Practice HADM225 Final
Name:_________________________________________________________
1. A stock has an expected rate of return of 8.3 percent and a standard deviation of 6.4 percent. Which one of the following best describes the probability that this stock will lose 11 percent or more in any one given year? A. less than 0.5 percent B. less than 1.0 percent C. less than 1.5 percent D. less than 2.5 percent E. less than 5 percent 2. One year ago, you purchased a stock at a price of $32 a share. Today, you sold the stock and realized a total return of 25 percent. Your capital gain was $6 a share. What was your dividend yield on this stock? A. 1.25 percent B. 3.75 percent C. 6.25 percent D. 18.75 percent E. 21.25 percent 3. The U.S. Securities and Exchange Commission periodically charges individuals for insider trading and claims those individuals have made unfair profits. Based on this fact, you would tend to argue that the financial markets are at best _____ form efficient. A. weak B. semiweak C. semistrong D. strong E. perfect 4. If you excel in analyzing the future outlook of firms, you would prefer that the financial markets be ____ form efficient so that you can have an advantage in the marketplace. A. weak B. semiweak C. semistrong D. strong E. perfect 5. The linear relation between an asset's expected return and its beta coefficient is the: A. reward-to-risk ratio. B. portfolio weight. C. portfolio risk. security market line. D. E. market risk premium.
6.
A. B. C. D. E. 7.
A. B. C. D. E. 8.
A. B. C. D. E.
Which of the following are examples of nondiversifiable risks? I. the inflation rate spikes nationwide II. an unexpected terrorist event occurs III. the price of lumber suddenly spikes IV. taxes are increased on hotels I and III only II and IV only I and II only II and III only I, II, and IV only The market has an expected rate of return of 9.8 percent. The long-term government bond is expected to yield 4.5 percent and the U.S. Treasury bill is expected to yield 3.4 percent. The inflation rate is 3.1 percent. What is the market risk premium? 2.2 percent 3.3 percent 5.3 percent 6.4 percent 6.7 percent Nuvo, Inc. stock has a beta of .86 and an expected return of 10.5 percent. The riskfree rate of return is 3.2 percent and the market rate of return is 11.2 percent. Which one of the following statements is true given this information? The return on Nuvo stock will graph below the Security Market Line. Nuvo stock is underpriced. The expected return on Nuvo stock based on the Capital Asset Pricing Model is 9.88 percent. Nuvo stock has more systematic risk than the overall market. Nuvo stock is correctly priced.
Douglass Enterprises has a capital structure which is based on 40 percent debt, 10 percent preferred stock, and 50 percent common stock. The after-tax cost of debt is 6 percent, the cost of preferred is 7 percent, and the cost of common stock is 9 percent. The company is considering a project that is equally as risky as the overall firm. This project has initial costs of $125,000 and cash inflows of $76,000 a year for two years. What is the projected net present value of this project? A. $11,275.07 B. $11,398.16 C. $11,403.03 D. $11,006.18 E. $11,783.43 10. Including flotation costs into the net present value of a project will: A. not affect that net present value. B. increase the net present value of the project. C. increase the discount rate applied to the project thereby lowering the project's
9.
D. E.
net present value. increase the initial cash outflow of the project thereby lowering the project's net present value. affect the net present value but the direction of that impact cannot be determined.
Problem #1 NOTE: This question is two pages long. Answer all of parts a-e. you Suppose have been hired as a financial consultant to Sikorsky Helicopter. The company is looking at setting up a manufacturing plant overseas to make helicopter rotors. This will be a 5-year project. The company bought some land 3 years ago for $3 million in anticipation of using it as a toxic dump site for waste chemicals, but it build a piping system to safely discard the chemicals instead. The land was appraised last week for $9.6 million. The company wants to build its new manufacturing plant on this land; the plant will cost $15 million to build. The following market data on Sikorsky's securities are current: Debt: 15,000 7 percent coupon bonds outstanding, 15 years to maturity, selling for 92 percent of par; the bonds have $1,000 par value each and make semiannual payments. Common stock: 300,000 shares outstanding, selling for $75 per share; the beta is 1.3. Preferred stock: 20,000 shares of preferred stock outstanding, selling for $72 per share. The dividend is $5 per share. Market: 8 percent expected market risk premium; 5 percent risk-free rate. Sikorsky's investment bankers charge floatation costs of 9 percent on new common stock issues, 7 percent on new preferred stock issues, and 4 percent on new debt issues. Sikorsky's tax rate is 35 percent. The project requires $900,000 in initial net working capital. Assume that the net working capital can be financed internally, i.e. no floatation costs. a. Calculate the project's initial Time 0 cash flow, including all floatation and opportunity costs.
Market value of debt Market value of equity Market value of preferred Market value of firm D/V E/V P/V a. Floatation costs The cost of the land 3 years ago is a sunk cost and is irrelevant. Land Plant (including floatation) Net working capital $ $ $ $ 13,800,000 22,500,000 1,440,000 37,740,000 0.3657 0.5962 0.0382 7.0954%
$ $ $ $
(9,600,000) (16,145,593) (900,000) (26,645,593)
b. Sikorsky has decided that this project should have a WACC that is 2 percent higher than its overall WACC, due to the higher risk of overseas operations. Calculate the WACC for this project.
b. Pretax cost of debt Aftertax cost of debt Cost of equity Cost of preferred WACC Discount rate for project 7.92% 5.15% 15.40% 6.94% 11.33% 13.33%
c. The plant has a 5 year life, and Sikorsky uses straight-line depreciation. At the end of the project (i.e. the end of Year 5), the plant can be scrapped for $5 million. What is the after-tax salvage value of the plant?
c. Book value in year 5 Aftertax salvage value $ $ 3,250,000
d. The company will incur $400,000 in annual fixed costs. The plan is to manufacture 12,000 rotors and sell them for $10,000 each; the variable production costs are $9,000 per rotor. What is the annual OCF from this project? (Remember there are no interest costs in this project, so you just have Sales, Variable Costs, Fixed Costs, Depreciation and Taxes.)
d. Sales Variable costs Fixed costs Depreciation EBIT Taxes Net income Depreciation Operating cash flow $ $ $ $ $ $ $ $ $ 120,000,000 (108,000,000) (400,000) (3,000,000) 8,600,000 (3,010,000) 5,590,000 3,000,000 8,590,000
e. What is the NPV of this project?
e. Year 0 1 2 3 4 5 IRR NPV $ $ $ $ $ $ Cash Flow (26,645,593) 8,590,000 8,590,000 8,590,000 8,590,000 12,740,000 21.15% $ 5,546,551.35
Problem #2 Consider the following investment opportunities: Investment A B C D Beta 1.20 1.00 0.95 0.70 E(R ) 14.0% 11.5% 11.0% 9.0%
The risk free rate is 4% and the expected return on the market is 12%. a) Graph the security market line and plot the investments described above b) Which of these investments would you choose to invest in? Why? You would want to buy A because it is underpriced (plots above the SML) and sell B, C and D (plot below the SML).