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FINAL EXAMINATION

Fall 2011
Student Last Name: __________________________________
Student First Name: __________________________________
Student Number:____________________
DURATION: 3 (THREE) HOURS
Department Name & Course Number:
BUSI 2504
Course Instructor(s) : Mitch Murphy, Yuriy Zabolotnyuk

No. of Students:
Section: C, D, E, F

AUTHORIZED MEMORANDA
Calculator
Hand-written notes on one side of 8.5 x 11 sheet
Students MUST count the number of pages in this examination question paper before beginning to
write, and report any discrepancy to a proctor.
This question paper has 8 (eight) pages.
This examination question paper may not be taken from the examination room.
In addition to this question paper, students require: an examination booklet yes
Scantron sheet
yes
Received
Multiple choice questions (50 marks):
Problems (50 marks):

1 - 25 50 marks

________

Q1 10 marks
Q2 10 marks
Q3 18 marks
Q4 12 marks

________
________
________
________

Total 100 marks

________

Do ALL 25 multiple choice problems: 2 marks per question for a total of 50 marks.
1. Ponderosa's bonds sell for $846.04. The coupon rate is 8%, the bonds mature in 25
years, and interest is paid semiannually. The tax rate is 34%. What is Ponderosa's
aftertax cost of debt?
A) 3.18%
B) 4.99%
C) 9.64%
D) 9.34%
E) 6.36%
2. Roberts Co.'s zero coupon bonds mature in 22 years and have a yield to maturity of
12.01%. Each zero has a face value of $1,000 and there are 2,000 of the bonds
outstanding. If the market value of Roberts' equity is $1,000,000, what capital structure
weight for debt would you use in calculating the WACC, assuming Roberts' only debt
consists of the zeros?
A) 11.9%
B) 14.2%
C) 15.8%
D) 18.9%
E) 66.7%
3. Anthony's Antiques, Inc. has preferred stock outstanding which pays a dividend of $4 per
share a year. The current stock price is $32 per share. What is the cost of preferred stock?
A) 8.0%
B) 9.0%
C) 10.0%
D) 11.0%
E) 12.5%
4. The common stock of a firm is currently priced at $53 a share. The company paid $1.40
in common dividends last year and expects to increase this amount by 3% annually. The
stock has a beta of 1.40, which is about equal to its industry average. Given this
information, what is the cost of equity financing?
A) 3.81%
B) 5.64%
C) 5.72%
D) 6.70%
E) 8.01%

5. The common stock of Chelsea, Inc. has a beta of 1.14, a market price of $38.90, and an
expected dividend of $.90 next year. The market risk premium is 6% and the risk-free
rate of return is 3%. What is the expected cost of equity for Chelsea, Inc.?
A) 6.42%
B) 8.31%
C) 9.08%
D) 9.42%
E) 9.84%
6. You have a portfolio consisting of stock A and stock B. The portfolio has an expected
return of 8.8 percent. Stock A has an expected return of 16 percent while stock B is
expected to return 6 percent. What is the portfolio weight of stock A?
A) 28 percent
B) 31 percent
C) 34 percent
D) 69 percent
E) 72 percent
7. Which one of the following stocks is correctly priced according to CAPM if the riskfree rate of return is 3.6 percent and the market rate of return is 10.5 percent?
Stock
A
B
C
D
E
A) A
B) B
C) C
D) D
E) E

Beta
.85
1.08
1.69
.71
1.45

Expected Return
9.2%
11.8%
15.3%
7.8%
12.3%

8. Which of the following is true regarding the beta coefficient?


A) It is a measure of unsystematic risk.
B) A beta greater than one represents lower systematic risk than the market.
C) Generally speaking, the higher the beta the higher the expected return.
D) A beta of one indicates an asset is totally risk-free.
E) The risk premium of an asset will increase if the beta of that asset decreases.
9. Which one of the following is an example of diversifiable risk?
A) the price of electricity just increased
B) the employees of Textile, Inc. just voted to go on strike
C) the government just imposed new safety standards for all employees
D) the government just lowered corporate income tax rates
E) the Workers Compensation Premiums just increased nationwide

10. Frederico's has a profit margin of 6 percent, a return on assets of 8 percent, and an
equity multiplier of 1.4. What is the return on equity?
A) 6.7 percent
B) 8.4 percent
C) 11.2 percent
D) 14.6 percent
E) 19.6 percent
11. Square D's has $42,700 in sales and a profit margin of 7.2 percent. There are 5,700 shares of
stock outstanding at a market price per share of $13.20. What is the price-earnings ratio?
A) 7.12
B) 17.63
C) 24.47
D) 26.08
E) 29.00
12. A firm with net income of $500,000 pays 48% of net income out in dividends. If the firm has
150,000 shares of common stock outstanding, what is the dividend paid per share of stock?
A) $0.30
B) $1.44
C) $1.60
D) $1.73
E) $3.33
13. What are the arithmetic and geometric average returns for a stock with annual returns of
21 percent, 8 percent, -32 percent, 41 percent, and 5 percent?
A) 5.6 percent; 8.6 percent
B) 5.6 percent; 6.3 percent
C) 8.6 percent; 5.6 percent
D) 8.6 percent; 8.6 percent
E) 8.6 percent; 6.3 percent
14. A stock has a beta of 1.4 and an expected return of 16%. The risk-free rate is 5%. What
is the slope of the Security Market Line?
A) 7.86%
B) 7.98%
C) 8.23%
D) 8.67%
E) 8.98%
15. You own a stock portfolio that is invested 10% in stock A, 30% in stock B, 40% in
stock C, and 20% in stock D. These stocks have betas of 1.2, .8, 1.1, and 1.5,
respectively. What is the beta of the portfolio?
A) 1.04
B) 1.07
C) 1.10
D) 1.13
E) 1.14

16. Suppose that Topstone Industries has a cost of equity of 14% and a cost of debt of 9%.
If the target debt/equity ratio is 75%, and the tax rate is 34%, what is Topstone's
weighted average cost of capital (WACC)?
A) 6.6%
B) 7.9%
C) 8.4%
D) 10.5%
E) 10.9%
17. Which one of the following actions is the best example of an agency problem?
A) Paying management bonuses based on the number of store locations opened during the year.
B) Paying management bonuses based on the current market value of the firms stock.
C) Accepting a project that enhances both management salaries and the market value of the firms
stock.
D) Requiring stockholders approval of all management compensation decisions.
E) Basing management bonuses on the attainment of specific financial goals.
18. Twenty years ago, Max invested $10,000. Thirty years ago, Julie invested $5,000. Today, both Max
and Julies investments are each worth $35,000. Which one of the following statements is correct
concerning their investments? Assume that they will continue earning the same rate of return.
A) Two years from now, Maxs investment will be worth more than Julies.
B) Last year, Julies investment was worth more than Maxs.
C) Max has earned more interest on interest than Julie.
D) Julie has earned an average annual interest rate of 6.7%.
E) Max has earned an average annual interest rate of 6.41%.
19. Curtis bought an 8.5% annual coupon bond at par. One year later, he sold the bond at a quoted price
of 98. During the year, market interest rates rose and inflation was 3%. What exact real rate of return
did Curtis earn on this investment?
A) 3.40%.
B) 3.50%.
C) 6.40%.
D) 6.50%.
E) 6.70%.
20. When a bondholder is granted the right to force the issuer to repay the bond prior to maturity, the
bond:
A) is an income bond.
B) is a convertible bond.
C) contains a call provision.
D) contains a put provision.
E) contains a zero-out provision.
21. Which one of the following statements is true concerning bond ratings?
A) Bond ratings are based on both the risk of default and the interest rate risk.
B) A bond rated BBB or lower is considered a junk bond.
C) All else equal, a bond rated BB should pay a higher return than a bond rated B.
D) Bond ratings are based only on the risk of default.
E) Bonds rated BBB and above are called junk bonds.

22. Liddy Products, Inc. just issued 10-year, 8% coupon bonds at par. Outstanding Limbaugh Corp.bonds,
which have a maturity of 10 years, sell at a premium to par and are viewed by investors as having the
same risk as the Liddy bonds. Therefore, it must be true that:
A) The coupon rate on the Limbaugh bonds is equal to that on the Liddy bonds.
B) The coupon rate on the Limbaugh bonds is higher than that on the Liddy bonds.
C) The coupon payment on the Limbaugh bonds is lower than that on the Liddy bonds.
D) The yield on Limbaugh bonds is higher than the yield on Liddy bonds.
E) The Limbaugh bonds pay coupons more often than twice a year.
23. MDK, Inc. is a high growth firm that has never paid a dividend. The company just issued a press
release stating that next year it plans on paying an annual dividend of $0.34. It also stated that
dividends are expected to increase by 40% a year for each of the following four years and then
increase by 4% annually thereafter. The required rate of return on this stock is 15%. What is the
expected price per share of MDK stock six years from now?
A) $9.12.
B) $9.42.
C) $12.35.
D) $12.84.
E) $14.14.
24. Main Street Tool & Die is in a downsizing mode. The company paid a $2 annual dividend last year.
The company has announced plans to lower the dividend by $.50 a year. Once the dividend amount
becomes zero, the company will cease all dividends permanently. You place a required rate of return of
18% on this particular stock given the companys situation. What is one share of this stock worth to
you today?
A) $2.29.
B) $2.47.
C) $2.68.
D) $2.72.
E) $2.83.
25. Leon purchased 1,000 shares of LJK stock this morning at a price of $45.67 a share. The stock will pay
a dividend this year of $1.80 per share. Leons required rate of return is 13% on this type of investment.
What is the capital gains yield on LJK stock?
A) 7.41%.
B) 8.72%.
C) 9.06%.
D) 13.85%.
E) 16.94%.

Do ALL FOUR problems.


Show how you arrived at your answer including (1) the general form of equation, (2) the equation with
the correct numbers substituted in, and (3) the solution!

1. (10 marks) You are planning to retire in exactly 30 years. You are capable of making regular
contributions to your savings at the end of every quarter over these 30 years. Your savings will earn an
APR of 18% compounded quarterly until retirement. During retirement, the interest rate will be an APR
of 12% compounded semi-annually.
a) You expect to live for 20 years past retirement and you anticipate withdrawing $10,000 at the
beginning of each month to cover living expenses. How much savings do you require at
retirement? (5 marks)
b) Prior to retirement, how much must you contribute to your savings each quarter to achieve this
amount? (5 marks)

2. (10 marks) You are considering the following two mutually exclusive projects with the following cash
flows. Both projects will be depreciated using straight-line depreciation to a zero book value over the
life of the project. Neither project has any salvage value. Your WACC is 4%, and your required
payback is two years.
Year
0
1
2
3

Project "Epic Fail"


-$45,000
$17,500
$18,000
$22,500

Project "FTW"
-$40,000
$5,000
$10,000
$39,000

a) Should you choose project "Epic Fail" or project "FTW", and why? (4 marks)
b) What is the crossover rate between these projects? (3 marks)
c) If the required rate of return was higher than the crossover rate, which project would you
choose? (3 marks)

3. (18 marks) Stock A has a beta of 0.8; Stock B has a beta of 1.1; the risk-free rate is 4%. Additional
information on securities A and B is provided below:
State Probability Return on A Return on B
Boom
.6
0.15
0.08
Bust
.4
0.05
0.20

a) What are the expected returns on security A and security B? (2 marks)


b) What are the standard deviations of returns of security A and security B? (4 marks)
c) What is the correlation between returns of Security A and Security B? (3 marks)
d) What is the standard deviation of returns on a portfolio that is 50% invested in A and 50%
invested in B? (3 marks)
e) What is the expected return on a portfolio that is equally-weighted amongst A, B, and the riskfree asset? (3 marks)
f) What is the beta of a portfolio that is equally-weighted amongst A, B, and the risk-free asset?
(3 marks)
4. (12 marks) Use the following to answer the questions:
Yuriy's Ukrainian Food (YUF), Inc.
Sales
COGS
Interest
Dividends
Depreciation
Cash
Accounts receivable
Current liabilities
Inventory
Long term debt
Net fixed assets
Common stock
Tax rate

2010
$1,240
820
25
25.50
270
110
145
380
410
300
620
500

2011
$1,385
910
20
25.90
240
95
165
469
440
320
660
350
34%

a) What is the YUF's operating cash flow for 2011 (4 marks)


b) What is the cash flow from assets for 2011? (4 marks)
c) What is the cash flow to stockholders for 2011 (4 marks)