Studying for the IB Midterm
Focus
Most of your studying should be based on the textbook; the lecture slides are mostly complementary. However,
concepts not explored in the book may come up in the lectures, so read those as well. One of the short answer
qu
The NPV if we abandon the project after two years is:
NPV = $11,300,000 + $4,019,000(PVIFA16%,2) + $8,625,000/1.163
NPV = $677,099.31
We should abandon the equipment after three years since the NPV of abandoning the project after
three years has the highe
Since the firm is able to resell the old harvester for $19,000, which is less than the $33,333 book
value of the machine, the firm will generate a tax credit on the sale. The aftertax salvage value of the
old harvester will be:
Aftertax salvage value = Ma
CHAPTER 8
INTEREST RATES AND BOND
VALUATION
Answers to Concept Questions
1.
No. As interest rates fluctuate, the value of a Treasury security will fluctuate. Long-term Treasury
securities have substantial interest rate risk.
2.
All else the same, the Trea
The book value of the equipment is:
Book value = $10,000,000 (1)($10,000,000/4)
Book value = $7,500,000
So the taxes on the salvage value will be:
Taxes = ($7,500,000 6,800,000)(.38)
Taxes = $266,000
This makes the aftertax salvage value:
Aftertax salvage
This makes the aftertax salvage value:
Aftertax salvage value = $6,200,000 456,000
Aftertax salvage value = $5,744,000
The NPV if we abandon the project after two years is:
NPV = $11,300,000 + $4,019,000/1.16 + $11,063,000/1.162
NPV = $386,266.35
If we ab
For a zero NPV, sales would have to decrease 8,172 units, so the minimum quantity is:
QMin = 55,000 8,172
QMin = 46,828
28. We will use the bottom up approach to calculate the operating cash flow. Assuming we operate the
project for all four years, the ca
b.
In the worst-case, the OCF is:
OCFworst = cfw_[($245)(0.9) 220](55,000) $520,000(0.62) + 0.38($1,955,000/5)
OCFworst = $156,770
And the worst-case NPV is:
NPVworst = $1,955,000 600,000(1.05) $156,770(PVIFA13%,5) +
[$600,000(1.05) + 300,000(0.85)(1 .38)
25. To calculate the unit sales for each scenario, we multiply the market sales times the companys
market share. We can then use the quantity sold to find the revenue each year, and the variable costs
each year. After doing these calculations, we will con
11. As a general constitutional principle, the federal government cannot tax the states without their
consent if doing so would interfere with state government functions. At one time, this principle was
thought to provide for the tax-exempt status of muni
Solutions to Questions and Problems
NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this
solutions manual, rou
PVIFAR,t = (cfw_1 [1/(1 + r)]t / r )
which stands for Present Value Interest Factor of an Annuity
These abbreviations are short hand notation for the equations in which the interest rate and the
number of periods are substituted into the equation and sol
24. a.
The rate of return you expect to earn if you purchase a bond and hold it until maturity is the
YTM. The bond price equation for this bond is:
P0 = $1,140 = $90(PVIFAR%,10) + $1,000(PVIF R%,10)
Using a spreadsheet, financial calculator, or trial and
Now, to find the weekly interest rate, we need to find the APR. Using the equation for discrete
compounding:
EAR = [1 + (APR / m)]m 1
We can solve for the APR. Doing so, we get:
APR = m[(1 + EAR)1/m 1]
APR = 52[(1 + .0696)1/52 1]
APR = .0673 or 6.73%
So,
21. The bond has 10 years to maturity, so the bond price equation is:
P = $871.55 = $41.25(PVIFAR%,20) + $1,000(PVIFR%,20)
Using a spreadsheet, financial calculator, or trial and error we find:
R = 5.171%
This is the semiannual interest rate, so the YTM i
Using a spreadsheet, financial calculator, or trial and error we find:
R = 4.650%
This is the semiannual interest rate, so the YTM is:
YTM = 2 4.650% = 9.30%
18. Accrued interest is the coupon payment for the period times the fraction of the period that h
The percentage change in price is calculated as:
Percentage change in price = (New price Original price) / Original price
PFaulk% = ($696.82 783.24) / $783.24 = 0.1103 or 11.03%
PGonas% = ($1,101.06 1,216.76) / $1,216.76 = 0.0951 or 9.51%
If the YTM decli
11. The coupon rate, located in the first column of the quote is 6.125%. The bid price is:
Bid price = 119:19 = 119 19/32 = 119.59375% $1,000 = $1,195.9375
The previous days ask price is found by:
Previous days asked price = Todays asked price Change = 11
Also, notice that the price of each bond when no time is left to maturity is the par value, even though
the purchaser would receive the par value plus the coupon payment immediately. This is because we
calculate the clean price of the bond.
14. Any bond t
6.
Here we are finding the YTM of an annual coupon bond. The fact that the bond is denominated in
yen is irrelevant. The bond price equation is:
P = 87,000 = 5,400(PVIFAR%,21) + 100,000(PVIFR%,21)
Since we cannot solve the equation directly for R, using a
23. a.
The NPV of the project is sum of the present value of the cash flows generated by the project.
The cash flows from this project are an annuity, so the NPV is:
NPV = $84,000,000 + $22,000,000(PVIFA19%,10)
NPV = $11,456,567.07
b.
The company should a
Note, this calculation solves for the annuity payment with the initial investment as the present
value of the annuity, in other words:
PVA = C(cfw_1 [1/(1 + R)]t / R)
$12,000 = Ccfw_[1 (1/1.12)3 ] / .12
C = $4,996.19
Now we can calculate the financial br
9.
a.
The accounting breakeven is the aftertax sum of the fixed costs and depreciation charge divided
by the aftertax contribution margin (selling price minus variable cost). So, the accounting
breakeven level of sales is:
QA = [(FC + Depreciation)(1 tC)]
The NPV of the focus group is:
NPV = C0 + CSuccess (Prob. of Success)
NPV = $135,000 + $1,500,000 (0.65)
NPV = $840,000
And the NPV of using the consulting firm is:
NPV = C0 + CSuccess (Prob. of Success)
NPV = $400,000 + $1,500,000 (0.85)
NPV = $875,000
T
We should not necessarily purchase the machine today. We would want to purchase the machine
when the NPV is the highest. So, we need to calculate the NPV each year. The NPV each year will be
the cost plus the present value of the increased cash savings. W
CHAPTER 7
RISK ANALYSIS, REAL OPTIONS, AND
CAPITAL BUDGETING
Answers to Concepts Review and Critical Thinking Questions
1.
Forecasting risk is the risk that a poor decision is made because of errors in projected cash flows.
The danger is greatest with a n
So, the change in NPV for every unit change in sales is:
NPV/S = ($439,001.55 672,342.27)/(75,000 80,000)
NPV/S = +$46.668
If sales were to drop by 500 units, then NPV would drop by:
NPV drop = $46.668(500) = $23,334.07
You may wonder why we chose 80,000
The worst-case NPV is:
NPVworst = $724,000 $146,100(PVIFA15%,8)
NPVworst = $1,379,597.67
3.
We can use the accounting breakeven equation:
QA = (FC + D)/(P v)
to solve for the unknown variable in each case. Doing so, we find:
(1): QA = 110,500 = ($820,000
10. When the additional analysis has a negative NPV. Since the additional analysis is likely to occur
almost immediately, this means when the benefits of the additional analysis outweigh the costs. The
benefits of the additional analysis are the reduction
Next, we need to account for the changes in inventory each year. The inventory is a percentage of
sales. The way we will calculate the change in inventory is the beginning of period inventory minus
the end of period inventory. The sign of this calculation