FI�3716- Fall 2010

MIDTERM 2 SOLUTIO�

Name ________________________________________________ Section____________

Time: 75 Min Total Point: 68

Work on this exam is to be yours alone. Any discussion of either the questions or your answers with anyone other than your instructor will be considered as cheating and, thus, as a violation of the LSU honor code. For Multiple Choice questions, circle the letter/s of the correct multiple-choice answer. You have to show your work to receive partial credit (if applicable and when possible) for the answer. Your answers must be COMPREHE�SIBLE and your work “CLEA�”.

Multiple Choice Questions (Each question 4 points)

1. The internal growth rate of a firm is best described as the: A. minimum growth rate achievable assuming a 100 percent retention ratio. B. minimum growth rate achievable if the firm maintains a constant equity multiplier. C. maximum growth rate achievable excluding external financing of any kind. D. maximum growth rate achievable excluding any external equity financing while maintaining a constant debt-equity ratio. E. maximum growth rate achievable with unlimited debt financing.

2. A firm is operating at 90 percent of capacity. This information primarily affects which one of the following accounts when compiling pro forma statements? A. sales B. costs of goods sold C. accounts receivable D. fixed assets E. long-term debt

3. Mary just purchased a bond which pays $60 a year in interest. What is this $60 called? A. coupon B. face value C. discount D. call premium E. yield

4. Which one of the following terms is used to describe a loan wherein each payment is equal in amount and includes both interest and principal? A. amortized loan B. modified loan C. balloon loan D. pure discount loan E. interest-only loan

5. You can deposit your savings at LSU Bank, which offers to pay 13.6 percent interest compounded quarterly, or at Region Bank, which will pay interest of 13.4 percent compounded daily (Assume 360 days in a year.). With this information, which bank offer should you choose? A. LSU Bank because its EAR is higher. B. Region Bank because its EAR is higher. C. LSU Bank because the compounding frequency is lower. D. LSU Bank because the APR is higher. E. Cannot compare, because the effective rates cannot be computed. Find the effective interest rate for both banks; choose the one that pays higher effective interest rate.

EAR for LSU = (1+ .136/4)4 -1 = 14.31%

EAR for Region = (1+ .134/360)360 -1 = 14.34%

6. The most recent financial statements for Last in Line, Inc. are shown here:

Assets and costs are proportional to sales. Debt and equity are not. A dividend of $992 was paid, and the company wishes to maintain a constant dividend payout ratio. Next year's sales are projected to be $21,830. What is the amount of the external financing needed? A. $12,711 B. $13,333 C. $13,556 D. $13,809 E. $14,357 Sales increase = ($21,830 - $18,500)/$18,500 = 0.18

External financing need = $105,622 - $91,265 = $14,357

7. What is the present value of perpetuity of $862.39 per year given an interest rate of 13 percent p.a.?

A. $6,159.93 B. $6,633.77 C. $5,987.46 D. $5,660.83 E. None of the above is within $10 of the correct answer.

PV = C/r = 862.39/.13 = 6,633.77

8. A stated rate (APR) is quoted as 10%, but has an effective annual rate (EAR) of 10.47%. What is the frequency of compounding during the year?

A. Annually B. Semiannually C. Quarterly D. Monthly E. Daily

Calculate effective interest rate for 10% stated rate for semiannual, quarterly, monthly and daily compounding. See which compounding gives you an effective rate of 10.47%

9. You just turned 30. If you deposit a single lump sum of $1,000 in an account that earns a 14% stated annual rate of return with semi-annual compounding what would your account be worth on your 60th birthday? Round your answer to 2 decimal places.

A. 57,946.427 B. 50,950.16 C. 7,612.26 D. 2,595,918.66

PV = -1000, PMT = 0, 1/Y= 14/2 = 7%, N = 30×2 = 60, FV =? 57,946.43 10. Trish receives $480 on the first of each month. Josh receives $480 on the last day of each month. Both Trish and Josh will receive payments for next three years. At a 9.5 percent discount rate, what is the difference in the present value of these two sets of payments? A. $118.63 B. $121.06 C. $124.30 D. $129.08 E. $132.50 Trish, Annuity due: FV = 0, PMT = 480, 1/Y= 9.5/12% =0.7917%, N = 3×12, PV of ordinary annuity =? 14,984.57 PV of annuity due: 14,984.57×(1.007917) = 15, 103.20 Josh, Ordinary Annuity: FV = 0, PMT = 480, 1/Y= 9.5/12% =0.7917%, N = 3×12, PV of ordinary annuity =? 14,984.57 The Difference = (15, 103.20 - 14,984.57) = 118.63

11. You borrow $165,000 to buy a house. The mortgage rate is 7.5 percent and the loan period is 30 years. Payments are made monthly. If you pay the mortgage according to the loan agreement, how much total interest will you pay? A. $206,408 B. $229,079 C. $250,333 D. $264,319 E. $291,406

PV = 165,000, N = 30× 12, 1/Y = 7.5/12 = 0.625%, FV = 0, PMT =? 1,153.70

2nd + amort : P1 = 1, P2 = 30× 12, Interest = 250,333.42

12. An ordinary annuity is best defined by which one of the following? A. increasing payments paid for a definitive period of time B. increasing payments paid forever C. equal payments paid at regular intervals over a stated time period D. equal payments paid at regular intervals of time forever E. unequal payments that occur at set intervals for a limited period of time

13. You make the following deposits into an account that pays interest at 8 percent p.a. Open the account today with a deposit of $10,000, then $10,000 for the following two years, $12,000 for the following three years, $9,000 at the end of the sixth year, and $15,000 at the end of the seventh year. How much will you have in your account at the end of ten years?

A. 68,769.87 B. 127,288.24 C. 160,346.52 D. 148,468.99 E. 90,000.00

CF0 = 10,000, CF1 = 10,000, F1 = 2, CF2 = 12,000, F2 = 3, CF3 = 9,000, F3 = 1, CF4 =15,000,

F4 =1, I = 8%, NPV = 68,769.87

PV = - 68,769.87, PMT = 0, N = 10, 1/y = 8%. FV = 148, 468.99

14. Mr. Steven needs $40,000 at t= 8 to attend graduate school. To finance this objective, he will deposit $6,000 today. In addition, he will deposit an equal annual amount at the end of each year for eight years, with the first deposit at t = 1. If the interest rate is 7%, what is the annual deposit amount? A. $2,893.90 B. $4,903.52 C. $6,000.00 D. $5,437.17 E. $ 32,000.00

PV = -6000, FV = 40,000, 1/Y = 7% N = 8, PMT =? 2893.90

15. An investor paid $34,158 for an investment that promised to pay her $1,000 per month for 42 months? What is the annual rate of return the investor is receiving?

A. 2.00%

B. 12.00%

C. 14.17%

D. 23.98%

E. 27.22%

PV = -34,158, FV = 0, N = 42, PMT =1,000, 1/Y = ? 1.00 per month Annual rate is 1.00 ×12 = 12% 16. You have just won the lottery and are told that you have two choices. Either you can receive an annual payment of $200,000 for 10 years (with the first payment occurring at t =1), or you can receive a lump sum payment today. If the discount rate is 8% annually, what lump sum would the lottery company have to offer you so that you are indifferent between these two choices?

A. $2000,000.00 B. $1,342,016.28 C. $2,897,312.49 D. $ 431,784.99 E. None of the above

PMT = 200, 000, N= 10, 1/Y = 8, FV = 0, PV = ? $1,342,016.28

17. What is the present value of receiving an annuity payment of $200 per year for 10 years, first payment beginning today (t = 0), assuming an annual interest rate of 6%?

A. $1,472.02 B. $1,310.09 C. $1,388.70 D. $1,235.93 E. $1,560.34

FV= 0; N= 10; PMT= 200; I/Y = 6; CPT PV = 1,472.02 of ordinary annuity PV of annuity due = = 1,472.02 × (1+.06) =1,560.34

Bonus Question (4 points) You are, finally, planning to acquire a commercial aircraft pilot license. In order to achieve this objective, you will have to pay five annual installments. Each installment of $40,000 must be paid at the end of the year starting at (t=1). Furthermore, you plan to retire in twenty-five years. When you retire, you will need $300,000 per year for twenty-five years with the first payment needed at t=26. If you can invest your money at 12% p.a., what amount of money must you deposit today (t=0) in order to be able to afford both your pilot license and your retirement plans?

Show your work. �o credit without work.

CF0 =0, CF1= 40,000, F01= 5, CF2= 0, F02= 20, CF3= 300,000, F03= 25, I = 12%, NPV =?

282,598.86