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Unformatted text preview: Each problem is worth two points (20 possible points) Chapter 4 1. You are planning to save for retirement over the next 30 years. To do this, you will invest $700 a month in a stock account and 300 a month in a bond account. The return of the stock account is expected to be 10 percent, and the bound account will pay 6 percent. When you retire, you will combine your money into an account with an 8 percent return. How much can you withdraw each month from your account assuming a 25 ­year withdrawal period? (answer: withdrawal=xx,x38.67) 2. Friendly’s Quick Loans, Inc. offers you a “three for four or I knock on your door.” This means you get $3 today and repay $4 when you get your paycheck in one week (or else). What’s the effective annual return Friendly’s earns on this lending business? If you were brave enough to ask, what APR would Friendly’s say you were paying? (answer: APR=___.33%; EAR=___.69%) 3. You need a 30 ­year, fixed rate mortgage to buy a new home of $250,000. Your mortgage bank will lend you the money at a 6.8 percent APR for this 360 ­month loan. However, you can only afford monthly payments of $1,200, so you offer to pay off any remaining loan balance at the end of the loan in the form of a single balloon payment. How large will this balloon payment have to be for you to keep your monthly payments at $1,200? (answer: Balloon payment = xxx,x29.05) Chapter 5 4. Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation (BRC). Both projects require an annual return of 14 percent. Year Deepwater Fishing New Submarine Ride 0  ­$750,000  ­2,100,000 1 310,000 1,200,000 2 430,000 760,000 3 330,000 850,000 As a financial analyst for BRC, you are asked the following questions: a. If you decision rule is to accept the project with the greater IRR, which project should you accept? b. Because you are fully aware of the IRR rule’s scale problem, you calculate the incremental IRR for the cash flows. Based on your computation, which project should you now approve? (hint, this involves taking the difference of the project cash flows; answer: Incremental IRR = xx.78%) c. To be prudent, you compute the NPV for both projects. Which project should you choose? Is it consistent with the incremental IRR rule? Chapter 6 5. Your company ha been approached to bid on a contract to sell 9,000 voice recognition (VR) computer keyboards a year for four years. Due to technological improvements, beyond that time they will be outdated and no sales will be possible. The equipment necessary for the production will cost $3.2 million and will be depreciated on a straight ­line basis to a zero salvage value. Production will require an investment in net working capital of $75,000 to be returned at the end of the project, and the equipment can be sold for $200,000 at the end of production. Fixed costs are $600,000 per year, and variable costs are $165 per unit. In addition to the contract, you feel your company can sell 4,000, 12,000, 14,000, and 7,000 additional units to companies in other countries over the next four years, respectively, at a price of $275. This price is fixed. The tax rate is 40 percent, and the required return in 13%. Additionally, the president of the company will undertake the project only if it has an NPV of $100,000. What bid price should you set for the contract? (answer: P = $___.41) Chapter 7 6. We are evaluating a project that costs $724,000, has an eight ­year life, and has no salvage value. Assume that depreciation is straight ­line to zero over the life of the project. Sales are projected at 75,000 units per year. Price per unit is $39, variable cost per unit is $23, and fixed costs are $850,000 per year. The tax rate is 35 percent, and we require a 15 percent return on this project. a. Calculate the accounting break ­even point. (answer: xx,x81 units) b. Calculate the base ­case cash flow and NPV. What is the sensitivity of NPV to changes in the sales figure? Explain what your answer tells you about a 500 ­ unit decrease in projected sales. (answer: NPV drop = $xx,x34.07) c. What is the sensitivity of OCF to changes in the variable cost figure? Explain what your answer tells you about a $1 decrease in estimated variable costs. (answer: OCF would increase by $xx,x50.00) Chapter 11 7. Suppose the risk ­free rate is 4.8 percent and the market portfolio has an expected return of 11.4 percent. The market portfolio has a variance of 0.0429. Portfolio Z has a correlation coefficient with the market of 0.39 and a variance of 0.1783. According to the capital asset pricing model, what is the expected return on portfolio Z? (Answer: xx.05%) Chapter 13 8. Given the following information for Huntington Power Co., find the WACC. Assume the company’s tax rate is 35 percent. (answer: WACC=____.56%) a. Debt: 5,000 8 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 103 percent of par; the bonds make semiannual payments. b. Common stock: 160,000 shares outstanding, selling for $57 per share; the beta is 1.10. c. Market: 7 percent market risk premium and 6 percent risk ­free rate. Chapter 16 9. Williamson, Inc., has a debt ­equity ratio of 2.5. The firm’s WACC is 15%, and its pretax cost of debt is 10 percent. Willamson is subject to a corporate tax rate of 35 percent. a. What is Willamson’s cost of equity capital? (Answer: Rs=xx.25%) b. What is Willamson’s unlevered cost of equity capital? (Answer: Ro=xx.00%) c. What would Willaimson’s WACC be if the firm’s debt ­equity ratio were 0.75? (Answer: x7.x0%)What if it were 1.5? (Answer: xx.80%) Chapter 17 10. Steinberg Corporation and Dietrich Corporation are identical firms except that Dietrich is more levered. Both companies will remain in business for one more year. The companies’ economists agree that the probability of the continuation of the current economic expansion is 80 percent for the next year, and the probability of a recession is 20 percent. If the expansion continues, each firm will generate earnings before interest and taxes (EBIT) of $2.4 million. If a recession occurs, each firm will generate earnings before interest and taxes (EBIT) of $900,000. Steinberg’s debt obligation requires the firm to pay $800,000 at the end of the year. Dietrich’s debt obligation requires the firm to pay $1.1 million at the end of the year. Neither firm pays taxes. Assume a discount rate of 15 percent. a. What is the value today of Steinberg’s debt and equity? (answer: S=$___ ,435; B=$___ ,652) What about that for Dietrich’s? (answer: S=$___ ,348; B=$___ ,739) b. Steinberg’s CEO recently stated that Steinberg’s value should be higher than Dietrich’s because the firm has less debt and therefore less bankruptcy risk. Do you agree or disagree with this statement? What is the respective values of Steinberg and Dietrich? ...
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This note was uploaded on 02/29/2012 for the course FINA 274 taught by Professor Williamhandorf during the Fall '11 term at GWU.

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