Fight Finance

Question 41  DDM, income and capital returns

The following is the Dividend Discount Model (DDM) used to price stocks:

### P_0 = \frac{d_1}{r-g} ###

Assume that the assumptions of the DDM hold and that the time period is measured in years.

Which of the following is equal to the expected dividend in 3 years, ## d_3 ##?

(a) ## d_1(1+g)^3 ##

(b) ## P_3(r-g) ##

(c) ## d_2(1+g)^2 ##

(d) ## P_0(1+g)^3(r-g) ##

(e) ## P_0(1+g)^2(r-g) ##

Question 109  credit rating, credit risk

Bonds with lower (worse) credit ratings tend to have:

(a) Lower yields to maturity.

(b) Higher probabilities of default.

(c) Lower coupon rates when priced at par.

(d) Lower total risk.

(e) Lower credit risk.

Question 200  NPV, no explanation

A stock is expected to pay the following dividends:

Cash Flows of a Stock
Time (yrs)	0	1	2	3	4	...
Dividend ($)	0	6	12	18	20	...

After year 4, the dividend will grow in perpetuity at 5% pa. The required return of the stock is 10% pa. Both the growth rate and required return are given as effective annual rates.

If all of the dividends since time period zero were deposited into a bank account yielding 8% pa as an effective annual rate, how much money will be in the bank account in 2.5 years (in other words, at t=2.5)?

(a) 14.85

(b) 15.84

(c) 16.89

(d) 19.20

(e) 21.82

Question 373  debt terminology

Which of the following statements is NOT correct? Lenders:

(a) Are long debt.

(b) Invest in debt.

(c) Are owed money.

(d) Provide debt funding.

(e) Have debt liabilities.

Question 378  leverage, capital structure, no explanation

A levered company's required return on debt is always less than its required return on equity. or ?

Question 389  real option, option

You're thinking of starting a new cafe business, but you're not sure if it will be profitable.

You have to decide what type of cups, mugs and glasses you wish to buy. You can pay to have your cafe's name printed on them, or just buy the plain un-marked ones. For marketing reasons it's better to have the cafe name printed. But the plain un-marked cups, mugs and glasses maximise your:

(a) Expansion option.

(b) Abandonment option.

(c) Timing (or delaying) option.

(d) Production (or switching) option.

(e) Underlying asset.

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 619  CFFA

To value a business's assets, the free cash flow of the firm (FCFF, also called CFFA) needs to be calculated. This requires figures from the firm's income statement and balance sheet. For what figures is the balance sheet needed? Note that the balance sheet is sometimes also called the statement of financial position.

(a) Net income, depreciation and interest expense.

(b) Depreciation and capital expenditure.

(c) Current assets, current liabilities and cost of goods sold (COGS).

(d) Current assets, current liabilities and capital expenditure.

(e) Current assets, current liabilities and depreciation expense.

Question 674  CAPM, beta, expected and historical returns

A stock has a beta of 1.5. The market's expected total return is 10% pa and the risk free rate is 5% pa, both given as effective annual rates.

Over the last year, bad economic news was released showing a higher chance of recession. Over this time the share market fell by 1%. So ##r_{m} = (P_{0} - P_{-1})/P_{-1} = -0.01##, where the current time is zero and one year ago is time -1. The risk free rate was unchanged.

What do you think was the stock's historical return over the last year, given as an effective annual rate?

(a) -12.5% pa

(b) -4% pa

(c) -1.5% pa

(d) -1% pa

(e) 12.5% pa

Question 823  option, option payoff at maturity, option profit, no explanation

A European call option should only be exercised if:

(a) It's 'out of the money'.

(b) It will give a positive profit: ##-c_0 + max(S_T-K_T,0) > 0##.

(c) It will give a positive payoff at maturity: ##max(S_T-K_T,0) > 0##.

(d) The underlying asset price is below the option strike price: ##S_T < K_T##.

(e) The underlying asset price is above the break-even price.