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Unformatted text preview: Part 1: Multiple Choice Instructions: 1. What is the effective annual rate on a loan if you are quoted a 12% APR (with monthly compounding)? a. 12% b. 11.935% c. 1% d. 0.83% e. 12.6825% 2. You know the following rates: r1 5% and f 2 7% . What is the two‐year discount factor? a. 0.88 b. 1.1235 c. 1.12 d. 6.9494% e. 0.8901 3. A 10 year zero‐coupon bond trades at 60. A ten year bond with a 5% coupon (paid annually) sells at 95. The face value of each bond is 100. What is the 10 year spot rate? a. 5.24% b. 1.64% c. 66.67% d. 21% e. ‐33.33% 4. The yield to maturity on a 2 year bond with semi‐annual coupon payments of $4 on a face value of $100 is 8% (APR with semiannual compounding). What is the price of the bond? a. $91.14 b. $100.04 c. $102.5 d. $100 e. $97.56 1 Put your name and ID on the Scantron Sheet! Only one answer is (exactly) correct. Clearly mark the correct answer on the Scantron Sheet 882‐E (questions 1‐8) Use common sense to rule out incorrect answers Every question counts 3 points, i.e. the multiple choice part yields 24 points 5. The forward rate f 3 is 5% and the forward rate f 4 is 6%. How much does an investment of $1 that will be made at date 2 grow to until date 4 (if you secure investment terms today at t=0)? a. Cannot say with this information b. 1.11 c. 1.113 d. 0.11 e. 0.89 6. The real interest rate is 10%. The inflation rate is 2%. What is the nominal interest rate? a. 8% b. 7.843% c. 12% d. 10% e. 12.2% 7. The discount rate is 15%. The return on new investment is 20%. What is the value of the stock if next period’s dividend is $100 and expected dividend growth is 5% forever? a. $666.67 b. $1,000 c. $200 d. $333.33 e. $2,000 8. The average multiple “Enterprise value over Sales” in industry X is 2. Using the comparable method what should be the market value of equity of a specific firm in this industry if sales are $1bn and the firm’s debt accounts for 40% of the enterprise value? Assume Cash is 0. a. $2bn b. $1bn c. $800mm d. $1.2bn e. Cannot tell 2 Part 2: Long Questions 1) Two large Japanese Banks enter a financial contract (called swap) that specifies payments from Bank A to Bank B and vice versa over the next 12 years. After 2 years, the contract has an NPV of ¥12,030 and an IRR of 12.61% viewed from the perspective of bank A. Can you infer anything about the NPV and the IRR from bank B’s perspective? Assume that both banks surely pay their respective obligations. [6 Points] 2) The German edition of a lifestyle magazine makes you the following subscription offer: A lifelong subscription for €500: that is you obtain a monthly issue for the rest of your life. The sales price for an individual issue is €10. Assume that the price of the magazine is constant in real terms over time and that the first delivery would occur a month from now. Also assume that you intend to buy the magazine for the rest of your active life (40 years). Determine the monthly real discount rate such that both alternatives are equally attractive to you (lifelong subscription vs. buying each issue). Round to two decimal places. [10 points] 3 3) You are considering the purchase of a shiny new convertible! The dealer is desperate to sell the car, and offers you a choice of two deals: Buy the car at its full price, $20,000, but finance it at the below market interest rate of 1% (EAR). In this case, you’d put down $5,000 in cash today, and borrow the rest of the purchase price from the dealer. The loan would require you to make equal payments at the end of each of the next 5 years (i.e. the payments would be 1, 2, 3, 4 and 5 years from today). Pay cash, but get the car for a discount of 15% off list price (i.e., $17,000). Assume you have plenty of cash in the bank, earning an interest rate of 8% per year. a. How big is each payment on the car loan? Round to two decimal places (i.e cents). [5 Points] b. What is the remaining balance on the loan immediately after you make the payment 3 years from today? Round to two decimal places (i.e cents). [5 Points] c. Assuming you are definitely going to buy the car, which option should you choose? [10 Points] 4 4) Innovation Co. is thinking about marketing a new software product. Initial, upfront costs to market and develop the product are $5,000,000. The product is expected to generate revenues of $1,000,000/yr for ten years (starting in period 1). The only cost is that the company will have is to provide support for the product and this is expected to cost $100,000/yr in perpetuity (starting in period 1). There are no taxes. a) What is the NPV of this particular investment opportunity as a function of the discount rate (denoted as r), i.e. use the specific cash flows but an arbitrary discount rate r? [9 Points] b) What is the NPV of this investment if the discount rate is 5.438761%? Should the project be taken on? Repeat the question for discount rates of 2.745784% and 10.879183%. Round to the nearest Dollar. [6 Points] c) Explain what is going on (briefly). For which (range of) opportunity cost of capital should the product be launched? Hint: Draw a (qualitative) graph. [5 Points] 5 5) New environmental regulation mandates that a firm closes down one of its divisions which generated steady positive cash flows of $100mm (mm=million) per year. It considers setting up a new (legal) division which is estimated to produce the following cash flows for the first 5 years: Period 0 1 2 3 4 5 From then on, cash flows are growing forever at 4%, i.e. year 6 cash flow is $520 mm. All cash flows are in nominal terms. The appropriate nominal market discount rate is 10%. IGNORE Taxes! a) Should you consider the $100mm from closing down its division in your project evaluation or not? (The cash flows above exclude the $100mm charge). Explain briefly. [5 Points] b) Calculate the NPV of the project. Should the firm undertake the project? Round to the nearest dollar (million)! [8 Points] 6 Cash Flow (in $ million) ‐6500 50 150 250 400 500 c) The managers from other divisions claim that the decision on the new division has to incorporate the annual administrative expenses for human resources and computing which are jointly used by all divisions of the firm. Based on the relative number of employees for the new division (25% of the whole firm), they argue that the new division should be allocated 25% of the new total overhead cost of $200mm, i.e. $50 million per year. Without the new division the total overhead cost are $160 million per year. Do these administrative expenses affect the NPV of the new business line? If so, by how much? Assume that the cash flow numbers in the table do not consider overhead. [7 Points] 7 ...
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This note was uploaded on 12/16/2009 for the course UGBA 08547 taught by Professor Odean during the Fall '09 term at University of California, Berkeley.
 Fall '09
 ODEAN

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