1.
Name (Please Print): Key
SSN (Last 4 digits): 0000
MBA643.001 Managerial Finance
School of Management, GMU
Spring 2004
Final Exam
(Total 100 points)
Please answer all problems. Show all work in the blank spaces provided following the
questions. Do not use the back pages for any purpose. Any writing on the back pages
will NOT be graded. Be careful to avoid arithmetic mistakes. Check your answers. This
is a closed-book, closed-note exam. You also need to turn in the formula sheet. After
you finish, sign the pledge below.
HONORABLE CONDUCT
In academic work is the spirit of conduct in this university
In recognition of and in the spirit of the Honor Code, I certify that I have neither given
nor received aid on this examination and that I will report all Honor Code violations
observed by me.
Note: It is an honor code violation to discuss this exam with students in the other section
if this class has multiple sections.
(Signed) _____________________________________________
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2.
Part A: Choose the correct answer
(Total 50 points: Q1~10: 3 points each, Q11~15: 4 points each)
1 Which of the following amounts is closest to the net present value of a project that
contributes $5,000 at the end of the first year and $8,000 at the end of the second
year. The initial cost is $3,000. The appropriate interest rate is 8% for the first year
and 10% for the second year.
(A) $8,585
(B) $8,426
(C) $8,363
(D) $8,073
2 Which of the following statements is most correct?
(A) Actions that increase net income will always increase net cash flow.
(B) One way to decrease EVA is to maintain the same operating income with less
capital.
(C) The use of debt in a company’s capital structure results in tax benefits to the
investors who purchase the company’s stock.
(D) A firm with financial leverage has a smaller equity multiplier than an otherwise
identical firm with no debt in its capital structure.
3 Which of the following statements is true?
(A) The security market line plots the historic relationship between returns on an
individual stock and the market risk premium.
(B) For mutually exclusive projects, the project with the highest NPV is always the
correct selection regardless of IRR.
(C) An annuity factor represents the present value of $1 that is deposited today.
(D) (B) and (C) are correct.
4 How much should you pay for a share of stock that offers a constant growth rate of
10%, requires a 16% rate of return, and is expected to sell for $50 two years from
now?
(A) $41.32
(B) $43.40
(C) $45.45
(D) $47.57
5 Which of the following statements is true?
(A) When a security is added to a portfolio, the appropriate return is the beta times
the market risk premium.
(B) When a security is added to a portfolio, the appropriate risk contribution is the
standard deviation of the asset.
(C) Once a portfolio is diversified, the type of risk remaining is the risk from risk-
free rates.
(D) Once a portfolio is diversified, the type of risk remaining is the risk related to the
market portfolio.
CCDAD
PAGE 2
3.
6 The reason that M/M Proposition I does not hold in the presence of corporate taxation
is because:
(A) Levered firms pay less tax compared with identical unlevered firms.
(B) Bondholders require higher rates of return compared with stockholders.
(C) Earnings per share are no longer relevant with taxes.
(D) Dividends are no longer relevant with taxes.
7 Which of the following is not one of the potential conflicts between stockholders and
bondholders?
(A) Differential risk exposure.
(B) Dividend payouts.
(C) Underinvestiments.
(D) Asset substitution.
8 The stock price of a firm under M/M Proposition I & II without taxes is:
(A) Invariant to the level of debt because the number of shares is reduced.
(B) The expected return to equity holders rises as debt increases offsetting the
leverage advantage.
(C) The value of the firm is constant with equity or debt financing.
(D) All of the above.
9 AT&B has a debt-to-equity ratio of 2.5. Its rWACC is 15%, and its cost of debt is 11%.
The corporate tax rate is 35%. What would the weighted average cost of capital be if
the debt-to-equity ratio is 0.8?
(A) 15.00%
(B) 11.85%
(C) 12.67%
(D) 12.75%
10 One of the indirect costs of bankruptcy is the incentive for managers to take large
risks. When following this strategy, the firm will:
(A) Rank all projects and take the project which results in the highest expected value
of the firm.
(B) Rank all projects and take the project which results in the highest expected value
of the firm’s bonds.
(C) Rank all projects and take the project which results in the highest expected value
of the firm’s stock.
(D) Always take the low risk project.
AADCC
PAGE 3
4.
11 Portfolio P has 30% invested in Stock X and the remaining in Stock Y. The risk-free
rate is 6% and the market risk premium is 5%. Portfolio P has a required rate of
return of 11.3% and Stock X has a beta of 0.75. What is the beta of Stock Y?
(A) 0.95
(B) 1.19
(C) 1.39
(D) 1.64
12 If the weak form of efficient markets holds, then:
(A) Technical analysis is useless.
(B) Stock prices reflect all public information.
(C) The prices follow a random walk.
(D) Statements (A) and (B) are correct.
13 The abnormal return on a security for a particular day can be estimated by the
equation:
(A) ARi = Rf - RM
(B) ARi = Ri - RM
(C) ARi = Ri - Rf
(D) ARi = Rf - Ri
14 Is this statement true? A risky security cannot have an expected return that is less
than the risk-free rate because no risk-averse investor would be willing to hold this
asset in equilibrium.
(A) False, because investors can buy this security to reduce the variance of their
portfolios.
(B) True, because investors require higher returns than the risk-free rate when they
buy risky securities.
(C) False, because investors can buy this security to increase the returns of their
portfolios.
(D) True, because risk-averse investors require higher returns than the risk-free rate.
15 Which of the following statements is not true? If a portfolio has a positive weight for
each asset,
(A) The expected return on the portfolio can not be greater than the return on the
asset in the portfolio that has the highest return.
(B) The expected return on the portfolio can not be less than the return on the asset
in the portfolio that has the lowest return.
(C) The expected return on the portfolio is simply the summation of individual
weights times the expected returns of the assets.
(D) The expected return on the portfolio equals the average of the highest return and
the lowest return.
BABAD
PAGE 4
5.
Part B: Points are indicated in each question. Please show all your
work.
Question 1: Define or Comment briefly (12 points)
(a). Premium in takeovers
Premium in takeovers is defined as the offer price minus the pre-announcement
market price.
(b). If the market is efficient, stock prices should only be expected to react to new
information that is released.
This statement is true. Under EMH, markets can not predict the future. All of the
prices only reflect the information that is released.
PAGE 5
6.
Question 2 (18 points)
(a). Suppose a Miller equilibrium exists (VL = VU) with corporate tax rate of 30% and
personal tax rate on income from bonds of 35%. What is the personal tax rate on income
from stocks?
0 = 1-(1-0.3)(1-TS)/(1-0.35) => TS = 0.071 = 7.1%
(b). The Zercon Company has EBIT of $50,000 and market value debt of $100,000
outstanding with a 9% coupon rate. The cost of equity for an all equity firm would be
14%. Zercon has a 35% corporate tax rate. Investors face a 20% tax rate on debt receipts
and a 15% rate on equity.
(b1). What is the value of Zercon if the firm is unlevered?
VU = 50,000*(1-0.35)/0.14 = 232,142.86
(b2). What is the current value of Zercon?
VL = 232,142.86 + 100,000*[1-(1-0.35)(1-0.15)/(1-0.2)] = 263,080.36
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7.
Question 3 (20 points)
Assume the CAPM is the model of market equilibrium. The risk-free rate is 3 percent.
The expected market risk premium is 7 percent. You, as a consultant for not-for-profit
organizations, are working on a fund raising project called “Save for Africa”. You plan
to raise a certain amount of funds at the end of each year for the next 4 years (year 1 to 4)
and save the funds into the Green Bio Mutual Fund with a beta of 0.8. At the end of the
fourth year, you will deposit the money into a savings account that earns 3.0 percent
annually. You will start your project in Africa in year 7 and expect to complete it in 5
years. To meet your goal, you have to withdraw a constant amount of $250,000 from this
account for five years. Assume that the expected return on the mutual fund will be the
same each year for the next four years after you make the first deposit to the mutual fund.
Given your investment strategy, answer the following questions:
(a). What is the expected return on your Green Bio Mutual Fund?
r = 0.03 + 0.8*0.07 = 0.086
(b). How much will you need to deposit in the Green Bio Mutual Fund each year?
1 1 1 1 1
D − 4
* (1.086) 4 = 250,000 − 5
* 2
0.086 (0.086)(1.086) 0.03 (0.03)(1.03) 1.03
=> D = 237,385.80
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