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Question 478  income and capital returns

Total cash flows can be broken into income and capital cash flows. What is the name given to the income cash flow from owning shares?



Question 477  income and capital returns

An asset's total expected return over the next year is given by:

###r_\text{total} = \dfrac{c_1+p_1-p_0}{p_0} ###

Where ##p_0## is the current price, ##c_1## is the expected income in one year and ##p_1## is the expected price in one year. The total return can be split into the income return and the capital return.

Which of the following is the expected capital return?



Question 151  income and capital returns

A share was bought for $30 (at t=0) and paid its annual dividend of $6 one year later (at t=1).

Just after the dividend was paid, the share price fell to $27 (at t=1). What were the total, capital and income returns given as effective annual rates?

The choices are given in the same order:

##r_\text{total}## , ##r_\text{capital}## , ##r_\text{dividend}##.



Question 404  income and capital returns, real estate

One and a half years ago Frank bought a house for $600,000. Now it's worth only $500,000, based on recent similar sales in the area.

The expected total return on Frank's residential property is 7% pa.

He rents his house out for $1,600 per month, paid in advance. Every 12 months he plans to increase the rental payments.

The present value of 12 months of rental payments is $18,617.27.

The future value of 12 months of rental payments one year in the future is $19,920.48.

What is the expected annual rental yield of the property? Ignore the costs of renting such as maintenance, real estate agent fees and so on.



Question 278  inflation, real and nominal returns and cash flows

Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year.

After one year, would you be able to buy , exactly the as or than today with the money in this account?


Question 353  income and capital returns, inflation, real and nominal returns and cash flows, real estate

A residential investment property has an expected nominal total return of 6% pa and nominal capital return of 3% pa.

Inflation is expected to be 2% pa. All rates are given as effective annual rates.

What are the property's expected real total, capital and income returns? The answer choices below are given in the same order.



Question 295  inflation, real and nominal returns and cash flows, NPV

When valuing assets using discounted cash flow (net present value) methods, it is important to consider inflation. To properly deal with inflation:

(I) Discount nominal cash flows by nominal discount rates.

(II) Discount nominal cash flows by real discount rates.

(III) Discount real cash flows by nominal discount rates.

(IV) Discount real cash flows by real discount rates.

Which of the above statements is or are correct?



Question 407  income and capital returns, inflation, real and nominal returns and cash flows

A stock has a real expected total return of 7% pa and a real expected capital return of 2% pa.

Inflation is expected to be 2% pa. All rates are given as effective annual rates.

What is the nominal expected total return, capital return and dividend yield? The answers below are given in the same order.



Question 466  limited liability

Which business structure or structures have the advantage of limited liability for equity investors?



Question 221  credit risk

You're considering making an investment in a particular company. They have preference shares, ordinary shares, senior debt and junior debt.

Which is the safest investment? Which will give the highest returns?



Question 577  inflation, real and nominal returns and cash flows

What is the present value of a real payment of $500 in 2 years? The nominal discount rate is 7% pa and the inflation rate is 4% pa.



Question 554  inflation, real and nominal returns and cash flows

On his 20th birthday, a man makes a resolution. He will put $30 cash under his bed at the end of every month starting from today. His birthday today is the first day of the month. So the first addition to his cash stash will be in one month. He will write in his will that when he dies the cash under the bed should be given to charity.

If the man lives for another 60 years, how much money will be under his bed if he dies just after making his last (720th) addition?

Also, what will be the real value of that cash in today's prices if inflation is expected to 2.5% pa? Assume that the inflation rate is an effective annual rate and is not expected to change.

The answers are given in the same order, the amount of money under his bed in 60 years, and the real value of that money in today's prices.



Question 745  real and nominal returns and cash flows, inflation, income and capital returns

If the nominal gold price is expected to increase at the same rate as inflation which is 3% pa, which of the following statements is NOT correct?



Question 531  bankruptcy or insolvency, capital structure, risk, limited liability

Who is most in danger of being personally bankrupt? Assume that all of their businesses' assets are highly liquid and can therefore be sold immediately.



Question 515  corporate financial decision theory, idiom

The expression 'you have to spend money to make money' relates to which business decision?



Question 2  NPV, Annuity

Katya offers to pay you $10 at the end of every year for the next 5 years (t=1,2,3,4,5) if you pay her $50 now (t=0). You can borrow and lend from the bank at an interest rate of 10% pa, given as an effective annual rate.

Ignore credit risk.

Will you or Katya's deal?


Question 288  Annuity

There are many ways to write the ordinary annuity formula.

Which of the following is NOT equal to the ordinary annuity formula?



Question 479  perpetuity with growth, DDM, NPV

Discounted cash flow (DCF) valuation prices assets by finding the present value of the asset's future cash flows. The single cash flow, annuity, and perpetuity equations are very useful for this.

Which of the following equations is the 'perpetuity with growth' equation?



Question 517  DDM

A stock is expected to pay its next dividend of $1 in one year. Future annual dividends are expected to grow by 2% pa. So the first dividend of $1 will be in one year, the year after that $1.02 (=1*(1+0.02)^1), and a year later $1.0404 (=1*(1+0.02)^2) and so on forever.

Its required total return is 10% pa. The total required return and growth rate of dividends are given as effective annual rates.

Calculate the current stock price.



Question 518  DDM

A stock just paid a dividend of $1. Future annual dividends are expected to grow by 2% pa. The next dividend of $1.02 (=1*(1+0.02)^1) will be in one year, and the year after that the dividend will be $1.0404 (=1*(1+0.02)^2), and so on forever.

Its required total return is 10% pa. The total required return and growth rate of dividends are given as effective annual rates.

Calculate the current stock price.



Question 4  DDM

For a price of $13, Carla will sell you a share which will pay a dividend of $1 in one year and every year after that forever. The required return of the stock is 10% pa.

Would you like to Carla's share or politely ?


Question 7  DDM

For a price of $1040, Camille will sell you a share which just paid a dividend of $100, and is expected to pay dividends every year forever, growing at a rate of 5% pa.

So the next dividend will be ##100(1+0.05)^1=$105.00##, and the year after it will be ##100(1+0.05)^2=110.25## and so on.

The required return of the stock is 15% pa.

Would you like to the share or politely ?


Question 528  DDM, income and capital returns

The perpetuity with growth formula, also known as the dividend discount model (DDM) or Gordon growth model, is appropriate for valuing a company's shares. ##P_0## is the current share price, ##C_1## is next year's expected dividend, ##r## is the total required return and ##g## is the expected growth rate of the dividend.

###P_0=\dfrac{C_1}{r-g}###

The below graph shows the expected future price path of the company's shares. Which of the following statements about the graph is NOT correct?

Saw tooth graph of stock price path



Question 201  DDM, income and capital returns

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

###P_0=\dfrac{C_1}{r-g}###

If the assumptions of the DDM hold, which one of the following statements is NOT correct? The long term expected:



Question 497  income and capital returns, DDM, ex dividend date

A stock will pay you a dividend of $10 tonight if you buy it today. Thereafter the annual dividend is expected to grow by 5% pa, so the next dividend after the $10 one tonight will be $10.50 in one year, then in two years it will be $11.025 and so on. The stock's required return is 10% pa.

What is the stock price today and what do you expect the stock price to be tomorrow, approximately?



Question 289  DDM, expected and historical returns, ROE

In the dividend discount model:

###P_0 = \dfrac{C_1}{r-g}###

The return ##r## is supposed to be the:



Question 36  DDM, perpetuity with growth

A stock pays annual dividends which are expected to continue forever. It just paid a dividend of $10. The growth rate in the dividend is 2% pa. You estimate that the stock's required return is 10% pa. Both the discount rate and growth rate are given as effective annual rates. Using the dividend discount model, what will be the share price?



Question 148  DDM, income and capital returns

The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation.

### p_0 = \frac{d_1}{r - g} ###

Which expression is NOT equal to the expected dividend yield?



Question 441  DDM, income and capital returns

A fairly valued share's current price is $4 and it has a total required return of 30%. Dividends are paid annually and next year's dividend is expected to be $1. After that, dividends are expected to grow by 5% pa in perpetuity. All rates are effective annual returns.

What is the expected dividend income paid at the end of the second year (t=2) and what is the expected capital gain from just after the first dividend (t=1) to just after the second dividend (t=2)? The answers are given in the same order, the dividend and then the capital gain.



Question 50  DDM, stock pricing, inflation, real and nominal returns and cash flows

Most listed Australian companies pay dividends twice per year, the 'interim' and 'final' dividends, which are roughly 6 months apart.

You are an equities analyst trying to value the company BHP. You decide to use the Dividend Discount Model (DDM) as a starting point, so you study BHP's dividend history and you find that BHP tends to pay the same interim and final dividend each year, and that both grow by the same rate.

You expect BHP will pay a $0.55 interim dividend in six months and a $0.55 final dividend in one year. You expect each to grow by 4% next year and forever, so the interim and final dividends next year will be $0.572 each, and so on in perpetuity.

Assume BHP's cost of equity is 8% pa. All rates are quoted as nominal effective rates. The dividends are nominal cash flows and the inflation rate is 2.5% pa.

What is the current price of a BHP share?



Question 535  DDM, real and nominal returns and cash flows, stock pricing

You are an equities analyst trying to value the equity of the Australian telecoms company Telstra, with ticker TLS. In Australia, listed companies like Telstra tend to pay dividends every 6 months. The payment around August is called the final dividend and the payment around February is called the interim dividend. Both occur annually.

  • Today is mid-March 2015.
  • TLS's last interim dividend of $0.15 was one month ago in mid-February 2015.
  • TLS's last final dividend of $0.15 was seven months ago in mid-August 2014.

Judging by TLS's dividend history and prospects, you estimate that the nominal dividend growth rate will be 1% pa. Assume that TLS's total nominal cost of equity is 6% pa. The dividends are nominal cash flows and the inflation rate is 2.5% pa. All rates are quoted as nominal effective annual rates. Assume that each month is exactly one twelfth (1/12) of a year, so you can ignore the number of days in each month.

Calculate the current TLS share price.



Question 488  income and capital returns, payout policy, payout ratio, DDM

Two companies BigDiv and ZeroDiv are exactly the same except for their dividend payouts.

BigDiv pays large dividends and ZeroDiv doesn't pay any dividends.

Currently the two firms have the same earnings, assets, number of shares, share price, expected total return and risk.

Assume a perfect world with no taxes, no transaction costs, no asymmetric information and that all assets including business projects are fairly priced and therefore zero-NPV.

All things remaining equal, which of the following statements is NOT correct?



Question 217  NPV, DDM, multi stage growth model

A stock is expected to pay a dividend of $15 in one year (t=1), then $25 for 9 years after that (payments at t=2 ,3,...10), and on the 11th year (t=11) the dividend will be 2% less than at t=10, and will continue to shrink at the same rate every year after that forever. The required return of the stock is 10%. All rates are effective annual rates.

What is the price of the stock now?



Question 348  PE ratio, Multiples valuation

Estimate the US bank JP Morgan's share price using a price earnings (PE) multiples approach with the following assumptions and figures only:

  • The major US banks JP Morgan Chase (JPM), Citi Group (C) and Wells Fargo (WFC) are comparable companies;
  • JP Morgan Chase's historical earnings per share (EPS) is $4.37;
  • Citi Group's share price is $50.05 and historical EPS is $4.26;
  • Wells Fargo's share price is $48.98 and historical EPS is $3.89.

Note: Figures sourced from Google Finance on 24 March 2014.



Question 341  Multiples valuation, PE ratio

Estimate Microsoft's (MSFT) share price using a price earnings (PE) multiples approach with the following assumptions and figures only:

  • Apple, Google and Microsoft are comparable companies,
  • Apple's (AAPL) share price is $526.24 and historical EPS is $40.32.
  • Google's (GOOG) share price is $1,215.65 and historical EPS is $36.23.
  • Micrsoft's (MSFT) historical earnings per share (EPS) is $2.71.

Source: Google Finance 28 Feb 2014.



Question 180  equivalent annual cash flow, inflation, real and nominal returns and cash flows

Details of two different types of light bulbs are given below:

  • Low-energy light bulbs cost $3.50, have a life of nine years, and use about $1.60 of electricity a year, paid at the end of each year.
  • Conventional light bulbs cost only $0.50, but last only about a year and use about $6.60 of energy a year, paid at the end of each year.

The real discount rate is 5%, given as an effective annual rate. Assume that all cash flows are real. The inflation rate is 3% given as an effective annual rate.

Find the Equivalent Annual Cost (EAC) of the low-energy and conventional light bulbs. The below choices are listed in that order.



Question 299  equivalent annual cash flow

Carlos and Edwin are brothers and they both love Holden Commodore cars.

Carlos likes to buy the latest Holden Commodore car for $40,000 every 4 years as soon as the new model is released. As soon as he buys the new car, he sells the old one on the second hand car market for $20,000. Carlos never has to bother with paying for repairs since his cars are brand new.

Edwin also likes Commodores, but prefers to buy 4-year old cars for $20,000 and keep them for 11 years until the end of their life (new ones last for 15 years in total but the 4-year old ones only last for another 11 years). Then he sells the old car for $2,000 and buys another 4-year old second hand car, and so on.

Every time Edwin buys a second hand 4 year old car he immediately has to spend $1,000 on repairs, and then $1,000 every year after that for the next 10 years. So there are 11 payments in total from when the second hand car is bought at t=0 to the last payment at t=10. One year later (t=11) the old car is at the end of its total 15 year life and can be scrapped for $2,000.

Assuming that Carlos and Edwin maintain their love of Commodores and keep up their habits of buying new ones and second hand ones respectively, how much larger is Carlos' equivalent annual cost of car ownership compared with Edwin's?

The real discount rate is 10% pa. All cash flows are real and are expected to remain constant. Inflation is forecast to be 3% pa. All rates are effective annual. Ignore capital gains tax and tax savings from depreciation since cars are tax-exempt for individuals.



Question 280  equivalent annual cash flow

You own a nice suit which you wear once per week on nights out. You bought it one year ago for $600. In your experience, suits used once per week last for 6 years. So you expect yours to last for another 5 years.

Your younger brother said that retro is back in style so he wants to wants to borrow your suit once a week when he goes out. With the increased use, your suit will only last for another 4 years rather than 5.

What is the present value of the cost of letting your brother use your current suit for the next 4 years?

Assume: that bank interest rates are 10% pa, given as an effective annual rate; you will buy a new suit when your current one wears out and your brother will not use the new one; your brother will only use your current suit so he will only use it for the next four years; and the price of a new suit never changes.



Question 462  equivalent annual cash flow

You own some nice shoes which you use once per week on date nights. You bought them 2 years ago for $500. In your experience, shoes used once per week last for 6 years. So you expect yours to last for another 4 years.

Your younger sister said that she wants to borrow your shoes once per week. With the increased use, your shoes will only last for another 2 years rather than 4.

What is the present value of the cost of letting your sister use your current shoes for the next 2 years?

Assume: that bank interest rates are 10% pa, given as an effective annual rate; you will buy a new pair of shoes when your current pair wears out and your sister will not use the new ones; your sister will only use your current shoes so she will only use it for the next 2 years; and the price of new shoes never changes.



Question 281  equivalent annual cash flow

You just bought a nice dress which you plan to wear once per month on nights out. You bought it a moment ago for $600 (at t=0). In your experience, dresses used once per month last for 6 years.

Your younger sister is a student with no money and wants to borrow your dress once a month when she hits the town. With the increased use, your dress will only last for another 3 years rather than 6.

What is the present value of the cost of letting your sister use your current dress for the next 3 years?

Assume: that bank interest rates are 10% pa, given as an effective annual rate; you will buy a new dress when your current one wears out; your sister will only use the current dress, not the next one that you will buy; and the price of a new dress never changes.



Question 215  equivalent annual cash flow, effective rate conversion

You're about to buy a car. These are the cash flows of the two different cars that you can buy:

  • You can buy an old car for $5,000 now, for which you will have to buy $90 of fuel at the end of each week from the date of purchase. The old car will last for 3 years, at which point you will sell the old car for $500.
  • Or you can buy a new car for $14,000 now for which you will have to buy $50 of fuel at the end of each week from the date of purchase. The new car will last for 4 years, at which point you will sell the new car for $1,000.

Bank interest rates are 10% pa, given as an effective annual rate. Assume that there are exactly 52 weeks in a year. Ignore taxes and environmental and pollution factors.

Should you buy the or the ?


Question 505  equivalent annual cash flow

A low-quality second-hand car can be bought now for $1,000 and will last for 1 year before it will be scrapped for nothing.

A high-quality second-hand car can be bought now for $4,900 and it will last for 5 years before it will be scrapped for nothing.

What is the equivalent annual cost of each car? Assume a discount rate of 10% pa, given as an effective annual rate.

The answer choices are given as the equivalent annual cost of the low-quality car and then the high quality car.



Question 548  equivalent annual cash flow, time calculation, no explanation

An Apple iPhone 6 smart phone can be bought now for $999. An Android Kogan Agora 4G+ smart phone can be bought now for $240.

If the Kogan phone lasts for one year, approximately how long must the Apple phone last for to have the same equivalent annual cost?

Assume that both phones have equivalent features besides their lifetimes, that both are worthless once they've outlasted their life, the discount rate is 10% pa given as an effective annual rate, and there are no extra costs or benefits from either phone.



Question 762  equivalent annual cash flow, no explanation

Radio-Rentals.com offers the Apple iphone 5S smart phone for rent at $12.95 per week paid in advance on a 2 year contract. After renting the phone, you must return it to Radio-Rentals.

Kogan.com offers the Apple iphone 5S smart phone for sale at $699. You estimate that the phone will last for 3 years before it will break and be worthless.

Currently, the effective annual interest rate is 11.351%, the effective monthly interest rate 0.9% and the effective weekly interest rate is 0.207%. Assume that there are exactly 52 weeks per year and 12 months per year.

Find the equivalent annual cost of renting the phone and also buying the phone. The answers below are listed in the same order.



Question 152  NPV, Annuity

The following cash flows are expected:

  • 10 yearly payments of $80, with the first payment in 3 years from now (first payment at t=3).
  • 1 payment of $600 in 5 years and 6 months (t=5.5) from now.

What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate?



Question 728  inflation, real and nominal returns and cash flows, income and capital returns, no explanation

Which of the following statements about gold is NOT correct? Assume that the gold price increases by inflation. Gold:



Question 729  book and market values, balance sheet, no explanation

If a firm makes a profit and pays no dividends, which of the following accounts will increase?



Question 730  DDM, income and capital returns, no explanation

A stock’s current price is $1. Its expected total return is 10% pa and its long term expected capital return is 4% pa. It pays an annual dividend and the next one will be paid in one year. All rates are given as effective annual rates. The dividend discount model is thought to be a suitable model for the stock. Ignore taxes. Which of the following statements about the stock is NOT correct?



Question 731  DDM, income and capital returns, no explanation

In the dividend discount model (DDM), share prices fall when dividends are paid. Let the high price before the fall be called the peak, and the low price after the fall be called the trough.

###P_0=\dfrac{C_1}{r-g}###

Which of the following statements about the DDM is NOT correct?



Question 734  real and nominal returns and cash flows, inflation, DDM, no explanation

An equities analyst is using the dividend discount model to price a company's shares. The company operates domestically and has no plans to expand overseas. It is part of a mature industry with stable positive growth prospects.

The analyst has estimated the real required return (r) of the stock and the value of the dividend that the stock just paid a moment before ##(C_\text{0 before})##.

What is the highest perpetual real growth rate of dividends (g) that can be justified? Select the most correct statement from the following choices. The highest perpetual real expected growth rate of dividends that can be justified is the country's expected:



Question 503  DDM, NPV, stock pricing

A share currently worth $100 is expected to pay a constant dividend of $4 for the next 5 years with the first dividend in one year (t=1) and the last in 5 years (t=5).

The total required return is 10% pa.

What do you expected the share price to be in 5 years, just after the dividend at that time has been paid?



Question 365  DDM, stock pricing

Stocks in the United States usually pay quarterly dividends. For example, the software giant Microsoft paid a $0.23 dividend every quarter over the 2013 financial year and plans to pay a $0.28 dividend every quarter over the 2014 financial year.

Using the dividend discount model and net present value techniques, calculate the stock price of Microsoft assuming that:

  • The time now is the beginning of July 2014. The next dividend of $0.28 will be received in 3 months (end of September 2014), with another 3 quarterly payments of $0.28 after this (end of December 2014, March 2015 and June 2015).
  • The quarterly dividend will increase by 2.5% every year, but each quarterly dividend over the year will be equal. So each quarterly dividend paid in the financial year beginning in September 2015 will be $ 0.287 ##(=0.28×(1+0.025)^1)##, with the last at the end of June 2016. In the next financial year beginning in September 2016 each quarterly dividend will be $0.294175 ##(=0.28×(1+0.025)^2)##, with the last at the end of June 2017, and so on forever.
  • The total required return on equity is 6% pa.
  • The required return and growth rate are given as effective annual rates.
  • Dividend payment dates and ex-dividend dates are at the same time.
  • Remember that there are 4 quarters in a year and 3 months in a quarter.

What is the current stock price?



Question 44  NPV

The required return of a project is 10%, given as an effective annual rate. Assume that the cash flows shown in the table are paid all at once at the given point in time.

What is the Net Present Value (NPV) of the project?

Project Cash Flows
Time (yrs) Cash flow ($)
0 -100
1 0
2 121
 



Question 126  IRR

What is the Internal Rate of Return (IRR) of the project detailed in the table below?

Assume that the cash flows shown in the table are paid all at once at the given point in time. All answers are given as effective annual rates.

Project Cash Flows
Time (yrs) Cash flow ($)
0 -100
1 0
2 121
 



Question 37  IRR

If a project's net present value (NPV) is zero, then its internal rate of return (IRR) will be:



Question 60  pay back period

The required return of a project is 10%, given as an effective annual rate.

What is the payback period of the project in years?

Assume that the cash flows shown in the table are received smoothly over the year. So the $121 at time 2 is actually earned smoothly from t=1 to t=2.

Project Cash Flows
Time (yrs) Cash flow ($)
0 -100
1 11
2 121
 



Question 190  pay back period

A project has the following cash flows:

Project Cash Flows
Time (yrs) Cash flow ($)
0 -400
1 0
2 500
 

What is the payback period of the project in years?

Normally cash flows are assumed to happen at the given time. But here, assume that the cash flows are received smoothly over the year. So the $500 at time 2 is actually earned smoothly from t=1 to t=2.



Question 500  NPV, IRR

The below graph shows a project's net present value (NPV) against its annual discount rate.

For what discount rate or range of discount rates would you accept and commence the project?

All answer choices are given as approximations from reading off the graph.



Question 501  NPV, IRR, pay back period

The below graph shows a project's net present value (NPV) against its annual discount rate.

Which of the following statements is NOT correct?



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?



Question 532  mutually exclusive projects, NPV, IRR

An investor owns a whole level of an old office building which is currently worth $1 million. There are three mutually exclusive projects that can be started by the investor. The office building level can be:

  • Rented out to a tenant for one year at $0.1m paid immediately, and then sold for $0.99m in one year.
  • Refurbished into more modern commercial office rooms at a cost of $1m now, and then sold for $2.3m when the refurbishment is finished in one year.
  • Converted into residential apartments at a cost of $2m now, and then sold for $3.4m when the conversion is finished in one year.

All of the development projects have the same risk so the required return of each is 10% pa. The table below shows the estimated cash flows and internal rates of returns (IRR's).

Mutually Exclusive Projects
Project Cash flow
now ($)
Cash flow in
one year ($)
IRR
(% pa)
Rent then sell as is -900,000 990,000 10
Refurbishment into modern offices -2,000,000 2,400,000 20
Conversion into residential apartments -3,000,000 3,400,000 13.33
 

Which project should the investor accept?



Question 579  price gains and returns over time, time calculation, effective rate

How many years will it take for an asset's price to double if the price grows by 10% pa?



Question 580  price gains and returns over time, time calculation, effective rate

How many years will it take for an asset's price to quadruple (be four times as big, say from $1 to $4) if the price grows by 15% pa?



Question 43  pay back period

A project to build a toll road will take 3 years to complete, costing three payments of $50 million, paid at the start of each year (at times 0, 1, and 2).

After completion, the toll road will yield a constant $10 million at the end of each year forever with no costs. So the first payment will be at t=4.

The required return of the project is 10% pa given as an effective nominal rate. All cash flows are nominal.

What is the payback period?



Question 141  time calculation, APR, effective rate

You're trying to save enough money to buy your first car which costs $2,500. You can save $100 at the end of each month starting from now. You currently have no money at all. You just opened a bank account with an interest rate of 6% pa payable monthly.

How many months will it take to save enough money to buy the car? Assume that the price of the car will stay the same over time.



Question 32  time calculation, APR

You really want to go on a back packing trip to Europe when you finish university. Currently you have $1,500 in the bank. Bank interest rates are 8% pa, given as an APR compounding per month. If the holiday will cost $2,000, how long will it take for your bank account to reach that amount?



Question 204  time calculation, fully amortising loan, APR

You just signed up for a 30 year fully amortising mortgage loan with monthly payments of $1,500 per month. The interest rate is 9% pa which is not expected to change.

To your surprise, you can actually afford to pay $2,000 per month and your mortgage allows early repayments without fees. If you maintain these higher monthly payments, how long will it take to pay off your mortgage?



Question 269  time calculation, APR

A student won $1m in a lottery. Currently the money is in a bank account which pays interest at 6% pa, given as an APR compounding per month.

She plans to spend $20,000 at the beginning of every month from now on (so the first withdrawal will be at t=0). After each withdrawal, she will check how much money is left in the account. When there is less than $500,000 left, she will donate that remaining amount to charity.

In how many months will she make her last withdrawal and donate the remainder to charity?



Question 333  DDM, time calculation

When using the dividend discount model, care must be taken to avoid using a nominal dividend growth rate that exceeds the country's nominal GDP growth rate. Otherwise the firm is forecast to take over the country since it grows faster than the average business forever.

Suppose a firm's nominal dividend grows at 10% pa forever, and nominal GDP growth is 5% pa forever. The firm's total dividends are currently $1 billion (t=0). The country's GDP is currently $1,000 billion (t=0).

In approximately how many years will the company's total dividends be as large as the country's GDP?



Question 490  expected and historical returns, accounting ratio

Which of the following is NOT a synonym of 'required return'?



Question 508  income and capital returns

Which of the following equations is NOT equal to the total return of an asset?

Let ##p_0## be the current price, ##p_1## the expected price in one year and ##c_1## the expected income in one year.



Question 136  income and capital returns

A stock was bought for $8 and paid a dividend of $0.50 one year later (at t=1 year). Just after the dividend was paid, the stock price was $7 (at t=1 year).

What were the total, capital and dividend returns given as effective annual rates? The choices are given in the same order:

##r_\text{total}##, ##r_\text{capital}##, ##r_\text{dividend}##.



Question 456  inflation, effective rate

In the 'Austin Powers' series of movies, the character Dr. Evil threatens to destroy the world unless the United Nations pays him a ransom (video 1, video 2). Dr. Evil makes the threat on two separate occasions:

  • In 1969 he demands a ransom of $1 million (=10^6), and again;
  • In 1997 he demands a ransom of $100 billion (=10^11).

If Dr. Evil's demands are equivalent in real terms, in other words $1 million will buy the same basket of goods in 1969 as $100 billion would in 1997, what was the implied inflation rate over the 28 years from 1969 to 1997?

The answer choices below are given as effective annual rates:


Question 363  income and capital returns, inflation, real and nominal returns and cash flows, real estate

A residential investment property has an expected nominal total return of 8% pa and nominal capital return of 3% pa.

Inflation is expected to be 2% pa. All rates are given as effective annual rates.

What are the property's expected real total, capital and income returns? The answer choices below are given in the same order.



Question 155  inflation, real and nominal returns and cash flows, Loan, effective rate conversion

You are a banker about to grant a 2 year loan to a customer. The loan's principal and interest will be repaid in a single payment at maturity, sometimes called a zero-coupon loan, discount loan or bullet loan.

You require a real return of 6% pa over the two years, given as an effective annual rate. Inflation is expected to be 2% this year and 4% next year, both given as effective annual rates.

You judge that the customer can afford to pay back $1,000,000 in 2 years, given as a nominal cash flow. How much should you lend to her right now?



Question 473  market capitalisation of equity

The below screenshot of Commonwealth Bank of Australia's (CBA) details were taken from the Google Finance website on 7 Nov 2014. Some information has been deliberately blanked out.

Image of CBA on Google finance on 7 Nov 2014

What was CBA's market capitalisation of equity?



Question 482  market capitalisation of equity

The below screenshot of Microsoft's (MSFT) details were taken from the Google Finance website on 28 Nov 2014. Some information has been deliberately blanked out.

Image of MSFT on Google finance on 28 Nov 2014

What was MSFT's market capitalisation of equity?



Question 467  book and market values

Which of the following statements about book and market equity is NOT correct?



Question 461  book and market values, ROE, ROA, market efficiency

One year ago a pharmaceutical firm floated by selling its 1 million shares for $100 each. Its book and market values of equity were both $100m. Its debt totalled $50m. The required return on the firm's assets was 15%, equity 20% and debt 5% pa.

In the year since then, the firm:

  • Earned net income of $29m.
  • Paid dividends totaling $10m.
  • Discovered a valuable new drug that will lead to a massive 1,000 times increase in the firm's net income in 10 years after the research is commercialised. News of the discovery was publicly announced. The firm's systematic risk remains unchanged.

Which of the following statements is NOT correct? All statements are about current figures, not figures one year ago.

Hint: Book return on assets (ROA) and book return on equity (ROE) are ratios that accountants like to use to measure a business's past performance.

###\text{ROA}= \dfrac{\text{Net income}}{\text{Book value of assets}}###

###\text{ROE}= \dfrac{\text{Net income}}{\text{Book value of equity}}###

The required return on assets ##r_V## is a return that financiers like to use to estimate a business's future required performance which compensates them for the firm's assets' risks. If the business were to achieve realised historical returns equal to its required returns, then investment into the business's assets would have been a zero-NPV decision, which is neither good nor bad but fair.

###r_\text{V, 0 to 1}= \dfrac{\text{Cash flow from assets}_\text{1}}{\text{Market value of assets}_\text{0}} = \dfrac{CFFA_\text{1}}{V_\text{0}}###

Similarly for equity and debt.



Question 446  working capital decision, corporate financial decision theory

The working capital decision primarily affects which part of a business?



Question 447  payout policy, corporate financial decision theory

Payout policy is most closely related to which part of a business?



Question 452  limited liability, expected and historical returns

What is the lowest and highest expected share price and expected return from owning shares in a company over a finite period of time?

Let the current share price be ##p_0##, the expected future share price be ##p_1##, the expected future dividend be ##d_1## and the expected return be ##r##. Define the expected return as:

##r=\dfrac{p_1-p_0+d_1}{p_0} ##

The answer choices are stated using inequalities. As an example, the first answer choice "(a) ##0≤p<∞## and ##0≤r< 1##", states that the share price must be larger than or equal to zero and less than positive infinity, and that the return must be larger than or equal to zero and less than one.



Question 137  NPV, Annuity

The following cash flows are expected:

  • 10 yearly payments of $60, with the first payment in 3 years from now (first payment at t=3).
  • 1 payment of $400 in 5 years and 6 months (t=5.5) from now.

What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate?



Question 58  NPV, inflation, real and nominal returns and cash flows, Annuity

A project to build a toll bridge will take two years to complete, costing three payments of $100 million at the start of each year for the next three years, that is at t=0, 1 and 2.

After completion, the toll bridge will yield a constant $50 million at the end of each year for the next 10 years. So the first payment will be at t=3 and the last at t=12. After the last payment at t=12, the bridge will be given to the government.

The required return of the project is 21% pa given as an effective annual nominal rate.

All cash flows are real and the expected inflation rate is 10% pa given as an effective annual rate. Ignore taxes.

The Net Present Value is:



Question 3  DDM, income and capital returns

The following equation is called the Dividend Discount Model (DDM), Gordon Growth Model or the perpetuity with growth formula: ### P_0 = \frac{ C_1 }{ r - g } ###

What is ##g##? The value ##g## is the long term expected:



Question 451  DDM

The first payment of a constant perpetual annual cash flow is received at time 5. Let this cash flow be ##C_5## and the required return be ##r##.

So there will be equal annual cash flows at time 5, 6, 7 and so on forever, and all of the cash flows will be equal so ##C_5 = C_6 = C_7 = ...##

When the perpetuity formula is used to value this stream of cash flows, it will give a value (V) at time:



Question 28  DDM, income and capital returns

The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation.

### P_{0} = \frac{C_1}{r_{\text{eff}} - g_{\text{eff}}} ###

What would you call the expression ## C_1/P_0 ##?



Question 216  DDM

A stock just paid its annual dividend of $9. The share price is $60. The required return of the stock is 10% pa as an effective annual rate.

What is the implied growth rate of the dividend per year?



Question 352  income and capital returns, DDM, real estate

Two years ago Fred bought a house for $300,000.

Now it's worth $500,000, based on recent similar sales in the area.

Fred's residential property has an expected total return of 8% pa.

He rents his house out for $2,000 per month, paid in advance. Every 12 months he plans to increase the rental payments.

The present value of 12 months of rental payments is $23,173.86.

The future value of 12 months of rental payments one year ahead is $25,027.77.

What is the expected annual growth rate of the rental payments? In other words, by what percentage increase will Fred have to raise the monthly rent by each year to sustain the expected annual total return of 8%?



Question 161  DDM

A share just paid its semi-annual dividend of $10. The dividend is expected to grow at 2% every 6 months forever. This 2% growth rate is an effective 6 month rate. Therefore the next dividend will be $10.20 in six months. The required return of the stock 10% pa, given as an effective annual rate.

What is the price of the share now?



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?



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 ##?



Question 51  DDM

A stock pays semi-annual dividends. It just paid a dividend of $10. The growth rate in the dividend is 1% every 6 months, given as an effective 6 month rate. You estimate that the stock's required return is 21% pa, as an effective annual rate.

Using the dividend discount model, what will be the share price?



Question 5  DDM

For a price of $6, Carlos will sell you a share which will pay a dividend of $1 in one year and every year after that forever. The required return of the stock is 10% pa.

Would you like to his share or politely ?


Question 8  DDM

For a price of $10.20 each, Renee will sell you 100 shares. Each share is expected to pay dividends in perpetuity, growing at a rate of 5% pa. The next dividend is one year away (t=1) and is expected to be $1 per share.

The required return of the stock is 15% pa.

Would you like to the shares or politely ?


Question 9  DDM, NPV

For a price of $129, Joanne will sell you a share which is expected to pay a $30 dividend in one year, and a $10 dividend every year after that forever. So the stock's dividends will be $30 at t=1, $10 at t=2, $10 at t=3, and $10 forever onwards.

The required return of the stock is 10% pa.

Would you like to the share or politely ?


Question 18  DDM, income and capital returns

The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation.

### p_{0} = \frac{c_1}{r_{\text{eff}} - g_{\text{eff}}} ###

What is the discount rate '## r_\text{eff} ##' in this equation?



Question 54  NPV, DDM

A stock is expected to pay the following dividends:

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

After year 4, the annual dividend will grow in perpetuity at -5% pa. Note that this is a negative growth rate, so the dividend will actually shrink. So,

  • the dividend at t=5 will be ##$1(1-0.05) = $0.95##,
  • the dividend at t=6 will be ##$1(1-0.05)^2 = $0.9025##, 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?



Question 142  DDM, income and capital returns

When using the dividend discount model to price a stock:

### p_{0} = \frac{d_1}{r - g} ###

The growth rate of dividends (g):



Question 270  real estate, DDM, effective rate conversion

You own an apartment which you rent out as an investment property.

What is the price of the apartment using discounted cash flow (DCF, same as NPV) valuation?

Assume that:

  • You just signed a contract to rent the apartment out to a tenant for the next 12 months at $2,000 per month, payable in advance (at the start of the month, t=0). The tenant is just about to pay you the first $2,000 payment.
  • The contract states that monthly rental payments are fixed for 12 months. After the contract ends, you plan to sign another contract but with rental payment increases of 3%. You intend to do this every year.
    So rental payments will increase at the start of the 13th month (t=12) to be $2,060 (=2,000(1+0.03)), and then they will be constant for the next 12 months.
    Rental payments will increase again at the start of the 25th month (t=24) to be $2,121.80 (=2,000(1+0.03)2), and then they will be constant for the next 12 months until the next year, and so on.
  • The required return of the apartment is 8.732% pa, given as an effective annual rate.
  • Ignore all taxes, maintenance, real estate agent, council and strata fees, periods of vacancy and other costs. Assume that the apartment will last forever and so will the rental payments.



Question 463  PE ratio, Multiples valuation

Private equity firms are known to buy medium sized private companies operating in the same industry, merge them together into a larger company, and then sell it off in a public float (initial public offering, IPO).

If medium-sized private companies trade at PE ratios of 5 and larger listed companies trade at PE ratios of 15, what return can be achieved from this strategy?

Assume that:

  • The medium-sized companies can be bought, merged and sold in an IPO instantaneously.
  • There are no costs of finding, valuing, merging and restructuring the medium sized companies. Also, there is no competition to buy the medium-sized companies from other private equity firms.
  • The large merged firm's earnings are the sum of the medium firms' earnings.
  • The only reason for the difference in medium and large firm's PE ratios is due to the illiquidity of the medium firms' shares.
  • Return is defined as: ##r_{0→1} = (p_1-p_0+c_1)/p_0## , where time zero is just before the merger and time one is just after.



Question 354  PE ratio, Multiples valuation

Which firms tend to have low forward-looking price-earnings (PE) ratios?

Only consider firms with positive earnings, disregard firms with negative earnings and therefore negative PE ratios.



Question 364  PE ratio, Multiples valuation

Which firms tend to have high forward-looking price-earnings (PE) ratios?



Question 265  APR, Annuity

On his 20th birthday, a man makes a resolution. He will deposit $30 into a bank account at the end of every month starting from now, which is the start of the month. So the first payment will be in one month. He will write in his will that when he dies the money in the account should be given to charity.

The bank account pays interest at 6% pa compounding monthly, which is not expected to change.

If the man lives for another 60 years, how much money will be in the bank account if he dies just after making his last (720th) payment?



Question 358  PE ratio, Multiples valuation

Estimate the Chinese bank ICBC's share price using a backward-looking price earnings (PE) multiples approach with the following assumptions and figures only. Note that the renminbi (RMB) is the Chinese currency, also known as the yuan (CNY).

  • The 4 major Chinese banks ICBC, China Construction Bank (CCB), Bank of China (BOC) and Agricultural Bank of China (ABC) are comparable companies;
  • ICBC 's historical earnings per share (EPS) is RMB 0.74;
  • CCB's backward-looking PE ratio is 4.59;
  • BOC 's backward-looking PE ratio is 4.78;
  • ABC's backward-looking PE ratio is also 4.78;

Note: Figures sourced from Google Finance on 25 March 2014. Share prices are from the Shanghai stock exchange.



Question 457  PE ratio, Multiples valuation

Which firms tend to have low forward-looking price-earnings (PE) ratios? Only consider firms with positive PE ratios.



Question 330  APR, effective rate, debt terminology

Which of the following statements about effective rates and annualised percentage rates (APR's) is NOT correct?



Question 16  credit card, APR, effective rate

A credit card offers an interest rate of 18% pa, compounding monthly.

Find the effective monthly rate, effective annual rate and the effective daily rate. Assume that there are 365 days in a year.

All answers are given in the same order:

### r_\text{eff monthly} , r_\text{eff yearly} , r_\text{eff daily} ###



Question 131  APR, effective rate

Calculate the effective annual rates of the following three APR's:

  • A credit card offering an interest rate of 18% pa, compounding monthly.
  • A bond offering a yield of 6% pa, compounding semi-annually.
  • An annual dividend-paying stock offering a return of 10% pa compounding annually.

All answers are given in the same order:

##r_\text{credit card, eff yrly}##, ##r_\text{bond, eff yrly}##, ##r_\text{stock, eff yrly}##



Question 372  debt terminology

Which of the following statements is NOT correct? Borrowers:



Question 373  debt terminology

Which of the following statements is NOT correct? Lenders:



Question 581  APR, effective rate, effective rate conversion

A home loan company advertises an interest rate of 6% pa, payable monthly. Which of the following statements about the interest rate is NOT correct? All rates are given to four decimal places.



Question 19  fully amortising loan, APR

You want to buy an apartment priced at $300,000. You have saved a deposit of $30,000. The bank has agreed to lend you the $270,000 as a fully amortising loan with a term of 25 years. The interest rate is 12% pa and is not expected to change.

What will be your monthly payments? Remember that mortgage loan payments are paid in arrears (at the end of the month).



Question 128  debt terminology, needs refinement

An 'interest payment' is the same thing as a 'coupon payment'. or ?


Question 130  debt terminology

An 'interest rate' is the same thing as a 'yield'. or ?


Question 134  fully amortising loan, APR

You want to buy an apartment worth $400,000. You have saved a deposit of $80,000. The bank has agreed to lend you the $320,000 as a fully amortising mortgage loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?



Question 172  fully amortising loan, APR

You just signed up for a 30 year fully amortising mortgage loan with monthly payments of $2,000 per month. The interest rate is 9% pa which is not expected to change.

How much did you borrow? After 5 years, how much will be owing on the mortgage? The interest rate is still 9% and is not expected to change.



Question 203  fully amortising loan, APR

You just signed up for a 30 year fully amortising mortgage loan with monthly payments of $1,500 per month. The interest rate is 9% pa which is not expected to change.

How much did you borrow? After 10 years, how much will be owing on the mortgage? The interest rate is still 9% and is not expected to change.



Question 222  fully amortising loan, APR

You just agreed to a 30 year fully amortising mortgage loan with monthly payments of $2,500. The interest rate is 9% pa which is not expected to change.

How much did you borrow? After 10 years, how much will be owing on the mortgage? The interest rate is still 9% and is not expected to change. The below choices are given in the same order.



Question 29  interest only loan

You want to buy an apartment priced at $300,000. You have saved a deposit of $30,000. The bank has agreed to lend you the $270,000 as an interest only loan with a term of 25 years. The interest rate is 12% pa and is not expected to change.

What will be your monthly payments? Remember that mortgage payments are paid in arrears (at the end of the month).



Question 107  interest only loan

You want to buy an apartment worth $300,000. You have saved a deposit of $60,000.

The bank has agreed to lend you $240,000 as an interest only mortgage loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?



Question 509  bond pricing

Calculate the price of a newly issued ten year bond with a face value of $100, a yield of 8% pa and a fixed coupon rate of 6% pa, paid annually. So there's only one coupon per year, paid in arrears every year.



Question 510  bond pricing

Calculate the price of a newly issued ten year bond with a face value of $100, a yield of 8% pa and a fixed coupon rate of 6% pa, paid semi-annually. So there are two coupons per year, paid in arrears every six months.



Question 616  idiom, debt terminology, bond pricing

"Buy low, sell high" is a phrase commonly heard in financial markets. It states that traders should try to buy assets at low prices and sell at high prices.

Traders in the fixed-coupon bond markets often quote promised bond yields rather than prices. Fixed-coupon bond traders should try to:



Question 133  bond pricing

A bond maturing in 10 years has a coupon rate of 4% pa, paid semi-annually. The bond's yield is currently 6% pa. The face value of the bond is $100. What is its price?



Question 159  bond pricing

A three year bond has a face value of $100, a yield of 6% and a fixed coupon rate of 12%, paid semi-annually. What is its price?



Question 227  bond pricing, premium par and discount bonds

Which one of the following bonds is trading at a premium?



Question 255  bond pricing

In these tough economic times, central banks around the world have cut interest rates so low that they are practically zero. In some countries, government bond yields are also very close to zero.

A three year government bond with a face value of $100 and a coupon rate of 2% pa paid semi-annually was just issued at a yield of 0%. What is the price of the bond?



Question 257  bond pricing

A 10 year bond has a face value of $100, a yield of 6% pa and a fixed coupon rate of 8% pa, paid semi-annually. What is its price?



Question 35  bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

A European company just issued two bonds, a

  • 1 year zero coupon bond at a yield of 8% pa, and a
  • 2 year zero coupon bond at a yield of 10% pa.

What is the company's forward rate over the second year (from t=1 to t=2)? Give your answer as an effective annual rate, which is how the above bond yields are quoted.



Question 485  capital budgeting, opportunity cost, sunk cost

A young lady is trying to decide if she should attend university or not.

The young lady's parents say that she must attend university because otherwise all of her hard work studying and attending school during her childhood was a waste.

What's the correct way to classify this item from a capital budgeting perspective when trying to decide whether to attend university?

The hard work studying at school in her childhood should be classified as:



Question 377  leverage, capital structure

Issuing debt doesn't give away control of the firm because debt holders can't cast votes to determine the company's affairs, such as at the annual general meeting (AGM), and can't appoint directors to the board. or ?


Question 94  leverage, capital structure, real estate

Your friend just bought a house for $400,000. He financed it using a $320,000 mortgage loan and a deposit of $80,000.

In the context of residential housing and mortgages, the 'equity' tied up in the value of a person's house is the value of the house less the value of the mortgage. So the initial equity your friend has in his house is $80,000. Let this amount be E, let the value of the mortgage be D and the value of the house be V. So ##V=D+E##.

If house prices suddenly fall by 10%, what would be your friend's percentage change in equity (E)? Assume that the value of the mortgage is unchanged and that no income (rent) was received from the house during the short time over which house prices fell.

Remember:

### r_{0\rightarrow1}=\frac{p_1-p_0+c_1}{p_0} ###

where ##r_{0-1}## is the return (percentage change) of an asset with price ##p_0## initially, ##p_1## one period later, and paying a cash flow of ##c_1## at time ##t=1##.



Question 374  debt terminology

Which of the following statements is NOT equivalent to the yield on debt?

Assume that the debt being referred to is fairly priced, but do not assume that it's priced at par.



Question 78  WACC, capital structure

A company issues a large amount of bonds to raise money for new projects of similar risk to the company's existing projects. The net present value (NPV) of the new projects is positive but small. Assume a classical tax system. Which statement is NOT correct?



Question 64  inflation, real and nominal returns and cash flows, APR, effective rate

In Germany, nominal yields on semi-annual coupon paying Government Bonds with 2 years until maturity are currently 0.04% pa.

The inflation rate is currently 1.4% pa, given as an APR compounding per quarter. The inflation rate is not expected to change over the next 2 years.

What is the real yield on these bonds, given as an APR compounding every 6 months?



Question 87  fully amortising loan, APR

You want to buy an apartment worth $500,000. You have saved a deposit of $50,000. The bank has agreed to lend you the $450,000 as a fully amortising mortgage loan with a term of 25 years. The interest rate is 6% pa and is not expected to change.

What will be your monthly payments?



Question 149  fully amortising loan, APR

You want to buy an apartment priced at $500,000. You have saved a deposit of $50,000. The bank has agreed to lend you the $450,000 as a fully amortising loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?



Question 187  fully amortising loan, APR

You just signed up for a 30 year fully amortising mortgage with monthly payments of $1,000 per month. The interest rate is 6% pa which is not expected to change.

How much did you borrow? After 20 years, how much will be owing on the mortgage? The interest rate is still 6% and is not expected to change.



Question 259  fully amortising loan, APR

You want to buy a house priced at $400,000. You have saved a deposit of $40,000. The bank has agreed to lend you $360,000 as a fully amortising loan with a term of 30 years. The interest rate is 8% pa payable monthly and is not expected to change.

What will be your monthly payments?



Question 160  interest only loan

You want to buy an apartment priced at $500,000. You have saved a deposit of $50,000. The bank has agreed to lend you the $450,000 as an interest only loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?



Question 298  interest only loan

A prospective home buyer can afford to pay $2,000 per month in mortgage loan repayments. The central bank recently lowered its policy rate by 0.25%, and residential home lenders cut their mortgage loan rates from 4.74% to 4.49%.

How much more can the prospective home buyer borrow now that interest rates are 4.49% rather than 4.74%? Give your answer as a proportional increase over the original amount he could borrow (##V_\text{before}##), so:

###\text{Proportional increase} = \frac{V_\text{after}-V_\text{before}}{V_\text{before}} ###

Assume that:

  • Interest rates are expected to be constant over the life of the loan.

  • Loans are interest-only and have a life of 30 years.

  • Mortgage loan payments are made every month in arrears and all interest rates are given as annualised percentage rates compounding per month.



Question 459  interest only loan, inflation

In Australia in the 1980's, inflation was around 8% pa, and residential mortgage loan interest rates were around 14%.

In 2013, inflation was around 2.5% pa, and residential mortgage loan interest rates were around 4.5%.

If a person can afford constant mortgage loan payments of $2,000 per month, how much more can they borrow when interest rates are 4.5% pa compared with 14.0% pa?

Give your answer as a proportional increase over the amount you could borrow when interest rates were high ##(V_\text{high rates})##, so:

###\text{Proportional increase} = \dfrac{V_\text{low rates}-V_\text{high rates}}{V_\text{high rates}} ###

Assume that:

  • Interest rates are expected to be constant over the life of the loan.
  • Loans are interest-only and have a life of 30 years.
  • Mortgage loan payments are made every month in arrears and all interest rates are given as annualised percentage rates (APR's) compounding per month.



Question 11  bond pricing

For a price of $100, Vera will sell you a 2 year bond paying semi-annual coupons of 10% pa. The face value of the bond is $100. Other bonds with similar risk, maturity and coupon characteristics trade at a yield of 8% pa.

Would you like to her bond or politely ?


Question 15  bond pricing

For a price of $95, Nicole will sell you a 10 year bond paying semi-annual coupons of 8% pa. The face value of the bond is $100. Other bonds with the same risk, maturity and coupon characteristics trade at a yield of 8% pa.

Would you like to the bond or politely ?


Question 33  bond pricing, premium par and discount bonds

Bonds A and B are issued by the same company. They have the same face value, maturity, seniority and coupon payment frequency. The only difference is that bond A has a 5% coupon rate, while bond B has a 10% coupon rate. The yield curve is flat, which means that yields are expected to stay the same.

Which of the following statements will be true about their prices?



Question 38  bond pricing

A two year Government bond has a face value of $100, a yield of 0.5% and a fixed coupon rate of 0.5%, paid semi-annually. What is its price?



Question 48  IRR, NPV, bond pricing, premium par and discount bonds, market efficiency

The theory of fixed interest bond pricing is an application of the theory of Net Present Value (NPV). Also, a 'fairly priced' asset is not over- or under-priced. Buying or selling a fairly priced asset has an NPV of zero.

Considering this, which of the following statements is NOT correct?



Question 53  bond pricing

A two year Government bond has a face value of $100, a yield of 2.5% pa and a fixed coupon rate of 0.5% pa, paid semi-annually. What is its price?



Question 56  income and capital returns, bond pricing, premium par and discount bonds

Which of the following statements about risk free government bonds is NOT correct?

Hint: Total return can be broken into income and capital returns as follows:

###\begin{aligned} r_\text{total} &= \frac{c_1}{p_0} + \frac{p_1-p_0}{p_0} \\ &= r_\text{income} + r_\text{capital} \end{aligned} ###

The capital return is the growth rate of the price.
The income return is the periodic cash flow. For a bond this is the coupon payment.


Question 63  bond pricing, NPV, market efficiency

The theory of fixed interest bond pricing is an application of the theory of Net Present Value (NPV). Also, a 'fairly priced' asset is not over- or under-priced. Buying or selling a fairly priced asset has an NPV of zero.

Considering this, which of the following statements is NOT correct?



Question 138  bond pricing, premium par and discount bonds

Bonds A and B are issued by the same Australian company. Both bonds yield 7% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.

The only difference is that bond A pays coupons of 10% pa and bond B pays coupons of 5% pa. Which of the following statements is true about the bonds' prices?



Question 153  bond pricing, premium par and discount bonds

Bonds X and Y are issued by different companies, but they both pay a semi-annual coupon of 10% pa and they have the same face value ($100) and maturity (3 years).

The only difference is that bond X and Y's yields are 8 and 12% pa respectively. Which of the following statements is true?



Question 163  bond pricing, premium par and discount bonds

Bonds X and Y are issued by different companies, but they both pay a semi-annual coupon of 10% pa and they have the same face value ($100), maturity (3 years) and yield (10%) as each other.

Which of the following statements is true?



Question 168  bond pricing

A four year bond has a face value of $100, a yield of 6% and a fixed coupon rate of 12%, paid semi-annually. What is its price?



Question 179  bond pricing, capital raising

A firm wishes to raise $20 million now. They will issue 8% pa semi-annual coupon bonds that will mature in 5 years and have a face value of $100 each. Bond yields are 6% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?



Question 183  bond pricing

A five year bond has a face value of $100, a yield of 12% and a fixed coupon rate of 6%, paid semi-annually.

What is the bond's price?



Question 193  bond pricing, premium par and discount bonds

Which one of the following bonds is trading at par?



Question 194  bond pricing, capital raising

A firm wishes to raise $8 million now. They will issue 7% pa semi-annual coupon bonds that will mature in 10 years and have a face value of $100 each. Bond yields are 10% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?



Question 207  income and capital returns, bond pricing, coupon rate, no explanation

For a bond that pays fixed semi-annual coupons, how is the annual coupon rate defined, and how is the bond's annual income yield from time 0 to 1 defined mathematically?

Let: ##P_0## be the bond price now,

##F_T## be the bond's face value,

##T## be the bond's maturity in years,

##r_\text{total}## be the bond's total yield,

##r_\text{income}## be the bond's income yield,

##r_\text{capital}## be the bond's capital yield, and

##C_t## be the bond's coupon at time t in years. So ##C_{0.5}## is the coupon in 6 months, ##C_1## is the coupon in 1 year, and so on.



Question 213  income and capital returns, bond pricing, premium par and discount bonds

The coupon rate of a fixed annual-coupon bond is constant (always the same).

What can you say about the income return (##r_\text{income}##) of a fixed annual coupon bond? Remember that:

###r_\text{total} = r_\text{income} + r_\text{capital}###

###r_\text{total, 0 to 1} = \frac{c_1}{p_0} + \frac{p_1-p_0}{p_0}###

Assume that there is no change in the bond's total annual yield to maturity from when it is issued to when it matures.

Select the most correct statement.

From its date of issue until maturity, the income return of a fixed annual coupon:



Question 229  bond pricing

An investor bought two fixed-coupon bonds issued by the same company, a zero-coupon bond and a 7% pa semi-annual coupon bond. Both bonds have a face value of $1,000, mature in 10 years, and had a yield at the time of purchase of 8% pa.

A few years later, yields fell to 6% pa. Which of the following statements is correct? Note that a capital gain is an increase in price.



Question 230  bond pricing, capital raising

A firm wishes to raise $10 million now. They will issue 6% pa semi-annual coupon bonds that will mature in 8 years and have a face value of $1,000 each. Bond yields are 10% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?



Question 233  bond pricing

A four year bond has a face value of $100, a yield of 9% and a fixed coupon rate of 6%, paid semi-annually. What is its price?



Question 266  bond pricing, premium par and discount bonds

Bonds X and Y are issued by the same company. Both bonds yield 10% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.

The only difference is that bond X pays coupons of 6% pa and bond Y pays coupons of 8% pa. Which of the following statements is true?



Question 287  bond pricing

A 30 year Japanese government bond was just issued at par with a yield of 1.7% pa. The fixed coupon payments are semi-annual. The bond has a face value of $100.

Six months later, just after the first coupon is paid, the yield of the bond increases to 2% pa. What is the bond's new price?



Question 328  bond pricing, APR

A 10 year Australian government bond was just issued at par with a yield of 3.9% pa. The fixed coupon payments are semi-annual. The bond has a face value of $1,000.

Six months later, just after the first coupon is paid, the yield of the bond decreases to 3.65% pa. What is the bond's new price?



Question 332  bond pricing, premium par and discount bonds

Bonds X and Y are issued by the same US company. Both bonds yield 6% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.

The only difference is that bond X pays coupons of 8% pa and bond Y pays coupons of 12% pa. Which of the following statements is true?



Question 460  bond pricing, premium par and discount bonds

Below are some statements about loans and bonds. The first descriptive sentence is correct. But one of the second sentences about the loans' or bonds' prices is not correct. Which statement is NOT correct? Assume that interest rates are positive.

Note that coupons or interest payments are the periodic payments made throughout a bond or loan's life. The face or par value of a bond or loan is the amount paid at the end when the debt matures.



Question 96  bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

An Australian company just issued two bonds:

  • A 1 year zero coupon bond at a yield of 8% pa, and
  • A 2 year zero coupon bond at a yield of 10% pa.

What is the forward rate on the company's debt from years 1 to 2? Give your answer as an APR compounding every 6 months, which is how the above bond yields are quoted.



Question 350  CFFA

Find Sidebar Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Sidebar Corp
Income Statement for
year ending 30th June 2013
  $m
Sales 405
COGS 100
Depreciation 34
Rent expense 22
Interest expense 39
Taxable Income 210
Taxes at 30% 63
Net income 147
 
Sidebar Corp
Balance Sheet
as at 30th June 2013 2012
  $m $m
Inventory 70 50
Trade debtors 11 16
Rent paid in advance 4 3
PPE 700 680
Total assets 785 749
 
Trade creditors 11 19
Bond liabilities 400 390
Contributed equity 220 220
Retained profits 154 120
Total L and OE 785 749
 

 

Note: All figures are given in millions of dollars ($m).

The cash flow from assets was:



Question 176  CFFA

Why is Capital Expenditure (CapEx) subtracted in the Cash Flow From Assets (CFFA) formula?

###CFFA=NI+Depr-CapEx - \Delta NWC+IntExp###



Question 225  CFFA

A firm has forecast its Cash Flow From Assets (CFFA) for this year and management is worried that it is too low. Which one of the following actions will lead to a higher CFFA for this year (t=0 to 1)? Only consider cash flows this year. Do not consider cash flows after one year, or the change in the NPV of the firm. Consider each action in isolation.



Question 351  CFFA

Over the next year, the management of an unlevered company plans to:

  • Achieve firm free cash flow (FFCF or CFFA) of $1m.
  • Pay dividends of $1.8m
  • Complete a $1.3m share buy-back.
  • Spend $0.8m on new buildings without buying or selling any other fixed assets. This capital expenditure is included in the CFFA figure quoted above.

Assume that:

  • All amounts are received and paid at the end of the year so you can ignore the time value of money.
  • The firm has sufficient retained profits to pay the dividend and complete the buy back.
  • The firm plans to run a very tight ship, with no excess cash above operating requirements currently or over the next year.

How much new equity financing will the company need? In other words, what is the value of new shares that will need to be issued?



Question 361  CFFA

Over the next year, the management of an unlevered company plans to:

  • Make $5m in sales, $1.9m in net income and $2m in equity free cash flow (EFCF).
  • Pay dividends of $1m.
  • Complete a $1.3m share buy-back.

Assume that:

  • All amounts are received and paid at the end of the year so you can ignore the time value of money.
  • The firm has sufficient retained profits to legally pay the dividend and complete the buy back.
  • The firm plans to run a very tight ship, with no excess cash above operating requirements currently or over the next year.

How much new equity financing will the company need? In other words, what is the value of new shares that will need to be issued?



Question 173  CFFA

Find Candys Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Candys Corp
Income Statement for
year ending 30th June 2013
  $m
Sales 200
COGS 50
Operating expense 10
Depreciation 20
Interest expense 10
Income before tax 110
Tax at 30% 33
Net income 77
 
Candys Corp
Balance Sheet
as at 30th June 2013 2012
  $m $m
Assets
Current assets 220 180
PPE    
    Cost 300 340
    Accumul. depr. 60 40
    Carrying amount 240 300
Total assets 460 480
 
Liabilities
Current liabilities 175 190
Non-current liabilities 135 130
Owners' equity
Retained earnings 50 60
Contributed equity 100 100
Total L and OE 460 480
 

 

Note: all figures are given in millions of dollars ($m).



Question 224  CFFA

Cash Flow From Assets (CFFA) can be defined as:



Question 359  CFFA

Which one of the following will have no effect on net income (NI) but decrease cash flow from assets (CFFA or FFCF) in this year for a tax-paying firm, all else remaining constant?

Remember:

###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c )### ###CFFA=NI+Depr-CapEx - ΔNWC+IntExp###



Question 360  CFFA

Find Ching-A-Lings Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Ching-A-Lings Corp
Income Statement for
year ending 30th June 2013
  $m
Sales 100
COGS 20
Depreciation 20
Rent expense 11
Interest expense 19
Taxable Income 30
Taxes at 30% 9
Net income 21
 
Ching-A-Lings Corp
Balance Sheet
as at 30th June 2013 2012
  $m $m
Inventory 49 38
Trade debtors 14 2
Rent paid in advance 5 5
PPE 400 400
Total assets 468 445
 
Trade creditors 4 10
Bond liabilities 200 190
Contributed equity 145 145
Retained profits 119 100
Total L and OE 468 445
 

 

Note: All figures are given in millions of dollars ($m).

The cash flow from assets was:



Question 504  CFFA

Read the following financial statements and calculate the firm's free cash flow over the 2014 financial year.

UBar Corp
Income Statement for
year ending 30th June 2014
  $m
Sales 293
COGS 200
Rent expense 15
Gas expense 8
Depreciation 10
EBIT 60
Interest expense 0
Taxable income 60
Taxes 18
Net income 42
 
UBar Corp
Balance Sheet
as at 30th June 2014 2013
  $m $m
Assets
Cash 30 29
Accounts receivable 5 7
Pre-paid rent expense 1 0
Inventory 50 46
PPE 290 300
Total assets 376 382
 
Liabilities
Trade payables 20 18
Accrued gas expense 3 2
Non-current liabilities 0 0
Contributed equity 212 212
Retained profits 136 150
Asset revaluation reserve 5 0
Total L and OE 376 382
 

 

Note: all figures are given in millions of dollars ($m).

The firm's free cash flow over the 2014 financial year was:



Question 188  CFFA

Find Trademark Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Trademark Corp
Income Statement for
year ending 30th June 2013
  $m
Sales 100
COGS 25
Operating expense 5
Depreciation 20
Interest expense 20
Income before tax 30
Tax at 30% 9
Net income 21
 
Trademark Corp
Balance Sheet
as at 30th June 2013 2012
  $m $m
Assets
Current assets 120 80
PPE    
    Cost 150 140
    Accumul. depr. 60 40
    Carrying amount 90 100
Total assets 210 180
 
Liabilities
Current liabilities 75 65
Non-current liabilities 75 55
Owners' equity
Retained earnings 10 10
Contributed equity 50 50
Total L and OE 210 180
 

 

Note: all figures are given in millions of dollars ($m).



Question 208  CFFA

Find UniBar Corp's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

UniBar Corp
Income Statement for
year ending 30th June 2013
  $m
Sales 80
COGS 40
Operating expense 15
Depreciation 10
Interest expense 5
Income before tax 10
Tax at 30% 3
Net income 7
 
UniBar Corp
Balance Sheet
as at 30th June 2013 2012
  $m $m
Assets
Current assets 120 90
PPE    
    Cost 360 320
    Accumul. depr. 40 30
    Carrying amount 320 290
Total assets 440 380
 
Liabilities
Current liabilities 110 60
Non-current liabilities 190 180
Owners' equity
Retained earnings 95 95
Contributed equity 45 45
Total L and OE 440 380
 

 

Note: all figures are given in millions of dollars ($m).



Question 209  CFFA

Find Piano Bar's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Piano Bar
Income Statement for
year ending 30th June 2013
  $m
Sales 310
COGS 185
Operating expense 20
Depreciation 15
Interest expense 10
Income before tax 80
Tax at 30% 24
Net income 56
 
Piano Bar
Balance Sheet
as at 30th June 2013 2012
  $m $m
Assets
Current assets 240 230
PPE    
    Cost 420 400
    Accumul. depr. 50 35
    Carrying amount 370 365
Total assets 610 595
 
Liabilities
Current liabilities 180 190
Non-current liabilities 290 265
Owners' equity
Retained earnings 90 90
Contributed equity 50 50
Total L and OE 610 595
 

 

Note: all figures are given in millions of dollars ($m).



Question 226  CFFA

Find World Bar's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

World Bar
Income Statement for
year ending 30th June 2013
  $m
Sales 300
COGS 150
Operating expense 50
Depreciation 40
Interest expense 10
Taxable income 50
Tax at 30% 15
Net income 35
 
World Bar
Balance Sheet
as at 30th June 2013 2012
  $m $m
Assets
Current assets 200 230
PPE    
    Cost 400 400
    Accumul. depr. 75 35
    Carrying amount 325 365
Total assets 525 595
 
Liabilities
Current liabilities 150 205
Non-current liabilities 235 250
Owners' equity
Retained earnings 100 100
Contributed equity 40 40
Total L and OE 525 595
 

 

Note: all figures above and below are given in millions of dollars ($m).



Question 291  CFFA

Find Scubar Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Scubar Corp
Income Statement for
year ending 30th June 2013
  $m
Sales 200
COGS 60
Depreciation 20
Rent expense 11
Interest expense 19
Taxable Income 90
Taxes at 30% 27
Net income 63
 
Scubar Corp
Balance Sheet
as at 30th June 2013 2012
  $m $m
Inventory 60 50
Trade debtors 19 6
Rent paid in advance 3 2
PPE 420 400
Total assets 502 458
 
Trade creditors 10 8
Bond liabilities 200 190
Contributed equity 130 130
Retained profits 162 130
Total L and OE 502 458
 

 

Note: All figures are given in millions of dollars ($m).

The cash flow from assets was:



Question 486  capital budgeting, opportunity cost, sunk cost

A young lady is trying to decide if she should attend university. Her friends say that she should go to university because she is more likely to meet a clever young man than if she begins full time work straight away.

What's the correct way to classify this item from a capital budgeting perspective when trying to find the Net Present Value of going to university rather than working?

The opportunity to meet a desirable future spouse should be classified as:



Question 491  capital budgeting, opportunity cost, sunk cost

A man is thinking about taking a day off from his casual painting job to relax.

He just woke up early in the morning and he's about to call his boss to say that he won't be coming in to work.

But he's thinking about the hours that he could work today (in the future) which are:



Question 492  capital budgeting, opportunity cost, sunk cost

A man has taken a day off from his casual painting job to relax.

It's the end of the day and he's thinking about the hours that he could have spent working (in the past) which are now:



Question 511  capital budgeting, CFFA

Find the cash flow from assets (CFFA) of the following project.

One Year Mining Project Data
Project life 1 year
Initial investment in building mine and equipment $9m
Depreciation of mine and equipment over the year $8m
Kilograms of gold mined at end of year 1,000
Sale price per kilogram $0.05m
Variable cost per kilogram $0.03m
Before-tax cost of closing mine at end of year $4m
Tax rate 30%
 

Note 1: Due to the project, the firm also anticipates finding some rare diamonds which will give before-tax revenues of $1m at the end of the year.

Note 2: The land that will be mined actually has thermal springs and a family of koalas that could be sold to an eco-tourist resort for an after-tax amount of $3m right now. However, if the mine goes ahead then this natural beauty will be destroyed.

Note 3: The mining equipment will have a book value of $1m at the end of the year for tax purposes. However, the equipment is expected to fetch $2.5m when it is sold.

Find the project's CFFA at time zero and one. Answers are given in millions of dollars ($m), with the first cash flow at time zero, and the second at time one.



Question 735  debt terminology

You deposit money into a bank. Which of the following statements is NOT correct? You:



Question 736  debt terminology

You bought a house, primarily funded using a home loan from a bank. Which of the following statements is NOT correct?



Question 737  financial statement, balance sheet, income statement

Where can a publicly listed firm's book value of equity be found? It can be sourced from the company's:



Question 738  financial statement, balance sheet, income statement

Where can a private firm's market value of equity be found? It can be sourced from the company's:



Question 113  WACC, CFFA, capital budgeting

The US firm Google operates in the online advertising business. In 2011 Google bought Motorola Mobility which manufactures mobile phones.

Assume the following:

  • Google had a 10% after-tax weighted average cost of capital (WACC) before it bought Motorola.
  • Motorola had a 20% after-tax WACC before it merged with Google.
  • Google and Motorola have the same level of gearing.
  • Both companies operate in a classical tax system.

You are a manager at Motorola. You must value a project for making mobile phones. Which method(s) will give the correct valuation of the mobile phone manufacturing project? Select the most correct answer.

The mobile phone manufacturing project's:



Question 369  interest tax shield, CFFA

One formula for calculating a levered firm's free cash flow (FFCF, or CFFA) is to use earnings before interest and tax (EBIT).

###\begin{aligned} FFCF &= (EBIT)(1-t_c) + Depr - CapEx -\Delta NWC + IntExp.t_c \\ &= (Rev - COGS - Depr - FC)(1-t_c) + Depr - CapEx -\Delta NWC + IntExp.t_c \\ \end{aligned} \\###
Does this annual FFCF or the annual interest tax shield?


Question 375  interest tax shield, CFFA

One formula for calculating a levered firm's free cash flow (FFCF, or CFFA) is to use net operating profit after tax (NOPAT).

###\begin{aligned} FFCF &= NOPAT + Depr - CapEx -\Delta NWC \\ &= (Rev - COGS - Depr - FC)(1-t_c) + Depr - CapEx -\Delta NWC \\ \end{aligned} \\###
Does this annual FFCF or the annual interest tax shield?


Question 91  WACC, capital structure

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



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 risk to the company's existing projects. Assume a classical tax system. Which statement is correct?



Question 337  capital structure, interest tax shield, leverage, real and nominal returns and cash flows, multi stage growth model

A fast-growing firm is suitable for valuation using a multi-stage growth model.

It's nominal unlevered cash flow from assets (##CFFA_U##) at the end of this year (t=1) is expected to be $1 million. After that it is expected to grow at a rate of:

  • 12% pa for the next two years (from t=1 to 3),
  • 5% over the fourth year (from t=3 to 4), and
  • -1% forever after that (from t=4 onwards). Note that this is a negative one percent growth rate.

Assume that:

  • The nominal WACC after tax is 9.5% pa and is not expected to change.
  • The nominal WACC before tax is 10% pa and is not expected to change.
  • The firm has a target debt-to-equity ratio that it plans to maintain.
  • The inflation rate is 3% pa.
  • All rates are given as nominal effective annual rates.

What is the levered value of this fast growing firm's assets?



Question 379  leverage, capital structure, payout policy

Companies must pay debt holders the interest and principal payments that they promise. But companies do not promise to pay dividends to share holders, dividends are only paid if the company can afford them. or ?


Question 301  leverage, capital structure, real estate

Your friend just bought a house for $1,000,000. He financed it using a $900,000 mortgage loan and a deposit of $100,000.

In the context of residential housing and mortgages, the 'equity' or 'net wealth' tied up in a house is the value of the house less the value of the mortgage loan. Assuming that your friend's only asset is his house, his net wealth is $100,000.

If house prices suddenly fall by 15%, what would be your friend's percentage change in net wealth?

Assume that:

  • No income (rent) was received from the house during the short time over which house prices fell.
  • Your friend will not declare bankruptcy, he will always pay off his debts.



Question 67  CFFA, interest tax shield

Here are the Net Income (NI) and Cash Flow From Assets (CFFA) equations:

###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c)###

###CFFA=NI+Depr-CapEx - \varDelta NWC+IntExp###

What is the formula for calculating annual interest expense (IntExp) which is used in the equations above?

Select one of the following answers. Note that D is the value of debt which is constant through time, and ##r_D## is the cost of debt.



Question 296  CFFA, interest tax shield

Which one of the following will decrease net income (NI) but increase cash flow from assets (CFFA) in this year for a tax-paying firm, all else remaining constant?

Remember:

###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c )### ###CFFA=NI+Depr-CapEx - ΔNWC+IntExp###



Question 89  WACC, CFFA, interest tax shield

A retail furniture company buys furniture wholesale and distributes it through its retail stores. The owner believes that she has some good ideas for making stylish new furniture. She is considering a project to buy a factory and employ workers to manufacture the new furniture she's designed. Furniture manufacturing has more systematic risk than furniture retailing.

Her furniture retailing firm's after-tax WACC is 20%. Furniture manufacturing firms have an after-tax WACC of 30%. Both firms are optimally geared. Assume a classical tax system.

Which method(s) will give the correct valuation of the new furniture-making project? Select the most correct answer.



Question 368  interest tax shield, CFFA

A method commonly seen in textbooks for calculating a levered firm's free cash flow (FFCF, or CFFA) is the following:

###\begin{aligned} FFCF &= (Rev - COGS - Depr - FC - IntExp)(1-t_c) + \\ &\space\space\space+ Depr - CapEx -\Delta NWC + IntExp(1-t_c) \\ \end{aligned}###
Does this annual FFCF or the annual interest tax shield?


Question 371  interest tax shield, CFFA

One method for calculating a firm's free cash flow (FFCF, or CFFA) is to ignore interest expense. That is, pretend that interest expense ##(IntExp)## is zero:

###\begin{aligned} FFCF &= (Rev - COGS - Depr - FC - IntExp)(1-t_c) + Depr - CapEx -\Delta NWC + IntExp \\ &= (Rev - COGS - Depr - FC - 0)(1-t_c) + Depr - CapEx -\Delta NWC - 0\\ \end{aligned}###
Does this annual FFCF with zero interest expense or the annual interest tax shield?


Question 413  CFFA, interest tax shield, depreciation tax shield

There are many ways to calculate a firm's free cash flow (FFCF), also called cash flow from assets (CFFA).

One method is to use the following formulas to transform net income (NI) into FFCF including interest and depreciation tax shields:

###FFCF=NI + Depr - CapEx -ΔNWC + IntExp###

###NI=(Rev - COGS - Depr - FC - IntExp).(1-t_c )###

Another popular method is to use EBITDA rather than net income. EBITDA is defined as:

###EBITDA=Rev - COGS - FC###

One of the below formulas correctly calculates FFCF from EBITDA, including interest and depreciation tax shields, giving an identical answer to that above. Which formula is correct?



Question 69  interest tax shield, capital structure, leverage, WACC

Which statement about risk, required return and capital structure is the most correct?



Question 84  WACC, capital structure, capital budgeting

A firm is considering a new project of similar risk to the current risk of the firm. This project will expand its existing business. The cash flows of the project have been calculated assuming that there is no interest expense. In other words, the cash flows assume that the project is all-equity financed.

In fact the firm has a target debt-to-equity ratio of 1, so the project will be financed with 50% debt and 50% equity. To find the levered value of the firm's assets, what discount rate should be applied to the project's unlevered cash flows? Assume a classical tax system.



Question 121  capital structure, leverage, costs of financial distress, interest tax shield

Fill in the missing words in the following sentence:

All things remaining equal, as a firm's amount of debt funding falls, benefits of interest tax shields __________ and the costs of financial distress __________.



Question 411  WACC, capital structure

A firm plans to issue equity and use the cash raised to pay off its debt. No assets will be bought or sold. Ignore the costs of financial distress.

Which of the following statements is NOT correct, all things remaining equal?



Question 741  APR, effective rate

A home loan company advertises an interest rate of 4.5% pa, payable monthly. Which of the following statements about the interest rate is NOT correct?



Question 742  price gains and returns over time, no explanation

For an asset's price to quintuple every 5 years, what must be its effective annual capital return? Note that a stock's price quintuples when it increases from say $1 to $5.



Question 743  price gains and returns over time, no explanation

How many years will it take for an asset's price to triple (increase from say $1 to $3) if it grows by 5% pa?



Question 744  income and capital returns, real and nominal returns and cash flows, inflation

If someone says "my shares rose by 10% last year", what do you assume that they mean?



Question 746  pay back period

A stock is expected to pay a dividend of $1 in one year. Its future annual dividends are expected to grow by 10% pa. So the first dividend of $1 is in one year, and the year after that the dividend will be $1.1 (=1*(1+0.1)^1), and a year later $1.21 (=1*(1+0.1)^2) and so on forever.

Its required total return is 30% pa. The total required return and growth rate of dividends are given as effective annual rates. The stock is fairly priced.

Calculate the pay back period of buying the stock and holding onto it forever, assuming that the dividends are received as at each time, not smoothly over each year.



Question 747  DDM, no explanation

A share will pay its next dividend of ##C_1## in one year, and will continue to pay a dividend every year after that forever, growing at a rate of ##g##. So the next dividend will be ##C_2=C_1 (1+g)^1##, then ##C_3=C_2 (1+g)^1##, and so on forever.

The current price of the share is ##P_0## and its required return is ##r##

Which of the following is NOT equal to the expected share price in 2 years ##(P_2)## just after the dividend at that time ##(C_2)## has been paid?



Question 749  Multiples valuation, PE ratio, NPV

A real estate agent says that the price of a house in Sydney Australia is approximately equal to the gross weekly rent times 1000.

What type of valuation method is the real estate agent using?



Question 750  PE ratio, Multiples valuation

Itau Unibanco is a major listed bank in Brazil with a market capitalisation of equity equal to BRL 85.744 billion, EPS of BRL 3.96 and 2.97 billion shares on issue.

Banco Bradesco is another major bank with total earnings of BRL 8.77 billion and 2.52 billion shares on issue.

Estimate Banco Bradesco's current share price using a price-earnings multiples approach assuming that Itau Unibanco is a comparable firm.

Note that BRL is the Brazilian Real, their currency. Figures sourced from Google Finance on the market close of the BVMF on 24/7/15.



Question 752  IRR, NPV

All other things remaining equal, a project is worse if its:



Question 751  NPV, Annuity

Telsa Motors advertises that its Model S electric car saves $570 per month in fuel costs. Assume that Tesla cars last for 10 years, fuel and electricity costs remain the same, and savings are made at the end of each month with the first saving of $570 in one month from now.

The effective annual interest rate is 15.8%, and the effective monthly interest rate is 1.23%. What is the present value of the savings?



Question 753  NPV, perpetuity, DDM, no explanation

The following cash flows are expected:

  • A perpetuity of yearly payments of $30, with the first payment in 5 years (first payment at t=5, which continues every year after that forever).
  • One payment of $100 in 6 years and 3 months (t=6.25).

What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate?



Question 754  fully amortising loan, interest only loan

How much more can you borrow using an interest-only loan compared to a 25-year fully amortising loan if interest rates are 4% pa compounding per month and are not expected to change? If it makes it easier, assume that you can afford to pay $2,000 per month on either loan. Express your answer as a proportional increase using the following formula:

###\text{Proportional Increase} = \dfrac{V_\text{0,interest only}}{V_\text{0,fully amortising}} - 1###



Question 755  bond pricing, capital raising, no explanation

A firm wishes to raise $50 million now. They will issue 7% pa semi-annual coupon bonds that will mature in 6 years and have a face value of $100 each. Bond yields are 5% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?



Question 756  bond pricing, capital raising, no explanation

A firm wishes to raise $50 million now. They will issue 5% pa semi-annual coupon bonds that will mature in 3 years and have a face value of $100 each. Bond yields are 6% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?



Question 757  bond pricing, capital raising, no explanation

A firm wishes to raise $50 million now. They will issue 5% pa semi-annual coupon bonds that will mature in 10 years and have a face value of $100 each. Bond yields are 5% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?



Question 758  time calculation, fully amortising loan, no explanation

Two years ago you entered into a fully amortising home loan with a principal of $1,000,000, an interest rate of 6% pa compounding monthly with a term of 25 years.

Then interest rates suddenly fall to 4.5% pa (t=0), but you continue to pay the same monthly home loan payments as you did before. How long will it now take to pay off your home loan? Measure the time taken to pay off the home loan from the current time which is 2 years after the home loan was first entered into.

Assume that the lower interest rate was given to you immediately after the loan repayment at the end of year 2, which was the 24th payment since the loan was granted. Also assume that rates were and are expected to remain constant.



Question 759  time calculation, fully amortising loan, no explanation

Five years ago you entered into a fully amortising home loan with a principal of $500,000, an interest rate of 4.5% pa compounding monthly with a term of 25 years.

Then interest rates suddenly fall to 3% pa (t=0), but you continue to pay the same monthly home loan payments as you did before. How long will it now take to pay off your home loan? Measure the time taken to pay off the home loan from the current time which is 5 years after the home loan was first entered into.

Assume that the lower interest rate was given to you immediately after the loan repayment at the end of year 5, which was the 60th payment since the loan was granted. Also assume that rates were and are expected to remain constant.



Question 760  time calculation, interest only loan, no explanation

Five years ago (##t=-5## years) you entered into an interest-only home loan with a principal of $500,000, an interest rate of 4.5% pa compounding monthly with a term of 25 years.

Then interest rates suddenly fall to 3% pa (##t=0##), but you continue to pay the same monthly home loan payments as you did before. Will your home loan be paid off by the end of its remaining term? If so, in how many years from now? Measure the time taken to pay off the home loan from the current time which is 5 years after the home loan was first entered into.

Assume that the lower interest rate was given to you immediately after the loan repayment at the end of year 5, which was the 60th payment since the loan was granted. Also assume that rates were and are expected to remain constant.



Question 761  NPV, annuity due, no explanation

The phone company Optus have 2 mobile service plans on offer which both have the same amount of phone call, text message and internet data credit. Both plans have a contract length of 24 months and the monthly cost is payable in advance. The only difference between the two plans is that one is a:

  • 'Bring Your Own' (BYO) mobile service plan, costing $80 per month. There is no phone included in this plan. The other plan is a:
  • 'Bundled' mobile service plan that comes with the latest smart phone, costing $100 per month. This plan includes the latest smart phone.

Neither plan has any additional payments at the start or end. Assume that the discount rate is 1% per month given as an effective monthly rate.

The only difference between the plans is the phone, so what is the implied cost of the phone as a present value? Given that the latest smart phone actually costs $600 to purchase outright from another retailer, should you commit to the BYO plan or the bundled plan?



Question 763  multi stage growth model, DDM, no explanation

A stock is expected to pay its first dividend of $20 in 3 years (t=3), which it will continue to pay for the next nine years, so there will be ten $20 payments altogether with the last payment in year 12 (t=12).

From the thirteenth year onward, the dividend is expected to be 4% more than the previous year, forever. So the dividend in the thirteenth year (t=13) will be $20.80, then $21.632 in year 14, and so on forever. The required return of the stock is 10% pa. All rates are effective annual rates. Calculate the current (t=0) stock price.



Question 764  bond pricing, no explanation

A 4.5% fixed coupon Australian Government bond was issued at par in mid-April 2009. Coupons are paid semi-annually in arrears in mid-April and mid-October each year. The face value is $1,000. The bond will mature in mid-April 2020, so the bond had an original tenor of 11 years.

Today is mid-September 2015 and similar bonds now yield 1.9% pa.

What is the bond's new price? Note: there are 10 semi-annual coupon payments remaining from now (mid-September 2015) until maturity (mid-April 2020); both yields are given as APR's compounding semi-annually; assume that the yield curve was flat before the change in yields, and remained flat afterwards as well.



Question 765  bond pricing, no explanation

An investor bought a 5 year government bond with a 2% pa coupon rate at par. Coupons are paid semi-annually. The face value is $100.

Calculate the bond's new price 8 months later after yields have increased to 3% pa. Note that both yields are given as APR's compounding semi-annually. Assume that the yield curve was flat before the change in yields, and remained flat afterwards as well.



Question 766  CFFA, WACC, interest tax shield, DDM

Use the below information to value a levered company with constant annual perpetual cash flows from assets. The next cash flow will be generated in one year from now, so a perpetuity can be used to value this firm. Both the cash flow from assets including and excluding interest tax shields are constant (but not equal to each other).

Data on a Levered Firm with Perpetual Cash Flows
Item abbreviation Value Item full name
##\text{CFFA}_\text{U}## $100m Cash flow from assets excluding interest tax shields (unlevered)
##\text{CFFA}_\text{L}## $112m Cash flow from assets including interest tax shields (levered)
##g## 0% pa Growth rate of cash flow from assets, levered and unlevered
##\text{WACC}_\text{BeforeTax}## 7% pa Weighted average cost of capital before tax
##\text{WACC}_\text{AfterTax}## 6.25% pa Weighted average cost of capital after tax
##r_\text{D}## 5% pa Cost of debt
##r_\text{EL}## 9% pa Cost of levered equity
##D/V_L## 50% pa Debt to assets ratio, where the asset value includes tax shields
##t_c## 30% Corporate tax rate
 

 

What is the value of the levered firm including interest tax shields?



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.



Question 507  leverage, accounting ratio

A firm has a debt-to-equity ratio of 60%. What is its debt-to-assets ratio?



Question 773  CFFA, WACC, interest tax shield, DDM

Use the below information to value a levered company with constant annual perpetual cash flows from assets. The next cash flow will be generated in one year from now, so a perpetuity can be used to value this firm. Both the cash flow from assets including and excluding interest tax shields are constant (but not equal to each other).

Data on a Levered Firm with Perpetual Cash Flows
Item abbreviation Value Item full name
##\text{CFFA}_\text{U}## $48.5m Cash flow from assets excluding interest tax shields (unlevered)
##\text{CFFA}_\text{L}## $50m Cash flow from assets including interest tax shields (levered)
##g## 0% pa Growth rate of cash flow from assets, levered and unlevered
##\text{WACC}_\text{BeforeTax}## 10% pa Weighted average cost of capital before tax
##\text{WACC}_\text{AfterTax}## 9.7% pa Weighted average cost of capital after tax
##r_\text{D}## 5% pa Cost of debt
##r_\text{EL}## 11.25% pa Cost of levered equity
##D/V_L## 20% pa Debt to assets ratio, where the asset value includes tax shields
##t_c## 30% Corporate tax rate
 

 

What is the value of the levered firm including interest tax shields?



Question 524  risk, expected and historical returns, bankruptcy or insolvency, capital structure, corporate financial decision theory, limited liability

Which of the following statements is NOT correct?



Question 578  inflation, real and nominal returns and cash flows

Which of the following statements about inflation is NOT correct?



Question 576  inflation, real and nominal returns and cash flows

What is the present value of a nominal payment of $1,000 in 4 years? The nominal discount rate is 8% pa and the inflation rate is 2% pa.



Question 182  NPV, IRR, pay back period

A project's NPV is positive. Select the most correct statement:



Question 607  debt terminology

You deposit cash into your bank account. Have you or your money?


Question 609  debt terminology

You deposit cash into your bank account. Have you or debt?


Question 610  debt terminology

You deposit cash into your bank account. Does the deposit account represent a debt or to you?


Question 611  debt terminology

You owe money. Are you a or a ?


Question 612  debt terminology

You are owed money. Are you a or a ?


Question 613  debt terminology

You own a debt asset. Are you a or a ?


Question 541  debt terminology

Which of the following statements is NOT correct? Bond investors:



Question 582  APR, effective rate, effective rate conversion

A credit card company advertises an interest rate of 18% pa, payable monthly. Which of the following statements about the interest rate is NOT correct? All rates are given to four decimal places.



Question 80  CAPM, risk, diversification

Diversification is achieved by investing in a large amount of stocks. What type of risk is reduced by diversification?



Question 112  CAPM, risk

According to the theory of the Capital Asset Pricing Model (CAPM), total risk can be broken into two components, systematic risk and idiosyncratic risk. Which of the following events would be considered a systematic, undiversifiable event according to the theory of the CAPM?



Question 79  CAPM, risk

Which statement is the most correct?



Question 559  variance, standard deviation, covariance, correlation

Which of the following statements about standard statistical mathematics notation is NOT correct?



Question 236  diversification, correlation, risk

Diversification in a portfolio of two assets works best when the correlation between their returns is:



Question 111  portfolio risk, correlation

All things remaining equal, the variance of a portfolio of two positively-weighted stocks rises as:



Question 83  portfolio risk, standard deviation

Portfolio Details
Stock Expected
return
Standard
deviation
Correlation ##(\rho_{A,B})## Dollars
invested
A 0.1 0.4 0.5 60
B 0.2 0.6 140
 

What is the standard deviation (not variance) of the above portfolio?



Question 557  portfolio weights, portfolio return

An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of 6% pa.

  • Stock A has an expected return of 5% pa.
  • Stock B has an expected return of 10% pa.

What portfolio weights should the investor have in stocks A and B respectively?



Question 563  correlation

What is the correlation of a variable X with itself?

The corr(X, X) or ##\rho_{X,X}## equals:



Question 284  covariance, correlation

The following table shows a sample of historical total returns of shares in two different companies A and B.

Stock Returns
Total effective annual returns
Year ##r_A## ##r_B##
2007 0.2 0.4
2008 0.04 -0.2
2009 -0.1 -0.3
2010 0.18 0.5
 

What is the historical sample covariance (##\hat{\sigma}_{A,B}##) and correlation (##\rho_{A,B}##) of stock A and B's total effective annual returns?



Question 82  portfolio return

Portfolio Details
Stock Expected
return
Standard
deviation
Correlation Dollars
invested
A 0.1 0.4 0.5 60
B 0.2 0.6 140
 

What is the expected return of the above portfolio?



Question 655  capital budgeting, opportunity cost, sunk cost

The 'time value of money' is most closely related to which of the following concepts?



Question 657  systematic and idiosyncratic risk, CAPM, no explanation

A stock's required total return will decrease when its:



Question 658  CFFA, income statement, balance sheet, no explanation

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 income statement needed? Note that the income statement is sometimes also called the profit and loss, P&L, or statement of financial performance.



Question 659  APR, effective rate, effective rate conversion, no explanation

A home loan company advertises an interest rate of 9% pa, payable monthly. Which of the following statements about the interest rate is NOT correct? All rates are given with an accuracy of 4 decimal places.



Question 660  fully amortising loan, interest only loan, APR

How much more can you borrow using an interest-only loan compared to a 25-year fully amortising loan if interest rates are 6% pa compounding per month and are not expected to change? If it makes it easier, assume that you can afford to pay $2,000 per month on either loan. Express your answer as a proportional increase using the following formula:

###\text{Proportional Increase} = \dfrac{V_\text{0,interest only}}{V_\text{0,fully amortising}} - 1###



Question 661  systematic and idiosyncratic risk, CAPM

A stock's total standard deviation of returns is 20% pa. The market portfolio's total standard deviation of returns is 15% pa. The beta of the stock is 0.8.

What is the stock's diversifiable standard deviation?



Question 662  APR, effective rate, effective rate conversion, no explanation

Which of the following interest rate labels does NOT make sense?



Question 663  leverage, accounting ratio, no explanation

A firm has a debt-to-assets ratio of 20%. What is its debt-to-equity ratio?



Question 664  real and nominal returns and cash flows, inflation, no explanation

What is the present value of real payments of $100 every year forever, with the first payment in one year? The nominal discount rate is 7% pa and the inflation rate is 4% pa.



Question 665  stock split

A company conducts a 10 for 3 stock split. What is the percentage increase in the stock price and the number of shares outstanding? The answers are given in the same order.



Question 626  cross currency interest rate parity, foreign exchange rate, forward foreign exchange rate

The Australian cash rate is expected to be 2% pa over the next one year, while the Japanese cash rate is expected to be 0% pa, both given as nominal effective annual rates. The current exchange rate is 100 JPY per AUD.

What is the implied 1 year forward foreign exchange rate?



Question 617  systematic and idiosyncratic risk, risk, CAPM

A stock's required total return will increase when its:



Question 618  capital structure, no explanation

Who owns a company's shares? The:



Question 561  covariance, correlation

The covariance and correlation of two stocks X and Y's annual returns are calculated over a number of years. The units of the returns are in percent per annum ##(\% pa)##.

What are the units of the covariance ##(\sigma_{X,Y})## and correlation ##(\rho_{X,Y})## of returns respectively?

Hint: Visit Wikipedia to understand the difference between percentage points ##(\text{pp})## and percent ##(\%)##.


Question 306  risk, standard deviation

Let the standard deviation of returns for a share per month be ##\sigma_\text{monthly}##.

What is the formula for the standard deviation of the share's returns per year ##(\sigma_\text{yearly})##?

Assume that returns are independently and identically distributed (iid) so they have zero auto correlation, meaning that if the return was higher than average today, it does not indicate that the return tomorrow will be higher or lower than average.



Question 293  covariance, correlation, portfolio risk

All things remaining equal, the higher the correlation of returns between two stocks:



Question 564  covariance

What is the covariance of a variable X with a constant C?

The cov(X, C) or ##\sigma_{X,C}## equals:



Question 283  portfolio risk, correlation, needs refinement

Three important classes of investable risky assets are:

  • Corporate debt which has low total risk,
  • Real estate which has medium total risk,
  • Equity which has high total risk.

Assume that the correlation between total returns on:

  • Corporate debt and real estate is 0.1,
  • Corporate debt and equity is 0.1,
  • Real estate and equity is 0.5.

You are considering investing all of your wealth in one or more of these asset classes. Which portfolio will give the lowest total risk? You are restricted from shorting any of these assets. Disregard returns and the risk-return trade-off, pretend that you are only concerned with minimising risk.



Question 556  portfolio risk, portfolio return, standard deviation

An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of 12% pa.

  • Stock A has an expected return of 10% pa and a standard deviation of 20% pa.
  • Stock B has an expected return of 15% pa and a standard deviation of 30% pa.

The correlation coefficient between stock A and B's expected returns is 70%.

What will be the annual standard deviation of the portfolio with this 12% pa target return?



Question 558  portfolio weights, portfolio return, short selling

An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of 16% pa.

  • Stock A has an expected return of 8% pa.
  • Stock B has an expected return of 12% pa.

What portfolio weights should the investor have in stocks A and B respectively?



Question 782  portfolio return, portfolio weights

An investor owns a portfolio with:

  • 80% invested in stock A; and
  • 20% invested in stock B.

Today there was a:

  • 10% rise in stock A's price; and
  • No change in stock B's price.

No dividends were paid on either stock. What was the total historical portfolio return on this day? All returns above and answer options below are given as effective daily rates.



Question 808  Markowitz portfolio theory, portfolio return

A graph of assets’ expected returns ##(\mu)## versus standard deviations ##(\sigma)## is given in the below diagram.

Each letter corresponds to a separate coloured area. The portfolios at the boundary of the areas, on the black lines, are excluded from each area. Assume that all assets represented in this graph are fairly priced, and that all risky assets can be short-sold.

Which of the following statements about this graph and Markowitz portfolio theory is NOT correct?

Image of CML graph



Question 279  diversification

Do you think that the following statement is or ? “Buying a single company stock usually provides a safer return than a stock mutual fund.”


Question 294  short selling, portfolio weights

Which of the following statements about short-selling is NOT true?



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, who's 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.



Question 307  risk, variance

Let the variance of returns for a share per month be ##\sigma_\text{monthly}^2##.

What is the formula for the variance of the share's returns per year ##(\sigma_\text{yearly}^2)##?

Assume that returns are independently and identically distributed (iid) so they have zero auto correlation, meaning that if the return was higher than average today, it does not indicate that the return tomorrow will be higher or lower than average.



Question 71  CAPM, risk

Stock A has a beta of 0.5 and stock B has a beta of 1. Which statement is NOT correct?



Question 90  CAPM, risk

According to the theory of the Capital Asset Pricing Model (CAPM), total variance can be broken into two components, systematic variance and idiosyncratic variance. Which of the following events would be considered the most diversifiable according to the theory of the CAPM?



Question 114  WACC, capital structure, risk

A firm's WACC before tax would decrease due to:



Question 235  SML, NPV, CAPM, risk

The security market line (SML) shows the relationship between beta and expected return.

Investment projects that plot on the SML would have:



Question 244  CAPM, SML, NPV, risk

Examine the following graph which shows stocks' betas ##(\beta)## and expected returns ##(\mu)##:

Image of CAPM SML graph

Assume that the CAPM holds and that future expectations of stocks' returns and betas are correctly measured. Which statement is NOT correct?



Question 292  standard deviation, risk

Find the sample standard deviation of returns using the data in the table:

Stock Returns
Year Return pa  
2008 0.3
2009 0.02
2010 -0.2
2011 0.4
 

The returns above and standard deviations below are given in decimal form.



Question 471  risk, accounting ratio

High risk firms in danger of bankruptcy tend to have:



Question 495  risk, accounting ratio, no explanation

High risk firms in danger of bankruptcy tend to have:



Question 628  CAPM, SML, risk, no explanation

Image of CML SML graph

Assets A, B, M and ##r_f## are shown on the graphs above. Asset M is the market portfolio and ##r_f## is the risk free yield on government bonds. Assume that investors can borrow and lend at the risk free rate. Which of the below statements is NOT correct?



Question 669  beta, CAPM, risk

Which of the following is NOT a valid method for estimating the beta of a company's stock? Assume that markets are efficient, a long history of past data is available, the stock possesses idiosyncratic and market risk. The variances and standard deviations below denote total risks.



Question 326  CAPM

A fairly priced stock has an expected return equal to the market's. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. What is the stock's beta?



Question 110  CAPM, SML, NPV

The security market line (SML) shows the relationship between beta and expected return.

Investment projects that plot above the SML would have:



Question 627  CAPM, SML, NPV

Image of CML SML graph

Assets A, B, M and ##r_f## are shown on the graphs above. Asset M is the market portfolio and ##r_f## is the risk free yield on government bonds. Which of the below statements is NOT correct?



Question 672  CAPM, beta

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.

What do you think will be the stock's expected return over the next year, given as an effective annual rate?



Question 116  capital structure, CAPM

A firm changes its capital structure by issuing a large amount of equity and using the funds to repay debt. Its assets are unchanged. Ignore interest tax shields.

According to the Capital Asset Pricing Model (CAPM), which statement is correct?



Question 302  WACC, CAPM

Which of the following statements about the weighted average cost of capital (WACC) is NOT correct?



Question 86  CAPM

Treasury bonds currently have a return of 5% pa. A stock has a beta of 0.5 and the market return is 10% pa. What is the expected return of the stock?



Question 232  CAPM, DDM

A stock has a beta of 0.5. Its next dividend is expected to be $3, paid one year from now. Dividends are expected to be paid annually and grow by 2% pa forever. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. All returns are effective annual rates.

What is the price of the stock now?



Question 72  CAPM, portfolio beta, portfolio risk

Portfolio Details
Stock Expected
return
Standard
deviation
Correlation Beta Dollars
invested
A 0.2 0.4 0.12 0.5 40
B 0.3 0.8 1.5 80
 

What is the beta of the above portfolio?



Question 92  CAPM, SML, CML

Which statement(s) are correct?

(i) All stocks that plot on the Security Market Line (SML) are fairly priced.

(ii) All stocks that plot above the Security Market Line (SML) are overpriced.

(iii) All fairly priced stocks that plot on the Capital Market Line (CML) have zero idiosyncratic risk.

Select the most correct response:



Question 98  capital structure, CAPM

A firm changes its capital structure by issuing a large amount of debt and using the funds to repurchase shares. Its assets are unchanged. Ignore interest tax shields.

According to the Capital Asset Pricing Model (CAPM), which statement is correct?



Question 408  leverage, portfolio beta, portfolio risk, real estate, CAPM

You just bought a house worth $1,000,000. You financed it with an $800,000 mortgage loan and a deposit of $200,000.

You estimate that:

  • The house has a beta of 1;
  • The mortgage loan has a beta of 0.2.

What is the beta of the equity (the $200,000 deposit) that you have in your house?

Also, if the risk free rate is 5% pa and the market portfolio's return is 10% pa, what is the expected return on equity in your house? Ignore taxes, assume that all cash flows (interest payments and rent) were paid and received at the end of the year, and all rates are effective annual rates.



Question 708  continuously compounding rate, continuously compounding rate conversion

Convert a 10% continuously compounded annual rate ##(r_\text{cc annual})## into an effective annual rate ##(r_\text{eff annual})##. The equivalent effective annual rate is:



Question 709  continuously compounding rate, APR

Which of the following interest rate quotes is NOT equivalent to a 10% effective annual rate of return? Assume that each year has 12 months, each month has 30 days, each day has 24 hours, each hour has 60 minutes and each minute has 60 seconds. APR stands for Annualised Percentage Rate.



Question 710  continuously compounding rate, continuously compounding rate conversion

A continuously compounded monthly return of 1% ##(r_\text{cc monthly})## is equivalent to a continuously compounded annual return ##(r_\text{cc annual})## of:



Question 712  effective rate conversion

An effective monthly return of 1% ##(r_\text{eff monthly})## is equivalent to an effective annual return ##(r_\text{eff annual})## of:



Question 725  return distribution, mean and median returns

If a stock's future expected effective annual returns are log-normally distributed, what will be bigger, the stock's or effective annual return? Or would you expect them to be ?


Question 707  continuously compounding rate, continuously compounding rate conversion

Convert a 10% effective annual rate ##(r_\text{eff annual})## into a continuously compounded annual rate ##(r_\text{cc annual})##. The equivalent continuously compounded annual rate is:



Question 711  continuously compounding rate, continuously compounding rate conversion

A continuously compounded semi-annual return of 5% ##(r_\text{cc 6mth})## is equivalent to a continuously compounded annual return ##(r_\text{cc annual})## of:



Question 713  effective rate conversion

An effective semi-annual return of 5% ##(r_\text{eff 6mth})## is equivalent to an effective annual return ##(r_\text{eff annual})## of:



Question 715  return distribution

If a variable, say X, is normally distributed with mean ##\mu## and variance ##\sigma^2## then mathematicians write ##X \sim \mathcal{N}(\mu, \sigma^2)##.

If a variable, say Y, is log-normally distributed and the underlying normal distribution has mean ##\mu## and variance ##\sigma^2## then mathematicians write ## Y \sim \mathbf{ln} \mathcal{N}(\mu, \sigma^2)##.

The below three graphs show probability density functions (PDF) of three different random variables Red, Green and Blue.

PDF graph

Select the most correct statement:



Question 724  return distribution, mean and median returns

If a stock's future expected continuously compounded annual returns are normally distributed, what will be bigger, the stock's or continuously compounded annual return? Or would you expect them to be ?


Question 726  return distribution, mean and median returns

If a stock's future expected future prices are log-normally distributed, what will be bigger, the stock's or future price? Or would you expect them to be ?


Question 799  LVR, leverage, accounting ratio, no explanation

In the home loan market, the acronym LVR stands for Loan to Valuation Ratio. If you bought a house worth one million dollars, partly funded by an $800,000 home loan, then your LVR was 80%. The LVR is equivalent to which of the following ratios?



Question 803  capital raising, rights issue, initial public offering, on market repurchase, no explanation

Which one of the following capital raisings or payouts involve the sale of shares to existing shareholders only?



Question 804  CFFA, WACC, interest tax shield, DDM, no explanation

Use the below information to value a levered company with annual perpetual cash flows from assets that grow. The next cash flow will be generated in one year from now, so a perpetuity can be used to value this firm. Note that ‘k’ means kilo or 1,000. So the $30k is $30,000.

Data on a Levered Firm with Perpetual Cash Flows
Item abbreviation Value Item full name
##\text{CFFA}_\text{U}## $30k Cash flow from assets excluding interest tax shields (unlevered)
##g## 1.5% pa Growth rate of cash flow from assets, levered and unlevered
##r_\text{D}## 4% pa Cost of debt
##r_\text{EL}## 16.3% pa Cost of levered equity
##D/V_L## 80% pa Debt to assets ratio, where the asset value includes tax shields
##t_c## 30% Corporate tax rate
 

 

Which of the following statements is NOT correct?



Question 805  short selling

Short selling is a way to make money from falling prices. In what order must the following steps be completed to short-sell an asset? Let Tom, Dick and Harry be traders in the share market.

  • Step P: Purchase the asset from Harry.
  • Step G: Give the asset to Tom.
  • Step W: Wait and hope that the asset price falls.
  • Step B: Borrow the asset from Tom.
  • Step S: Sell the asset to Dick.

Select the statement with the correct order of steps.



Question 806  stock split, no explanation

A firm conducts a two-for-one stock split. Which of the following consequences would NOT be expected?



Question 807  market efficiency, expected and historical returns, CAPM, beta, systematic risk, no explanation

You work in Asia and just woke up. It looked like a nice day but then you read the news and found out that last night the American share market fell by 10% while you were asleep due to surprisingly poor macro-economic world news. You own a portfolio of liquid stocks listed in Asia with a beta of 1.6. When the Asian equity markets open, what do you expect to happen to your share portfolio? Assume that the capital asset pricing model (CAPM) is correct and that the market portfolio contains all shares in the world, of which American shares are a big part. Your portfolio beta is measured against this world market portfolio.

When the Asian equity market opens for trade, you would expect your portfolio value to:



Question 810  CAPM, systematic and idiosyncratic risk, market efficiency

Examine the graphs below. Assume that asset A is a single stock. Which of the following statements is NOT correct? Asset A:

Image of CML graph



Question 811  log-normal distribution, mean and median returns, return distribution, arithmetic and geometric averages

Which of the following statements about probability distributions is NOT correct?



Question 812  rights issue, no explanation

A firm is about to conduct a 2-for-7 rights issue with a subscription price of $10 per share. They haven’t announced the capital raising to the market yet and the share price is currently $13 per share. Assume that every shareholder will exercise their rights, the cash raised will simply be put in the bank, and the rights issue is completed so quickly that the time value of money can be ignored. Disregard signalling, taxes and agency-related effects.

Which of the following statements about the rights issue is NOT correct? After the rights issue is completed:



Question 464  mispriced asset, NPV, DDM, market efficiency

A company advertises an investment costing $1,000 which they say is underpriced. They say that it has an expected total return of 15% pa, but a required return of only 10% pa. Assume that there are no dividend payments so the entire 15% total return is all capital return.

Assuming that the company's statements are correct, what is the NPV of buying the investment if the 15% return lasts for the next 100 years (t=0 to 100), then reverts to 10% pa after that time? Also, what is the NPV of the investment if the 15% return lasts forever?

In both cases, assume that the required return of 10% remains constant. All returns are given as effective annual rates.

The answer choices below are given in the same order (15% for 100 years, and 15% forever):



Question 813  market efficiency

The famous investor Warren Buffet is one of few portfolio managers who appears to have consistently beaten the market. His company Berkshire Hathaway (BRK) appears to have outperformed the US S&P500 market index, shown in the graph below.

Image of CML graph

Read the below statements about Warren Buffet and the implications for the Efficient Markets Hypothesis (EMH) theory of Eugene Fama. Assume that the first sentence is true. Analyse the second sentence and select the answer option which is NOT correct. In other words, find the false statement in the second sentence.



Question 767  idiom, corporate financial decision theory, no explanation

The sayings "Don't cry over spilt milk", "Don't regret the things that you can't change" and "What's done is done" are most closely related to which financial concept?



Question 768  accounting terminology, book and market values, no explanation

Accountants and finance professionals have lots of names for the same things which can be quite confusing.

Which of the following groups of items are NOT synonyms?



Question 769  short selling, idiom, no explanation

"Buy low, sell high" is a well-known saying. It suggests that investors should buy low then sell high, in that order.

How would you re-phrase that saying to describe short selling?



Question 770  expected and historical returns, income and capital returns, coupon rate, bond pricing, no explanation

Which of the following statements is NOT correct? Assume that all things remain equal. So for example, don't assume that just because a company's dividends and profit rise that its required return will also rise, assume the required return stays the same.



Question 771  debt terminology, interest expense, interest tax shield, credit risk, no explanation

You deposit money into a bank account. Which of the following statements about this deposit is NOT correct?



Question 772  interest tax shield, capital structure, leverage, no explanation

A firm issues debt and uses the funds to buy back equity. Assume that there are no costs of financial distress or transactions costs. Which of the following statements about interest tax shields is NOT correct?



Question 774  leverage, WACC, real estate

One year ago you bought a $1,000,000 house partly funded using a mortgage loan. The loan size was $800,000 and the other $200,000 was your wealth or 'equity' in the house asset.

The interest rate on the home loan was 4% pa.

Over the year, the house produced a net rental yield of 2% pa and a capital gain of 2.5% pa.

Assuming that all cash flows (interest payments and net rental payments) were paid and received at the end of the year, and all rates are given as effective annual rates, what was the total return on your wealth over the past year?

Hint: Remember that wealth in this context is your equity (E) in the house asset (V = D+E) which is funded by the loan (D) and your deposit or equity (E).


Question 775  utility, utility function

Below is a graph of 3 peoples’ utility functions, Mr Blue (U=W^(1/2) ), Miss Red (U=W/10) and Mrs Green (U=W^2/1000). Assume that each of them currently have $50 of wealth.

Utility curves

Which of the following statements about them is NOT correct?

(a) Mr Blue would prefer to invest his wealth in a well diversified portfolio of stocks rather than a single stock, assuming that all stocks had the same total risk and return.



Question 776  market efficiency, systematic and idiosyncratic risk, beta, income and capital returns

Which of the following statements about returns is NOT correct? A stock's:



Question 777  CAPM, beta

The market's expected total return is 10% pa and the risk free rate is 5% pa, both given as effective annual rates.

A stock has a beta of 0.5.

In the last 5 minutes, the federal government unexpectedly raised taxes. Over this time the share market fell by 3%. The risk free rate was unchanged.

What do you think was the stock's historical return over the last 5 minutes, given as an effective 5 minute rate?



Question 780  mispriced asset, NPV, DDM, market efficiency, no explanation

A company advertises an investment costing $1,000 which they say is under priced. They say that it has an expected total return of 15% pa, but a required return of only 10% pa. Of the 15% pa total expected return, the dividend yield is expected to be 4% pa and the capital yield 11% pa. Assume that the company's statements are correct.

What is the NPV of buying the investment if the 15% total return lasts for the next 100 years (t=0 to 100), then reverts to 10% after that time? Also, what is the NPV of the investment if the 15% return lasts forever?

In both cases, assume that the required return of 10% remains constant, the dividends can only be re-invested at 10% pa and all returns are given as effective annual rates. The answer choices below are given in the same order (15% for 100 years, and 15% forever):



Question 117  WACC

A firm can issue 5 year annual coupon bonds at a yield of 8% pa and a coupon rate of 12% pa.

The beta of its levered equity is 1. Five year government bonds yield 5% pa with a coupon rate of 6% pa. The market's expected dividend return is 4% pa and its expected capital return is 6% pa.

The firm's debt-to-equity ratio is 2:1. The corporate tax rate is 30%.

What is the firm's after-tax WACC? Assume a classical tax system.



Question 303  WACC, CAPM, CFFA

There are many different ways to value a firm's assets. Which of the following will NOT give the correct market value of a levered firm's assets ##(V_L)##? Assume that:

  • The firm is financed by listed common stock and vanilla annual fixed coupon bonds, which are both traded in a liquid market.
  • The bonds' yield is equal to the coupon rate, so the bonds are issued at par. The yield curve is flat and yields are not expected to change. When bonds mature they will be rolled over by issuing the same number of new bonds with the same expected yield and coupon rate, and so on forever.
  • Tax rates on the dividends and capital gains received by investors are equal, and capital gains tax is paid every year, even on unrealised gains regardless of when the asset is sold.
  • There is no re-investment of the firm's cash back into the business. All of the firm's excess cash flow is paid out as dividends so real growth is zero.
  • The firm operates in a mature industry with zero real growth.
  • All cash flows and rates in the below equations are real (not nominal) and are expected to be stable forever. Therefore the perpetuity equation with no growth is suitable for valuation.

Where:

###r_\text{WACC before tax} = r_D.\frac{D}{V_L} + r_{EL}.\frac{E_L}{V_L} = \text{Weighted average cost of capital before tax}### ###r_\text{WACC after tax} = r_D.(1-t_c).\frac{D}{V_L} + r_{EL}.\frac{E_L}{V_L} = \text{Weighted average cost of capital after tax}### ###NI_L=(Rev-COGS-FC-Depr-\mathbf{IntExp}).(1-t_c) = \text{Net Income Levered}### ###CFFA_L=NI_L+Depr-CapEx - \varDelta NWC+\mathbf{IntExp} = \text{Cash Flow From Assets Levered}### ###NI_U=(Rev-COGS-FC-Depr).(1-t_c) = \text{Net Income Unlevered}### ###CFFA_U=NI_U+Depr-CapEx - \varDelta NWC= \text{Cash Flow From Assets Unlevered}###

Question 706  utility, risk aversion, utility function

Mr Blue, Miss Red and Mrs Green are people with different utility functions.

Note that a fair gamble is a bet that has an expected value of zero, such as paying $0.50 to win $1 in a coin flip with heads or nothing if it lands tails. Fairly priced insurance is when the expected present value of the insurance premiums is equal to the expected loss from the disaster that the insurance protects against, such as the cost of rebuilding a home after a catastrophic fire.

Which of the following statements is NOT correct?

Utility curves



Question 705  utility, risk aversion, utility function

Mr Blue, Miss Red and Mrs Green are people with different utility functions.

Which of the following statements is NOT correct?

Utility curves



Question 704  utility, risk aversion, utility function, gamble

Mr Blue, Miss Red and Mrs Green are people with different utility functions.

Each person has $256 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $256. Each player can flip a coin and if they flip heads, they receive $256. If they flip tails then they will lose $256. Which of the following statements is NOT correct?

Utility curves



Question 695  utility, risk aversion, utility function

Mr Blue, Miss Red and Mrs Green are people with different utility functions. Which of the statements about the 3 utility functions is NOT correct?

Utility curves



Question 696  utility, risk aversion, utility function

Mr Blue, Miss Red and Mrs Green are people with different utility functions. Which of the statements about the 3 utility functions is NOT correct?

Utility curves



Question 698  utility, risk aversion, utility function

Mr Blue, Miss Red and Mrs Green are people with different utility functions. Which of the statements about the 3 utility functions is NOT correct?

Utility curves



Question 699  utility, risk aversion, utility function, gamble

Mr Blue, Miss Red and Mrs Green are people with different utility functions.

Each person has $50 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $50. Each player can flip a coin and if they flip heads, they receive $50. If they flip tails then they will lose $50. Which of the following statements is NOT correct?

Utility curves



Question 701  utility, risk aversion, utility function, gamble

Mr Blue, Miss Red and Mrs Green are people with different utility functions.

Each person has $50 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $50. Each player can flip a coin and if they flip heads, they receive $50. If they flip tails then they will lose $50. Which of the following statements is NOT correct?

Utility curves



Question 243  fundamental analysis, market efficiency

Fundamentalists who analyse company financial reports and news announcements (but who don't have inside information) will make positive abnormal returns if:



Question 339  bond pricing, inflation, market efficiency, income and capital returns

Economic statistics released this morning were a surprise: they show a strong chance of consumer price inflation (CPI) reaching 5% pa over the next 2 years.

This is much higher than the previous forecast of 3% pa.

A vanilla fixed-coupon 2-year risk-free government bond was issued at par this morning, just before the economic news was released.

What is the expected change in bond price after the economic news this morning, and in the next 2 years? Assume that:

  • Inflation remains at 5% over the next 2 years.
  • Investors demand a constant real bond yield.
  • The bond price falls by the (after-tax) value of the coupon the night before the ex-coupon date, as in real life.



Question 623  market efficiency, no explanation

The efficient markets hypothesis (EMH) and no-arbitrage pricing theory is most closely related to which of the following concepts?



Question 100  market efficiency, technical analysis, joint hypothesis problem

A company selling charting and technical analysis software claims that independent academic studies have shown that its software makes significantly positive abnormal returns. Assuming the claim is true, which statement(s) are correct?

(I) Weak form market efficiency is broken.

(II) Semi-strong form market efficiency is broken.

(III) Strong form market efficiency is broken.

(IV) The asset pricing model used to measure the abnormal returns (such as the CAPM) had mis-specification error so the returns may not be abnormal but rather fair for the level of risk.

Select the most correct response:



Question 242  technical analysis, market efficiency

Select the most correct statement from the following.

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



Question 416  real estate, market efficiency, income and capital returns, DDM, CAPM

A residential real estate investor believes that house prices will grow at a rate of 5% pa and that rents will grow by 2% pa forever.

All rates are given as nominal effective annual returns. Assume that:

  • His forecast is true.
  • Real estate is and always will be fairly priced and the capital asset pricing model (CAPM) is true.
  • Ignore all costs such as taxes, agent fees, maintenance and so on.
  • All rental income cash flow is paid out to the owner, so there is no re-investment and therefore no additions or improvements made to the property.
  • The non-monetary benefits of owning real estate and renting remain constant.

Which one of the following statements is NOT correct? Over time:



Question 569  personal tax

The average weekly earnings of an Australian adult worker before tax was $1,542.40 per week in November 2014 according to the Australian Bureau of Statistics. Therefore average annual earnings before tax were $80,204.80 assuming 52 weeks per year. Personal income tax rates published by the Australian Tax Office are reproduced for the 2014-2015 financial year in the table below:

Taxable income Tax on this income
0 – $18,200 Nil
$18,201 – $37,000 19c for each $1 over $18,200
$37,001 – $80,000 $3,572 plus 32.5c for each $1 over $37,000
$80,001 – $180,000 $17,547 plus 37c for each $1 over $80,000
$180,001 and over $54,547 plus 45c for each $1 over $180,000
 

The above rates do not include the Medicare levy of 2%. Exclude the Medicare levy from your calculations

How much personal income tax would you have to pay per year if you earned $80,204.80 per annum before-tax?



Question 449  personal tax on dividends, classical tax system

A small private company has a single shareholder. This year the firm earned a $100 profit before tax. All of the firm's after tax profits will be paid out as dividends to the owner.

The corporate tax rate is 30% and the sole shareholder's personal marginal tax rate is 45%.

The United States' classical tax system applies because the company generates all of its income in the US and pays corporate tax to the Internal Revenue Service. The shareholder is also an American for tax purposes.

What will be the personal tax payable by the shareholder and the corporate tax payable by the company?



Question 624  franking credit, personal tax on dividends, imputation tax system, no explanation

Which of the following statements about Australian franking credits is NOT correct? Franking credits:



Question 448  franking credit, personal tax on dividends, imputation tax system

A small private company has a single shareholder. This year the firm earned a $100 profit before tax. All of the firm's after tax profits will be paid out as dividends to the owner.

The corporate tax rate is 30% and the sole shareholder's personal marginal tax rate is 45%.

The Australian imputation tax system applies because the company generates all of its income in Australia and pays corporate tax to the Australian Tax Office. Therefore all of the company's dividends are fully franked. The sole shareholder is an Australian for tax purposes and can therefore use the franking credits to offset his personal income tax liability.

What will be the personal tax payable by the shareholder and the corporate tax payable by the company?



Question 454  NPV, capital structure, capital budgeting

A mining firm has just discovered a new mine. So far the news has been kept a secret.

The net present value of digging the mine and selling the minerals is $250 million, but $500 million of new equity and $300 million of new bonds will need to be issued to fund the project and buy the necessary plant and equipment.

The firm will release the news of the discovery and equity and bond raising to shareholders simultaneously in the same announcement. The shares and bonds will be issued shortly after.

Once the announcement is made and the new shares and bonds are issued, what is the expected increase in the value of the firm's assets ##(\Delta V)##, market capitalisation of debt ##(\Delta D)## and market cap of equity ##(\Delta E)##? Assume that markets are semi-strong form efficient.

The triangle symbol ##\Delta## is the Greek letter capital delta which means change or increase in mathematics.

Ignore the benefit of interest tax shields from having more debt.

Remember: ##\Delta V = \Delta D+ \Delta E##



Question 568  rights issue, capital raising, capital structure

A company conducts a 1 for 5 rights issue at a subscription price of $7 when the pre-announcement stock price was $10. What is the percentage change in the stock price and the number of shares outstanding? The answers are given in the same order. Ignore all taxes, transaction costs and signalling effects.



Question 625  dividend re-investment plan, capital raising

Which of the following statements about dividend re-investment plans (DRP's) is NOT correct?



Question 214  rights issue

In late 2003 the listed bank ANZ announced a 2-for-11 rights issue to fund the takeover of New Zealand bank NBNZ. Below is the chronology of events:

  • 23/10/2003. Share price closes at $18.30.

  • 24/10/2003. 2-for-11 rights issue announced at a subscription price of $13. The proceeds of the rights issue will be used to acquire New Zealand bank NBNZ. Trading halt announced in morning before market opens.

  • 28/10/2003. Trading halt lifted. Last (and only) day that shares trade cum-rights. Share price opens at $18.00 and closes at $18.14.

  • 29/10/2003. Shares trade ex-rights.

All things remaining equal, what would you expect ANZ's stock price to open at on the first day that it trades ex-rights (29/10/2003)? Ignore the time value of money since time is negligibly short. Also ignore taxes.



Question 633  personal tax

In 2014 the median starting salaries of male and female Australian bachelor degree accounting graduates aged less than 25 years in their first full-time industry job was $50,000 before tax, according to Graduate Careers Australia. See page 9 of this report. Personal income tax rates published by the Australian Tax Office are reproduced for the 2014-2015 financial year in the table below.

Taxable income Tax on this income
0 – $18,200 Nil
$18,201 – $37,000 19c for each $1 over $18,200
$37,001 – $80,000 $3,572 plus 32.5c for each $1 over $37,000
$80,001 – $180,000 $17,547 plus 37c for each $1 over $80,000
$180,001 and over $54,547 plus 45c for each $1 over $180,000
 

The above rates do not include the Medicare levy of 2%. Exclude the Medicare levy from your calculations

How much personal income tax would you have to pay per year if you earned $50,000 per annum before-tax?



Question 494  franking credit, personal tax on dividends, imputation tax system

A firm pays a fully franked cash dividend of $100 to one of its Australian shareholders who has a personal marginal tax rate of 15%. The corporate tax rate is 30%.

What will be the shareholder's personal tax payable due to the dividend payment?



Question 70  payout policy

Due to floods overseas, there is a cut in the supply of the mineral iron ore and its price increases dramatically. An Australian iron ore mining company therefore expects a large but temporary increase in its profit and cash flows. The mining company does not have any positive NPV projects to begin, so what should it do? Select the most correct answer.



Question 409  NPV, capital structure, capital budgeting

A pharmaceutical firm has just discovered a valuable new drug. So far the news has been kept a secret.

The net present value of making and commercialising the drug is $200 million, but $600 million of bonds will need to be issued to fund the project and buy the necessary plant and equipment.

The firm will release the news of the discovery and bond raising to shareholders simultaneously in the same announcement. The bonds will be issued shortly after.

Once the announcement is made and the bonds are issued, what is the expected increase in the value of the firm's assets (ΔV), market capitalisation of debt (ΔD) and market cap of equity (ΔE)?

The triangle symbol is the Greek letter capital delta which means change or increase in mathematics.

Ignore the benefit of interest tax shields from having more debt.

Remember: ##ΔV = ΔD+ΔE##



Question 513  stock split, reverse stock split, stock dividend, bonus issue, rights issue

Which of the following statements is NOT correct?



Question 567  stock split, capital structure

A company conducts a 4 for 3 stock split. What is the percentage change in the stock price and the number of shares outstanding? The answers are given in the same order.



Question 566  capital structure, capital raising, rights issue, on market repurchase, dividend, stock split, bonus issue

A company's share price fell by 20% and its number of shares rose by 25%. Assume that there are no taxes, no signalling effects and no transaction costs.

Which one of the following corporate events may have happened?



Question 212  rights issue

In mid 2009 the listed mining company Rio Tinto announced a 21-for-40 renounceable rights issue. Below is the chronology of events:

  • 04/06/2009. Share price opens at $69.00 and closes at $66.90.

  • 05/06/2009. 21-for-40 rights issue announced at a subscription price of $28.29.

  • 16/06/2009. Last day that shares trade cum-rights. Share price opens at $76.40 and closes at $75.50.

  • 17/06/2009. Shares trade ex-rights. Rights trading commences.

All things remaining equal, what would you expect Rio Tinto's stock price to open at on the first day that it trades ex-rights (17/6/2009)? Ignore the time value of money since time is negligibly short. Also ignore taxes.



Question 455  income and capital returns, payout policy, DDM, market efficiency

A fairly priced unlevered firm plans to pay a dividend of $1 next year (t=1) which is expected to grow by 3% pa every year after that. The firm's required return on equity is 8% pa.

The firm is thinking about reducing its future dividend payments by 10% so that it can use the extra cash to invest in more projects which are expected to return 8% pa, and have the same risk as the existing projects. Therefore, next year's dividend will be $0.90.

What will be the stock's new annual capital return (proportional increase in price per year) if the change in payout policy goes ahead?

Assume that payout policy is irrelevant to firm value and that all rates are effective annual rates.




Copyright © 2014 Keith Woodward