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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 multiplechoice 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 multiplechoice 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 multiplechoice problem similar to the following problem: A share of common stock has just paid a dividend of $1. If the expected longrun 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 multiplechoice 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 multiplechoice 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 multiplechoice 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. Theaftertax 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 multiplechoice 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 multiplechoice 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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 Fall '09
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