Fight Finance

Question 39  DDM, perpetuity with growth

A stock is expected to pay the following dividends:

Cash Flows of a Stock
Time (yrs)	0	1	2	3	4	...
Dividend ($)	0.00	1.00	1.05	1.10	1.15	...

After year 4, the annual dividend will grow in perpetuity at 5% pa, so;

• the dividend at t=5 will be $1.15(1+0.05),
• the dividend at t=6 will be $1.15(1+0.05)^2, and so on.

The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What is the current price of the stock?

(a) $25.6033

(b) $20.7476

(c) $20.0000

(d) $19.8835

(e) $18.3126

Question 115  capital structure, leverage, WACC

A firm has a debt-to-assets ratio of 50%. The firm then issues a large amount of debt to raise money for new projects of similar market risk to the company's existing projects. Assume a classical tax system. Which statement is correct?

(a) The debt-to-assets (D/V) ratio will decrease.

(b) The debt-to-equity ratio (D/E) will decrease.

(c) The firm's cost of equity will decrease.

(d) The company's after-tax WACC will decrease.

(e) The company's before-tax WACC will decrease.

Question 242  technical analysis, market efficiency

Select the most correct statement from the following.

'Chartists', also known as 'technical traders', believe that:

(a) Markets are weak-form efficient.

(b) Markets are semi-strong-form efficient.

(c) Past prices cannot be used to predict future prices.

(d) Past returns can be used to predict future returns.

(e) Stock prices reflect all publically available information.

Question 282  expected and historical returns, income and capital returns

You're the boss of an investment bank's equities research team. Your five analysts are each trying to find the expected total return over the next year of shares in a mining company. The mining firm:

• Is regarded as a mature company since it's quite stable in size and was floated around 30 years ago. It is not a high-growth company;
• Share price is very sensitive to changes in the price of the market portfolio, economic growth, the exchange rate and commodities prices. Due to this, its standard deviation of total returns is much higher than that of the market index;
• Experienced tough times in the last 10 years due to unexpected falls in commodity prices.
• Shares are traded in an active liquid market.

Your team of analysts present their findings, and everyone has different views. While there's no definitive true answer, whose calculation of the expected total return is the most plausible? Assume that:

• The analysts' source data is correct and true, but their inferences might be wrong;
• All returns and yields are given as effective annual nominal rates.

(a) Alice says 5% pa since she calculated that this was the average total yield on government bonds over the last 10 years. She says that this is also the expected total yield implied by current prices on one year government bonds.

(b) Bob says 4% pa since he calculated that this was the average total return on the mining stock over the last 10 years.

(c) Cate says 3% pa since she calculated that this was the average growth rate of the share price over the last 10 years.

(d) Dave says 6% pa since he calculated that this was the average growth rate of the share market price index (not the accumulation index) over the last 10 years.

(e) Eve says 15% pa since she calculated that this was the discount rate implied by the dividend discount model using the current share price, forecast dividend in one year and a 3% growth rate in dividends thereafter, which is the expected long term inflation rate.

Question 322  foreign exchange rate, monetary policy, American and European terms

The market expects the Reserve Bank of Australia (RBA) to decrease the policy rate by 25 basis points at their next meeting.

Then unexpectedly, the RBA announce that they will decrease the policy rate by 50 basis points due to fears of a recession and deflation.

What do you expect to happen to Australia's exchange rate? The Australian dollar will:

(a) Appreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will increase.

(b) Depreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will decrease.

(c) Appreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will decrease.

(d) Depreciate against the USD, so the 'American terms' quote of the AUD (USD per AUD) will increase.

(e) Be unaffected by the change in the policy rate, so the exchange rate will remain the same.

Question 489  NPV, IRR, pay back period, DDM

A firm is considering a business project which costs $11m now and is expected to pay a constant $1m at the end of every year forever.

Assume that the initial $11m cost is funded using the firm's existing cash so no new equity or debt will be raised. The cost of capital is 10% pa.

Which of the following statements about net present value (NPV), internal rate of return (IRR) and payback period is NOT correct?

(a) The NPV is negative $1m.

(b) The IRR is 9.09% pa, less than the 10% cost of capital.

(c) The payback period is infinite, the project will never pay itself off.

(d) The project should be rejected.

(e) If the project is accepted then the market value of the firm's assets will fall by $1m.

Question 493  PE ratio

A firm has 2m shares and a market capitalisation of equity of $30m. The firm just announced earnings of $5m and paid an annual dividend of $0.75 per share.

What is the firm's (backward looking) price/earnings (PE) ratio?

(a) 2.5

(b) 3

(c) 6

(d) 15

(e) 20

Question 496  NPV, IRR, pay back period

A firm is considering a business project which costs $10m now and is expected to pay a single cash flow of $12.1m in two years.

Assume that the initial $10m cost is funded using the firm's existing cash so no new equity or debt will be raised. The cost of capital is 10% pa.

Which of the following statements about net present value (NPV), internal rate of return (IRR) and payback period is NOT correct?

(a) The NPV is zero.

(b) The IRR is 10% pa, equal to the 10% cost of capital.

(c) The payback period is two years assuming that the whole $12.1m cash flow occurs at t=2, or 1.826 years if the $12.1m cash flow is paid smoothly over the second year.

(d) The project could be accepted or rejected, the owners would be indifferent.

(e) If the project is accepted then the market value of the firm's assets will increase by $2.1m more than it would otherwise if the project was rejected.

Question 502  NPV, IRR, mutually exclusive projects

An investor owns an empty block of land that has local government approval to be developed into a petrol station, car wash or car park. The council will only allow a single development so the projects are mutually exclusive.

All of the development projects have the same risk and the required return of each is 10% pa. Each project has an immediate cost and once construction is finished in one year the land and development will be sold. The table below shows the estimated costs payable now, expected sale prices in one year and the internal rates of returns (IRR's).

Mutually Exclusive Projects
Project	Cost now ($)	Sale price in one year ($)	IRR (% pa)
Petrol station	9,000,000	11,000,000	22.22
Car wash	800,000	1,100,000	37.50
Car park	70,000	110,000	57.14

Which project should the investor accept?

(a) Petrol station.

(b) Car wash.

(c) Car park.

(d) None of the projects.

(e) All of the projects.

Question 691  continuously compounding rate, effective rate, continuously compounding rate conversion, no explanation

A bank quotes an interest rate of 6% pa with quarterly compounding. Note that another way of stating this rate is that it is an annual percentage rate (APR) compounding discretely every 3 months.

Which of the following statements about this rate is NOT correct? All percentages are given to 6 decimal places. The equivalent:

(a) Continuously compounded rate is 5.955445% per annum. Note that this rate is the annual rate with continuous compounding.

(b) Continuously compounded rate is 1.500000% per quarter. Note that this rate is the quarterly rate with continuous compounding.

(c) Effective quarterly rate is 1.500000% per quarter. Note that this rate is the quarterly rate with discrete quarterly compounding.

(d) Effective annual rate is 6.136355% per annum. Note that this rate is the annual rate with discrete annual compounding.

(e) $1,000,000 invested in this bank account for one year will give $1,061,363.551 at the end of the year.