What country ranks first in wealth, according to the World Bank? [2]
17. What bank recently announced that it had lost $1.1 Billion dollars in the U.S. Treasury
market? [2]
18. What is the current ceiling on U.S. government borrowing? [2]
19. Give the current level of one stock index (pick any index). [2]
20. Who is the current Chairman of the Federal Reserve Board of Governors?[2]
PROBLEMS:
Show all work for partial credit.
1. Consider the following loan conditions:
Amount borrowed = $175,000
Term of Loan = 10 years
Interest Rate = 8.5% stated annual rate
Monthly Payment = $1,895
Answer the following questions:
A. What is the total dollar amount of interest you will pay over the life of the loan? [10]
B. For the 60th monthly payment, supply the following information:
Interest portion of the payment: _________________________ [2]
Principal portion of the payment: ________________________ [2]
Balance immediately following the payment: ________________ [2]
C. Suppose you make an extra payment of $100 with each required monthly payment. How
much money, in actual dollars, would you save using this payment scenario versus the original
loan scenario? [6]
D. What is the effective annual rate of the loan scenario described in part B? [5]
E. Under what conditions would a rational investor choose the scenario described in C over
the original loan scenario? Be specific. [3]
2. Consider the following annual cash flows:
TIME CASH FLOW
1 0
2 0
3 0
4 2000
5 2000
6 2000
7 2000
8 3500
9 ?
10 ?
11 ?
12 ?
13 1500
14 1500
15 1500
16 1500
17 2000
The missing cash flows (?s) are all equal amounts. Using a 7.5% discount rate, the TOTAL
present value of all of the cash flows is $8,000. Find the missing cash flows. [10]
3. Consider the following stream of cash flows:
TIME CASH FLOW
0 500
1 500
2 500
3 500
4 500
5 ?
6 ?
7 ?
8 ?
The missing cash flows (?) are all equal amounts. Suppose these cash flows represent quarterly
payments into an account that pays 10.5% annual interest compounded quarterly, and that the
total accumulated value in the account after 5 years (no payments into the account are made in the
last three years) is $8,000. Find the missing cash flows. [5]
B. Now suppose that the cash payments into the account are not changed (including the
missing ones that you just found), but instead of quarterly compounding the account pays 10.5%
with monthly compounding. What will be that accumulated value in the account at the end of 5
years? [5]
C. Suppose again that the cash payments into the account are not changed, but instead of
quarterly compounding the account pays 10.5% with annual compounding. What will be that
accumulated value in the account at the end of 5 years? [5]
4. You have the choice between two different loan plans to purchase a new car. The
purchase price of the car is $19,000. The two loan plans are described below:
Plan A Plan B
Required down payment $0 $2500
Loan Term 4 years 5 years
Annual Rate 9.5% 2.0%
Cash Rebate $2000 $0
The required down payment is the minimum that is acceptable to the lender. You can pay
more. If you choose to do so, you may use the cash rebate as part or all of the down payment on
Plan A. Regardless of how you finance the car, you plan to keep the car for at two years and then
sell it immediately after the 24th payment is made.
If your personal opportunity rate for cash is 7.5% describe the best way to finance the car
and calculate the value of the advantage of the best plan over the next best alternative. [10]
b. What personal opportunity rate would make you indifferent between the best plan and the
next best alternative? [5]
5. Suppose a government bond is listed today in the Wall Street Journal as shown below:
Ask
Rate Type Bid Ask Chg. Yld
9.25 Oct12 112:04 112:10 - 6
The next coupon payment is due in exactly 6 months. The bond pays semiannual interest.
A. Compute the Ask Yld for the bond.[6]
B. Suppose you purchased the bond today and held it for 6 years. Immediately after
receiving an interest payment (your 12th interest payment) you sell the bond. The market at that
time is pricing bonds to reflect a required annual return of 8.60%. What was your holding period
return on an annual basis for the 6 years of the investment? [10[
6. Your research into the XYZ Corporation has brought to expect the following concerning
the performance of the company and the stock in the future:
Annual dividends per share will remain at the current level of $1.50 for the next 4 years.
The next dividend is expected to be paid in exactly one year.
Beginning in the fifth year, dividends are expected to grow at a constant annual rate of 6%
from then on.
Your required annual return on the investment is 12.5%.
What is the maximum price you would be willing to pay for one share of this stock
(assuming you are a rational investor)? [6]
7. Using the spreadsheet set-up and the sample inputs shown, answer the questions
below:
| |
A |
B |
| 1 |
Loan Amount |
50000 |
| 2 |
Term in Years |
10 |
| 3 |
Annual Int. Rate |
9.5 |
| 4 |
Balloon Payment |
15000 |
| 5 |
Monthly Payment |
? |
A. Using ONLY the inputs given in the table, write ONE formula that computes the monthly
payment. Be sure to use good modeling techniques.
[5] Answer: _______________________________
B. Using ONLY the inputs given in the table (including the monthly payment), write ONE
formula that computes the total dollar amount of interest that will be paid on the loan over its life.
Be sure to use good modeling techniques.
[5] Answer: _______________________________
C. Using ONLY the inputs given in the table (including the monthly payment), write ONE
formula that computes the amount of interest that will be taken from the 24th monthly payment.
[5] Answer: _______________________________
ANSWERS:
Question 1:
A. $104,091
B. $901.02, $993.98, $126,209.19
C. $6,813.84
D. 8.84%
Question 2:
-1,090.99
Question 3:
A. $706.59
B. $8,028.39
C. $7,880.94
Question 4:
Best plan - Use A with rebate as down payment
Second best - Plan A without the down payment
Value of best over second best - $58.94
b. 9.5%
Question 5:
A. 7.92%
B. 7.30%
Question 6:
$19.78
Question 7:
Sounds like a good test question...
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