Chapter 4

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Exam Name___________________________________ TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false. 1) To determine the total return on an investment, one needs to know the purchase price, the current value and any income the investment produced. 1) 2) An investment that has earned a high rate of return over the last five years will necessarily continue to perform well in the future. 2) 3) Meaningful measures of an investment's return must consider both income and capital gains. 3) 4) In response to the same external force, the return on one investment may increase while the return on another investment may decrease. 4) 5) When investors expect higher inflation, they will generally require higher rates of return. 5) MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 6) A capital loss is computed by A) subtracting the original cost of an investment from the proceeds received from the sale of that investment. B) subtracting the original cost of an investment from the proceeds received from the sale of that investment minus any income from the investment. C) subtracting the proceeds received from the sale of an investment from the original cost of the investment. D) subtracting the original cost of an investment from the proceeds received from the sale of that investment plus any income from the investment. 6) 7) Rational investors are motivated to purchase an asset because of its A) emotional benefits. B) past returns. C) expected returns. D) all of the above 7) 8) The most predictable component of stock returns is A) capital gains. B) dividend income. C) inflation - adjusted return. D) capital losses. 8) 9) Krishna bought a stock at a price of $33.75. She received a $1.25 dividend and sold the stock for $36.10. What is Krishna's capital gain on this investment? A) $3.65 B) $2.35 C) $1.25 D) $(2.35) 9) 10) Ashley purchased a stock at $54 per share. She received quarterly dividends of $0.80 per share. After one year, Ashley sold the stock at a price of $53.25 a share. What is her percentage total return on this investment? A) 7.3% B) 4.5% C) 5.9% D) - 1.4% 10) 1

11) Historically, what is the correct ranking of the following securities from the lowest rate of return to the highest? A) long - term government bonds, short - term government bills, stocks B) stocks, short - term government bills, long - term government bonds C) short - term government bills, long - term government bonds, stocks D) Historical returns do not exhibit a consistent pattern. 11) 12) The greatest risk inherent in highly rated bonds is A) potential failure of the issue to repay the principal. B) the difficulty of selling them before their maturity date. C) loss of purchasing power due to inflation. D) a potential reduction in the expected interest rate. 12) 13) Which of the following investments may be impacted by government actions? A) corporate bonds B) stocks C) government bonds D) all of the above 13) 14) Over the long term, which of the following has historically had the lowest risk and lowest average annual rate of return? A) long - term government bonds B) US common stock C) short - term government bills D) German common stock 14) TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false. 15) The financial concept of the time value of money is dependent upon the opportunity to earn interest over time. 15) 16) An investor who requires a 7% rate of return should be willing to pay $934.58 now to receive $1,000 at the end of one year. 16) 17) If the discount rate is appropriate for the level of risk, a satisfactory investment will have a present value of benefits equal to or greater than the present value of costs. 17) MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 18) The present value of $10,000 discounted at 5% per year and received at the end of 5 years is A) $10,000/(1.05) 5 . B) $10,000(1.05) 5 . C) $10,000(1.05) 1/5 . D) $10,000/1.25. 18) 19) Vijay's house has doubled in value since he bought it 30 years ago. The house's value has increased by an annual rate of A) 2.34%. B) 100%. C) 6.67%. D) 3.33%. 19) 20) Which of the following statements is correct concerning the time value of money? A) The future value of $1 at the end of two years is equal to $1.00(1 + r)(1 + r). B) The future value of $1 decreases with the passage of time. C) The future value of $1.00 at the end of 2 years is $1.00 + 2($1.00 × r). D) As the interest rate increases for any given year, the future value interest factor will decrease. 20) 2

21) Christopher invests $400 today at a 4% rate of return which is compounded annually. What is the future value of this investment after four years? A) $342 B) $416 C) $464 D) $468 21) 22) Jimmy is going to receive a payment of $5,000 one year from today. He earns an average of 6% on his investments. What is the present value of this payment? A) $4,717 B) $4,821 C) $5,000 D) $5,300 22) 23) When the rate of return is equal to the discount rate, A) the present value of an investment's benefits must be greater than its cost. B) the cost of an investment equals the sum of its benefits. C) the cost of an investment equals the present value of its benefits. D) the cost of an investment equals the future value of its benefits. 23) 24) If the present value of an investment's benefits equals the present value of the investment's costs, then the investor would earn a A) return equal to the discount rate. B) return greater than the discount rate. C) 0% rate of return. D) negative rate of return. 24) 25) The present value of $1,000, discounted at the rate of 5% per year, to be received at the end of 3 years, is equal to A) $1,000 × (1.05) 3 . B) $1,000/(1.03) 5 . C) $1,000 - ($1,000) × .03 × 5. D) $1,000/(1.05) 3 . 25) ESSAY. Write your answer in the space provided or on a separate sheet of paper. 26) Zachary has purchased an investment that he expects to produce income of $3,000 at the end of the first year and $4,000 at the end of the second year. If he requires an 8% rate of return compounded annually, what is the maximum amount that he can pay and still earn the required rate of return? TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false. 27) The return that fully compensates for the risk of an investment is called the risk - free rate of return. 27) 28) The required return on a risky investment includes a real rate of return, an inflation premium and a risk premium. 28) 29) If the risk - free rate of return is less than the inflation rate, the real rate of return is negative. 29) 30) It is not possible for the nominal risk - free rate of return to be lower than the rate of inflation. 30) 31) Short - term US Treasury bills are yielding 1.5%. The expected inflation rate is 3%. Therefore, the real rate of interest must be 1.5%. 31) 32) The holding period return (HPR) includes the time value of money. 32) 33) One reason that the holding period return (HPR) should not be used to compare long - term investments is that it does not consider the time value of money. 33) 3

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34) The holding period return (HPR) is not useful for comparing investments with unequal holding periods. 34) MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 35) The closest approximation to the real, risk - free rate of interest is A) the short - term Treasury bill rate minus the inflation rate. B) the ten - year Treasury bond rate minus the inflation rate. C) the ten - year Treasury bond rate minus the one - year Treasury bill rate. D) the short - term Treasury bill rate plus the inflation rate. 35) 36) The risk - free rate is equal to the real rate of return plus A) an expected inflation premium. B) both an inflation and a risk premium. C) the prevailing prime rate. D) a risk premium. 36) 37) The markets, in general, are paying a 1% real rate of return. Inflation is expected to be 3%. RJH stock commands an 8% risk premium. What is the expected rate of return on RJH stock? A) 1% B) 4% C) 9% D) 12% 37) 38) The required rate of return on the Cosmos Corporation's common stock is 10%, the current real rate of return in the market is 1%, and the inflation rate is 3%. In this case, the risk premium associated with Cosmos stock is A) 5%. B) 6%. C) 7%. D) 8%. 38) 39) Which of the following will lower the required rates of return? A) lower rates of inflation B) lower dividend yields C) higher risk premiums D) higher rates of inflation 39) 40) The required return on Beta stock is 14%. The risk - free rate of return is 4%, and the real rate of return is 2%. How much are investors requiring as compensation for risk? A) 8% B) 10% C) 12% D) 14% 40) 41) Which of the following is(are) issue characteristics of an investment? I. type of investment such as stocks or bonds II. financial condition of the issuer III. coupon or dividend payments IV. time to maturity A) I and II only B) III only C) I, III and IV only D) I, II, III and IV 41) 42) A holding period return (HPR) is calculated by adding the current income to the capital gains and dividing this sum by the A) total income received. B) beginning investment value. C) selling price of the investment. D) average investment value. 42) 4

43) Kayla purchased a stock for $56 a share and sold it six months later for $62. While she owned the stock, Kayla received two quarterly dividends of $0.70 per share. Kayla's annualized holding period return (HPR) on this stock is A) 13.2%. B) 11.9%. C) 10.7%. D) 26.4%. 43) 44) In which of the following circumstances would it be most appropriate to use the holding period return (HPR)? A) To compare the calendar year performance of stocks purchased in March to stocks purchased in September. B) To compare the dividend yield of stocks to the interest rate on bonds. C) To compare the capital gains on a house held for eight years and a mutual fund held for six years. D) To compare the performance of several stocks, each of which was held throughout an entire year. 44) 45) Naveen purchased 200 shares of HAR stock at $25.30 per share and sold them nine months later for $27.20. HAR does not pay a dividend. At the same time, he bought 500 shares of WIG for $9.15 a share. He sold WIG for $9.65 one year later. During the year, WIG paid four quarterly dividends of $0.07 each. The most useful way to compare the holding period returns on these stocks is to A) multiply the nine - month return on HAR by 12/9. B) divide the one - year return on WIG by 9/12. C) divide the nine - month return on HAR by 9/12. D) The two holding period returns cannot be compared. 45) 46) The holding period return (HPR) can be appropriately used to A) determine the required reinvestment rate for long - term investments. B) compare returns among investments that are held for the same period of time. C) compare the yield on investments held for any time period. D) isolate realized capital gains. 46) 47) Jason purchased ABC stock at $40 per share and DEF stock at $35 per share on the same day in 2020. Exactly six months later, the ABC stock is worth $42.00 per share and has not paid a dividend while the DEF stock is worth $36 per share and has paid two quarterly dividends of $0.50 each. The holding period returns are A) ABC 5% and DEF 5.7%. B) ABC, $2.00 and DEF $2.00. C) ABC 5% and DEF 2.9%. D) The holding period return cannot be determined because we do not know the discount rate. 47) ESSAY. Write your answer in the space provided or on a separate sheet of paper. 48) Briefly explain the holding period return (HPR) and give several characteristics of this measure. TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false. 49) The internal rate of return is the rate of return that causes a project to have a zero net present value. 49) 50) The internal rate of return on an investment is the discount rate that produces a present value of benefits greater than the cost of the investment. 50) 5

51) The internal rate of return is a less meaningful measure of an investment's performance than the holding period return if the holding period is other than one year. 51) 52) The present value of an investment must be computed by discounting cash flows at the internal rate of return. 52) 53) The internal rate of return takes into account the purchase price, the selling price and the timing of any income received from the investment. 53) 54) The internal rate of return is the correct method to use when an investor wants to determine an investment's average annual yield. 54) 55) A suitable investment should have an internal rate of return equal to or greater than its required rate of return. 55) 56) The internal rate of return takes into account all of an investment's cash flows over a period of time. 56) 57) When all the cash flows from an investment, including its initial cost, are discounted at the internal rate of return, their present value will be zero. 57) MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 58) When computing an investment's internal rate of return using a financial calculator or spreadsheet such as Excel, which of the following should be entered as a negative number? A) the number of time periods B) the price at which the investment is sold C) dividend or interest payments D) the initial cost of the investment 58) 59) Table 1 A B 1 Year Cash Flow 2 0 $(5,000) 3 1 $4,000 4 2 $3,000 Given a spreadsheet similar to the one shown in Table 1, the command to compute the internal rate of return would be A) = RATE(3,B3,B4,B2). B) = IRR(B3:B4) - B2. C) = IRR(B2:B4). D) = TVM(A2:B4). 59) 60) Seven years ago, Matias invested $7,000. Today his investment is worth $11,500. The internal rate of return on this investment is A) 64.23%. B) 15.53%. C) 9.18%. D) 7.35%. 60) 61) Santiago bought a stock for $68 a share three years ago. The stock does not pay any dividends. Today he sold the stock for $57 a share. What was his internal rate of return on this investment? A) 19.30% B) - 6.43% C) - 5.71% D) 6.43% 61) 6

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62) An investment costs $3,500 today. This investment is expected to produce annual cash flows of $1,200, $1,400, $1,300 and $1,100, respectively, over the next four years. What is the internal rate of return on this investment? A) 8.1% B) 9.33% C) 14.6% D) 16.2% 62) 63) The following investment cash flows have been entered into cells B5 through B9 of an EXCEL spreadsheet. B5 $(5,200), B6 $2,100, B7 $1,300, B8 $1,800, B9 $1,200, where $(5,200) is the cost of the investment and the following amounts are cash flows at the end of years one through four. The correct function for computing the yield on this investment is A) = ytm(B5, B6:B9). B) = rate(4,0, - 5200, 1200). C) = irr(B6:B9) + B5. D) = irr(B5:B9). 63) 64) The Sorka Corp. has paid annual dividends of $0.60, $0.63, $0.65, $0.68 and $0.72, respectively, over the past five years. What is the dividend growth rate? A) 4.7% B) 5.2% C) 5.4% D) 5.9% 64) 65) A stock is purchased at the beginning of a year, a single dividend is paid at the end of the year, and the stock is sold immediately after the dividend has been received. In this case, A) it is not possible to calculate the internal rate of return. B) the holding period return. is lower than the internal rate of return. C) the internal rate of return equals the holding period return. D) the internal rate of return is lower than the holding period return. 65) 66) Ryan purchased a bond for $980 at the beginning of 2016. He received annual interest payments of $55 at the end of each year through 2020, when the bond was redeemed at its face value of $1,000. Compute the yield (internal rate of return) Ryan earned on his bond purchase. A) 5.61% B) 0.34% C) 5.97% D) 5.50% 66) 67) Mason purchased 100 shares of XOM at the beginning of 2016. He received dividends per share of $1.37 (2016), $1.55 (2017), $1.66 (2018), $1.74 (2019), $1.85 (2020). At the end of 2020, just after receiving the last dividend, he sold the stock for $84.76. At what rate did the dividends grow from the end of 2016 to the end of 2020? Assume that all dividends were received at the end of the year. A) 6.2% B) 13.1% C) 35% D) 7.8% 67) 68) Mason purchased 100 shares of XOM for $76.63 per share at the beginning of 2016. He received dividends per share of $1.37 (2016), $1.55 (2017), $1.66 (2018), $1.74 (2019), $1.85 (2020). At the end of 2020 just after receiving the last dividend, he sold the stock for $84.76. What was his average annual rate of return from both dividends and capital gains? (Hint: compute the IRR, assume that all dividends were received at the end of the year.) A) 3.774% B) 3.423% C) 9.831% D) 4.076% 68) 69) Eli purchased an investment for $1,000. It generated the following stream of cash flows. End of year 1 $300 End of year 2 $400 End of year 3 $500 His internal rate of return was A) 9.70%. B) 8.90%. C) 6.67%. D) 10.65%. 69) 7

70) Nathan has purchased an investment for $6,805.83. He will receive $10,000 five years from today. What is the internal rate of return on his investment? A) 9.40% B) 47% C) 10.36% D) 8.00% 70) 71) Mila purchased an investment for $1,000. It generated the following stream of cash flows. End of year 1 $500 End of year 2 $400 End of year 3 $300 Her internal rate of return was A) 10.65%. B) 9.70%. C) 6.67%. D) 8.90%. 71) ESSAY. Write your answer in the space provided or on a separate sheet of paper. 72) Zachary has purchased an investment that he expects to produce an income of $3,000 at the end of the first year and $4,000 at the end of the second year. If he pays $5,800 for this investment, what is the internal rate of return? 73) Explain the similarities and differences between the holding period return and the internal rate of return. 74) Mason purchased 100 shares of XOM for $76.63 per share at the beginning of 2016. He received dividends per share of $1.37 (2016), $1.55 (2017), $1.66 (2018), $1.74 (2019), $1.85 (2020). At the end of 2020, just after receiving the last dividend, he sold the stock for $84.76. What was his average annual rate of return from both dividends and capital gains? (Hint: compute the IRR, assume that all dividends were received at the end of the year.) TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false. 75) Risk can be defined as uncertainty concerning the actual return that an investment will generate. 75) 76) Business risk resulting from uncertainty over a firm's earnings is a concern for stockholders but not for debt holders. 76) 77) Lower risk investments are associated with lower expected rates of return. 77) 78) The potential for the Canadian Government to alter tax rates and deductions increases tax risk for Canadian businesses. 78) 79) Business risk is the risk associated with the amount of debt financing used by a firm. 79) 80) Investing in short - term debt, rather than long - term debt, decreases exposure to interest rate risk. 80) 81) Political actions concerning tariffs and trade agreements are a source of market risk. 81) 8

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 82) Liquidity risk is defined as the risk of A) not being able to sell an investment conveniently and at a reasonable price. B) having declining price levels affect the reinvestment rate of your current income stream. C) having inflation erode the purchasing power of your investment. D) having to trade a security in a broad market. 82) 83) In some markets, it may take many months to sell a residential property. This is an example of A) market risk. B) credit risk. C) business risk. D) liquidity risk. 83) 84) The stock of an automobile manufacturer falls sharply after its CEO behaves erratically during a TV appearance. This is an example of A) liquidity risk. B) flotation risk. C) accidental risk. D) event risk. 84) 85) The Bank of Canada announces a policy of raising interest rates shortly before OMG corporation needs to refinance a large issue of three - year notes. This is an example of A) liquidity risk. B) business risk. C) financial risk. D) political risk. 85) 86) A petroleum refinery in the Gulf region is forced to shut down for several months because of hurricane damage. This is an example of A) speculation. B) business risk. C) market risk. D) event risk. 86) 87) A business has strong sales and profits, but its stock price falls anyway because stock prices in general are declining. This is an example of A) business risk. B) market risk. C) liquidity risk. D) financial risk. 87) 88) The Canadian Parliament considers a bill that would eliminate the mortgage interest deduction for individuals. For the housing industry, this is an example of A) tax risk. B) business risk. C) event risk. D) interest rate risk. 88) 89) Which of the following will lower the rate of return on a stock whose price has doubled since you bought it? A) an increase in the tax rate on dividend income from 15% to 20% B) persistently low inflation rates C) an increase in the capital gains tax from 15% to 20% D) the Bank of Canada acts to lower interest rates 89) 90) Which of the following factors will increase the risk level of an investment? I. a firm's decision to use a high percentage of debt financing II. an economic situation in which consumer prices are rising at a rapid rate III. the ability to trade the investment in a broad market rather than in a thin market IV. unstable currency values A) I and II only B) I, III and IV only C) I, II and IV only D) II and IV only 90) 9

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ESSAY. Write your answer in the space provided or on a separate sheet of paper. 91) Identify and discuss five sources of risk. 92) Which types of risk can not be avoided by carefully researching a company's business prospects and financial statements? TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false. 93) The standard deviation indicates the magnitude of dispersion around a mean but not the direction. 93) 94) Historical returns are of no use in estimating the risk of an investment. 94) 95) Investments with lower standard deviations can be expected to produce higher rates of return. 95) 96) Historically speaking, the standard deviation of returns on US Treasury bills is zero. 96) 97) Most investors are risk - averse, meaning they will always be willing to sacrifice higher return if they can avoid risk. 97) MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 98) An investment produced annual rates of return of 5%, 12%, - 8% and 11%, respectively, over the past four years. What is the (sample) standard deviation of these returns? A) 9.2% B) 3.6% C) 3.2% D) 2.7% 98) 99) An investment produced annual rates of return of 7%, - 14%, 20% and 4%, respectively, over the past four years. What is the standard deviation of these returns? A) 7.0% B) 1.5% C) 12.1% D) 14.0% 99) 100) Which of the following choices is in the correct order from less risk to more risk? A) certificates of deposit, corporate bonds, common stock, mutual funds that invest in stock B) certificates of deposit, corporate bonds, mutual funds that invest in stock, common stock C) corporate bonds, certificates of deposit, mutual funds that invest in stock, common stock D) certificates of deposit, mutual funds that invest in stock, common stock, corporate bonds 100) 101) An investment produced annual rates of return of 4%, 8%, 14% and 6%, respectively, over the past four years. What is the standard deviation of these returns? A) 4.1% B) 3.7% C) 4.3% D) 4.6% 101) 102) Which of the following statements about the standard deviation are correct? I. The standard deviation is a measure of relative dispersion. II. Standard deviations should be considered in conjunction with expected returns to compare investments. III. The standard deviation is calculated by taking the square root of the variance. IV. The higher the standard deviation of an investment, the lower its risk. A) I and IV only B) I, II and III only C) II and III only D) I, III and IV only 102) 10

103) The expected rate of return and standard deviations, respectively, for four stocks are given below: ABC 9%, 3% CDE 11%, 9% FGH 12%, 8% IJK 14%, 10% Which investment offers the lowest expected return relative to its standard deviation? A) IJK B) ABC C) CDE D) FGH 103) 104) The expected rate of return and standard deviations, respectively, for four stocks are given below: OPQ 11%, 8% RST 11%, 9% UVW 12%, 10% XYZ 12%, 8% Which investment offers the highest expected return relative to its standard deviation? A) RST B) XYZ C) UVW D) OPQ 104) 105) Most investors are risk - averse, which means they A) invest only in government - insured securities. B) gain satisfaction from the excitement of risk. C) refuse to accept any financial risk. D) require an increase in return for any increase in risk. 105) 106) Investment A has an expected return of 8% with a standard deviation of 12%. Investment B has an expected return of 10% with a standard deviation of 15%. A) Investment B should be preferred because of its higher rate of return. B) Preference for A or B would depend on the investor's risk tolerance. C) Investment A should be preferred because of its lower risk. D) Neither investment is acceptable because their standard deviations are greater than their expected rates of return. 106) ESSAY. Write your answer in the space provided or on a separate sheet of paper. 107) Explain the relationship between risk, the expected rate of return and the actual rate of return. 108) Over the past four years, the annual rates of return on the stock of Brown & Warren Inc. have been - 2%, 4%, 14% and 6%, respectively. Compute the standard deviation of these returns. TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false. 109) Sydney invested $10,000 for an indefinite period at 5% per year. At the end of each year, she receives a $500 cheque for interest earned. This type of account pays simple interest. 109) 110) For a given stated rate of interest, a sum compounded monthly will earn more interest than a sum compounded annually. 110) 111) An ordinary annuity is defined as an annuity for which the cash flows occur at the beginning of each year or payment period. 111) 11

112) To calculate the interest rate or growth rate using a spreadsheet or financial calculator, the present value and the future value must have opposite signs. 112) 113) There is no limit to the increase in the true rate of interest as compounding becomes more frequent. 113) 114) Samantha invested $10,000 in an account paying 5% interest. After three years, the account balance was $11,576.25. Interest in this account was compounded annually. 114) MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 115) Omer invests $4,000 in a savings account for two years. The account pays 2% interest compounded annually. How much interest income will Omer earn on this investment? A) $160.00 B) $81.60 C) $161.60 D) $80.00 115) 116) Omer invests $4,000 in a savings account for two years. The account pays 2% interest compounded annually. How much money will be in the account at the end of the second year? A) $4,080.00 B) $1,161.60 C) $4,161.60 D) $4,160.00 116) 117) Which of the following is an example of an annuity? A) the receipt of $50 in January, March, April, June, August, September and December B) the payment of $259 a month for three consecutive years C) the receipt of $100 a month for three months and then $150 a month for two months D) the payment of $389 in January, $200 in February, and $200 in March 117) 118) Which is most true of an annual rate of 4% compounded quarterly? A) It is equivalent to 4.4% paid annually. B) It is equivalent to 4.06% paid annually. C) It is equivalent to 1% simple interest paid quarterly. D) It is equivalent to 16.99% paid annually. 118) 119) The maximum rate of return that can be earned for a given rate of interest occurs when interest is compounded A) continuously. B) daily. C) monthly. D) annually. 119) 120) If you invest $7,000 at the end of each year for seven years and you earn 7% interest compounded annually, how much will you have accumulated at the end of the seventh year to the nearest dollar? A) $52,430 B) $49,490 C) $10,430 D) $60,578 120) 121) Taylor has saved $400 at the end of every month for the last four years with the intention of paying cash for a new car. She has earned a fixed annual rate of 4% over the four - year period; interest is compounded monthly. How much can she pay for her new car at the end of the fourth year? A) $20,784 B) $22,272 C) $17,716 D) $55,705 121) 12

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122) Assume that $100 is deposited at the end of each year for five years at 10% compound interest and that no withdrawals are made over the five - year period. Based on this data, which of the following statements is correct? A) The present value can be determined by computing the present value of $500 in five years at 10%. B) The present value can be determined by computing the present value of a $100 ordinary annuity for five years at 10%. C) The present value will be $500. D) The future value will be $550. 122) 123) David has purchased an investment that he expects to produce an annual cash flow of $3,000 for five years. He requires an 8% rate of return compounded annually. What is the maximum amount that David can pay and still earn the required rate of return? A) $11,978 B) $15,000 C) $14,764 D) $19,008 123) 124) Yosef purchased 100 shares of FB for $19 per share in September 2012 and sold them three years later at $91 per share. At what annual rate did the value of his investment grow? A) about 69% B) about 12% C) about 48% D) about 95% 124) 125) Compute the present value of the following cash flow discounted at 6%. End of Year Cash flow 1 $450 2 $400 3 $300 A) $1,032.41 B) $1,024.65 C) $974.58 D) $973.97 125) 126) Compute the present value of the following cash flow discounted at 8%. End of Year Cash flow 1 $850 2 $500 3 $200 A) $1,024.65 B) $1,374.47 C) $973.97 D) $1,174.58 126) 127) Compute the future value three years from now of the following end - of - year cash flows growing at a rate of 6% per year. 1 $450 2 $400 3 $300 A) $1,229.61 B) $1,032.41 C) $1,220.38 D) $1,357.00 127) 13

Answer Key Testname: UNTITLED4 1) TRUE 2) FALSE 3) TRUE 4) TRUE 5) TRUE 6) A 7) C 8) B 9) B 10) B 11) C 12) C 13) D 14) C 15) TRUE 16) TRUE 17) TRUE 18) A 19) A 20) A 21) D 22) A 23) C 24) A 25) D 26) $3,000/(1.08) 1 + $4,000/(1.08) 2 = $6,207.13 27) FALSE 28) TRUE 29) TRUE 30) FALSE 31) FALSE 32) FALSE 33) TRUE 34) TRUE 35) A 36) A 37) D 38) B 39) A 40) B 41) C 42) B 43) D 44) D 45) A 46) B 47) A 14

Answer Key Testname: UNTITLED4 48) HPR is the total return earned from holding an investment for a specified period of time. HPR = [current income + capital gain (or loss)] beginning investment (a) HPR takes into account both current income and capital gains. (b) HPR should be used for holding periods of one year or less. (c) HPR does not take into account the time value of money. (d) HPR offers a relative comparison of investments of different sizes. (e) HPR indicates the return per invested dollar. (f) HPR can have a positive, a zero, or a negative value. 49) TRUE 50) FALSE 51) FALSE 52) FALSE 53) TRUE 54) TRUE 55) TRUE 56) TRUE 57) TRUE 58) D 59) C 60) D 61) C 62) D 63) D 64) A 65) C 66) C 67) D 68) D 69) B 70) D 71) A 72) $3,000/1.128 + $4,000/1.1282 = $5,800 Answer is approximately 12.8%. A more exact answer found with Excel is 12.8414%. 73) Both measures take into account total return from both income and capital gains. The holding period of return does not adjust returns for the length of time that an investment is held. The internal rate of return computes an average compound annual rate of return and is suitable for comparing investments held for different periods of time. 15

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Answer Key Testname: UNTITLED4 74) Mason's cash flows on a per share basis were as follows: PV at 4.076% 2016 (beginning) - $76.63 - 76.63 2016 (end) 1.37 1.32 2017 (end) 1.55 1.43 2018 (end) 1.66 1.47 2019 (end) 1.74 1.48 2020 (end) 1.85 + 84.76 70.93 Total 00.00 Josh has earned 4.076% on his investment in XOM. The solution involves finding the internal rate of return for all cash flows. The discount rate of 4.076%, which equates the present value of dividends and the 2020 price to the 2016 price can be found by trial and error or more efficiently using a financial calculator. Because the internal rate of return is a percentage, it does not matter whether you use the cash flows for 100 shares or a single share. 75) TRUE 76) FALSE 77) TRUE 78) TRUE 79) FALSE 80) TRUE 81) TRUE 82) A 83) D 84) D 85) C 86) D 87) B 88) A 89) C 90) C 16

Answer Key Testname: UNTITLED4 91) Students can select five from the following risk sources. (a) Business risk Uncertainty associated with an investment's earnings and the ability of an investment to pay the returns owed to investors (b) Financial risk Risk associated with the debt/equity mix of a firm (c) Purchasing power risk The chance that changes in the price level will affect the return on an investment (d) Interest rate risk The chance that changes in market interest rates will affect the return on an investment (e) Liquidity risk The possibility that an investment can not be sold conveniently at a reasonable price (f) Tax risk The possibility that governments can change the tax laws and affect the return on an investment (g) Market risk The possibility that market forces can affect the return of an individual investment (h) Event risk The chance that an unexpected event can have an immediate and significant effect on an investment's rate of return 92) Market risk is the risk that market forces can affect the return of an individual investment. Event risk is the risk that an unforeseeable event may have an immediate, significant effect on an investment's returns. Tax risk is the possibility that tax laws affecting an investment could change. All of these risks are caused by factors external to the company, so they cannot be avoided by researching internal factors. Although not firm related, we could also mention purchasing power risk tied to unanticipated changes in inflation and interest rate risk, which could affect stock values. 93) TRUE 94) FALSE 95) FALSE 96) FALSE 97) FALSE 98) A 99) D 100) B 101) C 102) B 103) C 104) B 105) D 106) B 107) The higher the risk, real or perceived, of an investment, the higher the expected rate of return. The higher the actual risk of an investment, the greater the probability that the actual rate of return will vary significantly from the expected rate of return. 17

Answer Key Testname: UNTITLED4 108) r t (rt - avg) 2 - 2.00% 0.56% 4.00% 0.02% 14.00% 0.72% 6.00% 0.00% sum 22.00% 1.31% avg. 5.50% variance 0.44% st. dev. 6.61% 109) TRUE 110) TRUE 111) FALSE 112) TRUE 113) FALSE 114) TRUE 115) C 116) C 117) B 118) B 119) A 120) D 121) A 122) B 123) A 124) A 125) A 126) B 127) A 18

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Chapter 4

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