1 AMERICAN UNIVERSITY IN BULGARIA BUS 3 30 : CORPORATE FINANCE I FALL 20 12 , AUBG MIDTERM EXAM 1 Name: ___________________________________ ID _________ Version 1 Solution Guide INSTRUCTIONS: 1. You have 75 minutes to complete the exam. 2. The exam is worth a total of 100 points. 3. You may use a calculator and scratch paper sheets. You must hand in the sheets with your exam (put your name on it). 4. Allocate your time wisely. Use the number of points assigned to each problem as your guide. 5. In order to get full credit on the problems, you must show ALL your work! 6. You can get partial credits if you show your calculations or provide arguments to support your answer. 7. No credits will be warded if you fail to state your assumptions or conclusions explicitly. 2 Part A: Multiple c hoice questions ( 16 points in total): 1. Which of the following statements is CORRECT? a. One of the disadvantages of incorporating a business is that the owners then become subject to liabilities in the event the firm goes bankrupt. b. Sole proprietorships are subject to more regulations than corporations. c. In any type of partnership, every partner has the same rights, privileges, and liability exposure as every other partner. d. Sole proprietorships and partnerships generally have a tax advantage over many corporations, especially large ones. e. Corporations of all types are subject to the corporate income tax. Answer: D 2. Which of the following statements is CORRECT? a. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods. b. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity. c. The cash flows for an annuity due must all occur at the ends of the periods. d. The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or once a month. e. If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a ‘ variable ’ annuity. Answer: D 3. Which of the following statements is CORRECT? a. The more depreciation a firm reports, the higher its tax bill, other things held constant. b. People sometimes talk about the firm’s net cash flow, which is shown as the lowest entry on the income statement, hence it is often called "the bottom line.” c. Depreciation reduces a firm’s cash balance, so an increase in depreciation would normally lead to a reduction in the firm’s net cash flow. d. Net cash flow (NCF) is often defined as follows: Net Cash Flow = Net Income + Depreciation and Amortization Charges. a. Depreciation and amortization are not cash charges, so neither of them has an effect on a firm’s reported profits. Answer: D 4. The term “additional funds needed (AFN)” is generally defined as follows: a. Funds that are obtained automatically from routine business transactions. b. Funds that a firm must raise externally from non - spontaneous sources, i.e., by borrowing or by selling new stock or bonds to support operations. c. The amount of assets required per dollar of sales. d. The amount of internally generated cash in a given year minus the amount of cash needed to acquire the new assets needed to support growth. e. A forecasting approach in which the forecasted percentage of sales for each balance sheet account is held constant. Answer: B 3 5. Which of the following statements is CORRECT? a. The primary difference between EVA and accounting net income is that when net income is calculated, a deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the dollar cost of the equity capital the firm uses. b. MVA gives us an idea about how much book value a firm’s management has added during the last year. c. MVA stands for market value added, and it is defined as follows: MVA = (Shares outstanding)(Stock price) + Book value of common equity. d. EVA stands for economic value added, and it is defined as follows: EVA = EBIT(1 - T) – (Investor - supplied op erating capital) x (A - T cost of capital). e. EVA gives us an idea about how much value a firm’s management has added over the firm’s overall life. Answer: D 6. A 15 - year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT? a. The bond’s coupon rate exceeds its current yield. b. The bond’s current yield exceeds its yield to maturity. c. The bond’s yield to maturity is greater than its coupon rate. d. The bond’s current yield is equal to its coupon rate. e. If the yield to maturity stays constant until the bond matures, the bond’s price will remain at $850. Answer: C 7. Inflation, recession, and high interest rates are economic events that are best characterized as being : a. S ystematic risk factors that can be diversified away. b. C ompany - specific risk factors that can be diversified away. c. A mong the factors that are responsible for market risk. d. R isks that are beyond the control of investors and thus should not be c onsidered by security analysts or portfolio managers. e. I rrelevant except to governmental authorities like the Federal Reserve. Answer: C 8. If markets are in equilibrium, which of the following conditions will exist? a. Each stock’s expected return should not equal its realized return as seen by the marginal investor. b. Each stock’s expected return should equal its required return as seen by the marginal investor. c. All stocks should have the same expected return as seen by the marginal investor. d. The expected and required returns on stocks and bonds should be equal. e. All stocks should have the same realized return during the coming year. Answer: B