Question 1. Which of the following statements is CORRECT

1. Which of the following statements is CORRECT?

a. One of the disadvantages of a sole proprietorship is that the proprietor is exposed to

unlimited liability.

b. It is generally easier to transfer one’s ownership interest in a partnership than in a

corporation.

c. One of the advantages of the corporate form of organization is that it avoids double

taxation.

d. One of the advantages of a corporation from a social standpoint is that every

stockholder has equal voting rights, i.e., “one person, one vote.”

e. Corporations of all types are subject to the corporate and personal income tax.

2. Which of the following statements is CORRECT?

a. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the

periods.

b. If a series of unequal cash flows occurs at regular intervals, such as once a year, then

the series is by definition an annuity.

c. The cash flows for an annuity due must all occur at the ends of the periods.

d. The cash flows for an annuity must all be equal, and they must occur at regular

intervals, such as once a year or once a month.

e. If some cash flows occur at the beginning of the periods while others occur at the

ends, then we have what the textbook defines as a ‘variable’ annuity.

3. Which of the following statements is most CORRECT?

a. The four most important financial statements provided in the annual report are the

balance sheet, income statement, cash budget, and the statement of stockholders’

equity.

b. The balance sheet gives us a picture of the firm’s financial position at a point in

time.

c. The income statement gives us a picture of the firm’s financial position at a point in

time.

d. The statement of cash flows tells us how much cash the firm has in the form of

currency and demand deposits.

e. The statement of cash needs tells us how much cash the firm will require during

some future period, generally a year or two.

4. The term “additional funds needed (AFN)” is generally defined as follows:

a. Funds that are obtained automatically from routine business transactions.

b. Funds that a firm must raise externally from non-spontaneous sources, i.e., by

borrowing or by selling new stock or bonds to support operations.

c. The amount of assets required per dollar of sales.

d. The amount of internally generated cash in a given year minus the amount of cash

needed to acquire the new assets needed to support growth.

e. A forecasting approach in which the forecasted percentage of sales for each balance

sheet account is held constant.

5. Spontaneous funds are generally defined as follows:

a. Assets required per dollar of sales.

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b. A forecasting approach in which the forecasted percentage of sales for each item is

held constant.

c. Funds that a firm must raise externally through short-term or long-term borrowing

and/or by selling new common or preferred stock.

d. Funds that arise out of normal business operations from its suppliers, employees,

and the government, and they include immediate increases in accounts payable,

accrued wages, and accrued taxes.

e. The amount of cash raised in a given year minus the amount of cash needed to

finance the additional capital expenditures and working capital needed to support

the firm’s growth.

6. If markets are in equilibrium, which of the following conditions will exist?

a. Each stock’s expected return should exceed its realized return as seen by the

marginal investor.

b. Each stock’s expected return should equal its required return as seen by the

marginal investor.

c. All stocks should have the same expected return as seen by the marginal investor.

d. The expected and required returns on stocks and bonds should be equal.

e. All stocks should have the same realized return during the coming year.

Part B: Simple problems (8 points each, 32 in total)

7.(8 points)To complete your last year in business school and them go through law

school, you will need $10,000 per year for 4 years, starting next year (that is, you will

need to withdraw the first $10,000 one year from today). Your rich uncle offers to put

you through school, and he will deposit in a bank paying 7% interest a sum of money

that is sufficient to provide the 4 payments of $10,000 each. His deposit will be made

today (time “0”).

a. How large must the deposit be?

b. How much will be in the account immediately after you make the first

withdrawal? After the last withdrawal?

8.(8 points)Alexandra Video Product’s sales are expected to increase by 20% from $5

million in 2010 to $6 million in 2011. Its assets totaled $3 million at the end of 2010.

Alexandra is already at full capacity, so its assets must grow at the same rate as

projected sales. At the end of 2010, current liabilities were $1 million, consisting of

$250,000 of accounts payable, $500,000 of notes payable, and $250,000 of accruals.

The after tax profit margin is forecasted to be 5%, and the forecasted payout ratio is

70%.Use the EFN equation to forecast Alexandra’s additional funds needed for the

coming year.

9.(8 points)Jackson Corporation’s bonds will mature in 10 years. The bonds have a face

value of $1,000, and an 8% coupon rate, paid semi-annually. The price of the bond is

$1,100. The bonds are callable in 5 years at a call premium of 5%.

a. What is their nominal yield to maturity (YTM)?

b. What is their nominal yield to call (YTC)?

10.(8 points)You buy a share of MIT Corporation stock for $21.40, which pays a dividend

of $1.05/share. You expect it to pay dividends of $1.1070, $1.1449, and 1.2250 in Year

1, 2 and 3 respectively, and you expect to sell it at a price of $26.22 at the end of the

year 3.

a. Calculate the growth rate in dividends for the last year.

b. Assuming that the calculated growth rate is expected to continue, what is the

expected dividend yield for the same year?

c. What is this stock’s expected total rate of return at t = 3?

C. Problem solving (13 points each, 39 in total)

10.(13 points) The most recent financial statements for Maritin, Inc. are shown below:

Income Statement Balance sheet

Sales $19,200 Assets $93,000 Debt $20,400

Cost $15,550 Equity $72,600

Taxable income $3,650 Total $93,000 Total $93,000

Taxes (34%) $1,241

Net income $2,409

Assets and costs are changingproportionallyto sales. Debt and common equity do not

change. A dividend of $963.60 was paid and Maritin wishes to maintain a constant

dividend payout ratio of 0.40. Next year’s sales are projected to be $23,040. What external

financing is needed? (Note: construct the pro-forma balance sheet to find EFN).

11.(13 points)A company currently pays a dividend of $2 per share, that is, D0 = $2. It is

estimated that the company’s dividend will grow at a rate of 20% per year for the next 2

years, then at a constant rate of 7% thereafter. The company’s stock has a beta of 1.2,

the risk-free rate is 7.5%, and the market return is 11.5%. What is your estimate of the

stock’s current price? What is the stock price in one year if it appreciates with the same

rate as dividends?

12. (13 points)Consider the possible rates of return that you might obtain over the next

year under each state of the economy. You can invest in stockUand stockV.

State of Probability of Stock A Return Stock B Return

Economy State Occurring if State Occurs (%) if State Occurs (%)

Recession 0.20 7.0% -5.0%

Normal 0.50 7.0 10.0

Bull 0.30 7.0 25.0

a. Determine the expected return, variance, and the standard deviation for stockA

andB.

b. Determine the covariance and correlation between the returns of stockAand

stockB.

c. Determine the expected return and standard deviation of an equally weighted

portfolio of stockAand stockB.

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Part D: Essay question (10 points in total)

List the three forms of market efficiency according to the EMH and give examples for each

of them.

Extract from an excellent student’s answer:

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Part D: Bonus questions (2 points each, 4 in total)

1. Which of the following classes use case-based learning approach?

a. Corporate finance 1 and 2

b. Political Anthropology

c. Introduction to Music

d. Beginning Drawing

2. Who is the current chair of the Business Department?

a. Lucia Miree

b. Donald Brady

c. Steve Sullivan

d. Cy Reed

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