University of Toronto (Mississauga)
FINANCE
Sample Midterm
QUESTION 1:
a) First National Bank charges 10.1 percent compounded monthly on is business loans. First
United Bank charges 10.4 percent compounded semiannually. As a potential borrower, to
which bank would you go for a new loan that lasts for a year?
b) For 40 years you will save $10,000 at the beginning of each year towards retirement. Your
first payment is today, and you expect that you make an 8% return each year (EAR),
reinvesting your proceeds from previous years (plus putting in a new amount of 10,000
every year).
i. How much money will you have saved for retirement at the end of 40 years?
ii. If you wanted to have $3.5 million in your retirement fund, how much should you be
saving at the beginning of each year?
QUESTION 2:
Your uncle has asked you for some advice as he has just retired and he heard that you know
about time value of money calculations. He has $500,000 saved in his pension account, and he
expects to live another 20 years. When he dies in 20 years’ time he would like all his money to
be left in a scholarship fund that will pay an amount of $7,500 per year forever (the first
payment will be at the end of year 21). How much is your uncle able to withdraw from his
retirement acount at the end of each month, starting from the end of this month (assume that
today is the first of the month) until he dies in 20 years’ time. Assume the interest rate is 10%,
compounded semiannually throughout. Display your % to two decimal places. Display your $
workings to the nearest $1.
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QUESTION 3:
PART A:
Suppose a one-year zero-coupon bond with a face value of $1,000 is sold at $980, a two-year
zero-coupon bond is sold at $950, and a three-year zero-coupon bond is sold at $920.
(a) Calculate the 1-year, 2-year and 3-year spot rates. (Display your workings to 2 places for
a percentage – e,g. 0.12%. Assume annual compounding)
(b) Assuming you wish to purchase a 3-year 5% annual coupon bond: Based on the spot
rates calculated in part (a), and the cash flows relating to this bond, calculate the price
of a 3-year 5% annual coupon bond with a face value of $1,000.
(c) Calculate the Yield-to-Maturity of this Bond. Show your answer to two decimal places.
PART B:
Describe the relationship between an increase in interest rates, the price of a bond and:
i. the size of coupon payments (i.e. if interest rates increase, how will the price of a
bond move if it has large coupons vs if it has small coupons)
ii. the time to maturity of the bond (i.e. if interest rates increase, how will the price of
a bond move if it has a long time to maturity vs if it has a short time to maturity)
iii. the market level of interest rates (i.e. if interest rates increase, how will the price of
a bond move if market interest rates are low vs if market interest rates are high)
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QUESTION 4:
PART A:
ZRide expects to have earnings this coming year of $5 per share (i.e. EPS for Year 1 is $5). From
year 2 onwards, earnings are expected to grow by 8% per year, and this earnings growth rate
will continue in perpetuity. ZRide plans to retain all of its earnings for the first two years (years
1 and 2). In the next two years (years 3 and 4), the firm will retain 50% of its earnings. Finally,
from year 5 onwards it will retain 30% of its earnings. Earnings that are not retained will be paid
out as dividends. Assume ZRide’s share count remains constant and all earnings growth comes
from the investment of retained earnings (Note for clarification: Assume that the growth rate is
not affected by the retention rate – i.e. it stays at 8% throughout this problem).
ZRide’s equity cost of capital is 10%.
a) Calculate DIV1, DIV2, DIV3, DIV4 and DIV5
b) Calculate P5 the expected stock price five years from now
c) What is ZRide’s stock price today?
d) What is the expected rate of return to an investor who buys the stock now and sells it in
one year? Calculate the breakdown between dividend yield and capital gains yield for year
1.
e) How do you expect dividend yield and capital gains yield to change relative to each other
over time from Year 1 to Year 5?
f) If ZRide share is trading today at $160, would you buy it? How about $180? How do you
expect the price to change in this two cases? Explain briefly.
g) Discuss the limitations of the dividend growth model, and propose an alternative valuation
model that could mitigate some of these limitations.
PART B:
The following table provides summary data for Cerner Corporation (CERN) and its competitors,
Allscripts Healthcare Solutions Inc. (MDX) and McKesson Corporation (MCK), operating in the
healthcare IT and solutions industry.
(in millions) CERN MDRX MCK
Market value of Equity $ 1,624 $ 21,268
Book value of equity $ 2,834 $ 1,284 $ 7,070
No. of Common shares outstanding 172.1 shares 172.4
shares
197.0 shares
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a) Compute the Price-to-Book ratio for both MDRX and MCK
b) Using MDRX and MCK as comparables, estimate what you think the intrinsic value of equity
is for CERN, in total and per share
c) Suggest some other comparables you could use to narrow the range of valuations for the
CERN share price