Study guide for exam 2 - part 1 - F1515 Exam 2 Study Guide...

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Unformatted text preview: F1515 Exam 2 Study Guide Tab Q) D i SB ') l///l g This exam will consist of 10 questions worth 10 points apiece and you will have three hours to complete it. Plus, it can only be taken one time. For the questions 1—3, the pool of potential questions is 5, 3 of which will be selected at random for you to take. They are of the following types: TCO B A calculation type problem similar to the following: Assume that you plan to buy a share of St. Moritz stock today and to hold it for 2 years. Your expectations are that you will not receive a dividend at the end of Year 1, but you will receive a dividend of $3.50 at the end of Year 2. In addition, you expect to sell the stock for $75 at the end of Year 2. Question: If your expected rate of return is 14 percent, how much should you be willing to pay for this stock today? Solution: $75 x (Present value factor 14% at 2 years) + $3.50 x (Present value factor 14% at 2 years) = $60.40 = Present value of the cash flows This can be done via math, financial calwlator, or Excel. And/or A multiple- choice question dealing with an understanding of the concepts of NPV, IRR, cash flows and cost of capital. And/ or A multiple— choice question dealing with an understanding of the concepts of WACC and IRR. And/or A multiple-choice question dealing with an understanding of the concepts of NPV, IRR, cash flows and WACC. And/or A multiple—choice question dealing with the disadvantages of the payback period as a capital budgeting tool. For the fourth question, the pool of potential questions is 2, one of which will be selected at random for you to take. They are both of the following type: TCO C A multiple-choice question dealing with an understanding of the concepts of the characteristic line, Security Market Line and diversifiable risk. For the fifth and sixth questions, the pool of potential questions is 4, two of which will be selected at random for you to take. They are of the following types: TCO D A calculation type multiple-choice problem similar to the following problem: A share of common stock has just paid a dividend of $1. If the expected long-run growth rate for this stock is 7%, and if investors required rate of return is 12%, what is the stock price? Solution: $1.07/(12%-7%)) = $21.40 And/or A calculation type multiple-choice problem similar to the following problem: Triumph Motorworks is expected to pay a year—end dividend of $2.00 a share (D1 = $2.00). The stock currently sells for $20 a share. The required (and expected) rate of return on the stock is 14 percent. Question: If the dividend is expected to grow at a constant rate, g, what is g? Solution: m. , K1 D1/P Lt‘b‘HG U3 2 0+g i I: .w s 55043 14%=2/20+g %\9‘: _\‘Q'¥C}t\ 14%=10%+g 4%=g And/ or A calculation type multiple-choice problem similar to the following problem: Gary Wells Inc. plans to issue perpetual preferred stock with an annual dividend of $5.00 per share If the required return on their preferred stock is 8%, at what price should the stock sell? Solution: $5.00/ 8% = $62.50 For the seventh question, the pool of potential questions is 2, one of which will be selected at random for you to take. They are both of the following type: TCO E A calculation type multiple-choice problem similar to the following problem: You were hired as a consultant to Jackson Hole Company, whose target capital structure is 30% debt, 5% preferred, and 65% common equity. The-after-tax cost of debt is 7%, the cost of preferred is 7.5%, and the cost of retained earmngs is 13.25%. the firm W111 not be issuing any new stock. What is its WACC? .3(7%) + 050.5%) + .65(13.25%) = 11.03% For the eight question, the question will of the following type: TCO B, F A problem very similar to the following: The Gstaad Corporation is in the process of determining which of the following two projects that they may invest in. The details are provided below: Project A B Cost of Capital 12% 12% Life Of Project 20 years 20 years Annual cash flow $250,000 $350,000 Initial 0051 $950,000 $1 250,000 Salvage Value 0 $250,000 a. What is the payback period? b. What is the net present value of the two projects? c. What is the Internal rate of return of the two projects? d. What is the profitability index? e. Which of the two projects would you choose and which criteria would you use? Solutions: a. Payback Period 3.80 3 .571428571 Present value of cash $1.867.360 $2.640,221.96 b. NPV $917360 $390,221.96 c.1ntemal rate of return 25.99% 27.83% (1. Profitability Index 1.965421 2112177568 e. Since the projects are mutually exclusive 1 would choose project B. Project B is also better in payback, NPV, IRR and in Profitability Index. For the ninth and tenth questions, the pool of potential questions is 3, two of which will be selected at random for you to take. They are of the following types: TCO B, F A question very similar to the following multiple—choice problem: St. Moritz Inc. is considering a project that has the following cash flows: Year Cash Flows (end of period) 1 $1,000 2 $2,000 3 $3,000 4 $2,000 The project has a payback of 2 years, and the firm's cost of capital is 10%. What is the project's NPV? Solution: Since we have a payback of 2 years we can determine the initial cost of the asset which is $3,000. The total present value of the cash flows over 4 years at 10% is 6180. When we subtract the initial cost fi'om the present value of the cash flows we get a value of $3180. And/ or A question very similar to the following multiple-choice problem: Gstaad Associates is considering a project that has the following cash flow data. What is the project's payback? Year Cash flow 0 ($2,000) 1 $600 2 $400 3 $600 4 $700 5 $500 Solution: We determine how quickly we will receive undiscounted dollars sufficient to pay back the investment. The 3 years is $1600 with the remaining $400 being returned in .57 of year 4. Hence, the payback period is 3.57 years. And/or A question very similar to the following multiple-choice problem: Capri Stores is considering a project that has the following cash flow data. What is the project's IRR‘? Note that a project's projected [RR can be less than the WACC (and even negative), in which case it will be rejected. Year Cash Flow 0 ($100) 1 $30 2 _ $35 3 $40 4 $45 Solution: 17.09%. The most efi‘ective method for this calculation is by the use of the IRR category in Excel. ...
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