Practice Exam Questions

FIN1FOF, Semester 1 2022

PART A: Multiple-choice questions (2 marks per question)

1. Which of the following is an advantage of a corporation as a form of business organisation?

A. The business ends when one of the owners dies.
B. It is relatively easy and inexpensive to set up.
C. The owners have unlimited liability for the debts of the business.
D. The owners have limited liability for the debts of the business.

2. What is the future value of $6000 invested for 4 years, if the interest rate is 12% p.a.,
compounding quarterly?
A. $9441
B. $9628
C. $9686
D. $8880

3. Assuming two investments have equal lives, a high discount rate tends to favour _______.
A. the investment with large cash flow early
B. the investment with large cash flow late
C. the investment with even cash flow
D. neither investment since they have equal lives

4. What is the price of a coupon bond with a face value of $300 and 7 years to maturity, which
makes semi‐annual coupon payments at the rate of 3% p.a., if it is trading at a yield of 6%?
A. $246.14
B. $249.17
C. $249.76
D. $246.73

5. ABC Co. has $15 million of debt outstanding with a coupon rate of 9%. Currently, the yield to
maturity on these bonds is 7%. If the firm’s tax rate is 35%, what is the after-tax cost of debt?
A. 10.76%
B. 5.85%
C. 4.55%
D. 5.40%

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6. What must be true of a project in order for it to increase the value of the firm?
A. The project must increase the firm's reported earnings for each year of the project.
B. The total number of dollars received over the life of the project must exceed the cash
invested in the project.
C. The project must make more than the cost of capital.
D. The project must increase the firm's reported earnings over the life of the project.

7. Corp Suite is considering two expansion options, but does not have enough capital to
undertake both. Project W requires an investment of $100,000 and has an NPV of $10,000.
Project D requires an investment of $80,000 and has an NPV of $8200. If Corp Suite uses the
profitability index to decide, it would
A. choose D because it has a higher profitability index.
B. choose W because it has a higher profitability index.
C. choose D because it has a lower profitability index.
D. choose W because it has a lower profitability index.

8. What is the NPV decision rule for discretionary mutually exclusive projects?
A. Accept the project with the highest NPV, even if the NPV is negative.
B. If there is sufficient capital, accept all positive-NPV projects.
C. Accept the project with the highest IRR.
D. Accept the project with the highest NPV, as long as the NPV is positive.

9. Which of the following would be considered a terminal cash flow?

A. The expected salvage value of the asset
B. Any tax payments or refunds associated with the salvage value of the asset
C. Recapture of any investment in working capital that was included as an incremental
cash outlay
D. All of the above

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10. A firm that manufactures paper is considering a project to set up a logging operation. Wood
pulp generated by the project - normally an unwanted by-product of a logging operation - is an
input to the paper manufacturing process. This will save the company $330,000 in wood pulp
purchases, but it will cost $60,000 more to transport the wood pulp to the paper factory than it
would cost to dump it as waste. How would you describe this situation in terms of the NPV
analysis for the logging operation?
A. There is a positive externality equal to $270,000 which should be included in the NPV
analysis.
B. There is a negative externality equal to $270,000 which should be included in the NPV
analysis.
C. There is a negative externality equal to $330,000 which should be included in the NPV
analysis.
D. There is a positive externality equal to $330,000 which should be included in the NPV
analysis.

11. You are considering investing in a project with the following possible outcomes:

States Probability of Occurrence Investment Returns

State 1: Economic boom 15% 16%
State 2: Economic growth 45% 12%
State 3: Economic decline 25% 5%
State 4: Depression 15% -5%

Calculate the expected rate of return for this investment.

A. 9.8%
B. 7.0%
C. 8.3%
D. 6.3%

12. You are considering investing in a portfolio consisting of 40% Melbourne Sports and 60%
Buckstar. If the expected rate of return on Melbourne Sports is 16% and the expected return on
Buckstar is 9%, what is the expected return on the portfolio?
A. 12.50%
B. 13.20%
C. 11.80%
D. 10.00%

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13. How is the realised percentage return from investing in a share calculated?
A. The cash flows received from the share divided by the price paid for the share.
B. Dividends received plus the difference between the selling price and the purchase
price, divided by the purchase price.
C. The price paid for the share divided by the selling price.
D. Both (b) and (c).

14. Changes in the general economy, such as changes in interest rates, represent what type of
risk?
A. Firm-specific risk
B. Market risk
C. Unsystematic risk
D. Diversifiable risk

15. A share has a beta of 1.1. The risk-free rate of return is 3.5% and the expected return on
the market is 10.0%. What is the market risk premium?
A. 12.45%
B. 6.50%
C. 10.65%
D. 7.15%

16. Which of the following is NOT something that is needed for a market to be efficient?
A. A large number of buyers and sellers.
B. Information being released in a random fashion.
C. No transactions costs.
D. None of the above. (In other words, ALL of the above are necessary for a market to
be efficient.)

17. The traditional view of markets assumes that investors are [blank].
A. overconfident
B. rational
C. unreasonable
D. sensitive

18. What does the Efficient Market Hypothesis tell us?

A. That the market is inefficient.
B. How to recognise an efficient market.
C. That the market is efficient.
D. That it is not possible for a market to be efficient.

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19. You write a put option over BHP shares. You do not currently hold BHP shares. How would
this transaction be described?
A. Hedging
B. Speculating
C. Abitraging
D. All of the above

20. A call option (with shares as the underlying asset) was originally purchased for $0.91 and is
now trading for $2.62. The exercise price is $35 and the underlying share is currently trading
for $37.43. What is the time value of the option?
A. $2.43
B. $-1.52
C. $2.62
D. $0.19

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PART B: Short-answer questions

Question 1 (6+6=12 marks)

a) You bought a CBA share on 1 January 2013 for $67.25 and sold it one year later for $64.75.
CBA paid dividends of $1.75 per share on 1 March 2013 and $2.00 per share on September 2013.
What is the dividend yield, the capital gain yield and the total yield? (6 marks)

b) A JBH share has just paid a dividend of $1.25 per share. This dividend is expected to grow at a
rate of 5% p.a. for the next three years, after which it is expected to grow at a constant rate of
2% p.a. in perpetuity. The equity cost of capital is 11% p.a. What is the value of the share? (6
marks)

Question 2 (6+6=12 marks)

a) What is a “sunk cost”. Should it be included as an incremental cash flow? Why/why not? (6
marks)

b) What role does correlation play in determining the value of diversification? (6 marks)

Question 3 (4+4+4+4+4+4=24 marks)

You are investing in two shares–X and Y. Your portfolio (referred as portfolio Z) is consisting of a
80% of your available funds invested in X and the balance invested in Y. The correlation between
the two shares is 0.6. The returns on these shares over the next year depends on the state of the
economy, which could be described as “Boom”, “Average” or “Recession”. The table below shows
the probability of each of these states of the economy, and the expected return on each share
given each possible state of the economy.
State of the economy Probability Share X return Share Y return
Boom 20% 10% 6%
Average 60% 4% 3%
Recession 20% -5% -1%

a) What is the expected return on Share X? (4 marks)

b) What is the variance of returns on Share X (provide 6 decimal places)? (4 marks)
c) What is the expected return on Share Y? (4 marks)
d) What is the variance of returns on Share Y (provide 6 decimal places)? (4 marks)
e) What is the expected return on Portfolio Z? (4 marks)
f) What is the variance of returns on Portfolio Z (provide 6 decimal places)? (4 marks)

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Question 4 (6+6=12 marks)
a) Consider the following graph. Which investment would a risk‐averse investor certainly choose
or not choose?

b) Consider the following graph. Which investment would a risk‐averse investor certainly choose
or not choose?