Blog

The University of Sydney – FINC2011 Page 1 Quiz I Practice Questions Multiple Choice Questions 1. Executive options can be used to address the agency problem in corporations because: a) they motivate managers to make decisions that will increase the share price b) they punish managers for falls in the share price c) managers must use the options to buy shares even if the share price has fallen d) they transfer wealth from managers to shareholders e) managers must use the options to buy shares even if the share price has increased 2. You have $100,000 now and will receive $130,000 in exactly one years’ time. If you spend $80,000 today and market interest rates are 10% p.a. compounded semi-annually, how much will you have in one year a) $130,000 b) $152,050 c) $150,000 d) $240,000 e) $240,250 3. Mr Simon de Money wishes to purchase a new Mercedes Benz C250 CDI. The car costs $73,200. Mr de Money has arranged a loan that only covers part of the purchase price. He intends to finance the rest of the purchase with money from his savings. The loan requires payments of $1,400 per month for 5 years. The interest rate on the loan is 12% p.a. compounded monthly. How much of his savings must Mr de Money use a) $13,649.87 b) $9,377.09 c) $12,639.76 d) $14,899.45 e) $10,262.95 FINC2011 The University of Sydney – FINC2011 Page 2 4. A 90-day security that promises to pay $1 million at its maturity was issued 37 days ago. Calculate its price today if it is traded at a simple interest yield of 3.6% p.a. a) $994,799.79 b) $979,240.11 c) $991,201.39 d) $994,818.60 e) $996,363.95 5. Shareholders are said to have a ‘residual claim’ on the firm’s assets. What does this mean a) Shareholders elect the Board of Directors b) Shareholders have limited liability if the firm experiences financial distress c) Shareholders can recover their investment first if the firm experiences financial distress d) Cash contributed by shareholders cannot be used to pay creditors e) In the event of liquidation, shareholders do not receive any payoff from the firm until all creditors are paid 6. You wish to have exactly $100,000 in one year’s time. If the interest rate is 8% p.a. compounded daily, how much must you deposit today to reach your goal a) $91,481.41 b) $92,312.44 c) $91,994.27 d) $92,592.59 e) $100,000.00 7. Mr Simon Smyth is considering depositing $10,000 in a BankEast high interest savings account that is paying interest of 18% p.a. compounded weekly. If Mr Smyth deposits his money for 3 years what will be his account balance at the end of that time a) $14,251.48 b) $15,894.15 c) $16,430.32 d) $17,144.07 e) $18,000.00 The University of Sydney – FINC2011 Page 3 Questions 8 and 9 relate to the following information. You are considering buying a new Volkswagen Passat. The car costs $45,000. BankEast Ltd is offering car loans at 7.5% p.a. compounded monthly. 8. You plan to make monthly payments on the loan over a 3 year period. How much would you need to pay each month to repay the interest and principal over three years a) $1,405.23 b) $1,386.47 c) $1,355.86 d) $1,399.78 e) $1,250.00 9. If instead you decided to make weekly repayments on the loan over a 4 year period, how much would each weekly repayment need to be to repay the interest and the principal (calculated on a 52 week year) a) $250.49 b) $251.59 c) $250.62 d) $251.83 e) $252.18 10. Jill Gates wishes to establish a perpetual scholarship fund at the Business School with the first annual scholarship to be paid in one year. The amount of the scholarship will initially be $40,000 but will then increase by 3% p.a. in line with expected inflation. How much is required to establish the fund if it is invested at 5.5% p.a. a) $727,272.73 b) $1,333,333.33 c) $1,600,000.00 d) $1,648,000.00 e) None of the above The University of Sydney – FINC2011 Page 4 Questions 11 to 13 relate to the following information. Auslandsdeutsche Tecnik (AUT) Ltd is considering investing in a new project called Typhoon. The project is expected to have the following cash flows: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 $8,000,000 $8,000,000 $8,000,000 $8,000,000 11. Suppose similar investments are paying a return of 12% p.a. compounded monthly. How much (to the nearest ‘000) should AUT be prepared to pay for Typhoon a) $19,371,000 b) $23,954,000 c) $21,258,000 d) $18,865,000 e) $24,299,000 12. If AUT were able to delay paying for the project until Year 1, how much more would the project likely cost (rounded to the nearest ‘000 and assuming the required rate of return remains the same) a) $2,324,000 b) $2,496,000 c) $2,458,000 d) $2,604,000 e) $2,393,000 13. What type of decision(s) best describes the action of the financial managers of AUT are undertaking in investing in Project Typhoon a) Financing decision b) Investment decision c) Dividend decision d) Investment and financing decision e) Financing and dividend decision The University of Sydney – FINC2011 Page 5 14. Deposits of $1,000 are placed into a fund at the beginning of each year for the next 20 years. At the end of the 20th year, annual payments from the fund commence and continue forever. If the balance in the fund earns 8% p.a., find the value of these payments. a) $3,660.96 b) $1,600.00 c) $3,953.83 d) $3,315.70 e) $848.29 15. What annually compounded rate per year will give the same value at the end of 6 years as 14% p.a. simple interest a) 19.92% b) 14.77% c) 12.63% d) 10.70% e) 8.51% Questions 16 and 17 relate to the following information. Mr Lewis Nixon is 19 years old and studying his first year at university. He plans to start working in 3 years’ time at which point he will begin depositing $3,000 per year in a BankEast Retirement Savings Account that pays interest of 12% p.a. compounded quarterly. He will make his first deposit immediately when he starts working. He then plans to continue making deposits every year until he retires at age 67 (inclusive). 16. How much money will Mr Nixon have accumulated in his retirement account by the time he makes his last deposit at age 67 a) $4,862,900.50 b) $4,074,690.10 c) $5,477,790.75 d) $4,324,584.82 e) $4,566,652.91 The University of Sydney – FINC2011 Page 6 17. If Mr Nixon expects to live off his retirement savings for 30 years how much can he afford to withdraw from his BankEast Retirement Savings Account each year after he retires a) $707,905.27 b) $526,288.17 c) $558,838.91 d) $590,119.89 e) $628,402.10 18. A management team that is inefficiently utilising the company’s scarce resources may find itself at risk of losing their jobs due to which of the following market mechanisms a) Corporate regulators b) The market for corporate control c) Management shareholdings d) Management remuneration incentive packages e) Fisher’s separation theorem 19. Mrs Rose Codrington expects to receive $100,000 from an investment in 5 years’ time. If the appropriate opportunity cost for this investment is 10% p.a. continuously compounded, what will be its value today a) $164,872.13 b) $95,452.74 c) $62,092.13 d) $161,051.00 e) $60,653.07 The University of Sydney – FINC2011 Page 7 20. Which of the following statements is true a) Simple interest applies when an investor receives payment while compound interest applies when an investor makes payments b) Simple interest annualises rates while compound interest allows interest to be stated in any time period c) Simple interest pays interest only on principal whereas compound interest also pays interest on interest d) Simple interest relates to present value whereas compound interest relates to future value e) Simple interest relates to future value whereas compound interest relates to present value Questions 21 and 22 relate to the following information. Axis Industries Pty Ltd is looking at investing in Project A that is expected to generate the following cash flows over its six-year life: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 $1m $1.5m $1m $1.5m $1m $1.5m 21. Suppose similar investments are paying a return of 10% p.a. compounded quarterly. How much (rounded to the nearest ‘000) should Project A cost Axis Industries a) $5,392,000 b) $5,452,000 c) $5,488,000 d) $5,331,000 e) $7,500,000 22. Suppose that Axis Industries is considering investing in Project B instead. Project B costs the same as Project A but it generates an equal cash flow each quarter for 6 years. How much are the cash flows that Project B generates each quarter a) $419,346 b) $306,850 c) $304,836 d) $301,482 e) $298,071 The University of Sydney – FINC2011 Page 8 23. Mr Robert Lee wishes to buy a new boat in two years’ time. He estimates the boat will cost $86,600 at that time. He wishes to deposit an equal sum of money into a BankEast Ltd savings account every two weeks for the next two years in order to accumulate enough money to purchase the boat. If the BankEast account is paying interest at a rate of 14% p.a. compounded annually, how much must Mr Lee deposit every two weeks a) $1,380 b) $1,400 c) $1,433 d) $1,448 e) $1,460 24. A court is trying to determine the present value of the future income of a man badly injured in a car accident. At the time of the accident the man was earning $80,000 a year and could reasonably anticipate receiving an 8% rise each year. He was 30 years away from retirement. If money is worth 5% p.a., what is the present value of his future income (Assume the payments are made at the end of each year with the first payment commencing one year from now) a) $1,018,631.36 b) $1,521,325.05 c) $2,400,000.00 d) $3,542,058.34 e) $3,825,423.01 25. You currently have $50,000 in a bank account that pays interest at 6% p.a. compounding monthly. You wish to withdraw an equal amount at the beginning of each month from this account, starting immediately, for the next 5 years. The most these monthly withdrawals can be is: a) $833.33 b) $961.83 c) $966.64 d) $1124.04 e) None of the above The University of Sydney – FINC2011 Page 9 26. Mr Richard Winters has been awarded an insurance payout of $100,000 now plus another $140,000 in a years’ time. What single amount today i

s equivalent to these payments if the opportunity cost is 10% p.a. compounded daily a) $250,510.00 b) $226,678.97 c) $227,272.73 d) $140,000.00 e) $100,000.00 27. Blaxland Group Ltd is considering issuing $100 million in corporate bonds. The company plans to use these funds to repurchase $40 million worth of equity from existing shareholders and purchase $60 million in new assets. Which of the following best describes what the directors of Blaxland are doing with these transactions a) Investment decisions b) Financing decisions c) Dividend decisions d) Investment, financing and dividend decisions e) None of the above 28. Which of the following would not constitute an investment decision by the financial managers of the firm a) ABC Ltd buys 20 per cent of the outstanding shares of DEF Ltd for $9 million b) GHI Ltd buys 10 new packaging machines for its factory for $1.2 million c) JKL Ltd sells a retail outlet that it owns for $2.1 million d) MNO Ltd buys 10 per cent of its outstanding shares for $8 million e) All the above are investment decisions The University of Sydney – FINC2011 Page 10 29. A project you are contemplating has the following cash flows: Month 0 1 2 3 4 5 6 Cash Flow -90 30 35 45 50 55 60 If the opportunity cost of capital is 12.5% p.a. compounding quarterly, what is the maximum price you would be willing to pay for this project a) $83.94 b) $87.26 c) $138.74 d) $174.28 e) $193.17 30. What is the corporate objective a) To maximise capital b) To maximise shareholder wealth c) To minimise capital d) To minimise shareholder wealth e) To maximise current profits 31. What simple interest rate per year will give the same value at the end of 3 years as 10% p.a. compounded semi-annually a) 10.00% b) 10.25% c) 11.34% d) 11.50% e) 11.66% 32. Mr Rogers deposits $20,000 in a term deposit with BankEast Ltd for 10 years. If the account is paying interest at a rate of 4% p.a. compounded quarterly, how much interest will Mr Rogers earn in the final year a) $812.08 b) $977.73 c) $1,138.65 d) $1,161.90 e) $9,777.28 The University of Sydney – FINC2011 Page 11 33. Which of these is the most effective way to encourage directors to make decisions that maximise the wealth of shareholders a) Pay bonuses to the directors based on the company’s earnings performance b) Impose fines on directors who fail to meet predetermined earnings performance levels c) Provide options to the directors that have a high exercise price d) Encourage directors to become shareholders in the firm e) Reduce the number of non-executive board members Questions 34 to 37 relate to the following information. The Directors of Quantum Property Group Ltd are looking at borrowing new capital for a term of five years from BankEast Ltd. The repayment schedule outlined by BankEast Ltd is given below. This schedule includes both principal and interest on the loan. Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 $1,000,000 $1,500,000 $1,800,000 $2,000,000 $2,500,000 34. Regardless of the discount rate used, ______________ in the frequency of the compound period will result in _____________ in the future value of the cash flows in Year 5 and ______________ in the present value of the cash flows in Year 0. a) an increase; an increase; an increase b) an increase; a decrease; an increase c) an increase; an increase; a decrease d) a decrease; an increase; an increase e) a decrease; a decrease; a decrease 35. What type of decision(s) are the directors of Quantum Property Group Ltd making a) an investment decision b) a financing decision c) a dividend decision d) a consumption decision e) an investment/consumption decision The University of Sydney – FINC2011 Page 12 36. Suppose BankEast Ltd requires a return of 12% p.a. compounded monthly on loans provided to Quantum Property Group Ltd. How much (rounded to the nearest ‘000) is Quantum Property Group looking to borrow a) $8,800,000 b) $7,473,000 c) $6,059,000 d) $5,944,000 e) $4,555,000 37. If Quantum Property Group Ltd would prefer to make equal repayments each month over the life of the loan rather than the repayments listed above, how much would each repayment be a) $132,220 b) $134,780 c) $130,390 d) $138,860 e) $136,940 The University of Sydney – FINC2011 Page 13 Questions 38 and 39 relate to the following information. Ms Montcalm is considering undertaking some banking transactions with BankEast Ltd. After doing some research she finds that BankEast Ltd is offering the following account types: Account A: paying 12.10% p.a. simple interest Account B: paying 11.90% p.a. compounded annually Account C: paying 11.50% p.a. compounded quarterly Account D: paying 11.35% p.a. compounded monthly Account E: paying 11.25% p.a. compounded daily 38. Ms Montcalm wishes to deposit $1,000 now in a BankEast account for a period of five years. Which account would give her the highest account balance at the end of that time a) Account A b) Account B c) Account C d) Account D e) Account E 39. If instead Ms Montcalm would like to have a balance of $1,000 in her account in one years’ time, which BankEast account would enable her to deposit the least amount of money today a) Account A b) Account B c) Account C d) Account D e) Account E The University of Sydney – FINC2011 Page 14 40. Mandy’s lifelong dream is a super-luxury holiday in the Caribbean. The trip will cost her $156,500 but she currently only has $93,000. If Mandy puts this money away in an account that pays 9.45% p.a. compounded monthly, how many more months must Mandy wait until she can go to the Caribbean a) 47 months b) 53 months c) 61 months d) 67 months e) 75 months Questions 41 and 42 relate to the following information. Melrose Property Group Ltd (MPG) is considering investing in a commercial property development that is expected to have the following cash flows. The required rate of return on MPG’s investments is 11% p.a. compounded annually. Year 1 2 3 4 5 6 7 8 9 10 11 12 $10m $10m $10m $10m 41. How much should MPG pay for this investment in Year 0 a) $64.92m b) $47.15m c) $31.02m d) $26.57m e) $19.43m 42. If MPG can reinvest each of the cash flows at 11% p.a. compounded annually, what will be the value of the investment in year 12 a) $67.96m b) $40.00m c) $227.13m d) $47.10m e) $1,137.28m The University of Sydney – FINC2011 Page 15 43. Mr Nigel Smythe has just been appointed the CEO of Polytech Industries Ltd. His contract with Polytech states that if Mr Smyth is able to increase the EPS by 20% in any given year he is entitled to receive a $10 million bonus payment. This mechanism is an example of using __________________ to minimise the effects of the ______________________. a) Market for corporate control; investment decision b) Regulators; financing decision c) The board of directors; capital problem d) Executive remuneration, agency problem e) Shareholder voting rights; dividend decision 44. Mr John Gray has just started work and has begun planning for his retirement. Mr Gray has turned 21 years old today and plans to retire on his 70th birthday. He wishes to live on $110,000 per year for 30 years after his retirement (with the first cash flow starting on his 70th birthday). The expected interest rate over the entire period from now until then is 7% p.a. compounded annually. Mr Gray starts putting money into his retirement account each year, starting immediately and continuing up to (and including) his 69th birthday. How much must Mr Gray deposit each birthday in order to reach his retirement goal a) $3,357.68 b) $3,592.72 c) $3,853.69 d) $3,863.88 e) $3,601.58 45. Gamma Corp has just issued $40 million in new shares and used the proceeds of the issue to pay back $40 million worth of debt. What type of decision(s) are the managers making with these transactions a) Investment decisions only b) Financing decisions only c) Dividend decisions only d) Investment and financing decisions e) Investment, financing and dividend decisions The University of Sydney – FINC2011 Page 16 Short Answer Questions 46. Ally Fashions is looking at establishing a new fashion retail outlet in a shopping centre being planned. To secure the outlet, Ally Fashions will have to pay an initial cash outlay of $100,000 now and another $250,000 in 4 years’ time when the outlet opens. The outlet is then expected to generate after-tax net cash flows of $380,000 p.a. for a period of 5 years (the first cash flow will be at the end of year 5). At the end of that time, the lease will expire and Ally Fashions does not anticipate that it will extend the lease. If Ally Fashions uses a cost of capital of 7.50% p.a. compounded annually, what is the present value of this project 47. Optus is considering a new investment opportunity. The investment will generate $1m per year for 10 years with the first cash flow in one years’ time. The opportunity cost for this type of investment is expected to be 8% p.a. for years 1 to 5 rising to 10% p.a. for years 6 to 10. What will be the present value of this investment 48. Chun Li is 22 years old today and her superannuation account contains exactly $10,000. Assume this balance will earn an average return rate of 5.5% p.a. compounding quarterly until her retirement at age 67. Compare the investment returns (in dollars) this sum will earn over the next year to the investment returns it will earn in the final year before retirement. 49. Alpha Ltd is considering acquiring a new security known as ‘Security X’. Security X is expected to generate cash flows of $1,000 every year for 4 years and then $2,000 every year for another 4 years. The timeline of the 8 years of cash flows is given below: Year 0 1 2 3 4 5 6 7 8 $1,000 $1,000 $1,000 $1,000 $2,000 $2,000 $2,000 $2,000 Suppose similar investments are paying a return of 12% p.a. compounded daily. How much should Alpha Ltd be prepared to pay for Security X 50. A housing loan for $400,000 is repayable over 15 years with monthly instalments at 4.8% p.a. compounding monthly. After 5 years, the interest rate increases to 5.4% p.a. compounding monthly. Calculate the increased monthly repayment assuming no change to the overall loan term.