Finance and risk management - international business - Practice Exam 2

Open questions

Question 1

You are considering two loans and would like to select cheaper alternative. The terms of the two loans are equivalent with the exception of the interest rates. Loan A offers a rate of 8 percent, compounded semi-annually. Loan B offers a rate of 7.75 percent, compounded monthly. Which loan should you select and why?

Question 2

You just bought a home for €250,000 and are to make payments of 11,162.71 in every two months at 12% annual interest rate. How many years will it take you to pay off your loan of €250,000?

Question 3

1. What is more important to a firm - to maximize profits or to maximize stock price? Explain shortly.
2. Suppose you own 100 shares of KPN which you intend to sell today. Since you will sell it in the secondary market, KPN will receive no direct cash flows as a consequence of your sale. Should KPN's management care about the price you get for your shares? Why?
3. Explain what is meant by Capital Structure. Describe the two main types of corporate financing and how they differ from each other.
4. What is corporate governance regulation intended to?

Question 4

A company has sales of €12,900, costs of €5,800, depreciation expense of €1,100, and no interest expense. What is the operating cash flow if the tax rate is 40%?

Question 5

You have an annuity of equal end-of-the year cash flows of €500 that begin two years from today (the end of the second year) and last for a total of ten cash flows. Using a discount rate of 4%, what are those cash flows worth in today’s Euros?

Answer indication Open questions

Question 1

EAR of B = {[1+(0.0775/12)]^12}-1 = 0.0803

EAR of A = {[1+(0.08/2)]^2}-1 = 0.0816 B, because the effective annual rate of B is 8.03 percent and cheaper than A.

Question 2

PV = PMT * (PVIFA %r, n) 250,000 = 11,162.71 * (PVIFA%2, n*6) (PVIFA%2, n*6) = 250,000 / 11,162.71 = 22,396 (10p) for the correct answer for number of months From table with 2% the period is 30, then 30/6= 5 years. (5p)

Question 3

a) Both are very important. However, a firm's profit is an accounting notion do not reflect real cash flows. Maximizing the stock price is more important because it is this that actually matters to investors. Since the financial goal of managers is shareholder wealth maximization, maximizing stock price will achieve this aim. Wealth is measured by market value and market value is obtained by stock price. Moreover, a firm can maximize value but be making a loss (this happens to many new companies).

b) Secondary market is important to obtain fair market value and liquidity of stocks. This will make easier for firms to raise additional financing whenever they need. The current market price of KPN equity reflects, among other things, market opinion about the quality of firm management. If the shareholder’s sale price is low, this indirectly reflects on the reputation of the managers, as well as potentially impacting their standing in the employment market. Alternatively, if the sale price is high, this indicates that the market believes current management is increasing firm value and therefore doing a good job.

c) Capital structure is the mix of financing sources in a firm. The two main types of financing are Debt and Equity. Debt is borrowing and Equity is ownership. Debt provides claims that are interest payments and principle payback. Interest payments are fixed claims. Interest payments are certain and has a priority over dividends. Ownership gives claims to residual earnings (dividends as cash), which are uncertain.

d) It is intended to protect investors from managers’ abuses because of agency problems.

Question 4

Sales 12900; Costs 5800; Depreciation 1100; EBIT 6000; Interest 0; EBT 6000; Tax 2400; Net Income 3600

Cash Flow= Net Income + Depreciation = 4700

Question 5

PV = PMT x PVIFA%4,10 PV = 500 x 8.1109 = 4,055.45 This is the present value at the end of year 1 Today’s PV = 4,055.45 x PVIF%4,1 = 4,055.45 x 0.9615= 3,899.32