Very Important (READ THIS):

Solutions
You should put your eight-digit ID in the above example) on both the exam and the bubble sheet.

Examination Cover Sheet

Print Family Name: Print Given Name: ID Number:
  
COURSE NUMBER SECTIONS: G, H, I, J, CC, DD, EE
FINANCE COMM 308
EXAMINATION DATE TIME: 3 hours # OF PAGES 16
Final Exam April, 30, 2019 14:00 to 17:00 Including this cover and
VERSION BLUE (Evening/Night) Formula sheets

INSTRUCTOR: Circle your Professor DIVISION

John Molson School of Business
Northrop Sprung-Much Jennifer Yang
Concordia University
Pedram Fardnia Chao He

Monir Wahhab

INSTRUCTIONS: Please read these carefully

1. Please ensure you have 16 pages (including this cover page and Formula sheet) in this exam.
2. For Part I of this exam (Multiple Choice Questions): All answers must be recorded IN PENCIL on
the computer sheet. Only the computer sheet will be graded.
3. For Part II: Show your calculations to earn part marks. Label clearly.
4. For Part II: All answers must be recorded IN INK within this exam.
5. In the event the exact answer is not provided, choose the CLOSEST response.

MATERIALS ALLOWED:
1. You must submit a BLUE computer answer sheet.
2. You are allowed to bring one or more calculators (ENCS sticker not necessary)
3. You are allowed to bring one language dictionary (no finance/ mathematics/economics etc.
dictionary)

MCQ Q1 Q2 Q3 Total
Max marks: 75 7 10 8 100

Marks awarded

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Part I: Multiple Choice Questions (30 Questions, 75 Points Total):
Only MCQ answers IN PENCIL on the computer answer sheet (scantron) will be graded.

1. Of the following, which statement regarding agency costs is true?

a. An agency problem exists when there is a conflict of interest between the stockholders and
management of a firm.
b. An agency problem does not exist when there are conflicts of interest between principals
and agents.
c. An agency cost occurs when firm management takes on risky projects that favorably affect
the stock price, even though the managers are worried about keeping their jobs.
d. A corporate expenditure that benefits stockholders but harms management is an agency
cost.
e. Both (a), and (c) are true.

2. John Doe Enterprises borrowed $149,500 for two years from the bank. At the end of the two
years, they repaid the loan with one payment of $176,590. What was the quoted interest rate
on the loan? Assume the interest rate is quoted as APR compounded semi-annually.
a. 4.25%
b. 8.36%
c. 8.50%
d. 8.68%
e. 18.12%

3. You are interested in investing your money in a bank account. Which of the following banks
provides you with the highest effective rate of interest?
a. Bank 1; 8 percent with monthly compounding.
b. Bank 2; 8 percent with annual compounding.
c. Bank 3; 8 percent with quarterly compounding.
d. Bank 4; 8 percent with daily (365-day) compounding.
e. Bank 5; 8.24 percent with annual compounding.

4. In a typical loan amortization schedule, the dollar amount of interest paid each period will
_________________
a. increases with each payment
b. decreases with each payment
c. remains constant with each payment
d. increase or decrease depending on the term of amortization
e. depend on the interest rate prevailing in the market during that period

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5. Which of the following has the greatest interest rate risk?
a. A 10-year, $1000 face value, 10% coupon bond with semi-annual interest payments.
b. A 10-year, $1000 face value, 10% coupon bond with annual interest payments.
c. A 10-year, $1000 face value, zero coupon.
d. A 10-year, $100 annuity.
e. All the above have the same interest rate risk since they all mature in 10 years.

6. Assume you are to receive a 20-year annuity with annual payments of $50. The first payment
will be received at the end of Year 1, and the last payment will be received at the end of Year
20. You will invest each payment in an account that pays 10 percent. What will be the value
in your account at the end of Year 30?
a. $1,000
b. $6,354.81
c. $6,752.57
d. $7,427.83
e. $8,170.61

7. A buyer can afford no more than $500 per month in payments. The most favorable loan
available in the market is a 30-year loan at 10% (APR compounded semiannually). What is the
maximum affordable house with a 10% down payment? (Pick the closest number)
a. $55,000
b. $57,959
c. $64,399
d. $65,679
e. $180,000

8. Suppose that Chloe borrows $300,000 from the First National State Bank at 2.5 percent interest
compounded annually to purchase a new home. Chloe agrees to repay the loan in 30 equal
annual installments, with the first payment due at the end of the first year. Chloe’s annual
payment is closest to _______________.
a. $14,333.25.
b. $15,666.35.
c. $16,777.45.
d. $17,888.55.
e. None of the above.

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9. The Money Shoppe will loan you cold hard cash until your next paycheck. You will write a
$832 cheque post-dated by two weeks and you will receive $800 right now. What is the
biweekly-compounded APR of this loan (assuming a year is exactly 52 weeks long)? Note:
Biweekly = happening every two weeks.
a. 104.00%
FV $ 832.00
b. 177.25% time 2 weeks
c. 204.00% PV $ 800.00
2 week interest 4.0%
d. 208.00%
APR com 2 week 104% =26*4%
e. 277.25%

10. Liddy Products, Inc. just issued 10-year, 8% coupon bonds at par. Outstanding Limbaugh
Corp. bonds, which have a maturity of 10 years, sell at a premium and are viewed by investors
as having the same risk as the Liddy bonds. Therefore, it must be true that:
a. The coupon rate on the Limbaugh bonds is equal to that on the Liddy bonds.
b. The coupon rate on the Limbaugh bonds is higher than that on the Liddy bonds.
c. The coupon payment on the Limbaugh bonds is lower than that on the Liddy bonds.
d. The yield on Limbaugh bonds is higher than the yield on Liddy bonds.
e. The Limbaugh bonds pay coupons more often than twice a year.

11. John invests $25,000 per year, for 40 years at an interest rate of 7%. He will make his first
payment of $25,000 in one year and he expects his subsequent annual contributions to increase
by 7% per year. What is the value of the investment at the end of the 40 years?
a. $934,579.44
b. $1,000,000.00
c. $4,990,877.80
d. $13,994,820.41
e. $33,550,627.47

12. Which of the following statements is most correct?

a. A. Assume that the required rate of return on a given stock is 13%. If the stock’s dividend
is growing at a constant rate of 5%, its expected dividend yield is 5% as well.
b. The dividend yield on a stock is equal to the expected return less the expected capital gain.
c. A stock’s dividend yield can never exceed the expected growth rate.
d. All of the answers above are correct
e. Answers B and C are correct.

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13. A stock is not expected to pay a dividend over the next four years. Five years from now, the
company anticipates that it will establish a dividend of $1.00 per share (i.e., D5 = $1.00). Once
the dividend is established, the market expects that the dividend will grow at a constant rate of
5 percent per year forever. The risk-free rate is 5 percent, the company's beta is 1.2 and the
market risk premium is 5 percent. The required rate of return on the company's stock is
expected to remain constant. What is the current stock price?
The required return on the stock is given by:
a. $7.36 ks = kRF + RPM(b)
ks = 5% + (5%)1.2 = 11%.
b. $8.62 The stock price is given by:
D5
c. $9.89 P̂4 =
ks − g
$1.00
d. $10.98 =
0.11 - 0.05
= $16.667.
e. $11.53 Thus, the current price is given by discounting the future price in Year 4
to the present at the required rate of return:
$16.667
P0 = = $10.98.
14. Perpetual Inc stock currently sells for $40 per share (immediately after mailing out its most
(1 11)4

recent dividend). The required rate of return for Perpetual’s equity is 10%. If the company
maintains a constant 4% growth rate in dividends, what was the most recent dividend per share
paid on the stock?
a. $4.00.
b. $1.60
c. $2.40
d. $2.31
e. $3.85

15. Zoopolis has 2 million preferred shares issued at a par value of $40. The preferred shares are
currently selling at $33.25 per share and the required rate is 8.42 percent. What is the dividend
rate?
a. 7.00%
b. 8.42%
c. 10.13%
d. 16.88%
e. Insufficient information

16. Preferred shareholders' claims on assets and income of a firm come _________ those of
creditors _________ those of common shareholders.
a. before; and also before
b. after; but before
c. after; and also after
d. before; but after
e. equal to; and equal to

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17. You have done a thorough study of the economy and Stock X and concluded that: (1) the
probability of having a boom next year is 20 percent, a stable economy is 55 percent, and a
recession is 25 percent, and (2) the price of Stock X will be $45 if there is a boom, $25 if the
economy is stable, and $15 if there is a recession. What is the expected return on Stock X if it
is currently selling for $24?
a. –9.43%
b. 10.42% Compute P1 = $45*20% + $25*55% + $15*25% = $26.50
$26.5 − $24
c. 18.06% The ex ante expected return,
= E ( R) = 10.42%
$24

d. 26.5%
e. None of the above

18. When two risky securities with correlation less than one, are held in a portfolio,
a. the portfolio standard deviation will be greater than the weighted average of the individual
security standard deviations.
b. the portfolio standard deviation will be less than the weighted average of the individual
security standard deviations.
c. the portfolio standard deviation will be equal to the weighted average of the individual
security standard deviations.
d. the portfolio standard deviation will always be equal to the securities' covariance.
e. none of the above are true.

19. Your personal opinion is that a security has an expected rate of return of 0.11. It has a beta of
1.5. The risk-free asset has a beta of zero and the market expected rate of return is 0.09.
According to the Capital Asset Pricing Model, this security is
a. underpriced.
b. overpriced.
c. fairly priced.
d. cannot be determined from data provided.
e. none of the above.

20. You are holding a stock that has a beta of 2.0 and is currently in equilibrium. The required
return on the stock is 15 percent, and the market return is 10 percent. What would be the
percentage change in the return on the stock, if the market return increased by 30 percent while
the risk-free rate remained unchanged?

a. +20%
b. +30%
c. +40%
d. +50%
e. +60%

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21. An investor invests $800 in a risky asset with an expected rate of return of 18% and a standard
deviation of 25%. The investor also invests $200 in a Treasury bill with a 4% rate of return.
Her portfolio's expected rate of return and standard deviation are ______and ______,
respectively.
a. 14.4%; 20.0%
b. 18.4%; 20.8%
c. 15.2%; 20.0%
d. 15.2%; 44.7%
e. Insufficient information.

22. An investor is forming a portfolio by investing $50,000 in stock A that has a beta of 1.50, and
$25,000 in stock B that has a beta of 0.90. The return on the market is equal to 6 percent and
Treasury bonds have a yield of 4 percent. What is the required rate of return on the investor’s
portfolio?
A B
a. 6.6% I $ 50,000.00 $ 25,000.00
Beta 1.5 0.9
b. 6.8% Weight 67% 33%
rm 6%
c. 5.8% rf 4%
d. 7.0% Beta(p) 1.3 =0.67*1.5+0.33*0.9
e. 7.5% Er(p) 6.60% =0.04+1.3*(0.06-0.04)

23. 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 project’s
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. Both A and D.

24. WidgetsRus will produce 55,000 widgets next year. Variable costs will equal 40 percent of
sales, while fixed costs will total $110,000. At what price must each widget be sold for the
company to achieve an EBIT (Earnings before interest and taxes) of $95,000?
a. $2.00 n 55,000
variable cost 40% of sales
b. $4.45 Fixed cost $ 110,000.00
EBIT $ 95,000.00
c. $5.00
d. $5.37 0.6*x-110000 = 95000
x= 341666.6667
e. $6.21 perunit $ 6.21

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25. Your quantitative research team at Technical Investment Strategies LLC reports that they
identified a successful trading strategy. The team claims that superior returns could be achieved
by purchasing Canadian stocks whose price has increased at a higher rate than the increase in
the Toronto Stock Exchange S&P/TSX stock market index over the past six month. If true, the
existence of such a trading strategy would be evidence...
a. against the stock market being strong form efficient.
b. against the stock market being semi-strong form efficient.
c. against the stock market being weak form efficient.
d. Both (a) and (b)
e. All (a), (b) and (c)

26. A profitability index of .85 for a project means that:

a. the present value of benefits is 85% greater than the project's costs.
b. the project's NPV is greater than zero.
c. the project returns 85 cents in present value for each current dollar invested.
d. the payback period is less than one year.
e. IRR of the project is higher than the required rate of return.

27. An investor has simultaneously sold a call option and a put option. Assuming that both options
are on the same underlying stock, with same strike price and expiration date, which of the
following statement/s are true?
I. The investor's maximum loss is zero because the call and the put will offset each other.
II. The investor’s maximum profit is the sum of the two option premiums.
III. The investor must profit when the stock decreases in value
IV. The investor must profit when the stock increases in value
a. I only
b. II only
c. I and II only
d. III and IV only
e. I, II, III, and IV

28. If the discounted payback period of a project with normal cash-flows is greater than its lifespan,
then its profitability index is

a. less than 1.
b. less than 0.
c. greater than 1.
d. greater than 0.
e. Profitability index cannot be inferred from the discounted payback period. Hence
insufficient information.

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29. FarNorth Airlines is considering two equally risky, mutually exclusive projects, both of which
have normal cash flows (initial negative cash flow followed by a set of net positive cash flows).
Project A has an IRR of 11%, while Project B’s IRR is 14%. When the WACC is 8%, the
projects have the same NPV. Given this information, which of the following statements is
correct?

a. If the WACC is 13%, Project A’s NPV will be higher than Project B’s.
b. If the WACC is 9%, Project A’s NPV will be higher than Project B’s.
c. If the WACC is 6%, Project B’s NPV will be higher than Project A’s.
d. If the WACC is greater than 14%, Project A’s NPV will exceed Project B’s.
e. If the WACC is greater than 8%, Project B’s NPV will be higher than Project A’s.

30. A new project with a life of 10 years, costs $210,000 and is expected to generates annual net
cash inflows of $x each year. The project has a discounted payback period of 10 years. Which
of the following statement/s is/are most correct: (Note: RRR stands for the required rate of
return for the project)

a. NPVA>0, and PIA>1

b. IRRA>RRRA, and Payback period will be less than 10 years
c. NPVA=0, and PIA=1
d. Both A and B
e. E. The answer will depend on the magnitude of “x”.

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Q2: (10 points) Consider the following cash flows of two mutually exclusive projects for Tropical
Rubber Company. Assume the discount rate for Tropical Rubber is 10 percent.
Year Forklift Conveyor
0 -$500,000 -$1,000,000
1 500,000 600,000
2 500,000 400,000
3 100,000 1,000,000
i. (4 points) Based on the NPV which project should be taken?
ii. (4 Points) Based on the Profitability Index, which project should be taken?
iii. (2 points) Assuming that (i) and (ii) provided contradicting recommendations. As the CEO of
Tropical Rubber, when should you follow PI recommendation? When do you follow the NPV
recommendation?

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Q3: Option portfolio payoff (8 Points): Suppose that the price of a share of stock in ABC
Corporation is currently trading at $30/share. Consider building a portfolio with the following
option positions:
a. Buy a Call option with a strike price of $25
c. Sell two call options each with a strike price of $40
d. Buy a call option with a strike price of $55
Draw a payoff diagram of this portfolio.
Note: Clearly label both axes as well as the location of each important point on the diagram.

Stock Price--> 0 25 40 55 80
C25 0 0 15 30 55
-2*C40 0 0 0 -30 -80
C55 0 0 0 0 25
Portfolio 0 0 15 0 0

Payoff
16
15
14
13
12
11
10
9
Payoff

8
7
6
5
4
3
2
1
0
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85
Stock Price

Axis labels 2X1 point each = 2 Points

Label 25, 40, 55 correctly  3X1 pts each = 3 points
Label 15 along the vertical axis 1 point
Get the overall graph accurately  2 Points
If individual option is plotted instead of the portfolio then a maximum of 4 points may be
awarded. 1 point for each long option and 2 points for the short option.

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 Equation Formula
Present Value FVn 1
PV0 = 𝑛𝑛
= FVn ×
(1 + k) (1 + 𝑘𝑘)𝑛𝑛
Future Value (Ordinary Annuity) (1 + k)𝑛𝑛 − 1
𝐹𝐹𝐹𝐹n = PMT � �
𝑘𝑘
Present Value (Ordinary Annuity)
PMT  1 
PV0 = 1 − 
k  (1 + k )n 

Future Value (Annuity Due)

 (1 + k )n − 1 
FVn = PMT   (1 + k )
 k 

Present Value (Annuity Due)

PMT  1 
PV0 = 1 −  (1 + k )
k  (1 + k )n 

Present Value (Perpetuity)

PMT
PV0 =
k
Growing Perpetuity
PMT0 (1 + g ) PMT1
=PV0 =
k−g k−g

Growing annuity
PMT1   1 + g  
n

PV
=0 × 1 −   
k − g   1 + k  

Effective Annual Rate m

 QR 
1 +
k=  −1
 m 
Effective Period Rate (for any period f) m
 QR  f
1 +
k=  −1
 m 
Bond Valuation
I  1  F
PV0 = 1 − n 
+
 (1 + kb )  (1 + kb )
n
kb

Fisher Relationship RF = [ (1 + Real rate)(1 + Expected inflation) ] – 1

Market Price of Preferred Shares
Dp
Pps =
kp

14
Constant Growth Dividend Discount Model
D0 (1 + g ) D1
=P0 =
kc − g kc − g
Sustainable Growth Rate g =b × ROE
P/E Ratio Approach P0 = Estimated EPS1 × Justified P/E ratio = EPS1 ×
P0/E1
P/E Ratio (Using Constant Growth DDM)
P0 P D1 / EPS1
= =
EPS1 E kc − g
Total Return Total return = Income yield + Capital gain (or loss) yield
CF + P − P
= 1 1 0
P0

Expected Return (Individual) n

ER =∑ ( r1 × Probi )
i =1

Standard Deviation for Individual Returns Ex-Post

( )
n 2
∑ ri − r
Ex post σ = i =1

n −1
Standard Deviation for Individual Returns Ex n
Ante
∑ ( Prob )( r − ER )
2
Ex ante σ
= i i
i =1

Expected Portfolio Return 𝑛𝑛

𝐸𝐸𝐸𝐸p = �(wi ∗ ER i )
i =1

Standard Deviation of a Two-Security Portfolio

𝜎𝜎𝑝𝑝 = �(𝑤𝑤𝐴𝐴 )2 (𝜎𝜎𝐴𝐴 )2 + (𝑤𝑤𝐵𝐵 )2 (𝜎𝜎𝐵𝐵 )2 + 2(𝑤𝑤𝐴𝐴 )(𝑤𝑤𝐵𝐵 )(𝐶𝐶𝐶𝐶𝐶𝐶𝐴𝐴𝐴𝐴 )
(Using Covariance)

Covariance of Returns n
COV
= AB ∑ Prob ( r
i =1
i A ,i )(
− r A rB ,i − r B )
Covariance of Returns (Using Correlation COVAB = ρAB σA σB
Coefficient)
Sharpe Ratio ER p − RF
Sharpe ratio =
σp

Beta COVi,M ρi,Mσ i

=βi = 2
σM σM

Portfolio Beta β= w1β1 + w2 β 2 + ... + wn β n

p

15
CAPM RF + ( ER M − RF ) βi
ki =

Alpha αi = (Ri − RF) − [βi(RM − RF)]

𝑛𝑛
Net Present Value 𝐶𝐶𝐶𝐶𝑡𝑡
NPV = � − 𝐶𝐶𝐶𝐶0
(1 + 𝑘𝑘)𝑡𝑡
𝑡𝑡=1

Profitability Index PV(cash inflows)

PI =
PV(cash outflows)
Initial Cash Outlay CF0 = C0 + ΔNWC0 + OC
Annual After-Tax Cash Flows CFt = CFBTt (1 − Τ) + CCAt (T)
Ending Cash Flow (ignoring tax implications) ECFn = SVn + ΔNWCn

Net Present Value NPV = PV(Annual CFs) + PV(ECFn) − CF0

WACC with Preferred Shares
S P D
WACC = K e + K p + Ki
V V V

16