Quiz I

September 24, 2007

Finance 3341
Section ---

Instructor: Nataliya Polkovnichenko

Name: _________________________

Please do not open the examination until you are told to do so.

Example
Instructions:

9 The exam has 4 problems and 10 multiple-choice questions.

9 Total number of points is 100.
9 All books and notes MUST be closed. You may use your calculators.
9 The last page contains formulas that you may find helpful. You may detach the
page with formulas.
9 For each of the multiple-choice questions, circle the best answer. You will not
receive any points if you circle more than one answer.
9 Be neat and show ALL your work to receive full credit. Partial credit will be
given.
9 You have 1 hour and 15 minutes to complete the exam.

Do not consult with anyone while you are working on the exam.

GOOD LUCK!!!

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 Multiple Choice Questions
Circle the correct answer. Each of the correct answers is worth 4 points.

1. What will be the approximate population of the United States, if its current
population of 280 million grows at a compound rate of 2% annually for 25 years?
A) 413 million
B) 430 million
C) 460 million
D) 488 million

2. The salesperson offers, “Buy this new car for $25,000 cash or, with appropriate
down payment, pay $500 per month for 48 months at 8% interest.” Calculate the
“appropriate” down payment, assuming that the salesperson does not offer a free
lunch.

A) $1,000.00
B) $4,520.64
C) $5,127.24
D) $8,000.00

3.

Example
How much more is perpetuity of $1,000 worth than an annuity of the same amount
for 20 years? Assume a 10% interest rate and cash flows at end of period.
A) $297.29
B) $1,486.44
C) $1,635.08
D) $2,000.00

4. Your car loan requires payments of $200 per month for the first year and payments
of $400 per month during the second year. The annual interest rate is 12% and
payments begin in one month. What is the present value of this two-year loan?
A) $6,246.34
B) $6,389.78
C) $6,428.57
D) $6,753.05

5. “Double taxation” refers to:

A) All partners paying equal taxes on profits
B) Corporations paying taxes on both dividends and retained earnings
C) Paying taxes on profits at the corporate level and dividends at the personal
level
D) The fact that marginal tax rates are doubled for corporations

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6. Which of the following would be considered a capital budgeting decision?
A) Planning to issue common stock rather than issuing preferred stock
B) A decision to expand into a new line of products, at a cost of $5 million
C) Repurchasing shares of common stock
D) Issuing debt in the form of long-term bonds

7. When corporations need to raise funds through stock issues, they rely upon the:
A) Primary market.
B) Secondary market.
C) Over-the-counter market.
D) Centralized NASDAQ exchange.

8. What is the current yield of a bond with a 6% coupon, four years until maturity,
and a price of $750?
A) 6.0%
B) 8.0%
C) 12.0%
D) 14.7%

9.

Example
Which of the following factors will change when interest rates change?
A) The expected cash flows from a bond
B) The present value of a bond’s payments
C) The coupon payment of a bond
D) The maturity value of a bond

10. What is the future value of $10,000 on deposit for five years at 6% simple
interest?
A) $7,472.58
B) $10,303.62
C) $13,000.00
D) $13,382.26

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 Problems
1. Present Value (15 points).
You are selling your house.
(a) The Smiths have offered you $250,000. They will pay you immediately.
(b) The Joneses have offered you three annual payments of $100,000, with a first
payment today.
(c) Your cousin offers you nine annual payments of $50,000 with a first payment 4
years from today.
The interest rate is 10%. Which offer should you choose?

Timelines for (a), (b), and (c):

Formulas with values:
Calculations:

Example

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2. APR&EAR (10 points)

If you take out an $8,000 car loan that calls for 48 monthly payments of $240 each, what
is the APR of the loan? What is the effective annual interest rate on the loan?

Formulas with values:

Calculations:

Example

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3. Retirement Planning (20 points)

Your friend is celebrating her 25th birthday today and wants to start saving for her
anticipated retirement at age 65. She wants to be able to withdraw $6,500 from her
savings account every month for 20 years following her retirement; the first withdrawal
will be one month after her 65th birthday. Your friend intends to invest her money in the
local credit union, which offers 12 percent interest per year (APR). She wants to make
equal annual payments on each birthday into the account established at the credit union
for her retirement fund.

(a) If she starts making these deposits on her 26th birthday and continues to make
deposits until she is 65 (the last deposit will be on her 65th birthday), what
amount must she deposit annually to be able to make the desired withdrawals
at retirement?

Example
(b) How your answer in (a) will change if your friend expects to receive $45,000
from a family trust fund on her 55th birthday, which she will also put into the
retirement account. What amount must she deposit annually now to be able to
make the desired withdrawals at retirement?

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4. Bond Valuation (15 points)

Ann buys a semiannual bond when its time to maturity is 9 years and YTM is 12%. She
sells the bond after one year when YTM is 10%. The coupon rate is 8%.
(a) Find the annual rate of return from this investment.
(b) What is the real annual rate of return if the inflation rate is 2%?

Timelines (two):
Formulas with values:
Calculations:

Example

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 Formula Sheet
C
Present value of perpetuity: PV =
r
C
Present value of a delayed by n periods perpetuity: PV =
r (1 + r ) n
C
Present value of a growing perpetuity: PV =
r−g
⎡1 1 ⎤
Present Value of an annuity: PVA = C ⎢ − n⎥
⎣ r r (1 + r ) ⎦
⎡ (1 + r ) n − 1⎤ ⎡1 ⎤
Future Value of an annuity: FVA = C ⎢ ⎥ or FVA = C ⎢ −
1
n ⎥
(1 + r )n
⎣ r ⎦ ⎣ r r (1 + r ) ⎦
⎡1 1 ⎤
Present Value of an annuity due: PVAD = C ⎢ − n⎥
(1 + r )
⎣ r r (1 + r ) ⎦
⎡ (1 + r ) n − 1⎤
Future Value of an annuity due: FVAD = C ⎢ ⎥ (1 + r )
⎣ r ⎦

Example
P1 − P0
%Change _ in _ Pr ice =
P0

1 + NOMINAL _ RATE
1 + REAL _ RATE =
1 + INFLATION _ RATE

m 1
⎛ APR ⎞
EAR = ⎜1 + ⎟ − 1 ⇔ APR = m(1 + EAR) m − m
⎝ m ⎠

Cpn Cpn Cpn Cpn Face.V .

P= + + + ...... + + =
1 + r (1 + r ) 2
(1 + r ) 3
(1 + r ) n
(1 + r ) n
Price of Bond
⎛1 1 ⎞ Face.V
= Cpn⎜⎜ − ⎟⎟ +
⎝ r r (1 + r ) ⎠ (1 + r )
n n

C
Bond Current yield =
P