Illinois Eastern University BUS 3710 Spring 2009 Final Exam Calculations 1) 2) 3) 4) Present value of an investment Present value of an annuity Future value on an investment Future value of an annuity Loan payments Expected return for an investment = sum of (possible returns x probability of those returns) Coefficient of variation = return / risk = expected return / beta or expected return/standard deviation Portfolio expected return = sum of (expected return for investment x portfolio weight) for each investment Capital asset pricing model: expected return for an asset = riskfree return + (market expected return riskfree rate of return) * beta Bond value Bond's yield to maturity (YTM) Net present value (NPV) = PV of estimated cash flow cost of investment Internal rate of return (IRR) = discount rate which gives future cash flows a NPV of zero Dividend growth model: price of stock = next year's dividend/(required rate of return dividend growth rate) Cash flows in capital budgeting a) Initial year (Year 0) b) Annual aftertax operating cash flow c) Year of project's disposition Weighted average cost of capital (WACC) = (equity percentage x equity required return) + (debt percentage x after tax debt required return) a) Cost of debt = aftertax of return (YTM) i) Aftertax rate of return = pretax rate of return x (100% company's marginal tax rate) Cost of preferred stock = dividend/net price of stock i) Net price is after paying costs of selling stock (flotation costs) Cost of existing equity (retained earnings) a) Methods of estimating the cost of equity i) CAPM approach: required rate of return = riskfree return + (market expected return riskfree rate of return) * beta ii) Dividend growth model: required return = dividend yield + growth rate Cost of new equity a) More expensive due to flotation costs Size of accounts receivable Implicit rate of return on cash discounts EOQ, carrying and holding costs of inventory Exchange rate crossrates Returns on foreign investments Purchasing power parity b) 17)
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Ratios
1)
Calculate and interpret these ratios:
a)
Shortterm solvency (used by shortterm creditors) i) Current: current assets/current liabilities ii) Acidtest (quick): current assetsinventory/current liabilities
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Longterm solvency (used by longterm creditors and stockholders) i) Debt: debt (liabilities)/assets c) Profitability (used by stockholders) i) Profit margin: net income/sales ii) Return on assets: net income/assets iii) Return on equity: net income/equity d) Market value (used by stockholders) i) EPS: net income/number of outstanding shares of common stock ii) P/E ratio: price of stock/earnings per share iii) PEG ratio: P/E ratio/growth rate of EPS e) Other i) Payout ratio = dividends/net income ii) Retention ratio = 100% payout ratio iii) Percentage change (growth rate) = (current year prior year)/prior year Interpret these ratios:
b)
a) b) c)
Beta Sustainable growth rate Standard deviation
Short Answer Questions 1) 2) From a finance perspective, what is the goal of the firm? Discuss the current status of the yield curve and the implications for future economic conditions in the United States. Why is the interest rate on onemonth Treasury bills currently less than .10% as of December 2009? If a market is efficient what should be the approximate Net Present Value of all assets in that market? Chucktown Chops had sales of $10 million in 2009. Total assets are $20 million and total debt is $5 million. If the profit margin is 20%, what is net income? What is ROE for the company? A stockholder would be most interested in which one of the following ratios? ____ Current ____ Beta
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____ Quick ____ Debt
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The accounts receivable of Chucktown Chops increased from $56,985 as of December 31, 2008 to $75,219 as of December 31, 2009. Would the increase in accounts receivable increase, decrease or have no impact on the firm's cash flow from operations? The following information is available from the financial statements of Greenup Grass Carp: 2008 2009 343,743 45,786 110,000
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Net Income Dividends Shares of common stock outstanding What are earnings per share for 2009?
257,093 31,765 100,000
9)
If the price of Greenup Grass Carp stock is $50 at the end of 2009, what is the company's P/E ratio at the end of 2009?
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10)
Paris Pigs has a P/E ratio of 16.2 and a PEG ratio of 1.92. Chucktown Chops has a P/E ratio of 34.6 and a PEG ratio of .88. Which stock would you buy?
11) Caterpillar has return on assets on 2.4% and return on equity of 35.6%. What does this tell you about the amount of debt the company has? 12) If you think the stock market is overvalued and will probably decline in the near future would you prefer to own high beta or low beta stocks?
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Building
Based on the following information from Saluki Slackers balance sheet as of December 31, 2009, what is this building worth? $200,000 Accumulated depreciation: building $175,000
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Between 1981 and 1996, the average inflationrisk premium demanded on threemonth Treasury bills was 3.06. As of December 7, 2004 the yield on threemonth Treasury bills was 2.20%. What does this tell you about the financial markets' opinion of inflation risk as of December 7, 2004? As of December 1, 2006, Google had a P/E ratio of 62 while Microsoft had a P/E ratio of 23. What does this tell you about the market's expectations regarding the future EPS of these companies' stocks?
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16) What type of risk is eliminated if you invest a diversified portfolio of common stocks? 17) If a market is efficient will all of the assets in this marketplace have the same coefficient of variation?
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Chucktown Chops has a chop crusher it is planning to replace. The firm paid $35,000 for the chop crusher in 2001 and has taken a total of $28,000 of deprecation on the asset. The company is planning to sell the chop crusher for $17,000 and buy a new machine for $40,000. Should Chucktown Chops sell the chop crusher or tradein the machine when it buys the new chop crusher if the copy has a 30% tax rate? On December 31, 2002, bonds issued by Lucent Technologies mature that in 2028 had a price of $785 and a yield to maturity of 13.9%. If the yield to maturity on these bonds remains 13.9% as of December 31, 2003, will the price of this bond increase, decrease or stay the same during 2003? Home Depot announces today earnings per share for the company's most recent year increased 17% to $1.53. The financial markets had anticipated earnings per share would increase to $1.41. What will be the impact on the price of Home Depot's stock and the S&P 500 (the overall stock market)? The Federal Reserve announces today it is increasing shortterm interest rates by %. The financial markets had anticipated an increase in shortterm interest rates of 1/4%. What will be the impact on the price of Home Depot's stock and the S&P 500 (the overall stock market)? As of December 31, 2008 Chucktown Chops had retained earnings of $45,353. During 2009 the company had net income of $61,464. As of December 31, 2009 the company had retained earnings of $53,342. What is the amount of dividends the company paid stockholders during 2009?
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23) The payout ratio for Chucktown Chops has averaged 94% for the past five years. Is this company growing rapidly?
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Ms. Chuck Townie wants to have $30,000 when she retires in 20 years. She plans to invest $1,000 today. What rate of return will be required for her funds to grow to the desired amount? Calculate your answer to the nearest tenth of a percent, for example, 13.1%
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Effingham Eggs experienced the following changes in ratios during the year. Place a checkmark in front of the change(s) that represent a change that is an improvement for the company.
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_____ The acidtest (quick) ratio decreased from .65 to .43 during the year. _____ The debt ratio increased from .44 to .57 during the year. _____ The profit margin increased from 13.2% to 17.6% during the year.
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Mrs. Chuck Townie wants to have $500,000 when she retires. She plans to invest $1,000 each year. If she can average a 10% rate of return on her investments, how many years will be required for her funds to grow to the desired amount? Calculate your answer to the nearest tenth of a year, for example, 13.4 years.
27) The payout ratio for Chucktown Chops increased from 47.1% to 72.1%. What would be the impact of the increase in the firm's payout ratio on the firm's sustainable rate of growth?
28)
Ms. Chuck Townie invested $1,000 a year for 40 years but she withdrew $13,000 from her investments 30 years ago to buy a bass boat. If Ms. Townie averages a 10% rate of return, how much will she have after 40 years? Chuck Townie, Jr. borrows $100,000 at 6% interest from the Next to Last National Bank of Pesotum to buy a home. If he repays the loan over 32 years, what will his annual payments be assuming the payments are the same every year? How much interest will Mr. Townie, Jr. pay over the life of the loan? The market price of Chucktown Chops bonds is $ 920. These bonds have a face value of $1,000, a coupon rate of 6% and mature in 25 years. What is the current yield, the beforetax and aftertax required rate of return (YTM) on the bonds if the company has a 30% tax rate? Would the yieldtomaturity on callable bonds issued by IBM be higher, lower or the same as the yieldto maturity on noncallable bonds issued by IBM if all the bonds matured on the same date?
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32) Chucktown Chops is considering the purchase of a new fake hog fryer. Here is information regarding the machine: The fake hog fryer costs $34,000. The company recently completed a study that found the machine should increase sales by $15,000 per year before tax. The cost to complete the study was $3,000 aftertax. It would cost $4,000 aftertax to install this machine properly. The machine will require an increase in raw materials inventory of $2,000. If the company enters the fake hog market, sales of the company's fresh hogs will increase by $3,000 per year. This machine has an expected life of three years for depreciation purposes and straightline depreciation will be used. At the end of year 3 the machine will be sold for $8,000. At the end of year 3 raw materials inventory will be reduced by $2,000. To purchase the new machine, it appears the firm would have to borrow $24,000 at 10 percent interest from its local bank. The company will make principal payments of $8,000 annually for three years in addition to the annual interest payments. The company has a 40% tax rate. It requires a 10% rate of return for the machine.
What is the annual cash flow in year 0? What is the increase in aftertax cash flow in years 1 and 2? What is the increase in aftertax cash flow in year 3?
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Chucktown Chops is considering the purchase of a winetenderizing machine. The company is evaluating two alternative machines: the 007 Cork Wacker or the XTZ Wine Smasher. Costs and projected cash flows are shown in the following table: 007 Cork Wacker 40,000 16,084 16,084 16,084 0 0 54,704 XTZ Wine Smasher 40,000
Year 0 1 2 3
What is the Net Present Value for the 007 Cork Wacker assuming the company requires a 9% rate of return on the project?
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What is the Internal Rate of Return for the 007 Cork Wacker? What is the Internal Rate of Return for the XTZ Wine Smasher? Based on the information below, calculate the expected return for Joliet Jam: Robinson Radios Joliet Jam Return 20% 10% 20% 10% 30% 60% Probability 10% 0% 8% Return
Probability 20% 40% 40%
37) Which stock has the highest standard deviation?
38)
Based on the information above, what would be the expected return for a portfolio invested 30% in Robinson Radio and 70% in Joliet Jam?
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39)
Greenup Apples' beta is 1.2, the riskfree rate of return is three percent and required rate of return in the company's market is 11%. What is the required rate of return using the CAPM approach?
40) Assume the stocks listed below trade in an inefficient market. Based on the information available concerning risk and reward, which stock should you purchase? Expected Return Springfield Spaghetti Leroy Lances Bloomington Bloomers 14.0% 19% 9%
Beta .7 1.0 0.5
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