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ENDOFSEMESTEREXAMINATION
SEMESTER2,2010/2011SESSION
KULLIYYAHOFECONOMICSANDMANAGEMENTSCIENCES
Programme : ENM/BBA/BECS
Time
Duration
Date
: 9.4. 2011
Section(s)
: 14
This Examination Paper Consists of 10 Printed Pages Including A Cover Page With 2 Parts)
INSTRUCTION TO CANDIDATES:
DO NOT OPEN THE QUESTION BOOKLET UNTIL YOU ARE ASKED TO DO SO
Answer ALL questions: (Total: 100 marks)
Part 1: Answer the MCQs in the answer sheet provided
Part 2: Answer in the answer booklet provided
Please refer to the instructor ONLY if you think something is seriously wrong with any of the
questions. DO NOT ask instructor to interpret and clarify the question.
SET 1
PART 1: Thirty (30) multiple choice questions (37.5 marks)
INSTRUCTION TO STUDENTS:
Please answer in the MCQ answer sheet provided.
1) The primary role of a financial system is to
a. channel funds from savers to borrowers who need funds for investment projects.
b. regulate the banking system.
c. provide employees in financial institutions with a code of ethics.
d. enable financial managers to evaluate investment projects with a system that always
selects the correct opportunity for their firm.
e. make savvy investors rich.
5) If interest rates are 5%, which of the following will produce the largest amount of money in
four years?
a. $500 earning simple interest
b. $400 with interest compounded annually
c. $300 with interest compounded semiannually
d. $100 with interest compounded quarterly
e. $25 with interest compounded monthly
2
SET 1
7) Which of the following most closely defines the term risk in finance?
a. A situation in which the required return on an asset equals its expected return.
b. Knowing that you will lose money on an investment.
c. A measure of the magnitude of cash flows.
d. A measure of the variability of cash flows.
e. A decision in which the potential outcomes are known with certainty.
SET 1
12) A $1,000 par value bond has a coupon rate of 5%. Bonds of similar risk currently yield 7%.
This bond should be selling
a. at a discount.
b. at a premium.
c. for its par value.
d. at the price Treasury bonds of the same maturity are currently selling for.
e. Cannot be determined without further information.
15) An increase in a firms market risk should be reflected in what part(s) of the Gordon growth
(Dividend Discount Model) model?
a. The dividend growth rate
b. The required return
c. Next years dividend
d. Answers (a) and (b) only
e. All of the above.
SET 1
16) A common source of error in estimating dividend growth rates is
a. mathematical errors committed by stock analysts.
b. the erratic earnings records of many firms.
c. the fact that growth rate predictions must be based on historical information.
d. analysts lack of training in modern forecasting techniques.
e. the fact that the Gordon growth model cannot be applied to real world situations.
17) The degree of market efficiency in which stock prices incorporate only all publicly
available information is called
a. weak form efficient.
b. semi-strong form efficient.
c. strong form efficient.
d. allocative efficient.
e. informational efficient.
18) When evaluating a project, a firms managers should select projects whose cash flows
a. result in a return that exceeds the cost of funds to finance the project.
b. are subject to less risk than competing projects.
c. produce higher returns than the firms average cost of capital.
d. have the lowest NPVs after discounting cash flows by the projects capital cost.
e. exceed some target cash flow level set by management.
19) Which of the following is not a component cost generally used to compute the WACC or
the WMCC?
a. After-tax cost of debt
b. Cost of preferred stock
c. Cost of retained earnings
d. Cost of new equity
e. All of the above are components generally used to compute the WACC.
20) Which of the following is not typically considered in the study of the capital budgeting
process?
a. The timing of the cash flows from a project.
b. The opportunity cost of the investment being considered.
c. The time value of money.
d. The amount of funds available for investment.
e. Non-cash expenses.
21) A project requires a current expenditure of $300 and expects to generate $100 cash inflows
at the end of each of the next 5 years. What conclusion can be drawn from examining an
NPV profile for this project?
a. Accept the project if the cost of capital exceeds 20%
b. Accept the project if the cost of capital is below 20%
c. Reject the project if the cost of capital exceeds 10%
d. Reject the project if the cost of capital exceeds 7%
e. Reject the project if the cost of capital exceeds 5%
5
SET 1
24) The NPV method assumes that cash inflows are reinvested at the
a. internal rate of return.
b. firms cost of capital.
c. average yield on corporate bonds.
d. average yield from an equity index fund.
e. risk-adjusted hurdle rate.
25) Financing costs should be excluded from the estimated cash flows associated with a project
because
a. the cost of capital is already reflected in the discount rate and including interest
expense would be double-counting.
b. most projects do not require external financing.
c. the cost of capital is difficult to estimate accurately.
d. capital costs are relevant only when there are mutually exclusive projects.
e. projects funded with equity always have an advantage over those financed with debt
because of interest payments.
SET 1
27) Wycliff Jeans Co. is a privately-held firm that has never paid a dividend. To establish a
share price before going public, investment bankers found that the P/E ratio for similar firms
is 15 and that Wycliffs projected EPS is $4.00. Based on these findings, what is the
estimated price per share of Wycliff stock?
a. $ 3.75
b. $ 4.00
c. $50.00
d. $60.00
e. $75.00
28) Billy Bob Co. contemplates acquiring another firm. The acquisition would slightly increase
Billy Bobs risk from a beta of 1.0 to a beta of 1.1. If T-bills current provide a return of
6.0% and the long-term return on the stock market is 11.0%, then Billy Bobs cost of equity
is
a. 6.0%
b. 11.0%
c. 14.3%
d. 15.0%
e. 11.5%
29) Kathy and her husband Chet plan to purchase a home in five years. If the present price of the
house they prefer is $200,000 and housing prices are expected to rise 5% per year, how
much will their house cost in five years?
a. $255,260
b. $210,000
c. $205,000
d. $250,000
e. $215,000
30) Maria wants to have $40,000 in her savings account in ten years. She currently has $10,000
in the account, and the account pays interest of 4%. How much should Maria save each year
to accomplish her goal?
a. $2,099
b. $3,332
c. $750
d. $4,565
e. $2,722
SET 1
PART 2: (62.5 marks)
INSTRUCTION TO STUDENTS:
i) Please answer all the six questions in the answer booklet provided.
ii) Draw the time line and show all workings, where applicable. Partial credits will be
given for your workings.
b) Your uncle has $1,135,000 and wants to retire. He expects to live for another 25 years and
to earn 7.5% on his invested funds. How much could he withdraw at the end of each of the
next 25 years and end up with zero in the account?
(3 marks)
c) Your sister turned 35 today, and she is planning to save $20,000 per year for retirement,
with the first deposit to be made one year from today. She will invest in a unit trust fund
that is expected to provide a return of 7.5% per year. She plans to retire 30 years from
today, when she turns 65, and she expects to live for 25 years after retirement, to age 90.
Under these assumptions, how much can she spend each year after she retires? Her first
withdrawal will be made at the end of her first retirement year.
(6 marks)
(Note: For question 1, please round-up all calculations to the nearest $1)
Question 2: (9 marks)
A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently sells
for $900. If the yield to maturity remains at its current rate, what will the price be 5 years from
now? (Note: Please round-up all calculations to the two decimal places)
Question 3: (9 marks)
Huang Company's last dividend was $1.25. The dividend growth rate is expected to be constant at
30% for 3 years, after which dividends are expected to grow at a rate of 6% forever. The
companys beta is 0.87, 10-year government securities yields 4.31% and expected market return is
12%. Based on this model and the assumptions hold, what is stock intrinsic value? (Note: Please
round-up all calculations to the two decimal places)
SET 1
Investment
$50,000
$50,000
$50,000
$50,000
$200,000
Beta
0.50
0.80
1.00
1.20
If Johan replaces Stock A with another stock, E, which has a beta of 1.50, what will the
portfolio's new beta be? (Note: Please round-up all calculations to the two decimal places)
6 marks)
SET 1
$ 80,000
$ 10,000
$ 11,000
$ 19,000
$ 3,000
$ 12,000
Sales revenues
Operating costs (excluding depreciation)
Straight-line depreciation, useful life
$ 85,000
$ 42,500
4 years
$ 6,000
35.0%
15.0%
10