From a hiring standpoint, I really do believe that if an organizations wants to go through the motions of the design exercise for something minimally time-consuming, it should be paid. Basecamp's approach to that for their interview process is a best practice in my opinion
... I just wrote a massive reply and hit save and none of it saved. WTF DesignerNews. I'm not writing it again.
Devs almost always do a pair code AND an algo test when being hired for good (and generally well paying) positions at tech companies. In my experience designers rejecting the notion of being tested can actually paint the profession as precious elitists to others (depending on how it's rejected). And it generally DOES catch some gaps with skills that some applicants can misrepresent.
I agree that the exercise outlined in this job interview was certainly a step too far. If you're being asked to do an exercise you feel is taking advantage of you I suggest explaining this to the recruiter and negotiating a different trial you feel is a fairer compromise.