Midtern

Midterm Test: Answers

Financial Management

Full Time & Part-time B

Term 1, 2005

Part 1: Multiple Choice Questions: (4 points each, 36 points total)

You do not need to write down your reasoning process.

1: John has just taken out a $150,000 mortgage at an annual percentage rate of 8% per year. If the mortgage calls for equal monthly payments for twenty years, what is the amount of each payment? (Assume monthly compounding.)

A) $1254.70

B) $1625.00

C) $1263.06

D) $1273.15

E) None of the above are true

Ans: A. Note: you find the monthly interest rate at 8%/12 = 0.6667%, then you apply the PV for annuity formula to get the monthly payment.

2: Valentine Company is considering investing in a new project. The project will need an initial investment of $1,200,000 and will generate $600,000 (after-tax) cash flows for three years. Calculate the NPV for the project if the cost of capital is 15%.

A) $169,935

B) $129,211

C) $600,000

D) $125,846

Ans: A

3: Mr. Crow has $100 income this year and zero income next year. The market interest rate is 10% per year. Mr. Crow also has an investment opportunity in which he can invest $50 today and receive $70 next year. Suppose Mr. Crow consumes $20 this year and invests in the project. What will be his consumption next year?

A) $88

B) $103

C) $80

D) $100

Ans: B. Mr. Crow consumes $20 this year and invests in the project which requires $50. So he has $30 remaining to deposit in the bank to earn the market interest rate of 10%. Thus, he will have $30*(1+10%) + $70 (the payoff from the investment project) = $103 to consume next year.

4: Profitability index is useful under:

A) Capital rationing

B) Mutually exclusive projects

C) Non-standard projects

D) None of the above

Ans: A. Note: (B) is not correct. Using PI will favour smaller projects among mutually exclusive projects.

5: A three-year bond has 8.0% coupon rate and face value of $1000. If the...