160
APPENDIX A
b. The current ratio is unaffected, since the firm merely exchanges one current asset (cash)
for another (inventories). However, the quick ratio will fall since inventories are not included among the most liquid assets.
3 Average daily expe
ACTSC 372 Corporate Finance 2
Assignment #2 Due Thursday February 16th at 1 pm
In the DROP BOXES
Question 1: Assume we believe securities follow a 2 factor APT model, i.e. assume for an asset
we have
= 5% + 1.5(1 0.5(2 2 ) +
1 )
Where represents the fa
The Time Value of Money
79
15 The present value is
PV =
$5,000
= $4,629.63
1.08
The real interest rate is 2.857 percent (see Self-Test 3.14a). The real cash payment is
$5,000/(1.05) = $4,761.90. Thus
PV =
$4,761.90
= $4,629.63
1.02857
16 Calculate the rea
The Time Value of Money
73
31. Annuity Due. A store offers two payment plans. Under the installment plan, you pay 25 percent down and 25 percent of the purchase price in each of the next 3 years. If you pay the
entire bill immediately, you can take a 10 p
76
SECTION ONE
67. Real versus Nominal Rates. You will receive $100 from a savings bond in 3 years. The
nominal interest rate is 8 percent.
a. What is the present value of the proceeds from the bond?
b. If the inflation rate over the next few years is exp
Accounting and Finance
129
a. What was the firms net income?
b. What must have been the firms revenues?
c. What was EBIT?
17. Profits versus Cash Flow. Butterfly Tractors had $14 million in sales last year. Cost of
goods sold was $8 million, depreciation
74
SECTION ONE
41. EAR versus APR. You invest $1,000 at a 6 percent annual interest rate, stated as an APR.
Interest is compounded monthly. How much will you have in 1 year? In 1.5 years?
42. Annuity Value. You just borrowed $100,000 to buy a condo. You w
308
SECTION THREE
8 a. The sustainable growth rate is
g = return on equity plowback ratio
= 10% .40 = 4%
b. First value the company. At a 60 percent payout ratio, DIV1 = $3.00 as before. Using the
constant-growth model,
P0 =
$3
= $37.50
.12 .04
which is $
Chapter 17
Firm Value
17.1 Janetta Corp. has an EBIT rate of $850,000 per year that is expected to continue in perpetuity.
The unlevered cost of equity for the company is 14 percent, and the corporate tax rate is 35
percent. The company also has a perpetu
Chapter 18
NPV and APV
18.1 Zoso is a rental car company that is trying to determine whether to add 25 cars to its fleet. The
company fully depreciates all its rental cars over five years using the straight-line method. The
new cars are expected to genera
Chapter 16
EBIT and Leverage
16.1 Money Inc. has no debt outstanding and a total market value of $225,000. Earnings before
interest and taxes, EBIT, are projected to be $19,000 if economic conditions are normal. If there
is strong expansion in the economy
Chapter 11
Determining Portfolio Weights
11.1 What are the portfolio weights for a portfolio that has 95 shares of stock A that sell for $53 per
share and 120 shares of stock B that sell for $29 per share?
Portfolio Expected Return
11.2 You own a portfoli
322
SECTION THREE
TABLE 3.11
The coin-toss game;
calculating variance and
standard deviation when
there are different
probabilities of each outcome
(1)
Percent Rate
of Return
(2)
Probability
of Return
(3)
Deviation from
Expected Return
(4)
Probability
Sq
Introduction to Risk, Return, and the Opportunity Cost of Capital 321
Head + head:
Head + tail:
Tail + head:
Tail + tail:
You make 20 + 20 = 40%
You make 20 10 = 10%
You make 10 + 20 = 10%
You make 10 10 = 20%
There is a chance of 1 in 4, or .25, that you
320
SECTION THREE
Average Standard
return, deviation,
percent percent
3.8
3.2
Number of years
FIGURE 3.15
Historical returns on major asset classes, 19261998.
50
45
40
35
30
25
20
15
10
5
0
Treasury bills
10
0
10
Rate of return, percent
25
5.7
9.2
Number
314
SECTION THREE
MARKET INDEXES
MARKET INDEX
Measure of the investment
performance of the overall
market.
DOW JONES
INDUSTRIAL AVERAGE
Index of the investment
performance of a portfolio of
30 blue-chip stocks.
STANDARD & POORS
COMPOSITE INDEX
Index of th
Introduction to Risk, Return, and the Opportunity Cost of Capital 315
ongoing study by Ibbotson Associates which reports the performance of several portfolios of securities since 1926. These include
1. A portfolio of 3-month loans issued each week by the
316
SECTION THREE
TABLE 3.9
Average rates of return on
Treasury bills, government
bonds, and common stocks,
19261998 (figures in
percent per year)
MATURITY PREMIUM
Extra average return from
investing in long- versus
short-term Treasury
securities.
RISK PR
318
SECTION THREE
Suppose there is an investment project which you knowdont ask howhas the
same risk as an investment in the portfolio of stocks in Standard & Poors Composite
Index. We will say that it has the same degree of risk as the market portfolio o
Introduction to Risk, Return, and the Opportunity Cost of Capital 319
These calculations assume that there is a normal, stable risk premium on the market
portfolio, so that the expected future risk premium can be measured by the average past
risk premium.
298
SECTION THREE
Plowing earnings back into new investments may result in growth in earnings
and dividends but it does not add to the current stock price if that money is
expected to earn only the return that investors require. Plowing earnings
back does
e have thus far skirted the issue of project risk; now it is time to confront
W
it head-on. We can no longer be satisfied with vague statements like
The opportunity cost of capital depends on the risk of the project. We
need to know how to measure risk an
FINANCE IN ACTION
A Small Spat about $1.6 Billion
Company valuation is not a precise science. When two
companies dispute the price that one should pay for the
other, a battle between their investment bankers can be
guaranteed.
AT&T bought McCaw Cellular i
FINANCE IN ACTION
New Paradigm View
for Stocks Is Bolstered
Maybe all the new-economy hype isnt just hype after
all.
Almost everyone agrees the revolution in information
technology has probably played some part in the extraordinary valuations that stocks
302
SECTION THREE
The present value of a share is equal to the stream of expected dividends per share up to
some horizon date plus the expected price at this date, all discounted at the return that
investors require. If the horizon date is far away, we si
304
SECTION THREE
14. Negative Growth. Horse and Buggy Inc. is in a declining industry. Sales, earnings, and dividends are all shrinking at a rate of 10 percent per year.
a.
b.
c.
d.
If r = 15 percent and DIV1 = $3, what is the value of a share?
What pric