# Principles of Modern Finance Sample Midterm Essay

February 22, 2012

Instructions

• You have 1 hour and 40 minutes. • The exam is out of 25 points. • There are 22 multiple-choice questions. 19 questions are worth one point, 3 questions are worth two points and are marked as such. • If you get stuck, move on and come back later.

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1. A stock is expected to pay a dividend of $10 next year, and this dividend is expected to grow by 5% each year thereafter. What should the price of the stock be if instruments of similar risk are paying 12%? (a) $83.33 (b) $142.86 (c) $150 (d) $200 2. A project has the following cashﬂows: Year 0 1 2 Cashﬂow +12000 −7080 −6654 The IRR of these cashﬂows is 9%. Assets of similar risk pay 5%. Should

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(a) Yes, the bond is better. (b) No, the bond is worse. (c) Can’t tell from information given 12. You are given the following information about portfolios of two risky assets, A and B: Weight in A Weight in B Std.dev. of portfolio 0 1 12 0.5 0.5 14 1 0 16 What is the covariance between A and B? (a) 192%2 (b) 168%2 (c) 224%2 (d) Cannot be determined 13. A ﬁrm in a well-functioning capital market has the following projects available. The risk-free rate is 10%. Which should it invest in? NPV IRR X 10 15% Y 0.1 3% Z -5 22% OCC 22% 5% 6%

(a) X only (b) Z only (c) X and Y (d) X and Z (e) All three

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14. You are considering investing in a bond. This bond costs $300 now and pays $550 in ten years. What is the IRR of this investment? (a) 1.06% (b) 6.25% (c) 8.33% (d) 9.01% Answer the next two questions using the following information: A project has the following expected cash ﬂows. Year 0 1 2 Expected cashﬂow −370 814 −447.7 The IRR of these cash ﬂows is 10%. 15. Which of the NPV functions on the following page best describes this project? (2pts) (a) Graph A (b) Graph B (c) Graph C