ITU

Faculty of Management
Depertament of Management Engineering
FINANCE – ISL 333E
FINAL EXAM
NAME:
2019-2020 Fall NO :
Duration: 90 minutes

SECTION A
MULTIPLE CHOICE QUESTIONS (each 3 pts)

1. Stock X and Stock Y each have an expected return of 12%, a beta of 1.2, and a
standard deviation of 25%. The returns on the two stocks have a correlation of 0.6.
Portfolio P has half of its money invested in Stock X and half in Stock Y. Which of the
following statements is most correct?

a. Portfolio P has an expected return of 12%.

b. Portfolio P has a standard deviation of 25%.
c. Portfolio P has a beta of 1.2.
d. Statements a and c are correct.
e. All of the statements above are correct.

2. A stock’s dividend is expected to grow at a constant rate of 10% a year. Which of

the following statements is most correct?

a. The expected return on the stock is 10% a year.

b. The stock’s dividend yield is 10%.
c. The stock’s price one year from now is expected to be 10% higher.
d. Statements a and c are correct.
e. All of the statements above are correct.

3. Which of the following statements is most correct?

a. Higher flotation costs reduce investor returns, and therefore reduce a

company’s WACC.
b. The WACC represents the historical cost of capital and is usually calculated
on a before-tax basis.
c. The cost of retained earnings is zero because retained earnings are readily
available and do not require the payment of flotation costs.
d. All of the statements above are correct.
e. None of the statements above is correct.

4. Which of the following statements is most correct?

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 a. If a project’s internal rate of return (IRR) exceeds the cost of capital, then the
project’s net present value (NPV) must be positive.
b. If Project A has a higher IRR than Project B, then Project A must also have a
higher NPV.
c. The IRR calculation implicitly assumes that all cash flows are reinvested at a
rate of return equal to the cost of capital.
d. Statements a and c are correct.
e. None of the statements above is correct.

5. A company is considering a new project. The company’s CFO plans to calculate the
project’s NPV by discounting the relevant cash flows (which include the initial up-front
costs, the operating cash flows, and the terminal cash flows) at the company’s cost of
capital (WACC). Which of the following factors should the CFO include when estimating
the relevant cash flows?

a. Any sunk costs associated with the project.

b. Any interest expenses associated with the project.
c. Any opportunity costs associated with the project.
d. Statements b and c are correct.
e. All of the statements above are correct.

6. Which of the following are not real options?

a. The option to expand production if the product is successful.

b. The option to buy additional shares of stock if the stock price goes up.
c. The option to expand into a new geographic region.
d. The option to abandon a project.
e. The option to switch sources of fuel used in an industrial furnace.

7. Stock A has an expected return of 10% and a standard deviation of 20%. Stock B
has an expected return of 12% and a standard deviation of 30%. The risk-free rate is 5%
and the market risk premium, r - r , is 6%. Assume that the market is in equilibrium.
M RF

Portfolio P has 50% invested in Stock A and 50% invested in Stock B. The returns of
Stock A and Stock B are independent of one another (i.e., their correlation coefficient
equals zero.). Which of the following statements is most correct?

a. Portfolio P’s expected return is 11%.

b. Portfolio P’s standard deviation is less than 25%.
c. Stock B’s beta is 1.25.
d. Statements a and b are correct.
e. All of the statements above are correct.

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8. If a company uses the same cost of capital for evaluating all projects, which of the
following results is likely?

a. Accepting poor, high-risk projects.

b. Rejecting good, low-risk projects.
c. Accepting only good, low-risk projects.
d. Accepting no projects.
e. Answers a and b are correct.

9. Normal projects C and D are mutually exclusive. Project C has a higher net present
value if the WACC is less than 12%, whereas Project D has a higher net present value if
the WACC exceeds 12%. Which of the following statements is most correct?

a. Project D has a higher internal rate of return.

b. Project D is probably larger in scale than Project C.
c. Project C probably has a faster payback.
d. Statements a and c are correct.
e. All of the statements above are correct.

10. Hemisco Industries has an overall (composite) WACC of 10%. This cost of capital
reflects the cost of capital for a project with average risk; however, there are large risk
differences among its projects. The company estimates that low-risk projects have a cost
of capital of 8% and high-risk projects have a cost of capital of 12%. The company is
considering the following projects:

Project Expected Return Risk

A 15% High
B 12 Average
C 11 High
D 9 Low
E 6 Low

Which of the projects should the company select to maximize shareholder wealth?

a. A and B.
b. A, B, and C.
c. A, B, and D.
d. A, B, C, and D.
e. A, B, C, D, and E.

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SECTION B

1) Tutunamayanlar Inc. has just paid a dividend of $2 on its stock. The growth rate in
dividends is expected to be 8% for the first two years, then 11% for the next two years,
and then a constant 10% thereafter. If investors require a 16% return on the stock, what
should be the current stock price for Tutunamayanlar Inc.? (15 pts)

2) Leopar Inc. is looking at a new cooking system with an installed cost of $200,000.
This cost will be depreciated straight-line to zero over the project’s four-year life (for tax
purposes residual value is zero), at the end of which the system can be sold for $20,000.
The system will save the firm $80,000 per year in pretax operating costs, and the system
requires an initial investment in net working capital of $40,000. If the tax rate is 30% and
the discount rate is 20%, what is the NPV of the project? (20 pts)

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3) Don Quijote has a capital structure that consists of 70 percent equity and 30 percent
debt. The company’s long-term bonds have a before-tax yield to maturity of 8.5 percent.
The company uses the DCF approach to determine the cost of equity. Don Quijote’s
common stock currently trades at $40 per share. The current year’s dividend is $2 and
is expected to be $2.50 per share next year, and the dividend is expected to grow forever
at a constant rate of 7 percent a year. The company estimates that it will have to issue
new common stock to help fund this year’s projects. The company’s tax rate is 40
percent. What is the company’s weighted average cost of capital, WACC? (18 pts)

4) Calculate the followings for Rüya and Perin Corporations: (show all your
computations)

Economy Probability Expected Returns

Rüya Co. Perin Co.
Recession 0.30 -0.40 -0.20
Average 0.40 0.30 0.20
Boom 0.30 0.60 0.50
Market Risk (beta)
Rüya 1.7
Perin 1.1
Risk-Free Rate (kRF) : 6 %
Market Return(kM) : 17 %

a) Compute the expected return of each stock. (3 points)

Rüya Inc.:

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 Perin Inc.:

b) Compute the total risk ( ) of each stock. (5 points)

Rüya:

Perin:

c) Compute the required return of each stock. (5 points)

Rüya:

Perin:

d) If you have to invest in a single stock, which stock would you like to invest? What are
your investment criteria? (4 points)

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