buisness Fall2006 Gorman bus342 - §DLUT10Q$ 7 Final Exam...

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Unformatted text preview: % §DLUT10Q$ 7% Final Exam Fundamentals of Finance (BUS-342) Cal Poly, SLO Fall 2006 Professor Larry Gorman [email protected] This exam is closed bool_c, closed notes. Put your name on the back of the last page. Circle your answers. Use a minimum of 3 significant digits in all calculations. Show all work, and support all arguments (typically in the form of equations). Partial credit for numerically correct final answers not supported by supporting work will not be given. Good Luck. D @gst(/) '77 (t: 5'7) :2 WWI; TM: a; ”8 14% ANSweL; WM 455 75 To ‘77 (Four), Yms) 774-2“ 6"”? WWW!“ Tit-é flaw/Jaw éww Ar?“ A [57; 25732.. W. 57 m\ CF’” 4 7 $ .1 '1 t 57 M'ifi Wm“) 543,00? [1’05 =2;;a€z- ,' p . {m Quayle-10') $ m; 61; 57 W? Caflffiéé 7'0 To (11:? flair—77 ...... _ 3‘? f ’ NPVM vzzma 4- 53;’ ‘Wlffl Z 7265 fé 123% W 0F» 72%“ § x7"? 7% mfi'LLWM ”LL FM 73% mama}. @ “LL 9 V3§£DV¢~ Yaw: www IN Q£QWL “Fa OETf‘uJ W Law—1 093; QAvré‘ /\/’/\’~~ ”~- 4. You, as CFO of the grocery store chain Trader Mo's, have been asked to evaluate the following investment proposal. The project will span 7 years. Your firm, Trader-Mo's, is a grocery store chain with 53 stores throughout California. The firm is profitable, and is expected to remain so. However, Trader Mo's is considering selling not just food, but stainless steel BBQ's as well. As such they will need an automated welding machine. hiitially, you will purchase the welding machine for $57,000 (tum key installed). The machine will be depreciated over 4 years using straight line depreciation to a value of zero. The machine will be sold for $15,500 afier 7 years. Revenues in the first three years are expected to be $34,000/year, and are expected to be $40,000 in the subsequent 4 years. Operating expenses are expected to be 40% of revenue in all seven years. The machine will require an immediate increase in inventory from zero to $1200, and the inventory level will grow thereafter at $40 per year. After 7 years the inventory level will immediately return to zero. Accounts payable will require an immediate increase from zero to $1000, and this level will grow thereafter at $50 per year. After 7 years the A/P level will immediately return to zero. Accounts receivable will require an increase in one year (not immediately) from zero to $900, and this level will grow thereafter $60 per year. After 7 years the A/R level will immediately retum to zero. At the moment, the Trader Mo's is solely involved in the grocery business. The BBQ project will be a new area of business for them At the moment, the beta of Trader Mo's stock is 0.70, and Trader Mo's bonds have a YTM of 7.0%. The firm is currently financed 30% with equity and 70% with bonds. . Other BBQ makers (such as Weber, Kamado, VCS etc) tend to have a capital structure with a debt to equity ratio of ‘/z (half as much debt as equity). The BBQ industry has an average equity beta of 1.3, and the YTM on it's debt is 8% typically. The expected return on the market is 10.3%, and the risk free rate is 4%. Inflation is expected to be 2.6%. It’s raining in Baltimore. President Bush is still incompetent. ' Trader Mo‘s will borrow money to purchase the machine. The machine’s purchase is being financed by a 5 year bank-loan, using an interest rate of 10% per year with payments once a year. The loan is structured so that only interest of $5,700 ( = 10% of the $57,000 loan) is paid in years 1 through 5, and in the 5‘h year the entire $57,000 is paid back as well. The marginal tax rate is 34% per year for all firms. What is the NPV of the project? Should the project be undertaken? Circle your answer. W. ”7,0610 35 DEFQw’Cr :2 Law... 5:412:55 :-> 4r 4‘ r 4‘». cFengfi g «57" 5’: =10 (‘7Le § ... Cfcgws? 7. + {5 gm + (ovlfiéeaDvégéa = @230 T! "v ..-M_,_ , H...”- A Of"??? 572 _. 5 «- z>,/te‘?"> “i” 5:“ a? 65» 3 5) 7, ”emf” PA fin-5"” . gag-N»... 0h 7n”? DiféaJN’T 222136 die/$453 fl...” my: “72%?” Firzm 55/7“ Wfic Féfim cwwmsg W 7%? 85:52 /Nr”u_§“rg.,‘7€ Vs/MA ms: VAL «E; 2% :‘Wx/ f6 Comfaw ’46" Ef’g’mzryjp: ,04+/5(!aé« 54?); [24'7 W' D ‘ w i . ‘ m” 4%“ Wm 6%" “'2‘? WPWfi “1729:? w“? = 77’; Wi3€<5=¢§€€>fl2¥éj=r - (2/5}(aé><1<%‘b ==~ .0755 f (mi/m Ur/ 4 5C3? M Dwarf” WDW 2’2“?” ugflm: ism :Hem {20055 “ML; “15‘ 215557 NW“ ‘56‘ t: firm (01150 075%) +0 07%) ((072%)? 05:255) Cm; >1 #5 continued. Part (ii) Assume: The covariance of Crazy] stock and the market is 0.0155. That is: COV(CrazyJ, Market) = 0.0155. The annualized effective YTM on a 30 day US government zero coupon bond is 5.3%, the expected inflation rate is 3.2%. The level ofthe S&P 500 is 1285. The broad stock market has an expected return of 10.3%, and an annualized volatility of 15%. Assume the CAPM is a reasonable depiction of the real world. In this situation, is the purchase of Crazy] stock a good idea? Why? Show all work. . 55¢ (ca/Stu; 3’ momma?" W): . 0155 = .W IECRA’L‘if VFFQV (Marmara?) G I"S)L 4 £[6Mw]: L? 'F I? . (aka? " 1?)" 053 4-. am (10310???) —— - 69$ é——‘ WM WE'- 75 Sfiouw: Mr] V4 77“? Iflfl 2V5; {WH‘ICH ’5 ”Of fM-«figfi j if} ,4 feat-e. {NVefiBTMmr swag 73$: rag 1% L559 W "mg“ fined-wt" gateway my, 249?»? 7715.8 NPV is: 4.. ”fly: __ 7? 90 4.35 5.25— /[email protected], OD ffwmef [ma-25)" flog-25)" /’/fl 5 ‘1 MW ; - [3’ 5 ? ‘9‘“ [WV 15 Mal/Wig. (91';sz “Bf-wrap; IT" 5735:? Mace Yam muggy) Question 6 Part (i) work cont: 1 V/ _, :ézgzjz ,4) + (2%)72429 4—Cw5’52043 + Question 6, continued next page... .p/‘f Question 6. Part (ii) 774.? mm! fem“ Wm... can/5:5?" aw— Wm} fissas {77‘5“ mm:4e.‘?“/ ma W8m;$, rr wmr #ME' v1: ,05‘378 5 Wrflcm-‘fi’fié x: QR w“ W”: +071“?! +ZW¥2®$€TS> mar “ma-r T8u¢7fi8nas M ,066787? = w;_(.03z43 =7 ML? == /. 47425 «75’ 77ng 55M”W $/%I?0 /= :éV? x 2555 . $ 2’ .. + ; ' 4 " Aw wagr 7545’ 940 K. Kééféx 25/2350) IN W MW?“ FMJ'Faaa, Mai—E; ”/7/ /?0 '5'- TééE : mean“; 27/ 650 + 4'3 040 +1 [945} =- an: Zfifi‘fi-Q .—— 49 #6. You have a portfolio consisting of four assets: 125 shares of GB, 110 shares of SUN, and 150 shares of HP, with respective prices of $48, $70, and $28 per share. You are also holding EIGHT 1 month US Treasury T-Bills, each with a current value of $993.75. These T-Bills mature in exactly one month with a nominal value of $ 1000. (They're a 1 month, zero coupon bonds). For clarity, these holdings are also described in the table below: i W? es“ ’ ‘6 V5 2= 22 a???) The 3x3 (annualized) variance-covariance matrix that describes the returns of the three risky assets is: 0.12, and 0.14 respectively. The expected annualized return on the broad market is 10.3%. The annualized variance of the market portfolio is 9,0223. J Inflation is expected to be 3.6% per year forever. Assume the CAPM is a reasonable depiction of the real world. a. 0324 qt ‘9} 3‘ You have run a market model regression on each of the three stocks and found R2 values for GB, SUN, and HP, to be 0.06, m< A (i) What is the annualized volatility of your FOUR-asset portfolio? Hint: You need to determine what the 4th row and column of the variance—covariance matrix look like when the T-Bill is included as a 4th asset. - We ar— - 7700 ..~ ' “3;; ’ 25, 660 3 2;; fiat/'27; 950 26% ’ 4290‘, 03/ a: .7350 :1 95 W; 'Z§,5?‘9 *,/QZ T3:éé~;.§ 25 550 3 ' g ! rat .' , ,4LL wmzaré» W W 47 my a“ 4 Catt/m} or: 7%,; Va/ xvi/mm Mr; Zcm’e fimr—E Cos/{mini 0:0 Mamet? We Wm gin v5“ “m m/cc upg’ 3a; 9 KNFFZEE m’ 72% %r% t/&:/ mam/x 4.50 vE‘ , Continued work next page: ll 5. Your "friend" tells you about a supposedly great investment in CrazyJ stock, and you are considering investing in it. The stock trades at $79 per share now, and your friend expects it to pay a $4.35 dividend per share in three years, and then another $5.25/share dividend three years after that (i.e. six years from today). Your friend says the stock will trade at $106 per share in seven years (at which time you expect to sell it - after collecting the two dividends at t=2 and F6). (i) If the above cash flow projections are correct, What is the annualized IRR on the investment? Use linear interpolation. (Circle your answer). ~$ {Ob e9 . g, - Rx. 5436’ 5-7:; ' AMA-awe. WM rmmth-1w~w> 7’7““? 736:5 5"” t” 2, 3 4% 5’ (‘9 7 3 'éréfifim 4 a; 52.; goal or: “ J; .. ‘ «e + ”Wt. 4 fmflflmmh ‘4‘ , ’ a / Nf’e “ 767‘ {2/ 0,3)”; {ADfRDw (£05)? 4 NM (awed/L. [Nt‘aaarpowwfit PM“ 5"" le—AIe—“é «mu-V... -. .......—~-« Question is continued next page... £74: (SW 5;? é“ 53?? :2 (54?” ”64%;??5062) [4&?§/<[”54"}* ii”; 3,54? w [5} $3539 _ 5;? ‘ ,x .. $ {3: ,5 {4mg ,{j4}(4qwa)_ [%Z5%!fi§€9+ #273 r:- gag. {9&5 ifigqagg ~fl4){4fi,aoa)— ){hgafio 3,5, 540- m um um: want-mm, .. ,:_~:u=-m.=mmmm . WW wage, Wdziifwza 615% {M— “FF; LEVEL) 6:: w vwmm/ I Aflz 251 N? W “Ema: «an 771% éwéé CFAW: ,/, [AW/‘2) -: "'1’- élfAlV—I—AA/Z —~ 234/59 ,1: ‘ \ ,Aw'a , $ Cf’ = ’Ir/I’ZooqLfio—daoa) = ’fiaa 21:0 '~ , a: é/FN'E’: ~I [40+ 50 - éa) = ‘33" («>9 3. There were four graphs used to explain our story regarding "Modern Portfolio Theory". For each of the four graphs, I want you to write the associated equation that relates to the graph. That is, For Graph 1, I want you to write the equation of the Capital Market Line For Graph 2, I want you to write the equation of the variance of a 3 asset portfolio (stocks A, B, and C). For Graph 3, I want you to write the equation of the Market Model Regression, For Graph 4, I want you to write the equation of the Security Market Line. Put your answers (equations) below: Part (i) The equation of the Capital Market Line is: ,. " up) [EL/2;]: Cg. + iii—QM? 1:“ . ‘7; ‘7: Part (ii) The equation of the variance of a 3 asset portfolio (for stocks A, B, and C) is: .2; '2. 'L '22 ‘2. '2; TS, win was; we; «4» A» 2 NZ. .U‘J—B ‘ éwéAiB> +1 2. Wk. W‘s, - 60x! (Arc) +2. WE «ufv- CW (35") Part (iii) The equation of the Market Model Regression is; A A, Part (iv) The equation of the Security Market Line is: (75") FT”) Fl LA at :35 ‘l’ :w > (T1 ("Tl £0 J t +7 2. You are about to buy a new car for $26,000. You will pay $4000 now, and you will borrow $22,000 immediately. You can borrow the $22,000 from a local bank. The interest rate for auto loans (available from the bank) is 15% APR, based on monthly payments. This interest rate of 15% APR holds for any auto loan from 2 to 5 years in length. The monthly payments begin in one month. As an example, a 3 year loan has a total of 36 monthly payments, beginning in one month. (CFs at t=1 to 3 6). However, you have borrowing sources other than just the local bank: The car dealer also finances cars, and he will be happy to loan you the money. The car dealer has the following financing plan: 0 Borrow the $22,000 at 9% APR for "3 years". 0 Actually, web—Em, there are.no payments for the first 11 months, then the first payment is paid (in 12 months from now), and continues to 36 months (from now). i.e. CFs at F12 to 36. o The monthly payments (1:12 to 36) are NOT equally sized. Rather they are growing nominally in size by 2% per month. The dealer charges charges a fee up from (paid at time zero to him) if you want to finance with him at the low low 9% rate. What is the largest dollar amount you would consider paying to the dealer in order to get the 'preferred' rate of 9%? P . ,-.-u. w", M _« ‘1 .9. 1“ fly; . . I ‘ j‘ .1 63:“- WE N ew/ fa) FWD Wig: Tat/E: W a, v5 9 it“ "new, fiéflzazé §VéStptlbID (Law IQA‘TE) PM 612:? 3.3 5:1,.9 W CEF‘IS \ §TZP 2: VMV'E 77W (Vfilfi/fi Wégfisw (a 577;? .1: 77h?" 52F? Age” continue work on next page if necessary... mm ~———‘7 Ag -~ . i; ._ / You just turned 20 years old, and you are planning for retirement. You will graduate in 2 years from Cal Poly, and expect to receive a $2000 (nominal) gift from grandma (God bless her). You plan on investing the money in Vanguard's S&P 500 Index mutual fund, with an expected Ml return of 6% per year. In addition to the $2000 you are due to receive in two years, you will also begin making annual deposits into the fund beginning in 9 years. Specifically, on your 29th birthday you will deposit $2900 (nominal) into the fund, and subsequent annual payments will grow at a gal rate of 2.0% per year. These deposits will continue until your 60th birthday, when you make the last deposit. You want to retire on your 73'dbirthday, and expect to die on your 94“ birthday. During retirement, you will make annual withdraws on your 73‘h through 93th birthdays. You want your standard of living (i.e. in real terms) to increase slightly over time (due to increased medical costs as you age). Hence you have decided to have the annual retirement cash flows increase in real terms by 1.8% per year. You forecast inflation to be 3% per year forever. You are curious as to how well the above plan will provide for you in your "Golden Years". As such, please answer the next two questions: (i) Given your plan, what is the size of the @ retirement payment you can expect to receive (in nominal terms) ? (i.e. on your 77th birthday). CIRCLE YOUR ANSWER (ii) How does your answer in part (i) compare, in terms of standard of living, to a $70,000 / year income today? That is, will you live better or worse (and by what percentage) from age 77 to 78, than you could today on $70,000 ? CIRCLE YOUR ANSWER £Z,’j : ' 03 FM”: (l-I’rfi‘m’)(t+ii) .[ =//~06)(f-0‘5)- 5 2,0735 = [(977,5’ +» 24,031.60? fzazeae’f err—pr we A»; swives. ...
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