Print Last Name: Print First Name: ID Number:

COURSE NUMBER SECTION

FINANCE COMM 308/2 All sections

EXAMINATION DATE TIME # OF PAGES 15

Final Exam DECEMBER 8, 2007 3 hours including cover, formula
VERSION BLUE sheets separate
INSTRUCTOR: DIVISION
John Molson School of Business
R. Atanasiadis, D. Hirsch, R. Jassim, Concordia University
J. Mannadiar, I. Rakita, R. Ravi, M. Wahhab

SPECIAL INSTRUCTIONS

- You are writing Version BLUE of the test. Please ensure that you have a BLUE computer
answer sheet. Your exam consists of two types of questions: Multiple Choice
Questions and Problems.

- Multiple Choice Questions:

- All your answers must be recorded IN PENCIL on the BLUE computer answer sheet
by darkening the appropriate letter corresponding to your choice. Only letters A, B, C, D
and E should be used. DARKENING ANY OTHER LETTER WILL RESULT IN AN INCORRECT
RESPONSE BEING RECORDED FOR THAT QUESTION.

- Problems:
- All your answers must be recorded on the exam sheets. Part marks will be awarded.
Write clearly and only in the space provided.

- Cell phones must be turned off, programmable calculators and PDAs are not allowed
during the final exam

- This exam contains 15 pages including cover. Formula sheets (3) are separate. Please ensure that
there are no pages missing.

- Fill in your name and other required information IN PENCIL on the Computer Answer sheet as
well as on this cover sheet.

- There is no negative marking on the multiple choice questions. Mark only one answer on the
computer answer sheet. Blank questions or those with multiple answers will not receive credit.

- Small differences may exist due to rounding. To minimize this problem, try to round only at
the end of multiple-step calculations.

- A minimum of 40% on this exam is required to pass this course.

- Allocate your time efficiently.

Blue exam Page 1 of 17

 For use by instructor

Maximum Grade
Multiple choice
60
questions
Problem 1 10

Problem 2

Part a 2

Part b 3

Part c 5

Problem 3 10

Problem 4 5

Problem 5 5

Total 100

Blue exam Page 2 of 17

Multiple Choice: answer on the Computer Sheet

Multiple Choice Questions (2 marks per question):

- Only answers on the computer answer sheet will be graded.
- Select only one answer per question, blank or multiple answers will not receive credit.
- You are encouraged to also circle your answer on the exam sheet as a back up.

Question 1: My exam is the _________ version:

A) Blue
B) Green

Note: you will not receive 2 marks for answering this question correctly; it is to help identify
any answer sheets that are mishandled in the grading process. If you answer it incorrectly, you
will receive a very low mark on the final exam!!!!

Question 2: Common shares include which of the following characteristics:

I. The right to vote for the board of directors
II. Right to receive income before any creditors
III. Company has no legal obligation to pay dividend

A) I and II only
B) I and III only
C) I only
D) II and III only
E) III only

Question 3: The exchange that acts as the Canadian national derivatives market and
conducts all options and futures trading is called the:

A) Winnipeg Commodity Exchange

B) Toronto Stock Exchange
C) Canadian Trading and Quotation System Inc.
D) Bourse de Montreal (The Montreal Exchange)

Question 4: You are evaluating an investment in a mine. The mine will require an
investment of $10 million today and is expected to generate revenues of $5 million per year
for 5 years. At the end of the life of the mine, you will have to pay $25 million to clean up
the site. Ignore taxes. Using the IRR to evaluate this project is:

A) Not appropriate because the sign of the cash flows change more than once
B) Not appropriate because the sum of the cash flows is negative
C) Appropriate because the sign of the cash flows changes more than once
D) Appropriate because the sign of the IRR is negative

Blue exam Page 3 of 17

Multiple Choice: answer on the Computer Sheet

Question 5: The RobM Bank has offers you the choice between two loans:
#1 charges interest at a rate of 9% compounded quarterly
#2 charges interest at a rate of 9.05% compounded semi-annually
Which loan do you prefer and why?

A) #1, lowest effective annual rate

B) #2, lowest effective annual rate
C) #1, highest effective annual rate
D) #2, highest effective annual rate

#1 effective annual rate = ;

#2 effective annual rate =
As this is a loan, I want the lowest rate.

Question 6: When computing the yield to maturity, the implicit reinvestment assumption is
that the reinvested coupons are reinvested at the __________.

A) coupon rate.
B) prevailing yield to maturity at the time the coupons are received.
C) average yield to maturity over the life of the bond.
D) yield to maturity at the time of the investment.

Question 7: Which of the following features of a bond are determined by the issuer
following the advice of the underwriter:
I. price
II. coupon
III. time to maturity
IV. yield to maturity

A) I and IV only
B) I and II only
C) II and IV only
D) III only
E) II and III only

Question 8: The concept of a strong form efficient market implies that:

A) All shares of stock have the same expected returns.

B) Throwing darts at a page of stocks will yield the same return as a carefully selected
portfolio.
C) Prices reflect all available information.
D) Stock prices do not fluctuate.

Blue exam Page 4 of 17

 Multiple Choice: answer on the Computer Sheet

Question 9: You are considering mutually exclusive projects: Burnout and Longlasting.
Burnout requires an initial investment of $36, has a 3 year life, and will have revenues of
$100 per year. Longlasting requires an investment of $60, has a 5 year life, and will have
revenues of $88 per year. The salvage value is zero in either case. Your tax rate is 30% and
required return is 10%. You must choose between the two and expect to replace them
forever. You should:

A) Take the option with the greater positive NPV

B) Take the option with the smaller positive NPV
C) Take the option with the greater positive EANPV (equivalent annual Net Present
Value)
D) Take the option with the smaller positive EANPV

Question 10: The appropriate discount rate to be used when analyzing an investment project
is __________

A) the rate of return that will results in the highest NPV

B) the internal rate of return on that investment
C) equal to the cost of capital based on the firm's existing assets
D) the rate of return financial markets offer on investments of similar risk
E) the rate of interest the firm would pay if it sold bonds

Question 11: Which of the following is a FALSE statement of the Sharpe ratio?

A) It is used to assess the performance of portfolios.

B) The Sharpe Ratio of a portfolio equals the beta of the portfolio
C) It describes how well an asset’s return compensates investors for the risk taken.
D) It is a “risk-adjusted” measure of portfolio performance.

Question 12: If a company uses the same discount rate to evaluate all projects, the firm will
most likely become

A) riskier over time, and its value will fall

B) riskier over time, and its value will rise
C) less risky over time, and its value will rise
D) less risky over time, and its value will decline
E) there is no reason to expect its risk position or value to change over time as a result
of its use of a single discount rate.

Question 13: The M&M theory of capital structure without taxes states that:
(Omit This Question)
A) a firm can affect its value by changing its capital structure
B) the cost of equity decreases as the financial leverage increases
C) the WACC increases as financial leverage decreases
D) the value of the firm is determined by its total cash flows
Blue exam Page 5 of 17
 Multiple Choice: answer on the Computer Sheet

(Omit Question 14)

Question 14: The KatPat Co operates in a world with zero taxes and no risk of financial
distress. Currently the firm has a D/E ratio of 3.5, a cost of debt of 8% and a cost of equity
of 15%. Jago, a junior analyst, states that if the firm increases their use of debt their WACC
should decrease. Jago is:

A) Correct because as we increase the use of debt the WACC should decrease as we are
increasing our use of a cheaper source of capital (cost of debt < cost of equity).
B) Correct because according to M&M the value of the firm is unchanged as we increase
the level of debt but the net income of the firm will decline (due to increased interest
payments). The only way the value of the firm can remain the same is if the WACC
decreases.
C) Incorrect because as we increase the use of debt we increase the riskiness of the
equity and therefore the cost of equity will increase. The net effect is that the WACC
remains constant.
D) Incorrect because the firm’s D/E ratio is already above the firm’s optimal level and
any further increase in debt will result in an increase in WACC and a decrease in firm
value.

(Omit Question 15)

Question 15: The SylliPutty and FoolishFudge Companies operate in a world with taxes and
no financial distress. SylliPutty has a debt/equity ratio of 1. The cost of equity to SylliPutty
is 15% and the cost of debt is 8%. The only difference between the FoolishFudge Company
and SylliPutty is that FoolishFudge has a debt/equity ratio of 2. According to M&M, the
weighted average cost of capital for FoolishFudge should be:

A) Less than the weighted average cost of capital for SylliPutty

B) The same as the weighted average cost of capital for SylliPutty
C) Greater than the weighted average cost of capital for SylliPutty
D) Cannot be determined, we need to know the tax rate.

Question 16: If a stock is selling for $45 per share at the expiration of an option contract, who
of the following will choose to exercise their option?

A) Buyer of a call option with $50 strike price

B) Seller of a call option with $50 strike price
C) Buyer of put option with $70 strike price
D) Seller of a put option with a $70 strike price
E) (a) and (c) are correct

Blue exam Page 6 of 17

Multiple Choice: answer on the Computer Sheet

Question 17: Xiang invests $25,000 per year, starting today, for 20 years at an interest rate of
7%. What is the value of the investment at the end of the 20 years?

A) $264,850.36
B) $283,389.88
C) $1,024,887.31
D) $1,096,629.42

FV of 20 year annuity due.

Question 18: Eight percent compounded semi-annually is equivalent to what percentage

compounded monthly?

A) 7.87%
B) 8.00%
C) 8.30%
D) 8.57%

Monthly rate:
The rate, compounded monthly, = 12*0.6558%=7.8698%

Question 19: Amir has obtained a $250,000 mortgage. The mortgage is amortized over 25
years and is renewed every 5 years. The mortgage interest rate is 9% compounded semi-
annually. Amir will begin making monthly payments at the end of the month. The monthly
payment is closest to:

A) $2,069.94
B) $2,097.99
C) $5,169.68
D) $5,189.59

Monthly rate =
Solve for payments for ordinary annuity of 25*12 = 300 monthly payments and face =
$250,000. Payment = $2,069.94

Question 20: What is the Yield-to-Maturity (market rate) of a four-year annual pay bond with
a par value of $1,000 and a 4 percent coupon rate when the bond is priced at $932.35?

A) 2.96%
B) 3.85%
C) 5.95%
D) 11.90%

By logic, can eliminate A and B; and as price is close to par, more likely to be 5.95%
than 11.90%.
Blue exam Page 7 of 17
Multiple Choice: answer on the Computer Sheet

Question 21: What is the holding period return of a 9% annual coupon bond with a face value
of $1000 and with five years to maturity if it is purchased at the beginning of year 1 at a
Yield-to-Maturity (market rate) of 6.0% and sold at the beginning of year 2? Assume that
rates do not change.

A) 7.4%
B) 7.1%
C) 6.8%
D) 6.0%
E) None of the above

If student understands YTM and notes that the YTM didn’t change, the answer is 6%. Can also
solve long way:
Purchase price: $1,126.3709
Sale price: $1,103.9532
Return = (1,103.9532+90-1,126.3709)/1,126.3709 = 6%

Question 22: Never-On-Time Transportation Inc. has issued $2.5 million in preferred shares
with a par value of $20 each and an annual dividend rate of 8.25 percent. The market value
of the preferred shares is ____________ if the required rate of return is 12 percent.

A) $3.64 million
B) $1.72 million
C) $17.19 million
D) $34.38 million

per share.

Market value of preferred stock = $2.5 million / $20 * $13.75 = $1,718,750.

Question 23: SlowGrowth, Inc. is expected to pay a dividend of $1 in one year. If the
dividend growth rate is 2 percent forever and the required return is 10 percent, what should
the stock be sold for five years from now?

A) $13.53
B) $13.80
C) $14.08
D) $14.62

Blue exam Page 8 of 17

Multiple Choice: answer on the Computer Sheet

Question 24: Canadian Resources is expected to pay a dividend of $2 in the upcoming year.
The risk free rate of interest is 4% and the expected return on the market portfolio is 14%.
Analysts expect the price of Canadian Resources to be $22 in one year. The beta of
Canadian Resources stock is 1.25. What is the intrinsic value of Canadian resources stock
today?
A) $12.12
B) $20.00
C) $20.60
D) $22.00
E) None of the above

Required rate of return = 4% + 1.25*(14% - 4%) = 16.5%

Intrinsic value of CR today = (22+2)/1.165 = $20.60

Question 25: Snape’s Elixers expects to pay dividends at the end of each of the next four
years of $2.00, $1.50, $2.50, and $1.50 respectively. Starting at the beginning of year 5,
dividend growth is expected to remain constant at 7%. If you require a 10% rate of return,
what is the price of Snape’s Elixers today?

A) $39.12
B) $42.50
C) $53.50
D) $61.00

Blue exam Page 9 of 17

Multiple Choice: answer on the Computer Sheet

Question 26: Green Compost Inc.’s current operations will generate cash flows of $100,000
in year one, $115,000 in year two, and $125,000 in year three. The company is considering
replacing their current setup with a new investment, which requires an immediate cash
outlay of $300,000. With the new investment, the company can instead expect to have cash
flows of $250,000 per year for the next three years. The appropriate discount rate is 15
percent. What is the NPV of the new investment? Assume that there is no salvage value
and no tax considerations.

A) $14,703.71
B) $65,439.36
C) $256,107.57
D) $270,806.28

Incremental Annual cash flows:

Year 0: -$300,000
Year 1: $250,000-$100,000 = $150,000
Year 2: $250,000-$115,000 = $135,000
Year 3: $250,000-$125,000 = $125,000
NPV @ 15% = $14,703.71

Question 27: A company is considering two separate, mutually exclusive projects A and B.
Project A requires an initial investment of $100,000 and is expected to generate after-tax
cash flows of $15,000 per year forever. Project B requires an initial investment of $150,000
and is expected to generate after-tax cash flows of $18,000 per year forever. The
appropriate discount rate is 10 percent. What is the crossover rate for projects A and B?

A) 5.00%
B) 6.00%
C) 9.00%
D) 10.00%

Cross-over rate = rate at which NPV projects are equal.

Blue exam Page 10 of 17

Multiple Choice: answer on the Computer Sheet

Question 28: The expected return of Security A is 12 percent with a standard deviation of 15
percent. The expected return of Security B is 9 percent with a standard deviation of 10
percent. Securities A and B have a correlation of 0.4. The market return is 11 percent with a
standard deviation of 13 percent and the risk free rate is 4 percent. What is the Sharpe ratio
of a portfolio if 35 percent of the portfolio is in Security A and the remainder in Security B?

A) 0.54
B) 0.61
C) 0.86
D) 1.02

Variance of portfolio:

Sharpe Ratio =

Question 29: The risk free rate is 4.5 percent. The expected return on the market is 13
percent with a standard deviation of 15 percent. What is the required rate of return for
Stock X if it has a beta of 1.4?

A) 16.40%
B) 18.20%
C) 20.50%
D) 22.70%

= 4.5% +1.4*(13% - 4.5%) = 16.4%

Blue exam Page 11 of 17

Multiple Choice: answer on the Computer Sheet

Question 30: The Excello Company currently has a policy of paying out 30% of its earnings
in dividends. Currently the market is expecting a return on equity if 10%. The firm has just
paid a dividend of $1 and the current stock price is $10. The required rate of return on
Excello stock is:

A) 10.0%
B) 13.3%
C) 17.0%
D) 17.7%
E) 18.1%

growth rate = b*ROE = (1-.3)*10% = 7%

Question 31: On December 7, 2007 The Tiny Company’s stock will go ex-dividend. The
dividend is $1.50 and is expected to grow at a rate of 4% forever. The required rate of return
for the Tiny Company is 6%. The stock price on December 8 is closest to ____ and the
stock price on December 6 is closest to __________.

A) $76.50; $78.00
B) $78.00; $76.50
C) $78.00; $79.50
D) $79.50; $78.00
E) None of the above

Price after dividend paid (Dec 8) =

Price before dividend paid (Dec 6) = $78+1.50 = $79.50

Blue exam Page 12 of 17

 Problems: Answer in the space provided on this exam

Problems:
- Answer on this document, in the space provided.
- Write clearly! Part marks will be awarded (when deserved). Write your final numerical
answer in the box provided.

Problem 1. (10 marks) Michael the MBA has come to you for help – he is preparing an
analysis of a long term investment and is unclear how to deal with the following items (the
first has been done for you).

Inflow/outflow
Exclude/include
Item or not applicable Explanation/reason
in the analysis
(N/A)
For example:
This is a cash expense associated with the
Maintenance costs Include Outflow
project.

Interest expense Interest expenses are taken into account in

associated with the the cost of capital. Including them in the
Exclude N/A
purchase of the new NPV analysis will result in double
machine counting.

Increasing accounts receivable is a use of

Increase in accounts
Include Outflow cash (opportunity cost) – we are delaying
receivable
the receipt of cash from the sale of goods.

Sunk costs are not considered in decision

Cost of renovations
making – we evaluate the present value of
carried out 2 months Exclude N/A
the future cash flows and compare to the
ago
current cost.

Decrease in marketing
The decrease in expenses caused by the
expenses of current
Include Inflow project is a benefit to the project and needs
products caused by new
to be considered.
project

Blue exam Page 13 of 17

 Problems: Answer in the space provided on this exam

(Omit Question 2)
Problem 2. (10 marks) Dumbledore Corporation expects an EBIT of $125,000 every year
forever. Dumbledore currently has no debt, and its cost of equity is 12%. The corporate tax
rate is 25%. The firm can borrow perpetual debt at 5%. The Dumbledore Corporation has
10,000 shares outstanding and there is no risk of financial distress.
a. What is the value of the firm with zero debt? (2 marks)

$781,250

b. Dumbledore issues $100,000 of debt and used the proceeds to repurchase stock.
i. What is the new value of Dumbledore? Show your work. (3 marks)

$806,250

ii. What is the weighted average cost of capital of Dumbledore? Show your work. (5
marks)

Long way:

WACC = (.127434 *706250+.05*100000*.75)/806,250 = 11.6279%

11.6279%

Blue exam Page 14 of 17

Problems: Answer in the space provided on this exam

Problem 3. (10 marks) A large printing company is considering purchasing a new printing
press to replace the existing one that cost the company $1million five years ago. The new
machine will cost the company $1.8 million, has an economic life of ten years, and an
expected salvage value of $150,000. The old machine can be sold for of $200,000 today
and could be sold for $10,000 in ten years. Both machines have a CCA rate of 30 percent.
Assume that the company has many printing presses and that the asset class will continue
after the printing press is disposed of. The company projects that sales will increase by
$250,000 per year due to the new machine. Maintenance costs of the old machine were
forecasted to be $30,000 per year for the next 10 years. Maintenance costs for the new
machine are expected to be $20,000 per year for the life of the machine. The company’s tax
rate is 40 percent and the cost of capital is 12 percent. Conduct an NPV analysis of this
replacement decision and make a recommendation.

Cash flows (new – old)

Year 0: net investment = $1.8 million - .2 million = $1.6 million

Year 1 to 10 (operating cash flows) = $250,000 – (20,000-30,000) = $260,000

after tax: $156,000

Year 10 (salvage) = $150,000 - $10,000 = $140,000

PV(operating cash flows) = $881,434.79

PV(CCA with salvage) =

PV of salvage = $45,076.25
NPV = $881,434.79 + 419,774.13 + 45,076.25 - 1,600,000 = -$253,714.83

NPV (round to nearest $): -$253,714.83

Recommendation: Do Not Replace

machine

Blue exam Page 15 of 17

Problems: Answer in the space provided on this exam

Problem 4. (5 marks) You have just completed an analysis of a project and have found that
the project has a payback period of 3 years and an NPV of $1,000,000. Your boss will only
accept projects with payback periods of at most 2 years. Provide two reasons why your
boss should not rely entirely on the payback period to choose projects. Provide a brief
explanation of each reason – point form is recommended.

Reason 1: Payback period doesn’t take into account the time value of money.

Time value of money takes into account both the timing of the cash flow and the opportunity
cost of the capital.

Reason 2: Payback period doesn’t take into account any cash flows that occur after the payback
period
- the payback period is an incomplete measure of the value the project can add to the firm

Blue exam Page 16 of 17

Problems: Answer in the space provided on this exam

Problem 5. (5 marks) Your Father is considering investing in one or more options but
doesn’t fully understand the impact that different factors will have on the value of calls and
puts. He has asked you to provide some guidance on what will happen to option prices as
various factors change. Fill in the table below to help your Father out with his dilemma.

Note: In considering the impact on each option price caused by each factor individually,
assume that each of the factors is INCREASED while the remaining factors are held
constant. Answer by inserting a “+” sign in the cell if the value of the call (put) is
expected to increase and a “–” sign if the value of the call (put) is expected to decrease.
The correct assignment has been provided for the first factor (dividends).

Affect on call Affect on put

Factor option value option value
Dividends – +
Asset Price + -
Strike Price - +
Time to Expiration + +
Volatility + +
Interest Rates + -

Blue exam Page 17 of 17