UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011

1:00pm 3:30pm

Note: it is your responsibility to verify that this examination has 13 pages.

Name: ID number: Check (!) the box (") corresponding to the section in which you are registered. " A01 Falk, T/Th 8:30 9:45 " A04 Singh T/Th 11:30 12:45 " A02 Dua, T/Th 8:30 9:45 " A05 Singh, T/Th 1:00 2:15 " A03 Singh, T/Th 10:00 11:15 " A06 Falk T/Th 2:30 3:45

Answer all questions in the spaces provided. Show all relevant work (i.e., formulas and substitutions). NO MARKS WILL BE AWARDED FOR INDICATING WHICH CALCULATOR BUTTONS YOU HAVE PRESSED. Do not round any intermediate calculations. - Final dollar answers should be rounded to 2 decimal places (e.g. $1,234.56). - Final interest rate answers should be rounded to 6 decimal places (e.g. 6.123456%). Page # 2 3 4 5 6 7/8 9 10 11 12 13 Total Marks Maximum Marks on Page 10 9 7 6 6 11 7 3 4 3 4 70 Marks Awarded

UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011 1:00pm 3:30pm

1. (5 marks, 11 minutes) Suppose your firm receives a $15.0 million order on the last day of the year. You fill the order with $8.2 million worth of inventory. The customer picks up the products the same day, pays $4.9 million, and will pay the remaining balance in 30 days. Suppose your firms tax rate is 35%. Determine the consequences of this transaction for each of the following: a. Revenues

b. Earnings

c. Receivables

d. Inventory

e. Cash

2. (5 marks, 11 minutes) Fill in the missing cells in the table below. $ Today $ In One Year Cash Flow Strong Given Weak Expected Economy Value Economy Cash Probability Probability Flows = 0.35 = 0.65 Risk-free 100 100 Bond Market 80 120 Index Security W Security S 75 20 100 0 0 100

Expected One-Year Return

UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011 1:00pm 3:30pm

3. (2 marks, 4 minutes) Convert 120% per year compounded monthly into the equivalent effective rate per ten months.

4. (2 marks, 4 minutes) Convert 1% per day compounded daily into the equivalent effective annual rate.

5. (3 marks, 6 minutes) Convert 90% per six-months compounded monthly into the equivalent rate per year compounded quarterly.

6. (2 marks, 4 minutes) You have taken out a mortgage for $400,000 to be repaid over 30 years of monthly payments. The interest rate is 0.5% per month effective. What is your monthly payment?

UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011 1:00pm 3:30pm

7. (7 marks, 15 minutes) Some time ago, you took out a mortgage. The mortgage has payments of $5,000 per month. The interest rate is 0.4% per month effective. You are about to make a payment and there are now 300 payments remaining (including the one you are about to pay). a. How much of the payment you are about to pay will go to paying interest and how much will go to paying principal? (4 marks)

b. Following the payment made above, how much interest in total will you pay over the subsequent payments of the mortgage? (3 marks)

UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011 1:00pm 3:30pm

8. (6 marks, 13 minutes) You have just turned 23 years old, having just received your degree, and have accepted your first job. Now you must decide how much money to put into your RRSP. Your RRSP works as follows: Every dollar in the plan earns 9% per year. You cannot make withdrawals until you retire on your 66th birthday. After that point, you can make withdrawals as you see fit. You decide that you will plan to live to 101 years old and work until you turn 66 years old. You estimate that to live comfortably in retirement, you will need $50,000 per year starting at the end of the first year of retirement and ending on your 101st birthday. You will contribute the same amount to the plan at the end of every year that you work. a. How much do you need in your fund by the time you reach your retirement date? (3 marks)

Assume your answer in part a. is $100,000, how much will your first contribution to your RRSP be if each contribution is 2% greater than the previous one? Your first contribution will be one year from today. (3 marks)

UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011 1:00pm 3:30pm

9. (6 marks, 13 minutes) Zero coupon 1-year bonds have an interest rate of 5% (effective per year, or 0r1). Zero coupon 2-year bonds have an interest rate of 6% (effective per year, or 0r2). Consider Bonds A and B issued by the US Government that are 2-year riskless bonds that have annual coupons. a. Bond A has coupon rate is 6%. What is its Yield to Maturity (express as an effective annual rate)? (3 marks)

b. Is it possible that Bond B would have a different Yield to Maturity than Bond A? If yes, explain why. If no, explain why not. In either case, provide an example to illustrate your point. (3 marks)

UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011 1:00pm 3:30pm

10. (11 marks, 24 minutes) Apple Inc (AI) is considering launching a portable Wi-Fi media player called I-Hustle, with a Product Life Cycle of 4 years and expects to sell 100,000 units per year over the next four years. The R&D costs of I-Hustle are already at $10 million, and the actual cost of production (including packaging) would be $120 per unit. Marketing and support costs for this product are expected to be $2.5 million per year. Both production and marketing and support costs are expected to grow at 2% per year during the project life. AI expects to sell I-Hustle at $240 per unit, which will decline by 1% a year, and has a cost of capital of 9%. Initial capital expenditures are $4 million, 20% of which are expected to be salvaged at the end of year 4 (beginning of year 5). There is an initial increase in net working capital (NWC) of $2 million during each of the first two years. In year three, NWC will remain at the level of year two. Investment in NWC will be recovered at the end of year 4. An additional complication of the project is that it is expected to cannibalize the sale of AIs current products. This will result in a cash flow loss of $10,000 per year for each of the four years of the project. Purchased capital assets become part of asset pool depreciated at the rate d = 40% per year. It is expected that in year 4 there will still be other assets in the pool, so the pool will continue. The companys income tax rate is 40%. a. What is the effect on the projects NPV caused by net working capital changes? (3 marks).

UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011 1:00pm 3:30pm

b. What is the effect on the projects NPV caused by the R&D costs? (1 mark)

c. What is the effect on the projects NPV caused by side effects? (2 marks)

d. What is the effect on the projects NPV caused by the CCA tax shields? (3 marks)

e. What is the effect on the projects NPV caused by the net capital expenditures? (2 marks)

UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011 1:00pm 3:30pm

11. (7 marks, 15 minutes) The following table describes the cash flows per year for a capital budgeting project. Year(s) Cash flows 0 -5000 1 0 2 2500 3 1000 4 500 5 300 6 4000

a. Determine the NPV using a cost of capital of 12%. Make your recommendation. (2 marks)

b. Determine the IRR. Make your recommendation, given a cost of capital of 12%. (2 marks)

c. Determine the PI (as per text) using a cost of capital of 12%. Make your recommendation. (1 mark)

d. Determine the Payback. Explain what payback means. (2 marks)

UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011 1:00pm 3:30pm

12. (3 marks, 6 minutes) Suppose the term structure of risk-free interest rates is as shown below: Term Rate (EAR, %) 1 yr 2.0505 2 yr 2.7606 3 yr 4.8505

a. Taking the data in the table above as your opportunity cost of capital, calculate the present value of an investment that pays $1000 with certainty at the end of each of years 1, 2, and 3. (1 mark)

b. What discount rate would you use if you wanted to use the annuity formula? (2 marks)

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UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011 1:00pm 3:30pm

13. (4 marks, 9 minutes) The Winnipeg Liquor Company (WLC) produces several types wine. It sells wine in 4 age categories: aged 6 months, 12 months, 24 months, and 48 months. At the producers store, it sells 1 bottle of each age of wine for the following prices: $8.95, $10.50, $12.75, an $18.95, respectively. Consider the wine makers decision whether to continue to age a particular bottle of wine. A batch of wine has aged for the past 6 months. So, she can either sell the wine immediately or let it age further. If she sells now, she receives $8.95 immediately. If she ages the wine, she must give up $8.95 today to receive a higher amount in the future. What is the IRR (expressed as a percent per month) of the investment of giving up $89.50 today by choosing to store 10 bottles of wine that is currently 6 months old and instead selling 5 bottles of this wine when it has aged 12 months, 3 bottles when it has age 15 months, and the remaining 2 bottles when it has aged 48 months? Show your timeline and setup of formulas with substitutions. You do not need to compute the final answer, however.

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UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011 1:00pm 3:30pm

14. (3 marks, 6 minutes) You are considering a new investment opportunity. The investment will cost $50.1 million upfront and will take one year to build. Once put into operation, the investment is expected to produce profits of $24.6 million at the end of every year of production. The profits are expected to last forever. Calculate the IRR of the new investment opportunity.

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UNIVERSITY OF MANITOBA Department of Accounting and Finance FIN 2200 Corporation Finance Midterm Examination March 5th, 2011 1:00pm 3:30pm

15. (2 marks, 4 minutes) With respect to stakeholders versus shareholders, briefly describe the prevailing view in North America.

16. (2 marks, 4 minutes) With respect to NPV of Trading Securities define and explain the Separation Principle presented in the text.

Do not write anything below this point. X X X X X X X X X X X X X X

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