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COVER PAGE FOR A WRITTEN EXAMINATION/TEST

Mandatory section: Name of subject : Corporate Finance 1 for Internationa. Business Subject code : 323 001 Date of examination : July 06, 2009 Length of examination : 180 minutes Lecturer : Dr. M. Da Rin, Dr. F. Braggion, Dr M. Penas Telephone number of departmental secretariat: 8367/ 3025

Students are expected to conduct themselves properly during examinations and to obey any instructions given to them by examiners and invigilators.

Firm action will be taken in the event that academic fraud is discovered.

Optional section:

1. The exam is closed book 2. There are 30 multiple-choice questions to be answered on the separate computer card. Students

must use a dark pencil or a pen with black ink. Each multiple-choice question has only one correct answer; so mark only one box. Wrong answers and answers with more than one box marked will result in a 0.25 points penalty. Correct answers carry one full point. Blank answers carry no point and no penalty.

3. Write down the student number and all required information at the appropriate place of the computer card.

4. Students must hand in the computer card; they can keep the calculation sheets. 5. A simple calculator can be used to answer, but not a programmable calculator.

Good luck!

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Question 1 Use the data in the following table:

Security

Cash flow today

Cash flow in 365 days

A 0 100 B 100 0 C 200 100

Which following statements are true? A) If the value of security C is $293.02, then the value of security A is $90.00 B) The value of security B does not depend on the risk-free interest rate. C) If the value of security C is $293.02 and the risk-free rate is 7.5%, there exit an arbitrage opportunity. D) Both B and C Answer: B Explanation: A) wrong: P(C)=P(A)+2P(B) B) correct C) wrong: P(A) = 100 / 1.075 = 93.02 D) wrong Question 2 Assume the risk-free interest rate is 4%. Then the one-year discount factor is closest to: A) 0.96 B) 1.04 C) 0.04 D) none of the above Answer: A Explanation: Discount Factor = 1/(1.04) = 0.9615 Question 3 Consider the following stream of cash flows:

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If the current risk-free interest rate is 8%, then the future value of this stream of cash flows, valued at time T=4, is closest to: A) $11,699 B) $10,832 C) $12,635 D) $10,339 Answer: A Explanation: FV = 1000(1.08)4 + 2000(1.08)3 + 3000(1.08)2 + 4000(1.08) = $11,699 Question 4 You win the Braabant provincial lottery. You are offered two alternative ways to cash in: Alternative 1: you cash in 500,000 today Alternative 2: you cash in 100,000 today and 100,000 on July 6th of each of the next four years. Which of the following statements is true, if the risk-free interest rate is 2%: A) The PV of the lottery is 380.772 B) You prefer Alternative 2 C) You are indifferent between the two Alternatives D) You do not need to know the risk-free interest rate to make your decision Answer: D Explanation: Alternative 1 dominates Alternative 2 irrespective of the risk-free interest rate, whose PV is 480.772. Question 5 Consider an investment that pays $1000 for certain at the end of each of the next four years. The risk-free interest rates at 1, 2 and 3 years are 5.0%, 4.8%, and 4.6%, respectively. If the

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investment costs $3,500 and has an NPV of $74.26, then the risk-free interest rate at 4 years is closest to: A) 4.50% B) 4.58% C) 4.55% D) 4.53% Answer: D Explanation: let x be the (unknow) value of the risk-free interest rate. Then: NPV = 74.26 = 3500 + 1000/(1.05) + 1000/(1.048)2 + 1000 / (1.046)3 + 1000 / (1 + x)4 This implies: 3574.26 = 1000/(1.05) + 1000/(1.048)2 + 1000 / (1.046)3 + 1000 / (1 + x)4 837.60 = 1000 / (1 + x)4 (1 + x)4 = 1000 / 837.60 x = 0.0453 Question 6 The real interest rate is equal to: A) the nominal interest rate plus the inflation rate B) the nominal interest rate less the inflation rate C) (1 plus the nominal interest rate) divided by (1 plus the inflation rate) D) [(1 plus the nominal interest rate) divided by (1 plus the inflation rate)] minus 1 Answer: D Explanation: definition from chapter 5 of the textbook. Question 7 Which of the following statements is correct: A) The NPV of an investment opportunity increases with the discount rate. B) A project can have more than one Internal Rate of Return. C) The opportunity cost is not part of an investments NPV because it is a non-monetary cost. D) The EVA investment rule is the same as the IRR investment rule. Answer: B

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Explanation:A is the contrary of the truth. C is wrong because the opportunity cost must always be included in computing an investments value. D is wrong because the two rules are based on different assumptions. Question 8 Which of the following statements is false? A) The IRR investment rule states you should turn down any investment opportunity where the IRR is less than the opportunity cost of capital. B) The NPV investment rule requires that one considers the opportunity costs of capital. C) Since the IRR rule is based upon the rate at which the NPV equals zero, like the NPV decision rule, the IRR decision rule will always identify the correct investment decisions. D) There are situations in which multiple IRRs exist. Answer: C Explanation: The IRR decision may fail to identify the correct investment decisions because the IRR may not exist or there may be multiple IRRs. Question 9 The Tarimatimi Company reported net income of $300 million for the most recent fiscal year. The firm had depreciation expenses of $125 million and capital expenditures of $150 million. During the year the salary expense was $80 million. Although they had no interest expense, the firm did have an increase in net working capital of $20 million. What is Tarimatimi 's free cash flow? A) $335 million B) $255 million C) $175 million D) $130 million Answer: B Explanation: FCF = Net Income + Depreciation Capital Expenditure Change in Net Working Capital = 300 + 125 150 20 = 255 Question 10 Which of following statements about the choice whether to add a new project to your company or not is incorrect? A) The choice must take into account all incremental earnings due to the new project. B) The choice must consider the cannibalization of current revenues due to the new project. C) The choice must not take into account marketing studies that have already been paid for.

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D) The choice must not include the opportunity cost of existing buildings that will be used for the new project. Answer: D Explanation: all opportunity costs must me considered in the choice Question 11 Consider a zero-coupon bond with a $1000 face value and 15 years left until maturity. If the yield to maturity is currently 3% and tomorrow becomes to 4%, the change in the bond price is closest to: A) 80.0 B) 86.6 C) 76.6 D) 88.3 Answer: B When YTM=0.03: P = 1000/(1.03)15 = 1000*0.64186 = 641.86 When YTM=0.04: P = 1000/(1.04)15 = 1000*0.55526 = 555.26 Therefore the difference is 86.60 Question 12 Consider two bonds issued by the European Investment Bank (an AAA borrower guaranteed by the EU). Both bonds have a 10% coupon rate, and 100 face value. Bond Short has 10 year maturity and Bond Long has 12 year maturity. Consider a sudden decrease of the yield-to-maturity of both bonds from 5% to 4%. Which of the following statements is correct? A) There is not enough information to answer this question B) The PV of the coupon payments will change, but the PV of the principal repayment will not. C) Both bonds prices will decrease; the change in absolute terms will be higher for Bond Short D) Both bonds prices will increase; the change in percentage terms will be higher for Bond Long Answer: D Explanation: Initial situation Bond Short: NPV = 10(1/0.05) (1-1/(1.05)10) + 100/(1.05)10) = 772.17 + 61.39 = 833.56 Bond Long: NPV = 10(1/0.05) (1-1/(1.05)12) + 100/(1.05)12) = 886.32 + 55.68 = 942.01 Final situation Bond Short: NPV = 10(1/0.04) (1-1/(1.04)10) + 100/(1.04)10) = 811.09 + 67.56 = 878.65 Bond Long: NPV = 10(1/0.04) (1-1/(1.04)12) + 100/(1.04)12) = 938.51 + 62.46 = 1000.97

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Price increase for Bond Short: 45.09, or 5.4% Price increase for Bond Long: 58.95, or 6.2% Question 13 Marrimon has a dividend yield of 4.5% and a cost of equity capital of 12%. Marrimons dividends are expected to grow at a constant rate indefinitely. The grow rate of Luther's dividends is closest to: A) 7.5% B) 5.5% C) 16.5% D) 12% Answer: A Explanation: rE = Div/P + g

0.12 = .045 + g g = .075

Question 14 Fabra Inc expects earning per share of 8. With expectations of not reinvesting any earnings, the company has currently a valuation of 80. Suppose the company cuts its dividend by half and reinvests what is not paid out. If the expected return on the reinvestment is 16%, the change in stock price would be closest to: A) 250% B) 100% C) 150% D) 120% Answer: C Explanation: The dividend yield is currently 10%. So Fabras cost of capital is rE = Div/P + g = 0.1 + 0 = 0.1, or 10%. If Fabra reduces its dividend to reinvest, the dividend will become 4, and the growth rate of the company becomes g = 0.5*0.16 = 0.08, or 8%. Therefore, the new share price becomes: P = Div/( rE g) = 4/0.02 = 200. The change is share price is then 120/80 = 150%. Question 15 Which of the following adjustments to net income is not correct if you want to calculate cash flow from operating activities?

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A) Add increases in accounts payable B) Add back depreciation C) Add increases in accounts receivable D) Deduct increases in inventory Answer: C Explanation: See definitions in chapter 2. Question 16 Which of the following is not an operating expense? A) Depreciation and amortization B) Acquisition of a competitor C) Selling, general and administrative expenses D) Research and development Answer: B Question 17 Consider the following covariance matrix:

Dabbo Matsuo WallataDabbo 0.0568 -0.0193 0.0037Matsuo -0.0193 0.2420 0.1277Wallata 0.0037 0.1277 0.1413

The variance on a portfolio that consists of equal investments in Dabbo and Matsuo stock is closest to: A)0.065 B) 0.090 C) 0.149 D) 0.020 Answer: A Explanation: Var(Rp) = x12Var(R1) + x22Var(R2) + 2 x1x2Cov(R1, R2) = (.50)2(0.0568) + (.50)2(0.2420) + 2(.5)(.5)(-0.0193) = 0.0651 Question 18 Use the same information as in the previous question. The variance on a portfolio that is made up of a $6000 investments in Dabbo and a $4000 investment in Wallata stock is closest to:

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A) 0.050 B) 0.045 C) 0.051 D) 0.020 Answer: B Explanation: X1 = 0.60 and X2= 0.40. Therefore: Var(Rp) = Var(Rp) = x12Var(R1) + x22Var(R2) + 2 x1x2Cov(R1, R2) = (.60)2(0.0568) + (.40)2(0.1413) + 2(.6)(.4)(0.0037) = 0.0449 Question 19 Which of the following statements is false? A) The most familiar stock indices in the United States are the Dow Jones Industrial Average (DJIA) and the Standard&Poors (S&P). B) A portfolio in which each security is held in proportion to its market capitalization is called a price-weighted portfolio. C) The reason why investors compute value weighted portfolios is to account for the different size of companies. D) A price-weighted portfolio should require new investments every day. Answer: B Explanation: A portfolio in which each security is held in proportion to its market capitalization is called a value-weighted portfolio. Question 20 Consider a portfolio made up of the following four stocks:

Stock Beta Investment($)Eenie 1.3 10,000Meenie 1.0 10,000Minie 0.8 -5,000Moe -0.5 -5,000

Assuming that the risk-free rate is 4% and the expected return on the market is 12%, then required return on this portfolio is closest to: A) 16% B) 12% C) 21% D) 8%

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Answer: C Explanation: P= xii ri = rf + (E[RMkt] rf) =0 .04 + 2.15(0.12 0.04) = 0.212

Stock Beta Investment WeightsEenie 1.3 10000 100%Meenie 1.0 10000 100%Minie 0.8 5000 50%Moe 0.5 5000 50%

PortBeta= 2.15 Question 21 Which of following statements is correct? A) Idiosyncratic risk can be fully diversified away, so one needs not price it. B) Idiosyncratic risk is a component of systematic risk. C) Idiosyncratic risk affects stock prices through the risk premium. D) Idiosyncratic risk is measured by a stocks standard deviation. Answer: A Question 22 The current stock price for Marifabanter Inc. is $25. Consider the following data:

StockPriceinOneYear($) ReturnR Probability

$35 40% 25%$25 0% 50%$20 -20% 25%

The standard deviation of the return on Marifabanter is closest to: A) 22.4% B) 19.0% C) 21.8% D) 19.4% Answer: C Explanation:

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E[R] = = .25(40%) + .50(0%) + .25(-20%) = 5% Var(R) = = .25(.40 - .05)2 + .50(.00 - .05)2 + .25(-20 - .05)2 = .0475 or 4.75% SD(R) = = = .2179 or 21.79% Question 23 Which of the following statements is false? A) If the CAPM correctly computes the risk premium, investors would stop investing only when they expected the alpha of an investment strategy to be negative. B) If the CAPM correctly computes the risk premium, an investment opportunity with a positive alpha is a positive NPV investment opportunity. C) If the CAPM correctly computes the risk premium, investors should invest in positive alpha stocks. D) If the CAPM is correct then the Fama-French-Carhart model does not provide any additional investment opportunity. Answer: A Question 24 Consider two firms, My Corporation and Your Industries that are each expected to pay the same $1.5 million dollar dividend every year in perpetuity. My Corporation is riskier and has a cost of capital of 15%. Your Industries is not as shaky as My, so Your has a cost of capital of only 10%. Assume that the market portfolio is not efficient. Both stocks have the same beta and the CAPM would assign them both an expected return of 12% to both. The alpha for My Corporation is closest to: A) 2% B) 27% C) 3% D) 3% Answer: D Explanation: Alpha = actual return - predicted return (from CAPM) = 0.15 0.12 = 0.03 Question 25 Given the information in the table below, assuming that the CAPM is true, which statement is correct?

Stock A Stock B T-Bills Market

Portfolio

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Expected Return 13% 15% 7% 18% Standard Deviation of return 9.33% 3.10% 0% 8% Covariance with market portfolio 0.0070 0.0045 0.0000 0.0064

A) Buy stock A since the expected return under CAPM is smaller than 13% B) Do not buy stock B since the expected return under CAPM is larger than 15%. C) Buy stock B since the expected return under CAPM is smaller than 15%. D) None of the above.

Answer: C Explanation: The CAPM implies E(A) = 0.07 + (0.007/0.08^2)*(0.18-0.07) = 0.190 E(B) = 0.07 + (0.0045/0.08^2)*(0.18-0.07) = 0.1473 This implies that statement C is the only correct one. Question 26 Which of the following statements is false? A) Because of the Law of One Price, two bonds with the same maturity and expected cash flows, issued by two different companies, must have the same price. B) On the day of their issue, the price of a zero coupon bond is lower than the price of a cum-coupon bond, if they are issued on the same day, have the same risk, and their maturity is the same. C) Consider two bonds with the same characteristics, except maturity. The one with longer maturity will increase its price more if the yield-to-maturity falls. D) The standard deviation of a stock includes both idiosyncratic and systematic risk. Answer: A Explanation: the two bonds may differ for their risk. Hence their prices may differ. Question 27 Which of the following statements is false? A) Under the CAPM the beta of a riskless asset must be zero. B) Diversification can be higher when stocks are negatively correlated with each other. C) An efficient portfolio cannot consist of long positions in all available stocks. D) A fully diversified portfolio has an expected return that is not far from the average return of the individual stocks it employs.

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Answer: C Explanation: efficient portfolios can consist of any combinations of stocks. Question 28 Consider TootleTi AG, whose beta under the CAPM is 0.20. If the risk-free interest rate is 3%, and the expected return on the market is 9%, what is the expected return on TootleTi? A) 2.0% B) 2.2% C) 1.5% D) 1.8% Answer: D Explanation: E(TottleTi) = 0.03 0.2(0.090.03) = 0.03 0.012 = 0.018 Question 29 Which of the following statements is true? A) Under the CAPM, a stocks beta depends on the riskless interest rate. B) Under the CAPM, a stocks beta depends on the stocks idiosyncratic risk. C) Under the CAPM, the capital market line coincides with the efficient portfolio if the risk-free interest rate is high enough. D) Under the CAPM, the volatility of a portfolio equals the value-weighted average of the volatilities of the stocks included in the portfolio. Answer: B Explanation: look at the formula for beta. Question 30 Which of the following statements is true? A) The yield-to-maturity of a zero-coupon bond is equal to the ratio between face and market value minus one. B) The yield-to-maturity of a coupon bond is always higher than the yield-to-maturity of a zero-coupon bond of the same maturity and risk. C) The price of a coupon bond falls more as the yield-to-maturity increases when the bond has a higher maturity. D) The price of a coupon bond falls more on coupon date when the bond is closer to maturity.

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Answer: C