Exam I review FIN6320 - Exam 1 Review FIN 6320 About exams...

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Unformatted text preview: Exam 1 Review FIN 6320 About exams •  Time limited: 90 minutes •  Format: 30 multiple choice questions •  Contents related: Module #1, #2 and #3 •  Refer to study guide on the blackboard for specific topics covered •  2 types of questions •  Conceptual •  calculation Practice Exam •  Q 1. : It will cost $2,600 to acquire an ice cream cart. Cart sales are expected to be $1,800 a year for three years. After the three years, the cart is expected to be worthless as the expected life of the refrigeration unit is only three years. What is the payback period? •  Payback period = $2,600/$1,800 = 1.44 years •  2,600-­‐1,800=800; 800/1,800=0.44 •  1+.44=1.44 Practice Exam Con’t Q2 Ginny is considering an investment costing $55,000 that has cash flows of $35,000 in Year 2, $36,000 in Year 3, and −$5,000 in Year 4. Ginny requires a rate of return of 8 percent and has a required discounted payback period of three years. Based on the discounted payback method should she make this investment? All things considered, do you agree with this decision? Why or why not? 3. Your portfolio has a beta of 1.29. The portfolio consists of 17 percent U.S. Treasury bills, 28 percent in stock A, and 55 percent in stock B. Stock A has a risk-­‐level equivalent to that of the overall market. What is the beta of stock B? •  4. Atlas Insurance wants to sell you an annuity which will pay you $600 per quarter for 25 years. You want to earn a minimum rate of return of 5.0 percent compounded quarterly. What is the most you are willing to pay as a lump sum today to buy this annuity? 5. You would be making a wise decision if you chose to: •  A. assume all loans and investments are based on simple interest. •  B. accept the loan with the lower effective annual rate rather than the loan with the lower annual percentage rate. •  C. invest in an account paying 6 percent, compounded quarterly, rather than an account paying 6 percent, compounded monthly. •  (1+6%/4)^4 -­‐1 =6.14%; (1+6%/12)^12 -­‐1 =6.17% •  D. ignore the effective rates and concentrate on the annual percentage rates for all transactions. •  Amy is 12 years old now and will attend college at age 18. Her parents plan to fund her college for four years. College costs $20,000 per year by the time Amy starts college. If her parents have saved $10,000 for this goal, how much more do they need to save at the end of each month in order to be able to fully fund her four-­‐year college? Assume they can invest for 10% per year and inflation is 3.5% per year compounding annually. Five Steps to Plan for College Fund Step 1: estimate PV of needs PV=73,184.49 Today Amy : 12 years College Begins Amy: 18 years PMT: 20,000 I/Y=6.28%=(1+10%)/(1+3.5%)-­‐1 N=4 FV=0 Solving for PV: 73,184.49 College Ends Five Steps to Plan for College Fund Step 2: estimate FV of currently available resources when college begins FV = 14,411.67 Today Amy: 12years College Begins Amy ; 18 yrs PV: 10,000 I/Y=6.28%=(1+10%)/(1+3.5%)-­‐1 N=6 PMT=0 Solving for FV: 14,411.67 College Ends Five Steps to Plan for College Fund Step 3: determine if there is a deficit FV – PV < 0? 14,411.67-­‐-­‐ 73,184.49 Now College Begins College Ends Five Steps to Plan for College Fund Step 4: determine the size of the deficit Now (if present) PV(Needs) – FV (Savings) = FV2(Gap)= 14,411.67-­‐-­‐ 73,184.49 =($58,772.82) College Begins College Ends Five Steps to Plan for College Fund Step 5: determine monthly savings needed PV= 0 Today Amy: 12 yrs PMT=? $674.24 FV2=($58,772.82) N=6*12=72 I/Y=6.28%/12 College Begins Amy: 18yrs College Ends •  Jack's Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding 8.5%. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. Treasury bill is yielding 4% and the market risk premium is 8%. Jack's tax rate is 35%. What is Jack's weighted average cost of capital? Calculate the WACC Equity Debt RWACC = × REquity + × RDebt ×(1 – T) Equity + Debt Equity + Debt = weight of the equity * the cost of equity + weight of the debt * after-tax cost of debt •  Rs=Rf+βequity*(Rm-­‐Rf)=4%+1.1*8%=.128 •  Rdebt=8.5% •  Debt: 80,000 × $1,000 = $80m •  Equity: 4m × $40 = $160m •  Total(Debt+Equity)=$240m •  Weight of D: 80/240; weight of E: 160/240 •  Wacc=10.38% ...
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