Very Important (READ THIS):

All students with seven digit ID numbers must add “2” in front of their
ID number to make it eight digit. For example:
ID # 6770177 should be made 26770177
You should put the eight-digit ID (26770177 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 SECTION:
FINANCE COMM 308 D
EXAMINATION DATE TIME # OF PAGES 14
Midterm October 15, 2017 2 hours Including this cover
VERSION GREEN 10:00:00 to
12:00:00
INSTRUCTOR: please circle your instructor DIVISION
Ian Rakita John Molson School of Business
Concordia University

INSTRUCTIONS: Please read these carefully

1. Please ensure you have 14 pages (including this cover page) in this exam.
2. For this exam (All Multiple Choice Questions): Answers must be recorded IN PENCIL on the
computer sheet. Only the computer sheet will be graded.

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

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Multiple Choice (25 Questions, 25 Points Total):

- This test consists of 25 Multiple Choice Questions. Each question is worth 1 point.
- Only answers on the computer answer sheet will be graded.
- Use a pencil to mark your answers on the Computer Sheet.

1. Present value and future value are:

A) unrelated to each other.

B) directly, positively related.
C) the result of respectively compounding and discounting operations applied to one or more
cash flows over time. Respectively means that the order of the actions corresponds to
each of the items that they refer to.
D) inversely related to each other. *

Answer: D

2. Which of the following are agency costs arising from the shareholder/manager agency
relationship?

A) Expenditures to monitor managerial actions.

B) An opportunity cost that would arise as a result of a manager refusing to accept a project
that would add value to the firm for fear that it might affect his/her annual bonus.
C) Management salaries
D) Statements A and B are both correct. *

Answer: D

3. Your bank account pays a 6 percent nominal rate of interest. The interest is compounded
quarterly. Which one of the following statements is most correct?

A) The interest rate per quarter is 3 percent and the EAR is greater than 6 percent.
B) The interest rate per quarter is 1.5 percent and the EAR is greater than 6 percent. *
C) The interest rate per quarter is 3 percent and the EAR is 6 percent.
D) The interest rate per quarter is 1.5 percent and the EAR is 6 percent.

Answer: B

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4. The effective annual interest rate (EAR) is (choose the most accurate alternative):

A) always equal to the annual percentage rate (APR).

B) greater than the APR rate when the annual compounding frequency is greater than one
and at least one year of time is considered. *
C) less than the APR when the annual compounding frequency is greater than one and at
least one year of time is considered.
D) never equal to the APR.

Answer: B

5. If the common stock price of a listed firm decreases by 50 percent, what does it mean to
the shareholders?

A) Their proportional ownership of the firm will decrease by 50 percent.

B) The total value of their holdings decreases by 50 percent. *
C) The debt of the firm decreases by 50 percent.
D) It means nothing to shareholders.

Answer: B

6. Four years from now you will begin to receive cash flows of $100 per year. These cash
flows will continue forever. If the appropriate discount rate is 6%, what is the present
value of these cash flows? Choose the closest value.

A) $1,399 *
B) $1,567
C) $1,767
D) $1,945

Answer: A

PV0 = [100/0.06]×PV6%, 3 = $1,399.37 The present value of a delayed perpetuity

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7. A Canadian firm bought an asset for $100,000 with a capital cost allowance (CCA) rate
of 30 percent and useful life of five years. Calculate the amount of CCA associated with
this asset in the third year.

A) $12,495
B) $17,850 *
C) $41,650
D) $59,500

Answer: B

0.3
𝑈𝑈𝑈𝑈𝑈𝑈𝑏𝑏𝑏𝑏𝑏𝑏 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦3 = 100,000 �1 − � (1 − 0.3)1 = 59,500
2
𝐶𝐶𝐶𝐶𝐶𝐶𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦 3 = 𝐶𝐶𝐶𝐶𝐶𝐶𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 × 𝑈𝑈𝑈𝑈𝑈𝑈𝑏𝑏𝑏𝑏𝑏𝑏 𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦3 = 0.3 × 59,500 = 17,850

8. You are contributing money to an investment account so that you can purchase a house in
five years. You plan to contribute six payments of $3,000 a year. The first payment will
be made today (t = 0) and the final payment will be made five years from now (t = 5). If
you earn 11 percent in your investment account compounded annually, how much money
will you have in the account (rounded to the nearest dollar) five years from now (at t = 5)
right after the final deposit is made? Choose the closest alternative.

A) $18,683
B) $20,856
C) $21,683
D) $23,739 *

Answer: B

Could be worked out as an ordinary annuity or an annuity due as follows:

FV6 = 3,000 × FVA11%, 6 = 3,000 × FVA11%, 5(Due) + 3,000 = $23,738.58

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Use the following information to answer the next TWO questions.

Two years ago you purchased a new SUV. You financed your SUV purchase over 60 months
(with payments made at the end of the month) using a bank loan quoted at 5.9% APR (the quoted
rate) with monthly compounding. Your monthly payments are $617.16. You have just made
your 24th monthly payment.

9. The amount of your original loan was closest to:

A) $32,000 *
B) $35,000
C) $37,000
D) $39,000

Answer: A

The initial loan = PV(All 60 payments) = 617.16 × PVA(5.9%/12), 60 = $31,999.86

10. Assuming you have made all of the first 24 payments on time, the outstanding balance on your
loan right after the 24th payment is closest to:

A) $32,000
B) $28,250
C) $26,000
D) $20,300 *

Answer: D

Balance after the 24th payment = PV(Remaining 36 payments)

= 617.16 × PVA(5.9%/12), 36 = $20,316.92

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11. You are considering an investment in a 40-year security. The security will pay $25 a year
at the end of each of the first three years. The security will then pay $30 a year at the end
of each of the next 20 years. The nominal interest rate is assumed to be 8%, and the current
price (the present value) of the security is $375.92. Given this information, what is the
equal annual payment to be received at the end of Year 24 through to the end of Year 40
(17 pmts)? Choose the closest alternative. Reviewed in class. Hope you all get this one!

A) $35
B) $40
C) $45
D) $50 *

Answer: D

Solve for PMT in:

PV0 = 375.92 = 25 × PVA8%, 3 + (30 × PVA8%, 20)PV8%, 3 + (PMT × PVA8%, 17)PV8%, 23

Much faster to solve using trial and error CFs until you get NPV = 0
Start by letting the unknown PMT = $40.
Then: CF0 -375.92; C01 25; F1 3; C02 30; F2 20; C03 40; F3 17; NPV I = 8; CPT = -15.53
Since NPV < 0 we need a higher C03. If you choose C03 = 45 then CPT = -7.76. Solution
must be C03 = 50; CPT = 0.00. Only need 2 trial and error attempts at most.

12. How much interest will be accumulated in five years assuming a $1,000 deposit (DEP) is
made today and interest is continuously compounded at a quoted rate (QR) of 10%? Note
that future value with continuous compounding is given by FV = DEP × e(QR×T) . T= time.

A) $600.00
B) $607.26
C) $648.72 *
D) $681.50

Answer: C

FV = 1,000 × e(0.1 × 5) = 1,648.72 This includes the deposit.

Interest = $1,648.72 - $1,000 = $648.72

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13. In two years you will pay the first of eleven annual $100 payments. The current interest
rate is 10%, but after seven years (by t=7) the rate will have dropped to 8%. What is the
total value of your payments at the end of twelve years following your last payment?

A) $1,034.47
B) $1,224.37
C) $1,528.22
D) $1,720.34 *

Answer: D

Similar to problem #5 on the TVM handout.

First need to find the FV at t = 7 right after the 6th $100 payment.

FV7 = 100 × FVA10%, 6 = $771.561. Calculator: -100 PMT; 10 I/Y; 6 N; CPT FV

Then we can use the calculator to find FV12

-771.561 PV; -100 PMT; 8 I/Y; 5 N; CPT FV = $1,720.3363

14. Which of the following bonds will have the greatest percentage increase in value if all
interest rates decrease by 1%?

A) 20-year zero coupon bond. *

B) 10-year zero coupon bond.
C) 20-year 10 percent coupon bond.
D) 20-year 5 percent coupon bond.

Answer: A

The 20-year zero has the longest maturity and lowest coupon (0%). It is the most sensitive
bond on the list to changes in interest rates.

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15. A stock, which currently does not pay a dividend, is expected to pay its first dividend of
$1.00 in five years (D5 = $1.00). Thereafter, the dividend is expected to grow at an
annual rate of 25 percent for the next three years and then grow at a constant rate of 5
percent per year thereafter. The required rate of return is 10.3 percent. What is the
expected price of the stock today?

A) $30.56
B) $23.87
C) $22.72
D) $20.65 *

Answer: D

Using CF is the easiest way to get the result

CF0 0; C01 0; F1 4; C02 1.00; F2 1; C03 1.25; F3 1; C04 1.252; F4 1;
C05 1.253 + [1.253(1.05)]/(0.103 – 0.05); F5 1; NPV I = 10.3; CPT = 20.6469

16. Your friend is a stockbroker and is trying to sell you shares of stock with a current market
price of $25 per share. A recent dividend of $2.00 per share was paid and earnings and
dividends are expected to grow at a constant rate of 10 percent. Your required return on
the stock is 20 percent. From a strict valuation point of view, you should:

A) Buy the shares; they are fairly valued.

B) Buy the shares; they are undervalued by $3.00 per share.
C) Not buy the shares; they are overvalued by $3.00 per share. *
D) Not buy the shares; they are overvalued by $2.00 per share.

Answer: C

Using the constant growth dividend discount model we can obtain an estimate of the current
value of the stock. P0 = 2(1.1)/(0.2 – 0.1) = $22.00. If shares are selling for $25 then they are
overpriced by $25.00 – $22.00 = $3.00. You should not buy them.

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17. Last year, ABC Corporation issued 15-year, $1,000 bonds at par. The coupon rate was 6%
with interest paid annually. Today, 1-year later, investors are demanding a return that is 2%
higher (added on to the previous yield to maturity rate). What is the value of the bond
today? Be sure to round to the nearest dollar.

A) $1,015
B) $1,000
C) $835 *
D) $829

Answer: C

For bonds sold at par, the YTM = Coupon rate = 6%. 1 year later, the rate has gone up to 8%.
We can find the value of the bond: 14 N; 8 I/Y; 60 PMT; 1,000 FV; CPT PV = -835.12

18. Which one of the following assumptions would cause the constant growth, dividend
discount model used in stock valuation to be invalid?

A) The growth rate is zero.

B) The growth rate is negative.
C) The growth rate is less than the required rate of return.
D) None of the above assumptions would invalidate the model. *

Answer: D

19. Assume that a 10-year Treasury bond has an 8% annual coupon, while a 15-year Treasury
bond has a 12% annual coupon. All Treasury securities have a 10% yield to maturity.
Which of the following statements is most correct?

A) The 10-year bond is selling at a par, while the15-year bond is selling at a premium.
B) The 10-year bond is selling at a premium, while the 15-year bond is selling at a discount.
C) If the yield to maturity on both bonds remains at 10% over the next year, the price of the
10-year bond will increase, but the price of the 15-year bond will fall. *
D) Statements B and C are correct.

Answer: C

The 10-year bond is sold at a discount since the coupon rate (8%) is less than the YTM
(10%). The 15-year bond is sold at a premium since the coupon rate (12%) is greater than
the YTM (10%). All else the same, with the passage of time the price of a bond sold at a
premium will decline to approach its par value and the price of a bond sold at a discount
will rise to approach its par value.

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20. Today, a 6% coupon bond paying interest semi-annually selling for $1,038.46 with a 14-
year life is purchased with the idea that future coupons can be reinvested at a 4% quoted
interest rate with annual compounding. Reliable information states that the future value
of the coupons to be received when added to reinvested coupon interest amounts to
$257.49. The bond is expected to be sold in four years from now (end of year 4). If the
yield to maturity for similar bonds is expected to be 8% four years from now, what is the
percentage expected annualized return?

A) 1.55%
B) 1.94% *
C) 6.35%
D) 7.32%

Answer: B

Return is made up of three components. i. The coupons; ii. Interest on reinvested

coupons and iii. The capital gain or loss

Coupons plus interest on reinvested coupons is given = 30*FVA(2%, 8) = -$257.49

Price when sold based on SA YTM of 8% and 10 years left to maturity =

20 N; 30 PMT; 1,000 FV; 4 I/Y; CPT PV = -$864.10

Total $ Return over four years = $257.49 + ($864.10 - $1,038.46) = $83.13

Four-year percentage return = Net $ received/price paid = $83.13/$1,038.46 = 8.005%

Annualized return = (1 + 0.08005)(1/4) – 1 = 1.94%

21. If investors require a 6% nominal return and the expected inflation rate is 2.4%, what is
the expected real return? Choose the closest alternative.

A) 8.40%
B) 3.50% *
C) 3.40%
D) 3.30%

Answer: B

Real rate = (1 + Nominal rate) / (1 + expected inflation) – 1 = 1.06/1.025 - 1 = 0.035

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22. An analyst is attempting to value shares of the Keystone Company. The company has
just paid a dividend of $0.58 per share. Dividends are expected to grow by 20 percent
next year and 15 percent the year after that. From the third year onward, dividends are
expected to grow at 5.6 percent per year indefinitely. Using what you know about stock
valuation and the Dividend Discount Model and given a required rate of return of 8.5
percent, the value of the stock is closest to:

A) $25.40
B) $26.00 *
C) $28.00
D) $32.50

Answer: B

0.58*1.2 0.58*1.2*1.15 0.58*1.2*1.15*1.056 1

+ + * =
$26.08
1.085 (1.085) 2 0.085 − 0.056 (1.085) 2

23. A company has an issue of 5.00 percent, $25 par value, perpetual, non-convertible, non-
callable preferred shares outstanding. The required rate of return on similar issues is 4.39
percent. The value of a preferred share is closest to:

A) $25.00
B) $26.75
C) $28.50 *
D) $30.00

Answer: C

Value of Preferred = (5%*25)/(0.0439) = $28.47

24. The semi-annual 6 percent coupon paying bonds of “ABC” company, have a quoted price
(i.e., clean price) of $910. If the last coupon payment occurred on August 31st, 2017; the
cash price of the bond on October 31st, 2017 is closest to which one of the following
alternatives? Assume that the face value of the bond is $1,000.

A) $950
B) $935
C) $920 *
D) $915

Answer: C

Cash price = quoted price + accrued interest

Cash price = $910 + (2/6) × ($30) = $920

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25. You borrowed $4,000 for three years and you are charged interest as indicated below:

First year: 8% simple interest

Second year: 10% simple interest
Third year: 12% simple interest

You repay the loan at the end of the 3rd year (principal and interest). How much do you
have to pay back at the end of year three? Please round your answer to the nearest dollar.

A) $5,120
B) $5,322
C) $5,440
D) $5,618

Anyone who did NOT answer A) was given credit for this question since there was no correct
solution listed.

With simple interest, amount owed after three years =

$4,000 + $4,000*(0.08) + $4,000*(0.10) + $4,000*(0.12) = $4,000 + $1,200

= $5,200

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 Additional space for calculations. Nothing written here will be graded.
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