Financial Management Final Exam

1. Portfolio diversification reduces the variability of the returns on each security
held in the portfolio.

a. True
b. False

2. A stock’s beta is more relevant as a measure of risk to an investor with a
well-diversified portfolio than to an investor who holds only one stock.

a. True
b. False

3. You are an investor in common stock, and you currently hold a well-diversified
portfolio which has an expected return of 12 percent, a beta of 1.2, and a total
value of $9,000. You plan to increase your portfolio by buying 100 shares of AT&E at
$10 a share. AT&E has an expected return of 20 percent with a beta of 2.0. What
will be the expected return and the beta of your portfolio after you purchase the new

a. k p = 20.0%; b p = 2.00
b. k p = 12.8%; b p = 1.28
c. k p = 12.0%; b p = 1.20
d. k p = 13.2%; b p = 1.40
e. k p = 14.0%; b p = 1.32

4. Calculate the standard deviation of the dollar returns for Ditto Copier Center, given
the following distribution of returns:

Probability Return

0.2 $50
0.5 $20
0.3 -$15

a. $36.0
b. $23.0
c. $18.0
d. $13.0
e. $30.0

5. You have determined the profitability of a planned project by finding the present
value of all the cash flows from that project. Which of the following would cause
the project to look more appealing in terms of the present value of those cash flows?

a. The discount rate decreases.
b. The cash flows are extended over a longer period of time, but the total amount of
the cash flows remains the same.
c. The discount rate increases.
d. Answers b and c above.
e. Answers a and b above.

6. As the winning contestant in a television game show, you are considering the prizes
to be awarded. You must indicate to the sponsor which of the following two choices
you prefer, assuming you want to maximize your wealth. Assume it is now January 1,
and there is no danger whatever that the sponsor won’t pay off.

(1) $1,000 now and another $1,000 at the beginning of each of the 11 subsequent
months during the remainder of the year, to be deposited in an account paying a
12 percent nominal annual rate, but compounded monthly (to be left on deposit for
the year).

(2) $12,750 at the end of the year.

Which one would you choose?

a. Choice 1.
b. Choice 2.
c. Choice 1, if the payments were made at the end of each month.
d. The choice would depend on how soon you need the money.
e. Either one, since they have the same present value.

7. Assume you are to receive a 20-year annuity with annual payments of $50. The first
payment will be received at the end of Year 1, and the last payment will be received
at the end of Year 20. You will invest each payment in an account that pays 10
percent. What will be the value in your account at the end of Year 30?

a. $6,354.81
b. $7,427.83
c. $7,922.33
d. $8,591.00
e. $6,752.46

8. Other things held constant, an increase in the cost of capital discount rate will
result in a decrease of a project’s IRR.

a. True
b. False

9. As the director of capital budgeting for Denver Corporation, you are evaluating two
mutually exclusive projects with the following net cash flows:


Year Project X Project Z

0 -$100,000 -$100,000
1 50,000 10,000
2 40,000 30,000
3 30,000 40,000
4 10,000 60,000

If Denver’s cost of capital is 15 percent, which project would you choose?
a. Neither project.
b. Project X, since it has the higher IRR.
c. Project Z, since it has the higher NPV.
d. Project X, since it has the higher NPV.
e. Project Z, since it has the higher IRR.

10. Los Angeles Lumber Company (LALC) is considering a project with a cost of $1,000 at
time = 0 and inflows of $300 at the end of Years 1 – 5. LALC’s cost of capital is 10
percent. What is the project’s modified IRR (MIRR)?

a. 10.0%
b. 12.9%
c. 15.2%
d. 18.3%
e. 20.7%

11. Financial risk refers to the extra risk stockholders bear as a result of the use of
debt as compared with the risk they would bear if no debt were used.

a. True
b. False

12. Two firms, although they operate in different industries, have the same expected
earnings per share and the same standard deviation of expected EPS. Thus, the two
firms must have the same business risk .

a. True
b. False

13. Business risk is concerned with the operations of the firm. Which of the following is
not associated with (or not a part of) business risk?

a. Demand variability.
b. Sales price variability.
c. The extent to which operating costs are fixed.
d. Changes in required returns due to financing decisions.
e. The ability to change prices as costs change.

14. If you know that your firm is facing relatively poor prospects but needs new capital,
and you know that investors do not have this information, signaling theory would
predict that you would

a. Issue debt to maintain the returns of equity holders.
b. Issue equity to share the burden of decreased equity returns between old and new
c. Be indifferent between issuing debt and equity.
d. Postpone going into capital markets until your firm’s prospects improve.
e. Convey your inside information to investors using the media to eliminate the
information asymmetry.

15. Copybold Corporation is a start-up firm considering two alternative capital structures
C one is conservative and the other aggressive. The conservative capital structure
calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75 . Once the
firm selects its target capital structure it envisions two possible scenarios for its
operations : Feast or Famine. The Feast scenario has a 60 percent probability of
occurring and forecast EBIT in this state is $60,000 . The Famine state has a 40
percent chance of occurring and the EBIT is expected to be $20,000 . Further, if the
firm selects the conservative capital structure its cost of debt will be 10 percent, while
the aggressive capital structure its debt cost will be 12 percent. The firm will have
$400,000 in total assets, it will face a 40 percent marginal tax rate, and the book
value of equity per share under either scenario is $10.00 per share.

What is the difference between the EPS forecasts for Feast and Famine under the
aggressive capital structure?

a. $ 0
b. $1.48
c. $0.62
d. $0.98
e. $2.40

16. According to today’s Wall Street Journal, the spot exchange rate for the Deutsche mark is
DM 1 = $.83. The six-month forward exchange rate is DM 1 = $.67. Which statement
below is true?

I. The Deutsche mark is selling at a discount relative to the dollar.

II. The Deutsche mark is selling at a premium relative to the dollar.

III. The dollar is selling at a discount relative to the Deutsche mark.

IV. The dollar is selling at a premium relative to the Deutsche mark.

A. I only
B. II and IV only
C. I and III only
D. I and IV only
E. II and III only

17. Suppose you are reviewing the exchange rates for the Irish Punt (P), the Swiss France (SF)
and the U.S. Dollar ($). You see the following quotes: P6 per $1; SF .5 per $1. What is
the cross-rate for Punts per Swiss France?

A. P.083 per SF1 D. P7.50 per SF1
B. P.50 per SF1 E. P12.00 per SF1
C. P4 per SF1

18. Suppose U.S. inflation is predicted to be 4% next year. The Barnes group tells you that
inflation in England is expected to be 10%. The current exchange rate is ,1.2 pounds per
$1.00. What is your best guess as to next year’s exchange rate?

a.. 1.001 pounds per $1.00
B. 1.038 pounds per $1.00
C. 1.117 pounds per $1.00
D. 1.272 pounds per $1.00
E. 1.480 pounds per $1.00

19. The current exchange rate between the U.S. and Mexico is Ps800 per $1.00. The nominal
risk-free rate in the U.S. is 4 %, while the Mexican rate is 17 %. What is the only possible
forward rate that could prevail that would eliminate any arbitrage opportunities?

A. Ps455.00 per $1.00
B. Ps558.72 per $1.00
C. Ps645.00 per $1.00
D. Ps885.00 per $1.00
E. Ps900.00 per $1.00

20. The 60-day forward rate for Japanese Yen is -112.16 per $1.00. The spot rate is -103.9
per $1.00. In 60 days you expect to receive -500,000. If you agree to a forward contract,
how many dollars will you receive in 60 days?

A. $4,458
B. $4,812
C. $5,312
D. $51.95 million
E. $56.08 million


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