12.5 - Practice Test Solutions

Chapter
Agency Problems
In Finance, Management is an agent of the shareholder

Agency problems occur when Managers make decisions to benefit themselves rather than company.
Agency problems occure when the interests of managers are not alligned with interests of the shareholders
That’s why so many managers and employees are offered stock programs.
CEO, and the company is struggling and having cash flow trouble
CEO has told everyone that they wont be getting a bonus
However the CEO has approved a bonus for his daughter who works in sales.
Chapter 10
The market yield on a fifteen-year 7.5 percent bond is 6.5%. The bond makes semi-annual coupon
payments and is callable in five years at a call price of $1,075. Par value 1000
a) What is the bond price based on the market yield? 4 marks Coupon 7.50% Interest Payments
b) What is the bond’s yield to call? 4 marks Yield 6.50% Market rate for similar bonds
c) Is this bond likely to be called? (1 mark) Explain. ( 3marks Call price 1075
Term 15 Years
A) Callabale term 5 years
Set P/Y = 2, C/Y = 1 PMT 37.5
N = 30, I/Y = 6.5%, PMT = 37.5, FV = 1000, CPT-PV = 1,105.31
B)
Set P/Y = 2, C/Y = 1
N = 10, PMT = 37.5, FV = 1000, CPT-PV = -1,075, CPT-IY = 5.83

Explain the primary reason why some securities are more liquid than others.
A security is a financial Asset

And a security is liquid (When it can be easily converted into cash)
Volume
Marketable securities are the most liquid and can be converted easily into cash
Cash & Marketable securities

Heister Corporation produces class rings to sell to college and high school students. These rings sell
for $75 each, and cost $35 each to produce. Heister has fixed costs of $50,000. Heister's president, Angelo, expects an annual profit of $100,000. How
many rings must be sold to attain this profit?
3750
Price 75 Sales 281250 Target Profit 100,000
Variable Cost 35 VC 131250 Fixed 50,000
CM 40 Per ring CM 150000 150,000
Fixed Cost 50,000 Fixed Cost 50,000 3750
Profit 100,000
Chapter 9
Mastercard: 19.9% Nominal interest, compounded monthly 21.82% 2nd-ICONV, NOM = 19.9%, C/Y = 12, EFF ---->CPT
Visa: 19.6% Nominal interest, compounded Daily (Assume 360 days) 21.65% 2nd-ICONV, NOM = 19.6%, C/Y = 360, EFF ---->CPT
American Express: 20.5% Nominal Interest, compounded semi-monthly 22.65% 2nd-ICONV, NOM = 20.5%, C/Y = 24, EFF ---->CPT
Amount Borrowed 5000
Term 1 year
Interest Compounded Semi-Annually 3%
P/y = 1, C/Y =2
N = 1, PV = 5000, PMT = 0, I/Y = 3%, CPT-FV = 5,151.13
Effective Rate 5.40%
Compounded Monthly 12
5.27%
2nd----->ICONV
EFF = 5.4%
C/Y = 12
CPT---->NOM 5.27%
Debt to Equity Ratio
Previous Year Current Year
Assets 8,000,000 9,000,000
Equity Book Value 4,000,000 4,000,000
Retained Earnings 2,000,000 3,000,000
Total Equity 6,000,000 7,000,000
A= L + SE
There Debt 2,000,000 2,000,000
D/E 0.3333333 0.28571428571

p/y, c/y 1
N 5
FV 2500
PMT 0
Interest Rate 6%
CPT-PV -$1,868.15
What is the current yield of a four-year semi-annual pay bond with a par value of $1,000 and a
4 percent coupon rate when the bond is priced at $932.35?
P/Y = 2, C/Y =1
FV = 1000
PV = -932.35
PMT = 1000 x 4% divided by 2 = 20
N=4x2=8
CPT-I/Y = 6.01%
Which is a better economic objective for financial managers: maximizing profit or maximizing shareholder wealth
price? Why? Give three reasons.
The way you maximize shareholder wealth, maximzing the stock price
1. Sustainability. Profits are for 1 year, but when you maximize the wealth its for a longer time
2. By increasing the share price the shareholder will only be half taxed on capital gains
3. Long term decision making. Accounting profit is not a good indicator of a company doing well.
*Free Cash Flow to Equity
You have just obtained a $150,000 10-year 6% fixed-rate mortgage. The mortgage is amortized over
25 years. The interest rate is compounded semi-annually and you make monthly payments at the end
of each month.
Immediately after you signed the paper work, mortgage rates dropped to 5%. Your bank has offered
you the opportunity to renegotiate the mortgage for a penalty of $10,000. Should you take this
opportunity?
P/Y = 12, CY = 2 P/Y = 12, CY = 2
N = 25 * 12 = 300, I/Y =6, PV = 150,000, FV = 0, CPT - PMT = 959.71 N = 25 * 12 = 300, I/Y =5, PV = 150,000, FV = 0, CPT - PMT = 872.41
How much of the payment is principal and how much is going to be interest How much of the payment is principal and how much is going to be interest
N = 10 * 12 = 120, I/Y = 6, Pv =150,000, PMT -959.71, CPT-FV = 114,267.12 N = 10 * 12 = 120, I/Y = 5, Pv =150,000, PMT -872.41, CPT-FV = 110,693.82
Total Payments $ 115,165.20 Total Payments $ 104,689.20

Total principle $ 35,732.88 Total Principal $ 39,306.18
Interest $ 79,432.32 Total Interst $ 65,383.02
Less interest paid over 10 years $ 14,049.30
N = 120, I/Y = 6, FV = 14,049.30, PMT = 0, CPT -PV = 7,787
N = 120, I/Y = 6, FV = 14,049.30, PMT = 0, CPT -PV = 8,573.7
No
Rosie wants to retire in 30 years. At retirement she wants to be able to withdraw $100,000 at the end
of each year forever (she plans on establishing a scholarship fund at her local university after her
death). Assuming that her investments can earn 10% compounded semi-annually prior to her
retirement and only 5% compounded annually after her retirement (retired people and universities are
very conservative investors), how much must Rosie invest each year for the next 30 years? Assume
her first deposit will occur in one year.
Post retirement $ 2,000,000.00 to withdraw $100,000, with an interest rate of 5%
P/Y = 1, C/Y = 2
N = 30, I/Y = 10, PV =0, FV = 2000000, CPT PMT-----> 11,595.56

The Bubble Company has a return on equity of 4.5%.
Bubble’s debt-equity ratio is 0.4 and Debt 0.4
Bubble’s management intends to maintain it at this
level for the foreseeable future. If Bubble’s Equity 1 4.50%
asset turnover remains the same for the foreseeable
future at 2.0, Assets 1.4
1) What is Bubble’s current net profit margin? (4
marks) Asset Turnover 2
2) What would Bubble’s net profit margin have to be
to raise the return on equity to 5%? (3 Turnover 2.8 12.6%
marks)
Debt to equity ratio of 5

5 debt dollars to 1 equity dollars
Assets = Debt + Equity
5%
14.00%

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Chapter

In Finance, Management is an agent of the shareholder

Set P/Y = 2, C/Y = 1

N = 10, PMT = 37.5, FV = 1000, CPT-PV = -1,075, CPT-IY = 5.83

A security is a financial Asset

Cash & Marketable securities

many rings must be sold to attain this profit?

D/E 0.3333333 0.28571428571

4 percent coupon rate when the bond is priced at $932.35?

price? Why? Give three reasons.

P/Y = 12, CY = 2 P/Y = 12, CY = 2

Total Payments $ 115,165.20 Total Payments $ 104,689.20

N = 120, I/Y = 6, FV = 14,049.30, PMT = 0, CPT -PV = 7,787

N = 120, I/Y = 6, FV = 14,049.30, PMT = 0, CPT -PV = 8,573.7

her first deposit will occur in one year.

Post retirement $ 2,000,000.00 to withdraw $100,000, with an interest rate of 5%

N = 30, I/Y = 10, PV =0, FV = 2000000, CPT PMT-----> 11,595.56

Debt to equity ratio of 5

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