Name Student Number MGF 301 Corporation Finance Spring 2012 TEST 1 Please sign name in box Please tear off the answer sheet and answer all of the following questions on the answer sheet Note Total Points 100 Multiple Choice 4 points each If you are paying interest at a 5 annual rate on a loan which of the following would 1 you have the lowest cost a a loan that compounds interest quarterly i e 4 times per year b a loan that compounds interest daily i e 365 times per year c a loan that uses simple interest without compounding d cannot be determined ABC corp reported no news yesterday but its price decreased yesterday by 10 in 2 trading on the New York Stock Exchange Which of the following is true about ABC yesterday a we need to know the number of shares to know if the market value of equity went down b the decrease in the stock price decreased the amount of cash that ABC has c the book value of the equity stayed the same d none of the above If you make payments on a monthly basis and the interest is compounded daily how 3 would you calculate the effective monthly interest rate with daily compounding Set up a calculation using r as the annual interest rate 6 points Effective Monthly Rate monthly rate with daily compounding To find this first find the daily rate and then compound this by about 30 days to get a monthly rate Daily rate r 365 Effective monthly rate 1 r 365 30 1 4 A 6 year bond with a coupon rate of 7 was issued two years ago It has a 1 000 face value and pays a semi annual coupon If the yield to maturity is 6 how would you calculate the bond price Set up your calculation in detail but do not solve it 6 points Price 35 1 03 35 1 032 1035 1 038 5 Julia is planning for retirement and wants to have 500 000 forty years from now in time 40 Which formula will calculate how much she needs to save today time 0 to reach her goal a PV 500 000 x 40 1 r 40 b PV 500 000 1 r 40 c PV 500 000 x 1 r 40 1 r 40 d FV40 500 000 x 1 r 40 Name Test 1 Spring 2012 Student Number 6 Your retirement plan will pay you a series of monthly payments that begin 30 years from today in month 360 and that continue forever in perpetuity The first monthly payment will be 1000 and this will grow by 3 every month after this Set up a formula to calculate the present value of this retirement plan if the annual discount rate is 5 Note you do not need to solve 6 points Note this question has a flaw as written because 5 annually is a smaller interest rate than 3 monthly which will cause the growing perpetuity model to not work So I accepted two answers Answer 1 as written in question PV 1000 05 12 03 1 05 12 359 Answer 2 if 5 is a monthly rate PV 1000 05 03 1 05 359 7 You have won the lottery s 1 000 a week for life contest If you expect to live for 60 more years set up a formula to calculate the present value of the prize if the appropriate discount rate is 5 on an annual basis Note you do not need to solve your calculation 6 points PV 1000 x annuity factor at 05 52 interest for t 60 52 or PV 1000 1 05 52 1000 1 05 52 2 1000 1 05 52 60 52 8 Using the lottery payout from question 7 mark each of the following as T rue or F alse F a If the payment stream was a perpetuity instead of limited to 60 years the present value of the prize would be an infinite amount of money T b The present value of the payments will be greater than earning 4 000 each month over the next 60 years F c If the discount rate goes up the present value of your prize will go up 9 Jason has a choice of receiving 25 000 next year time 1 or 30 000 in two years time 2 If the discount rate is 10 which choice has a higher present value Write your solution method along with your answer on the answer sheet 6 points PV1 25000 1 10 22 727 27 PV2 30000 1 102 24 793 39 Choice 2 has a higher PV 10 Mark each of the following as True T or False F 2 points each F a If a company does not pay a dividend there is no way to estimate the stock price T b Book value of equity is usually lower than market value of equity 2 Name Test 1 Spring 2012 Student Number F c In the secondary market the company issues stocks and or bonds to investors 11 Which of the following is false about a 10 year 8 bond with a face value of 1 000 that is selling for 1050 a if the yield to maturity remains constant over the next year the price will be higher next year b the yield to maturity is less than 8 c the bond will pay 80 each year as interest d none of the above 12 Today WXZ issued a bond paying interest of X with face value of 1 000 and a 30 year maturity The bond was issued with a price of 1 010 and was rated A by Standard Poors Without doing any calculations which of the following is false a the bond currently pays more interest than investors require given the risk b the bond s rating may change over the life of a bond c the yield to maturity for this bond is fixed when issued and will not change over the 30 year life d none of the above 13 For the bond in question 12 assume that two changes happen over the next 5 years a overall interest rates in the economy fall by two percent and b WXZ struggles financially and its rating changes to B What will be the effect of these two changes on the bond price Explain your answer in the space on the answer sheet 6 points a if interest rates fall by 2 in the economy this will cause YTM to go down for the WXZ bond So the price of WXZ bond will go up b if the bond rating falls to B the company has higher risk of default and YTM will go up which will cause the price of the bond to go down As the two effects are in different directions it is not possible to tell without more information whether the net effect is an increase of decrease You have won 100 000 in a contest You are given two choices A receive 10 14 payments 10 000 today time …