FIN 6100 Name _______________________________ Spring 2010 Exam #1 Multiple choice – 3 points each – 30 points total

1. If the yield to maturity on a bond is lower than its coupon rate, a bond will sell at a _____, and decreases in market interest rates will _____.

A. discount; decrease this discount B. discount; increase this discount C. premium; decrease this premium D. premium; increase this premium E. None of the above.

2. If a company purchases inventory with cash, the current ratio will:

A. increase only if it was originally greater than one. B. increase only of it was originally less than one. C. decrease only if it was originally less than one. D. increase regardless of its original value. E. remain constant.

3. You are evaluating two annuities. They are identical in every way, except that one is an ordinary

annuity and one is an annuity due. Which of the following is FALSE? A. The ordinary annuity must have a lower present value than the annuity due. B. The ordinary annuity must have a lower future value than the annuity due. C. The annuity due must have the same present value as the ordinary annuity. D. The two annuities will differ in present value by the amount (1 + R). E. The annuity due and the ordinary annuity will make the same number of total payments over

time.

4. A firm has a current ratio of 1.5, a quick ratio of 1.2, net income of $40,000, a profit margin of 9%, and an accounts receivable balance of $20,000. What is the firm’s average collection period?

A. 51.3 days B. 72.6 days C. 16.4 days D. 24.5 days E. 30.0 days

5. All else the same, a(n) _______ will decrease the required return on a bond.

A. call provision B. lower bond rating C. sinking fund D. increase in inflation E. increase in the size of the bond issue

6. The ______ component of the term structure does not influence the shape of the term structure; rather it affects the overall level of interest rates.

A. interest rate risk premium B. real rate of interest C. inflation risk premium D. nominal return premium E. None of the above.

7. You have decided to refinance your home. Exactly five years ago, you obtained a $100,000 30-

year mortgage with a fixed rate of 10%. Today you can refinance the loan with a 25-year fixed rate mortgage of 8% on the outstanding balance. How much will your payments be after you refinance your mortgage? Assume monthly payments.

A. $877.57 B. $733.76 C. $745.37 D. $771.82 E. $832.45

8. Which of following items(s) is/are included in the bond indenture?

I. Call provisions, if any II. Sinking fund provisions, if any III. Negative covenants, if any IV. A description of the property used as security, if any

A. I, II, and IV only B. I and II only C. I and III only D. I, II, III, and IV only E. II, III, and IV only

9. When would a firm’s return on equity equal the return on assets?

A. Whenever a firm’s return on equity is equal to 100%. B. Whenever a firm has no long-term debt. C. Whenever a firm’s debt to equity ratio is equal to one. D. Whenever a firm’s total debt ratio is equal to zero. E. Whenever a firm’s long-term debt ratio is equal to zero.

10. Which of the following assets is generally considered the most liquid?

A. A warehouse. B. Accounts receivable. C. Inventory. D. Manufacturing equipment. E. A patent.

Partial Credit Problems --- SHOW ALL WORK Problem 1 (8 points) What is the ask yield of the bond listed below? Did interest rates move up or down on this day?

Maturity Ask Rate Mo./Yr. Bid Asked Chg Yld. 7.375 Feb34 124:09 124:12 +6

Problem 2 (10 points) You plan to save $750 per month in real terms until you retire in 30 years. You currently have $40,000 in your retirement account. Before you retire, your return will be an 11 percent nominal EAR and after your retire you will earn a 7 nominal percent EAR. The effective annual inflation rate over this entire period will be 3.9 percent. How much will you be able to withdraw each month in real terms if you make equal monthly withdrawals for 30 years? How much will your last withdrawal be in nominal terms?

Problem 3 (10 points) You have won the Perpetual Winner Lottery. The lottery will make payments of $100,000 every other year beginning one year from now, and payments of $200,000 every other year beginning two years from now. Both payments last forever. If the interest rate is an 8 percent APR compounded quarterly, what is the value of your winnings today?

Problem 4 (10 points) Elizabeth Hughes is responsible for financial planning at the Faulty Widget Company. The company has just developed a new widget and Elizabeth has been instructed to develop a fund to cover all necessary repair costs over the next two years. Below are the estimated repair costs each month: Month Repair cost per month 1 – 4 $250,000 5 – 18 $500,000 19 – 24 $400,000 Elizabeth already has $1,500,000 in a fund to cover repair costs. The appropriate interest rate is a 6 percent EAR. How much does the company have to deposit each month in order to cover all repair costs?

Problem 5 (10 points) You have decide to buy a house at a price of $250,000. The mortgage broker has informed you that the APR for a 30-year mortgage with monthly payments is 5.75 percent, with 2.5 points. One point means you pay one percent of the loan amount up front. What interest rate are you actually paying? Assume you are borrowing the full purchase price of the house. Assuming all the other information is the same, how would this rate change if the loan term was 25 years?

Problem 6 (12 points) The Alfred Bowles Company (ABC) is offering an 8-year bond for sale at a par value of $1,000 and semi-annual interest payments. The bond is unusual in that the interest rate is based on the federal deficit, Super Bowl winners and Hillary Clinton’s personality index (which has to increase). After you examine the features of the bond, you feel that it will have an annual interest rate of 10% for the first four years and 12% for the last four years. Since these interest payments are too small to invest in more bonds, you will put your interest payments into a savings account. The savings account will pay a 5% effective annual rate the first three years and a 7% effective annual rate for the last five years. Assuming all these facts are correct, what is your effective annualized return on this investment? NOTE: This is a time value of money problem, not a typical bond problem.

Problem 7 (10 points) The most recent financial statements for 3 Doors Down, Inc., follow. Sales for next year are projected to grow by 20 percent. Interest expense will remain constant; the tax rate and the dividend payout rate will also remain constant. Costs, other expenses, current assets, and accounts payable increase spontaneously with sales. If the firm is operating at 80 percent capacity and no new debt or equity is issued, what is the external financing needed to support the 20 percent growth rate in sales? Assume the company does not sell any fixed assets. Show the pro forma financial statements for next year and calculate the EFN. Sales $805,000 COGS 634,000 Other expenses 15,000 EBIT $156,000 Interest 43,500 Taxable income $112,500 Taxes (35%) 39,375 Net income $73,125 Dividends $29,250 Add to RE 43,875

Assets Liabilities & Equity Current Assets Current liabilities Cash $20,000 Accounts payable $70,000 Accounts rec. 39,000 Notes payable 10,000 Inventory 58,000 Total CL $80,000 Total CA $117,000 Long-term debt $93,000 Fixed assets Net PP&E $318,000 Shareholder equity Common stock $15,000 Retained earnings 247,000 Total equity $262,000 Total assets $435,000 Total L&E $435,000

Answer Key FIN 6100 EXAM #1 Spring 2010 1. D 6. B 2. E 7. C 3. C 8. D 4. C 9. D 5. C 10. B Problem #1 Enter 48 ±$1,243.75 $36.875 $1,000 N I/Y PV PMT FV Solve for 2.76% 2.76% × 2 = 5.53% Since the price increased, interest rates decreased. Problem #2 Real return pre-retirement: 1 + .11 = (1 + r)(1 + .039); r = 6.8334937% Enter 6.8334937% 12 NOM EFF C/Y Solve for 6.6284% Real return post-retirement: 1 + .07 = (1 + r)(1 + .039); r = 2.9836381% Enter 2.9836381% 12 NOM EFF C/Y Solve for 2.9436% Retirement savings Enter 360 6.6284%/12 $40,000 $750 N I/Y PV PMT FV Solve for $1,141,224.39 Real withdrawal Enter 360 2.9436%/12 $1,141,224.39 N I/Y PV PMT FV Solve for $4,776.80 Last nominal withdrawal Enter 60 3.9% $4,776.80 N I/Y PV PMT FV Solve for $47,431.86

Problem #3 2-year rate: (1 + .02)8 – 1 = 17.166% PV of $100,000: PV = $100,000/.17166 = $582,549.00 This is the value one year ago. The value today is: Enter 4 2% $582,549.00 N I/Y PV PMT FV Solve for $630,569.77 PV of $200,000: PV = $200,000/.17166 = $1,165,097.99 Total value today = $1,165,097.99 + 630,569.77 = $1,795,667.76 Problem #4 Enter 6% 12 NOM EFF C/Y Solve for 5.84106% CFo $0 C01 $250,000 F01 4 C02 $500,000 F02 14 C03 $400,000 F03 6 I = 5.84106% / 12 NPV CPT $9,771,196.40 Enter 24 5.84106%/12 $8,271,196.40 N I/Y PV PMT FV Solve for $365,992.40

Problem #5 The dollar cost of the points is .025($250,000) = $6,250 The mortgage payments on a $250,000 loan for 30 years are: Enter 360 5.75%/12 $250,000 N I/Y PV PMT FV Solve for $1,458.93 Since you are required to pay $6,250 in points, you are effectively borrowing only $243,750, so: Enter 360 –$243,750 $1,458.93 N I/Y PV PMT FV Solve for 0.4987 % So, the APR is: 0.4987% × 12 = 5.98% and the EAR is: 6.151% The mortgage payments on a $250,000 loan for 25 years are: Enter 300 5.75%/12 $250,000 N I/Y PV PMT FV Solve for $1,572.77 Since you are required to pay $6,250 in points, you are effectively borrowing only $243,750, so: Enter 300 –$243,750 $1,572.77 N I/Y PV PMT FV Solve for 0.50130% So, the APR is: 0.5013% × 12 = 6.02% and the EAR is: 6.184%

Problem #6 Enter 5% 2 NOM EFF C/Y Solve for 4.9390% Enter 7% 2 NOM EFF C/Y Solve for 6.8816% In 3 years: Enter 6 4.9390 / 2 $50 N I/Y PV PMT FV Solve for $319.14 In 4 years: Enter 2 6.8816 / 2 $319.14 $50 N I/Y PV PMT FV Solve for $443.20 In 7 years: Enter 8 6.8816 / 2 $443.20 $60 N I/Y PV PMT FV Solve for $1,122.90 Enter 8 $1,000 +/- $2,122.90 N I/Y PV PMT FV Solve for 9.87%

Problem #7 Dividend payout ratio = 0.40 2006 Pro Forma Income Statement Sales $966,000Costs 760,800Other expenses 18,000EBIT $187,200Interest expense 43,500Taxable income $143,700Taxes 50,295Net income $93,405Dividends $37,362Add. To RE 56,043

Full capacity sales = Sales / Operating capacity = $ 1,006,250 Fixed assets required at full capacity = Fixed assets / Full capacity sales = 0.31602Total fixed assets = Fixed assets required X Sales = $ 537,500

Since the company will still not be at full capacity, no new fixed assets are needed. The fixed assets will remain constant, so:

Assets Liabilities and owners' equity Current assets Current liabilities Cash $24,000 Accounts payable $84,000 Accounts receivable 46,800 Notes payable 10,000 Inventory 69,600 Total $ 94,000 Total $140,400 Long-term debt 93,000Fixed assets Net plant and Owners' equity equipment 318,000 Common stock and $15,000 paid-in surplus Retained earnings 303,043 Total $318,043 Total liabilities and Total assets $458,400 owners' equity $505,043

EFN = $458,400 – 505,043 = –$46,643