FOREIGN TRADE UNIVERSITY MID-TERM EXAM PAPER

FACULTY OF BANKING AND FINANCIAL ECONOMICS TCHE341

FINANCE __________________________________

DEPARTMENT OF
SECURITIES INVESTMENT
_________________________
Phase 1 Semester 2 Academic year: 2021 – 2022
Full-time Class: TCHE341(GD1-HK2-
2122)CLC.1

Date: 16/03/2022 Time: 12:30 - 13:15

Duration: 45 minutes (not include paper distribution time)

Question 1 (3 marks): Suppose your production opportunity set in a world of certainty

consists of the possible investments as shown in the following table, and your endowment
point is ($10,000, $10,000).
(a) Graph the production opportunity set in the intertemporal consumption diagram.
(b) If the market interest rate is 11%, how much should you invest?
Project Investment Rate of Return
Outlay (in %)
A $1,000 25
B $2,000 5
C $3,000 10
D $1,000 15

Question 2 (3 marks): The Dauten Toy Corporation is considering the replacement of an

8-year-old riveting machine with a new one that will increase earnings before depreciation
from $24,000 to $46,000 per year. The new machine will cost $80,000; and it will have an
estimated life of 8 years and no salvage value. The new machine will be depreciated over
its 5-year MACRS recovery period, so an asset may be fully depreciated before the end of
its service life. Following are the applicable depreciation rates.
Year 1 2 3 4 5 6 Sum
Applicable MACRS Rate 20% 32% 19% 12% 11% 6% 100%
The applicable corporate tax rate is 40%, and the firm’s WACC is 10%. The old machine
has been fully depreciated and has no salvage value. Should the old riveting machine be
replaced by the new one? Explain your answer.
Question 3 (4 marks): Consider an individual with a current wealth of $100,000, who
faces a chance of 25% of losing $20,000. Suppose that this person’s utility function is
expressed as U(W) = ln(W).
(a) What is his expected utility if he does not purchase insurance?
(b) How much is the fair insurance premium?
(c) What is the expected utility if this individual purchases the insurance and pays the fair
insurance premium?
(d) What is the maximum insurance premium he is willing to pay?
(e) What is his risk-premium?

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Note: - This paper contains 03 questions.
- Students must not use any material during the examination.
- Invigilators will not provide further explanation.