FIN 534 Final Exam Solution

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Question 1

Cazden Motors' stock is trading at $30 a share. Call options on the company's stock are also available, some with a strike price of $25 and some with a strike price of $35. Both options expire in three months. Which of the following best describes the value of these options?Answer

Question 2

BLW Corporation is considering the terms to be set on the options it plans to issue to its executives. Which of the following actions would decrease the value of the options, other things held constant?Answer

Question 3

Which of the following statements is CORRECT?Answer

Question 4

An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?Answer

Question 5


Question 6

Which of the following statements is most correct, holding other things constant, for XYZ Corporation's traded call options?Answer

Question 7

To help them estimate the company's cost of capital, Smithco has hired you as a consultant. You have been provided with the following data: D1 = $1.45; P0 = $22.50; and g = 6.50% (constant). Based on the DCF approach, what is the cost of common from reinvested earnings?Answer

Question 8

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?Answer

Question 9


Question 10

Adams Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05. What is the firm's cost of common from reinvested earnings based on the CAPM?Answer

Question 11


Question 12

Perpetual preferred stock from Franklin Inc. sells for $97.50 per share, and it pays an $8.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company's cost of preferred stock for use in calculating the WACC?Answer

Question 13

Which of the following statements is NOT a disadvantage of the regular payback method?Answer

Question 14


Question 15

Projects C and D both have normal cash flows and are mutually exclusive. Project C has a higher NPV if the WACC is less than 12%, whereas Project D has a higher NPV if the WACC exceeds 12%. Which of the following statements is CORRECT?Answer

Question 16


Question 17

Suppose a firm relies exclusively on the payback method when making capital budgeting decisions, and it sets a 4-year payback regardless of economic conditions. Other things held constant, which of the following statements is most likely to be true?Answer

Question 18


Question 19


Question 20

Collins Inc. is investigating whether to develop a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated?Answer

Question 21


Question 22


Question 23

When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT:Answer

Question 24


Question 25

The capital intensity ratio is generally defined as follows:Answer

Question 26


Question 27


Question 28

Which of the following assumptions is embodied in the AFN equation?Answer

Question 29

The term "additional funds needed (AFN)" is generally defined as follows:Answer

Question 30


FIN 534 Final Exam Set 2

Question 1 The current price of a stock is $50, the annual risk-free rate is 6%, and a 1-year call option with a strike price of $55 sells for $7.20. What is the value of a put option, assuming the same strike price and expiration date as for the call option? Question 2

Suppose you believe that Basso Inc.'s stock price is going to increase from its current level of $22.50 sometime during the next 5 months. For $3.10 you can buy a 5-month call option giving you the right to buy 1 share at a price of $25 per share. If you buy this option for $3.10 and Basso's stock price actually rises to $45, what would your pre-tax net profit be? Question 3

Which of the following statements is CORRECT? Question 4

An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options? Question 5


Braddock Construction Co.'s stock is trading at $20 a share. Call options that expire in three months with a strike price of $20 sell for $1.50. Which of the following will occur if the stock price increases 10%, to $22 a share? Question 7

Perpetual preferred stock from Franklin Inc. sells for $97.50 per share, and it pays an $8.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company's cost of preferred stock for use in calculating the WACC? Question 8

For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure. Question 9

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting? Question 10

Adams Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05. What is the firm's cost of common from reinvested earnings based on the CAPM? Question 11


You have been hired as a consultant by Feludi Inc.'s CFO, who wants you to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30. Based on the CAPM approach, what is the cost of common from reinvested earnings? Question 13

Projects S and L are both normal projects with an initial cost of $10,000, followed by a series of positive cash inflows. Project S's undiscounted net cash flows total $20,000, while L's total undiscounted flows are $30,000. At a WACC of 10%, the two projects have identical NPVs. Which project's NPV is more sensitive to changes in the WACC? Question 14

Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT? Question 15






Puckett Inc. risk-adjusts its WACC to account for project risk. It uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects. Which of the following independent projects should Puckett accept, assuming that the company uses the NPV method when choosing projects? Question 21

Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product? Question 22

Collins Inc. is investigating whether to develop a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated? Question 23 To increase productive capacity, a company is considering a proposed new plant. Which of the following statements is CORRECT?Answer Question 24


The Besnier Company had $250 million of sales last year, and it had $75 million of fixed assets that were being operated at 80% of capacity. In millions, how large could sales have been if the company had operated at full capacity? Question 26

Last year National Aeronautics had a FA/Sales ratio of 40%, comprised of $250 million of sales and $100 million of fixed assets. However, its fixed assets were used at only 75% of capacity. Now the company is developing its financial forecast for the coming year. As part of that process, the company wants to set its target Fixed Assets/Sales ratio at the level it would have had had it been operating at full capacity. What target FA/Sales ratio should the company set? Question 27



Which of the following assumptions is embodied in the AFN equation? Question 30

Which of the following statements is CORRECT?

FIN 534 Final Exam Set 3

Question 31

An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?Question 32

The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year call option on the stock, with an exercise price of $22, is available. Based on the binomial model, what is the option's value? (Hint: Use daily compounding.)

Question 33

Which of the following statements is most correct, holding other things constant, for XYZ Corporation's traded call options?

Question 34

Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the

Question3 5

Braddock Construction Co.'s stock is trading at $20 a share. Call options that expire in three months with a strike price of $20 sell for $1.50. Which of the following will occur if the stock price increases 10%, to $22 a share?

Question3 6

Cazden Motors' stock is trading at $30 a share. Call options on the company's stock are also available, some with a strike price of $25 and some with a strike price of $35. Both options expire in three months. Which of the following best describes the value of these options?

Question 37

As a consultant to Basso Inc., you have been provided with the following data: D1 = $0.67; P0 = $27.50; and g = 8.00% (constant). What is the cost of common from reinvested earnings based on the DCF approach?

Question 38

Which of the following statements is CORRECT?Question 39

For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.

Question 40


Question 41

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting?Question 42

Adams Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 1.05. What is the firm's cost of common from reinvested earnings based on the CAPM?Question 43


Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?Question 45

Which of the following statements is NOT a disadvantage of the regular payback method?Question 46

The WACC for two mutually exclusive projects that are being considered is 12%. Project K has an IRR of 20% while Project R's IRR is 15%. The projects have the same NPV at the 12% current WACC. Interest rates are currently high. However, you believe that money costs and thus your WACC will soon decline. You also think that the projects will not be funded until the WACC has decreased, and their cash flows will not be affected by the change in economic conditions. Under these conditions, which of the following statements is CORRECT?Question 47



Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

Question 50

To increase productive capacity, a company is considering a proposed new plant. Which of the following statements is CORRECT?Question 51

The CFO of Cicero Industries plans to calculate a new project's NPV by estimating the relevant cash flows for each year of the project's life (i.e., the initial investment cost, the annual operating cash flows, and the terminal cash flow), then discounting those cash flows at the company's overall WACC. Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows?Question 52

When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT:Question 53


Which of the following rules is CORRECT for capital budgeting analysis?Question 55

Last year Baron Enterprises had $350 million of sales, and it had $270 million of fixed assets that were used at 65% of capacity last year. In millions, by how much could Baron's sales increase before it is required to increase its fixed assets?Question 56


Question 57



Last year National Aeronautics had a FA/Sales ratio of 40%, comprised of $250 million of sales and $100 million of fixed assets. However, its fixed assets were used at only 75% of capacity. Now the company is developing its financial forecast for the coming year. As part of that process, the company wants to set its target Fixed Assets/Sales ratio at the level it would have had had it been operating at full capacity. What target FA/Sales ratio should the company set?Question 60

F. Marston, Inc. has developed a forecasting model to estimate its AFN for the upcoming year. All else being equal, which of the following factors is most likely to lead to an increase of the additional funds needed (AFN)?

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FIN 534 Final Exam Solution