PROFESSOR: Mr. Konstantinos Kanellopoulos, MSc (L.S.E.), M.B.A.

COURSE: MBA-680-50-SUII13 Corporate Financial Theory

SEMESTER: Summer Session II

Coursework 1

SECTION A

INSTRUCTIONS

Students are required to complete the following 2 parts. The first part consists of self-test
questions while the second part consists of two exam-type problems. Part 1 counts to 5%
of the final evaluation and Part 2 to 10% of the final evaluation, i.e. the whole
coursework counts towards 15% of the final evaluation. The questions are based on the
syllabus and lectures.

Answers to the Parts 1-2 should be filled in the spaces provided. However, for part 2,
underlying reasoning and calculations showing how you got your answers should also be
attached to the answer sheet in order to make the marking easier.

The deadline for delivering the coursework is August 22nd 2013.

This is not a group project. Answers should be your own work and should not involve
collaboration with other students. The policy for suspected plagiarism (copying) is very
severe at the UIA and it may provoke penalties.

Konstantinos Kanellopoulos
August 13th 2013
 SECTION B

PART 1 SELF-TEST QUESTIONS

1. Casino Inc. is expected to pay a dividend of $3 per share at the end of year-1 (D1) and these
dividends are expected to grow at a constant rate of 6% per year forever. If the required rate of
return on the stock is 18%, what is current value of the stock today?
a. $25
b. $50
c. $100
d. $54

2. MJ Co. pays out 60% of its earnings as dividends. Its return on equity is 15%. What is the stable
dividend growth rate for the firm?
a. 9%
b. 5%
c. 6%
d. 15%

3. If the discount rate is stated in real terms, then in order to calculate the NPV in a consistent
manner requires that project: I) cash flows be estimated in nominal terms II) cash flows be
estimated in real terms III) accounting income be used:
a. I only
b. II only
c. III only
d. None of the above

4. Proper treatment of inflation in the NPV calculation involves: I) Discounting nominal cash flows
using the nominal discount rate II) Discounting real cash flows using the real discount rate III)
Discounting nominal cash flows using the real discount rates
a. I only
b. II only
c. III only
d. I and II only

5. The cost of a resource that may be relevant to an investment decision even when no cash changes
hand is called a (an):
a. Sunk cost
b. Opportunity cost
c. Working capital
d. None of the above
6. If the average annual rate of return for common stocks is 11.7%, and for treasury bills it is
4.0%, what is the market risk premium?
a. 15.8%
b. 4.1%
c. 7.7%
d. None of the above

7. A statistical measure of the degree to which securities' returns move together is called:
a. Variance
b. Correlation Coefficient
c. Standard Deviation
d. None of the above

8. Investments A and B both offer an expected rate of return of 12%. If the standard deviation of A is
20% and that of B is 30%, then investors would:
a. Prefer A to B
b. Prefer B to A
c. Prefer a portfolio of A and B
d. Cannot answer without knowing investor's risk preferences

9. A stock with a beta of zero would be expected to: 
a. Have a rate of return equal to zero
b. Have a rate of return equal to the market risk premium
c. Have a rate of return equal to the risk-free rate
d. Have a rate of return equal to the market rate of return

10. The historical returns data for the past three years for Company A's stock is -6.0%, 15%, 15% and
that of the market portfolio is 10%, 10% and 16%. According to the security market line (SML),
the Stock A is:
a. Over priced
b. Under priced
c. Correctly priced
d. Need more information
 PART 2 PROBLEM 1

Stephen Oblonsky, ace mutual fund manager, produced the following percentage rates of return
from 2002 to 2006. Rates of return on the market are given for comparison.

2002 2003 2004 2005 2006

Stephen Oglonsky -12,1 28,2 11,0 8,9 15,0
S&P 500 -20,9 31,6 12,5 6,4 15,8

Calculate the average return and standard deviation of Mr. Interchange’s mutual fund.
Did he do better or worse than the market by these measures?

PROBLEM 2

The following table shows standard deviations and correlation coefficients for seven stocks from
different countries.

Deutsche Standard
Alcan BP Bank Fiat Heineken LVMH Nestle Deviation

Alcan 1,00 0,34 0,53 0,30 0,20 0,53 0,08 29,7%

BP 1,00 0,44 0,26 0,20 0,27 0,29 18,4%

Deutsche
Bank 1,00 0,52 0,22 0,56 0,24 30,1%

Fiat 1,00 0,17 0,42 0,26 35,9%

Heineken 1,00 0,33 0,50 17,2%

LVMH 1,00 0,31 31,0%

Nestle 1,00 13,8%

a. Calculate the variance of a portfolio with equal investments in each stock.

b. Your eccentric Aunt Claudia has left you $50,000 in Alcan shares plus $50,000 cash.
Unfortunately her will requires that the Alcan stock not be sold for one year and the $50,000
cash must be entirely invested in one of the stocks shown in the above Table. What is the
safest attainable portfolio under these restrictions?
 PROBLEM 3
Phoenix Corp. faltered in the recent recession but has recovered since. EPS and dividends have
grown rapidly since 2014.

2014 2015 2016 2017 2018

EPS $.75 2.00 2.50 2.60 2.65
Dividends $0 1.00 2.00 2.30 2.65
Dividend growth - - 100% 15% 15%

The figures for 2017 and 2018 are of course dividends. Phoenix’s stock price today in 2016 is
$21.75. Phoenix’s recovery will be complete in 2018, and there will be no further growth in EPS
or dividends.

A security analyst forecasts next year’s rate of return on Phoenix as follows:

DIV 2.30
r  g  0 .15  0 256  25.6%
P0 21.75

What’s wrong with the security analyst’s forecast? What is the actual expected rate of return over
the next year?