9.220 Corporation
Nnancc
N.
Bhattacharyya/
L.
Elkow/
G.
Jacoby/
L.
Longobartli
Midterm Examination II March
15,ZOOl
7:00 p.m.

9:00 p.m. Total: 100 marks
______..__

Note: It is
your
responsibility to verify that this examination has 15 pages.
1. Multiple
C.‘hoice
Section.
.
_..

..
.
.
1S;lch
nf
the
following questions or statements is followed by several suggested answers or
completions. Select the best alternative and place the corresponding letter on the
;Icconlp:lnying
computerized answer sheet. (Value: 12 x 2.5
=
30 marks)
; The
l‘ollowing
information applies to questions
I
and 2
I..
I__
A
Spot rates of interest
for
zerocoupon Government of Canada bonds are observed for different
terms to maturity
as
follows:
2.
A
~~‘IWJI~I~I~II
bond has a face value of $1,000 and matures 4 years from today.
If’
you
believe in the pure expectations theory of the term structure, what do you expect the price of
3.
Your
broker
has recommended that you buy the stock of a new company. She told you that
~hc
~:ompany
will not be paying any dividend for the next
five
years and in the fifth year the
con~pany
is
cspected
to pay its first semiannual dividend of $3.20 per share. The company is
~IXII
cxpccted
to maintain this semiannual dividend indefinitely.
If
the broker
recomrncnds
that
you
use
an
effective annual required rate of return of 25
44%,
then what is the price you
shoi~ld
pay
for
the stock?
0
i
2
‘5
iI)
$4
0s
1,)
S’i,.X4
c)
$X.59
QSW
cg
TJ(lllC
crl‘rhc
above
P%.s:
$f$
1.
The
ll<R
of
;in
itn’cstment
in a fairly priced stock must be
~1)
calculated based on
all
future earnings per share
I)‘,
squd
to
Lcro
g!c;~lci’
1h11
t\Ie
rcqulred
rate
of
return
c~lual
1.0
the required rate of return
gre;lter
than or equal to the required rate of return
9.220 Corporation Finance N.
Bhattacharyyaj
L.
Elkow/
G.
,Jacoby/
L. Longobardi
LMidterm
Esamination
IIMarch
15,200l
7:00
pm,

9:00 p.m. Total: 100 marks
__
__
.__
5.
The
ek~vv
required
annA
rate of return on the ordinary shares of Northwest Corporation
is
II”‘0 ‘I’he
shares’
annu~~l
dividends are expected to grow at a constant rate of 4% a year
l’orcvcr
Which
of
the following is a correct statement?
a
d
I‘llC
SllitWS’
cspected dividend yield for year one is 4%.
x,
dig4
3~obi
I,
m.y(d:
b
The
shares’ cspected dividend yield for year one is 10%.
FL2
p3
c)
The
shares’ expected dividend yield for year one is 14%.
d)
The
shares’ expected capital gains yield for year one is
10%.
=\
01:
=o.\yo.oy=
,a%
c)
Nolm
of
the above.
p&
‘r3
c.3.
984
I4
6.
A
prcrjcct
will pay
a
constant nominal cash flows of X per year, at the end of each year for
the
nest ten years. The expected inflation rate per year is 6%. The expected growth rate in the
project’s
real
Cxh
flows
i:;
\\
@
5.661)40/1,
3
0.e
zv
^
\a
\
I .06
\
=cLoS660~
b)
6.(1000%
C)
~!.~.mo?~;,
(1) ‘I,
‘:s300~,,
(‘)
11(:111:
toI'
1111"
;Llx,\'c:
7.
Consider
project
Z
with
IRR=20%,
and with the following cash flows: CO
=
?,
C
I
=
600.00,
C2=
Z,I60.00,
C3
=
1,72X.OO,C4=3,11O.4O,C5=2,488.32.
‘l‘hc
payback
pcriocl
li,r
the
prc>.jcct
a) is
bctwcen
i
and 2 years.
b)
ic
between
;1
and 3 years.
(?J
is
between
1
and 4 years.
d)
is
between
4
and 5
ye;us.
e)
cannot
be calculated with the given information.
. )
<in
independenl
project that has initial cash inflows followed by a series of
cash
0uIIloLvs
:,hould
always he
acccptecl
when the
prqject’s
IRR
is lower than the discount
rate.
1,)
I
Ill<
always reaches the same decision as NPV when
tile
initial
investment
outlays
01‘
~111
~nJcpencic~tt
project
arc
Ibllowed
by a series of cash inflows.
@)
,\I!
indcpcndent
proj(:cI
with two
IRRs
should always be accepted
when
the
project’:;
tllsx)unt
rate is
between
the two
IRRs.
d) ‘when
an
lrrdependent
project always has a positive
NW,
IRR cannot be calculated.
c)
IRR,
Payback
I’criod,
and Profitability Index may mislead when used for mutually
~.~\rcius:v~~
projects,
wnile
NW
will always lead to selecting the correct project.
9.
Whrch
of
rhc
t~~llowing
‘s
NOT a correct statement of a
capital
budgeting decision rule for a
invc:stment
pr~,>,ject’!
;I) I!‘,1
project has a pro itability index greater than one the prqject should be accepted.
II)
It‘
a
tirnl’s
target
average
accounting return is lower than the average accounting return
Q
~~!mputecl
ibr
a given prqject then the project should be accepted.
c
‘UK
pro.jcc:t
should always be accepted when the firm’s target discounted payback
period
IS higher
thaIi
the payback period computed for,
a
given project.
(1)
I‘ilc
prC)Ject
should always he accepted when the firm’s target payback period is
highcl
than
the
discounted payback period computed for a given
prqject.
e)
lt’thc
NP’G
of a
project
is positive, it should be accepted
yA‘C
r,PQ
loks
r\/F/\
\
;\
0
OcCtoL
?
*
b
,
\
L:,
a\b~y,
\t\rl&hQ
&A
bW>
pp
Tkbs,
(A)
ij
(0’1)cc)r
3ikcc
‘11
;hy\b(S
+\A’
PilgC
2 Of 15
0.220
C~Or[~OKltiOIl
Finance N.
Bhattacharyya/
L,
Elkow/
G.
Jacoby/
L.
Longobnrdi
Midterm Examination
IIMarch
15,200l
7:00 p.m.

9:00 p.m. Total: 100 marks
10. The
TSE
3S
stock index has recorded the following annual percentage returns over a 6year
period
Based on this data. the geometric average rate of return for the
TSE
35 index is
211
8.506750
I
I.
I&NxI
OII
historical
data, you estimated the mean and standard deviation of annual returns
li)~
Eastcl
Networks common stock to be 17.70% and
12.50%,
respectively. Assume that the
histoncal
return distribution is a good estimate for the distribution of future returns, and that
returnc
are
normally distributed. Each of the following statements is false except
a) I‘hcrc
is approximately 32% chance for the rate of return on Eastel common stocks to be
Il1L;ide
the 5.20% to 30.20% range.
b)
l’llerc
IS
approximately 68
%
chance for the rate of return on
Eastel
common stocks to be
inside
the:
~~7.30”/0
to 42.70% range.
c)
l‘hcrc
is
qq)roximately
95%
chance for the rate of return on
I:astel
common stocks to
IX
liritsidc
the
‘7.300/o
to 4’2.70% range.
(1)
!‘l~rc
is
q~proxinratel~~
5%
chance for the rate of return on
Eastel
common stocks to be
(3
t~~iisitlc
the
5
20%
to 30.20% range.
c)
l‘l~~c
is
~ll~pl.“‘xilliatel~,
5% chance for the rate of return on
Iiastel
common stocks to be
cbk~t~idc
tlic
7.30% to 42.70% range.
‘i)tob
(3

I($.$
‘r
$
F+id)~o.q~ =\
PL.5
(k<
614
*:
17FWj?M
12.
Wliich
01
111~
lc>\lowing
is a correct statement for the historical return statistics of Canadian
assets
.)
:I)
‘I’leasuq
Ijills
have a higher variance when compared with Long Bonds.
I))
l?c:illg
the
portfolio of
the
largest and strongest Canadian stocks, the TSE 300 index has a
\otvcr
var.iance
when compared with Long Bonds.
c)
Hcing
riskless
securities, the average return on Treasury bills is zero.
0
d)
l,crng
L~onds
have a
higher
variance when compared with Treasury Bills, and therefore
thcv
tend
io
pay a higher mean of return.
c) ‘I‘*tlils\l[.)
llills
p:~y
a positive risk premium, since there is
some
variation in their
returns.
I’ilgC
3 Of
IS
Document Summary
______. . __ : bhattacharyya/ l. elkow/ g. jacoby/ l. longobartli. Note: it is your responsibility to verify that this examination has 15 pages: multiple c. hoice section. 1s;lch nf the following questions or statements is followed by several suggested answers or completions. Select the best alternative and place the corresponding letter on the. ;icconlp:lnying computerized answer sheet. (value: 12 x 2. 5 = 30 marks) ; the l ollowing information applies to questions i and 2. Spot rates of interest for zerocoupon government of canada bonds are observed for different terms to maturity as follows: a ~~ iwji~i~i~ii bond has a face value of ,000 and matures 4 years from today. If" you believe in the pure expectations theory of the term structure, what do you expect the price of. Your broker has recommended that you buy the stock of a new company.