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Finance 340 – Financial Management 1
Spring 2008 Midterm Exam 1 − Version A − Solutions
Multiple-choice questions (20 points)
______ 1. Khol has $45,000 invested in a stock with a beta of 0.8 and another $55,000 invested in a stock with a beta of 1.4. These are the only two investments in his portfolio. What is his portfolio’s beta? A. 1. B. 1. C. 0. D. 1. E. None of the above; the correct answer is __________.
______ 2. Most studies of stock market efficiency suggest that the stock market is highly efficient in the weak-form, reasonably efficient in the semistrong-form, and not efficient in the strong-form. Assuming these findings are correct, which of the following statements is CORRECT? A. You have been tracking a stock’s price over the past 6 months, and you note that this particular stock has tended to rise sharply immediately after it has fallen for three days. You can use this information to devise a trading strategy that will help you beat the market. B. If you apply financial analysis properly, you can use information provided in companies’ annual reports to earn above-average returns. C. I NFORMATION YOU READ IN THE W ALL STREET JOURNAL CANNOT BE USED TO SELECT STOCKS THAT ARE LIKELY TO PRODUCE ABOVE- AVERAGE RATES OF RETURN. D. Even if you possess insider information, you cannot use this information to earn above-average returns because such information will already be reflected in stock prices. E. You notice that a company’s stock price always seems to swing back and forth − whenever it by 10% or more, it seems to recover and to eventually exceed its former high. Since its price has fallen during the past 2 months, now is a great time to buy it before it takes off again.
______ 3. Engrav Motors recently paid a dividend of $2.00 per share. The stock currently sells for $45 a share. The required rate of return on the stock is 16 percent. If the dividend is expected to grow at a constant rate, g, what is g? A. 11.06% B. 11.56% C. 4.44% D. 2.25% E. None of the above; the correct answer is __________.
______ 4. Suppose 1-year T-bills currently yield 5.00 percent and the future inflation rate is expected to be constant at 3.10 percent per year. What is the real risk-free rate of return, r*? Disregard cross-product terms (i.e., if averaging is required, use the arithmetic average). A. 1.90% B. 5.00% C. 3.10% D. 8.10% E. None of the above; the correct answer is __________.
______ 5. The Carter Company just paid a dividend of $1 per share, and that dividend is expected to grow at a constant rate of 5 percent per year in the future. The company’s beta is 1.2, the market risk premium is 5 percent, and the risk-free rate is 3 percent. What is Carter’s expected current stock price? A. $11. B. $26. C. $15. D. $11. E. None of the above; the correct answer is __________.
______ 6. The Gillaspie Company’s bonds mature in 10 years have a par value of $1,000 and an annual coupon payment of $80. The market interest rate for the bonds is 9 percent. What is the price of these bonds? A. $3,582. B. $1,000. C. $935. D. $1067. E. None of the above; the correct answer is __________.
______ 7. Lassley Enterprises’ bonds currently sell for $1,025. They have a 9-year maturity, an annual coupon of $80, and a par value of $1,000. What is their current yield? A. 7.61% B. 8.00% C. 8.19% D. 7.80% E. None of the above; the correct answer is __________.
______ 8. True or FALSE : The price of a discount bond will fall over time if market required returns remain constant.
______ 14. Kemp Inc. recently paid a $3.00 dividend. This dividend is expected to remain constant for 4 years, after which time it is expected to grow by 6 percent annually for the indefinite future. The required return on Kemp’s stock is 14 percent. What is the value of this stock today? A. $39. B. $32. C. $39. D. $30. E. None of the above; the correct answer is __________.
______ 15. Fleming Inc. stock has a beta of 0.75. Recently its required return was 7 percent and the market risk premium was 5.5 percent. Today reports indicated that expected inflation will be 2 percent higher than previously thought. What will be Fleming’s new required return? A. 7.00% B. 9.00% C. 8.50% D. There is not enough information to answer this question. E. None of the above; the correct answer is __________.
______ 16. Suppose the yield on a 2-year Treasury security is 5.0 percent and the yield on a 3-year Treasury security is 6.0 percent. Assuming the pure expectations theory is correct, what does the market expect a 1-year Treasury security will yield two years from now? A. 5.50% B. 7.01% C. 6.00% D. 8.03% E. None of the above; the correct answer is __________.
______ 17. Capra Inc’s bonds currently sell for $1,275 and have a par value of $1,000. They pay a $120 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,120. What is their yield to call (YTC)? A. 5.55% B. 8.98% C. 12.85% D. 9.17% E. NONE OF THE ABOVE;^ THE CORRECT ANSWER IS^ 7.31%.
______ 18. You must estimate the intrinsic value of Muncrief Technologies’ stock. Muncrief’s free cash flow (FCF) next year is expected to be $25 million, and it is expected to grow at a constant rate of 8.5 percent a year thereafter. The company’s WACC is 11 percent. Muncrief has $200 million of long-term debt plus preferred stock, and there are 30 million shares of common stock outstanding. What is Muncrief’s estimated intrinsic value per share of common stock? A. $9. B. $26. C. $7. D. $33. E. None of the above; the correct answer is __________.
______ 19. If the Treasury yield curve is downward sloping, how would the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill? A. It is impossible to tell without knowing the coupon rates of the bonds. B. The yield on a 10-year bond would have to be higher than that on a 1-year bill because of the maturity risk premium. C. The yields on the two securities would be equal. D. It is impossible to tell without knowing the relative risks of the two securities. E. THE YIELD ON A 10- YEAR BOND WOULD BE LESS THAN THAT ON A 1- YEAR BILL.
______ 20. Sisney Enterprises’ stock is currently sells for $25 per share. The stock’s dividend is projected to increase at a constant rate of 7 percent per year. The required rate of return on the stock, rs, is 10 percent. What is Sisney’s expected price 4 years from today? A. $36. B. $32. C. $32. D. There is not enought information to answer this question. E. None of the above; the correct answer is __________.
______ 21. (Bonus) What do all of the names on this exam have in common? A. They are all names of WSU baseball players. B. They will all win a National Championship for WSU before the year is out. C. Gosh, they’re just fun to watch! D. ALL OF THE ABOVE!
