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NUS / Business Finance / FIN 2004 / suppose you have a \$1.5 million loan with semi-annual installments ove

# suppose you have a \$1.5 million loan with semi-annual installments ove Description

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Tutorial 10 #1:  Consider the following financial statement information for the Mediate Corporation: Item Beginning

Ending Inventory \$9,780

\$11,380 Accounts receivable 4,108

4,938 Accounts payable 7,636

7,927  Credit sales

\$89,804

Cost of goods sold

56,384

## How do you interpret your answer?

Calculate the operating and cash cycles. How do you interpret your answer? #2:  You’ve worked out a line of credit arrangement that allows you to borrow up to \$50 million at any time.  The interest rate is 0.64% per month. In addition, 5% of the amount that you borrow must be deposited in  a non-interest-bearing account. Assume that your bank uses compound interest on its line of credit loans. a. What is the effective annual interest rate on this lending arrangement? b. Suppose you need \$15million today and you repay it in six months. How much interest will you  pay? #3:  Each business day, on average, a company writes checks totaling \$14,000 to pay its suppliers. The usual  clearing time for the checks is four days. Meanwhile, the company is receiving payments from its  customers each day, in the form of checks, totaling \$26,000. The cash from the payments is available to  the firm after two days. a. Calculate the company’s disbursement float, collection float, and net float.  b. How would your answer to part (a) change if the collected funds were available in one day instead  of two?  #4:  The Arizona Bay Corporation sells on credit terms of net 30. Its accounts are, on average, 8 days past  due. If annual credit sales are \$8.4 million, what is the company’s balance sheet amount in account  receivable? #5:  A Firm offers terms of 1/10, net 35. What effective annual interest rate does the firm earn when a  customer does not take the discount? Without doing any calculations, explain what will happen to this  effective rate if: a. This discount is changed to 2%.  b. The credit period is increased to 60 days.  c. The discount period is increased to 15 days. #6:  The Harrington Corporation is considering a change in its cash-only policy. The new terms would be net  one period. Based on the following information, determine if Harrington should proceed or not. The  required return is 2.5 percent per period.

Current Policy New Policy Price per unit \$91 \$94 Cost per unit \$47 \$47 Unit sales per month 3,850 3,940

## What is the effective annual interest rate on this lending arrangement?

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#7: a. For Qn #6, what is the break-even quantity for the new credit policy? b. For Qn #6, what is the break-even price per unit that should be charged under the new credit policy  assuming that the sales figure under the new policy is 4,100 units and all other values remain the  same? Tutorial 2 #1:  First City Bank pays 8 percent simple interest on its savings account balances, whereas Second  City Bank pays 8 percent interest compounded annually. If you made a \$5,000 deposit in each  bank, how much more money would you earn from your Second City Bank account at the end of  10 years? #2:  You are scheduled to receive \$20,000 in two years. When you receive it, you will invest it for six  more years at 8.4 percent per year. How much will you have in eight years? #3:  You are to make monthly deposits of \$300 into a retirement account that pays 10 percent interest  compounded monthly. If your first deposit will be made one month from now, how large will  your retirement account be in 30 years? #4:  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 11 percent, and the bond account will pay 6 percent. When you retire, you will  combine your money into an account with a 9 percent return. How much can you withdraw each  month from your account assuming a 25-year withdrawal period? #5:  Your job pays you only once a year for all the work you did over the previous 12 months. Today,  December 31, you just received your salary of \$50,000 and you plan to spend all of it. However,  you want to start saving for retirement beginning next year. You have decided that one year from  today you will begin depositing 5 percent of your annual salary in an account that will earn 11  percent per year. Your salary will increase at 4 percent per year throughout your career. How  much money will you have on the date of your retirement 40 years from today? #6:  You need a 30-year, fixed-rate mortgage to buy a new home for \$240,000. Your mortgage bank  will lend you the money at a 6.35 percent APR for this 360-month loan. However, you can afford  monthly payments of only \$1,150, 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 \$1,150?#7: The present value of the following cash flow stream is \$6,550 when discounted at 10 percent  annually. What is the value of the missing cash flow? Year Cash Flow  1 \$1,700  2 ?  3 \$2,100 4 \$2,800 #8: Suppose you are going to receive \$10,000 per year for five years. The appropriate interest rate is  11 percent. a. What is the present value of the payments if they are in the form of an ordinary annuity?  What is the present value if the payments are an annuity due?  b. Suppose you plan to invest the payments for five years. What is the future value if the  payments are an ordinary annuity? What if the payments are an annuity due?  c. Which has the highest present value, the ordinary annuity or annuity due? Which has the  highest future value? Will this always be true?  #9: Suppose you have a \$1.5 million loan with semi-annual installments over 10 years. How much do  you pay towards the principal in the second installment if the interest rate of this loan is 1.8%  compounded quarterly? Tutorial 8 #1: When is EAC analysis appropriate for comparing two or more projects? Why is this method used? Are  there any implicit assumptions required by this method that you find troubling? Explain. #2:  Parker & Stone, Inc is looking at setting up a new manufacturing plant in South Park to produce garden  tools. The company bought some land six years ago for \$6 million in anticipation of using it as a  warehouse and distribution site, but the company has since decided to rent these facilities from a  competitor instead. If the land were sold today, the company would net \$6.4 million. The company wants  to build its new manufacturing plant on this land; the plant will cost \$14.2 million to build, and the site  requires \$890,000 worth of grading before it is suitable for construction. What is the proper cash flow  amount to use as the initial investment in fixed assets when evaluating this project? Why? #3:  Winnebagel Corp. currently sells 30,000 motor homes per year at \$53,000 each, and 12,000 luxury motor coaches per year at \$91,000 each. The company wants to introduce a new portable camper to fill out its  product line; it hopes to sell 19,000 of these campers per year at \$13,000 each. An independent  consultant has determined that if Winnebagel introduces the new campers, it should boost the sales of its  existing motor homes by 4,500 units per year, and reduce the sales of its motor coaches by 900 units per  year. What is the amount to use as the annual sales figure when evaluating this project? Why? #4:  You are considering expanding your product line that currently consists of skateboards to include gas powered skateboards, and you feel you can sell 10,000 of these per year for 10 years (after which time  this project is expected to shut down with solar-powered skateboards taking over). The gas skateboards  would sell for \$100 each with variable cost of \$40 for each one produced, while annual fixed costs  associated with production would be \$160,000. In addition, there would be a \$1,000,000 initial  expenditure associated with the purchase of new production equipment. It is assumed that this initial  expenditure will be depreciated using the simplified straight-line method down to zero over 10 years. The  project will also require a one-time initial investment of \$50,000 in net working capital associated with  inventory, and this working capital investment will be recovered when the project is shut down. Finally,  assume that the firm’s marginal tax rate is 34 percent. a. What is the initial cash outlay associated with this project?  b. What are the annual net cash flows associated with this project for years 1 through 9?  c. What is the terminal cash flow in year 10?  d. What is the project’s NPV given a 10 percent required rate of return?  #5:  The Minot Kit Aircraft Company of Minot, ND uses a plasma cutter to fabricate metal aircraft parts for  its plane kits. The company currently is using a cutter that it purchased used 4 years ago which has an  \$80,000 book value and is being depreciated \$20,000 per year over the next 4 years. If the old cutter  were to be sold today, the company estimates that it would bring in an amount equal to the book value of  the equipment. The company is considering the purchase of a new automated plasma cutter that would  cost \$400,000 to install and which would be depreciated over the next 4 years toward a \$40,000 salvage  value using straight-line depreciation. The primary advantage of the new cutter is the fact that it is fully  automated and can be run by one operator rather than the three employees that are currently required.  The labour savings would be \$100,000 per year. The firm faces a marginal tax rate of 30%. a. What are the differential operating cash flow savings per year during year 1 through 4 for the new  plasma cutter? b. What is the initial cash outlay required to replace the existing plasma cutter with the newer model? c. If the company requires a 15 percent discount rate for new investments, should the fleet be replaced? #6:  Dangerfield Industrial Systems Company (DISC) is trying to decide between two different conveyor belt  systems. System A costs \$430,000, has a four-year life, and requires \$110,000 in pretax annual operating  costs. System B costs \$570,000, has a six- year life, and requires \$98,000 in pretax annual operating  costs. Both systems are to be depreciated straight-line to zero over their lives and will have zero salvage  value. Whichever project is chosen, it will be replaced when it wears out. If the tax rate is 34 percent and  the discount rate is 11 percent, which project should the firm choose? #7: As the manager of The Homey Depot, you are tasked with upgrading a computerized inventory system at  a retail outlet. The remaining period of the lease of this outlet is 10 years and management has no intention of renewing the lease. The required return is 12.5% and the tax rate is 34%. The expected life  and incremental cash flows for the two models of computerized inventory systems are as follows: Current Computerized Inventory System: Initial cost outlay: \$1.2m Annual depreciation: \$100,000 Accumulated depreciation: \$400,000 Remaining useful life: 10 years Annual operating costs (excluding depreciation): \$450,000 Current Salvage Value: \$400,000 Estimated salvage value at year 10: \$50,000 New Computerized Inventory System: Initial cost outlay: \$1.5m Useful life: 10 years Annual depreciation: Straight-line full depreciation  Annual operating costs (excluding depreciation): \$215,000 Estimated salvage value at year 10: \$180,000 a. What is the initial cash outlay associated with this project?  b. What are the net cash flows associated with this project for years 1 through 10?  c. What is the terminal cash flow in year 10?  d. What is the project’s NPV? Would you replace the current inventory system with the new one?:  Evaluate the following statement: Managers should not focus on the current stock value  because doing so will lead to an overemphasis on short-term profits at the expense of  long-term profits.  #2:  Tutorial 1  Suppose you own stock in a company. The current price per share is \$25. Another  company has just announced that it wants to buy your company and will pay \$35 per  #1:  Evaluate the following statement: Managers should not focus on the current stock value because doing so  share to acquire all the outstanding stock. Your company’s management immediately  will lead to an overemphasis on short-term profits at the expense of long-term profits. begins fighting off this hostile bid. Is the management acting in the shareholders’ best  interest? Why or why not?  #2:  Suppose you own stock in a company. The current price per share is \$25. Another company has just  #3:  announced that it wants to buy your company and will pay \$35 per share to acquire all the outstanding  Dahlia Industries had the following operating results for 2009: sales = \$22,800; cost of  stock. Your company’s management immediately begins fighting off this hostile bid. Is the management  goods sold = \$16,050; depreciation expense = \$4,050; interest expense = \$1,830;  acting in the shareholders’ best interest? Why or why not? dividends paid = \$1,300. At the beginning of the year, net fixed assets were \$13,650,  current assets were \$4,800, and current liabilities were \$2,700. At the end of the year, net  #3:  fixed asset \$16,800, current assets were \$5,930, and current liabilities were \$3,150. The  Dahlia Industries had the following operating results for 2009: sales = \$22,800; cost of goods sold =  tax rate for 2009 was 34 percent.  \$16,050; depreciation expense = \$4,050; interest expense = \$1,830; dividends paid = \$1,300. At the  a. `What is net income for 2009?  beginning of the year, net fixed assets were \$13,650, current assets were \$4,800, and current liabilities  b. What is the operating cash flow for 2009?  were \$2,700. At the end of the year, net fixed asset \$16,800, current assets were \$5,930, and current  c. What is the cash flow from assets for 2009? Is this possible? Explain.  liabilities were \$3,150. The tax rate for 2009 was 34 percent.  d. If no new debt was issued during the year, what is the cash flow to creditors? What is  a. What is net income for 2009? the cash flow to stockholders? Explain and interpret the positive and negative signs  b. What is the operating cash flow for 2009?  of your answers in (a) through (d).  c. What is the cash flow from assets for 2009? Is this possible? Explain. d. If no new debt was issued during the year, what is the cash flow to creditors? What is the cash flow to  stockholders? Explain and interpret the positive and negative signs of your answers in (a) through (d).  #4:  The Ashwood Company has long-term debt ratio of 0.45 and a current ratio of 1.25.  #4:  Current liabilities are \$875, sales are \$5,780, profit margin is 9.5 percent, and ROE is  The Ashwood Company has long-term debt ratio of 0.45 and a current ratio of 1.25. Current liabilities  18.5 percent. What is the amount of the firm’s net fixed assets?  are \$875, sales are \$5,780, profit margin is 9.5 percent, and ROE is 18.5 percent. What is the amount of  the firm’s net fixed assets? #5:  #5:  Some recent financial statements for Smolira Golf Corp. follow: Some recent financial statements for Smolira Golf Corp. follow: SMOLIRA GOLF  2008 AND 2009 Balance Sheets   Assets Liabilities and Owners’ Equity   2008 2009

2008 2009 Current assets

Current liabilities

Cash \$21,860 \$22,050 Accounts payable \$19,320

\$22,850  Account receivable 11,316 13,850 Notes payable 10,000 9,000  Inventory 23,084 24,650 Other 9,643 11,385  Total \$56,260 \$60,550 Total \$38,963 \$43,235

Long-term debt \$75,000 \$85,000

Owner’s equity

Common stock  and paid-in  surplus \$25,000 \$25,000 Fixed assets

Accumulated  retained earnings 151,365 167,840 Net plant and  equipment \$234,068 \$260,525  Total \$176,365 \$192,840  Total assets \$290,328 \$321,075 Total liabilities and  owner’s equity \$290,328 \$321,075

## How much interest will you pay?

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Find the following financial ratios for Smolira Golf Corp. (use year-end figures rather than average  values where appropriate): Short-term solvency ratios: a. Current ratio  b. Quick ratio  c. Cash ratio  Asset utilization ratios: d. Total asset turnover  e. Inventory turnover  f. Receivables turnover  Long-term solvency ratios: g. Total debt ratio  h. Debt-equity ratio  i. Equity multiplier  j. Times interest earned ratio  k. Cash coverage ratio Profitability ratios: l. Profit margin  m. Return on assets  n. Return on equity #6: Calculate Smolira Golf Corp’s 2009 ROE by using the Extended Du Pont Equation. Clearly show all  parts of the Du Pont Equation values using answers from #5.  #7:  Smolira Gold Corp uses Accounts Payable to fund \$5,000 increase in Inventory in 2009. Without using  any calculations, what is the resultant impact to Current Ratio for 2009 – Increase, Decrease or Stay the  same?   #1: The most recent financial statements for Summer Tyme, Inc., are shown here: Tutorial 9 Tutorial 9 #1: The most recent financial statements for Summer Tyme, Inc., are shown here: #1:  Income Statement Balance Sheet Sales \$4,200 Current assets \$3,600 Current liabilities \$2,100 The most recent financial statements for Summer Tyme, Inc., are shown here: Costs 3,300 Fixed assets 7,900 Long-term debt 3,650 Income Statement Balance Sheet Taxable  income \$900 Equity 5,750 Sales \$4,200 Current assets \$3,600 Current liabilities \$2,100 Taxes (34%) 306 Total \$11,500 Total \$11,500 Costs 3,300 Fixed assets 7,900 Long-term debt 3,650 Net income \$594 Taxable  income \$900 Equity 5,750 Taxes (34%) 306 Total \$11,500 Total \$11,500 Net income \$594 Assets, costs and current liabilities are proportional to sales. Long-term debt and equity  are not. The company maintains a constant 40% dividend payout ratio. As with every  Assets, costs and current liabilities are proportional to sales. Long-term debt and equity are not. The  other firm in its industry, next year’s sales are projected to increase by exactly 15%.  company maintains a constant 40% dividend payout ratio. As with every other firm in its industry, next  What is the external financing needed? Assets, costs and current liabilities are proportional to sales. Long-term debt and equity  year’s sales are projected to increase by exactly 15%. What is the external financing needed? are not. The company maintains a constant 40% dividend payout ratio. As with every  other firm in its industry, next year’s sales are projected to increase by exactly 15%.  What is the external financing needed? #2:  #2: The most recent financial statements for Live Co. are shown here: The most recent financial statements for Live Co. are shown here: Income Statement Balance Sheet #2: Sales \$13,250 Current Assets \$10,400 Debt \$17,500 The most recent financial statements for Live Co. are shown here: Costs 9,480 Fixed assets 28,750 Equity 21,650 Income Statement Balance Sheet Taxable  \$3,770 Total \$39,150 Total \$39,150 Sales \$13,250 Current Assets \$10,400 Debt \$17,500 income Costs 9,480 Fixed assets 28,750 Equity 21,650 Taxes (35%) 1,508 Taxable  \$3,770 Total \$39,150 Total \$39,150  Net income \$2,262 income Taxes (35%) 1,508 Assets and costs are proportional to sales. Debt and equity are not. The company maintains a constant 30  Assets and costs are proportional to sales. Debt and equity are not. The company   Net income \$2,262 percent dividend payout ratio. No external equity financing is possible. What is the internal growth rate? maintains a constant 30 percent dividend payout ratio. No external equity financing is  possible. What is the internal growth rate? Assets and costs are proportional to sales. Debt and equity are not. The company  #3:  maintains a constant 30 percent dividend payout ratio. No external equity financing is  #3: For the company in the previous problem, what is the sustainable growth rate? possible. What is the internal growth rate? For the company in the previous problems, what is the sustainable growth rate?#3: #4:  For the company in the previous problems, what is the sustainable growth rate? McCormac Co. wishes to maintain a growth rate 12 percent a year, a debt-equity ratio of 1.20, and a  dividend payout ratio of 30 percent. The ratio of total assets to sales is constant at 0.75. What profit  margin must the firm achieve? #5:  You’ve collected the following information about St. Pierre, Inc,: Sales = \$195,000 Net income = \$17,500 Dividends = \$9,300 Total debt = \$86,000 Total equity = \$58,000 What is the sustainable growth rate for St. Pierre, Inc.? If it does grow at this rate, how much new  borrowing will take place in the coming year, assuming a constant debt-equity ratio? What growth rate  could be supported with no outside financing at all? #6: U-Dunno Corporation's Balance Sheet and Income Statement are as shown below. Note that the firm  maintains a cash balance as required for its operations (none of its cash is ‘excess cash’):  U-Dunno Corporation  2012 and 2013 Balance Sheet 2012 2013 2012 2013 Cash \$260,000 \$290,000 Accounts Payable \$110,000 \$130,000 Accounts Receivable 180,000 240,000 Notes Payable 120,000 140,000 Inventory 250,000 270,000 Total \$230,000 \$270,000 Total \$690,000 \$800,000 Long-Term Debt 290,000 328,000 Net Fixed Assets 410,000 450,000 Common Stock 250,000 250,000 Retained Earnings 330,000 402,000 Total Assets \$1,100,000 \$1,250,000 Total Liab & Equity \$1,100,000 \$1,250,000 U-Dunno Corporation 2013 Income Statement Sales \$1,600,000 Cost of Goods Sold 1,100,000 Depreciation Expense 200,000 Earnings before Interest and Tax \$300,000 Interest Expense 60,000 Taxable Income \$240,000 Less: Taxes (40%) 96,000 Net Income \$144,000 a. Assume that all assumptions for application of the AFN Equation hold (as discussed in your course  notes, i.e. the firm is operating at full capacity, it maintains the same operating relationships, payout  ratios, etc.). What is U-Dunno Corporation’s AFN given a desired increase in Sales to \$1,800,000 for  2014? b. If Fixed Assets had only been operating at 80% of capacity in 2013, would additional Fixed Assets  still be required given desired sales of \$1,800,000 for 2014? If not, what would be the resultant AFN  required as per the AFN Equation (as covered in your notes)? c. Given that Fixed Assets had only been operating at 80% of capacity in 2013, if desired Sales  increased to \$2,200,000 for 2014 instead, what would be the increase in Fixed Asset requirement?Tutorial 3 #1:  You've observed the following returns on Crash-n-Burn Computer's stock over the past five years:  7 percent, –12 percent, 11 percent, 38 percent, and 14 percent. a. What was the arithmetic average return on Crash-n-Burn’s stock over this five-year period?  b. What was the variance of Crash-n-Burn’s return over his period? The standard deviation?  #2:  For the problem above, suppose the average inflation rate over this period was 3.5 percent and the  average rate T-bill rate over the period was 4.2 percent. a. What was the average real return on Crash-n-Burn’s stock?  b. What was the average nominal risk premium on Crash-n-Burn’s stock?  #3:  Given the information in Problem just above, what was the average real risk-free rate over this time  period? What was the average real risk premium? #4:  A stock has had the following year-end prices and dividends: Year Price Dividends 1 \$60.18 2 73.66 \$0.60 3 94.18 0.64 4 89.35 0.72 5 78.49 0.80 6 95.05 1.20 What are the arithmetic and geometric returns for the stock? #5: #5:  Consider the following information on three stocks: Consider the following information on three stocks: State of  Economy Probability of  State of  Economy Rate of Return if State Occurs Stock A Stock B Stock C Boom 0.35 0.24 0.36 0.55 Normal 0.50 0.17 0.13 0.09 Bust 0.15 0.00 -0.28 -0.45

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a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is  a.If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the portfolio  the portfolio expected return? The variance? The standard deviation? expected return? The variance? The standard deviation?  b. If the expected T-bill rate is 3.80 percent, what is the expected risk premium on the portfolio?  b. If the expected T-bill rate is 3.80 percent, what is the expected risk premium on the  c.If the expected inflation rate is 3.50 percent, what are the approximate and exact expected real returns  portfolio? on the portfolio? What are the approximate and exact expected real risk premiums on the portfolio?  c. If the expected inflation rate is 3.50 percent, what are the approximate and exact  expected real returns on the portfolio? What are the approximate and exact expected  real risk premiums on the portfolio?#6:  Consider the following information on 2 stocks: Year Stock A return Stock B return 1 0.12 0.07 2 0.09 0.11 3 0.15 -0.02 4 0.05 0.04

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a. What is the arithmetic average return for Stocks A and B? b. What is the estimated standard deviation of returns for Stocks A and B? c. What is the covariance of returns for Stock A and Stock B? d. What is the correlation coefficient of returns for Stock A and Stock B? Tutorial 4 #1:  In broad terms, why is some risk diversifiable? Why are some risks non-diversifiable? Does it follow that  an investor can control the level of unsystematic risk in a portfolio, but not the level of systematic risk? #2:  Indicate whether the following events might cause stocks in general to change price, and whether they  might cause Big Widget Corp.’s stock to change price: a. The government announces that inflation unexpectedly jumped by 2 percent last month. b. Big Widget’s quarterly earnings report, just issued, generally fell in line with analysts’ expectations. c. The government reports that economic growth last year was at 3 percent, which was generally agreed  with most economists’ forecasts.  d. The directors of Big Widget die in a plane crash.  e. Congress approves changes to the tax code that will increase the top marginal corporate tax rate. The  legislation had been debated for the previous six months.  #3:  Stock Y has a beta of 1.3 and an expected return of 18.5 percent. Stock Z has a beta of 0.70 and an  expected return of 12.1 percent. If the risk-free rate is 8 percent and the market risk premium is 7.5  percent, are these stock correctly priced? #4:  A stock has a beta of 1.35 and an expected return of 16%. A risk-free asset currently earns 4.8%. a. What is the expected return on a portfolio that is equally invested in the two assets?  b. If a portfolio of the two assets has a beta of 0.95, what are the portfolio weights?  c. If a portfolio of the two assets has an expected return of 8%, what is its beta?  d. If a portfolio of the two assets has a beta of 2.70, what are the portfolio weights? How do you  interpret the weights for the two assets in this case? Explain.  #5:  #5: Consider the following information about Stock I and II: Consider the following information about Stock I and II: State of Economy Probability of  State of  Economy Rate of Return if State Occurs Stock I Stock II Recession 0.25 0.11 -0.40 Normal 0.50 0.29 0.10 Irrational exuberance 0.25 0.13 0.56

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The market risk premium is 8 percent, and the risk-free rate is 4 percent. Which stock  The market risk premium is 8 percent, and the risk-free rate is 4 percent. Which stock has the most  has the most systematic risk? Which one has the most unsystematic risk? Which stock is  systematic risk? Which one has the most unsystematic risk? Which stock is “riskier”? Explain. “riskier”? Explain. #6: Suppose you observe the following situation: Security Beta Expected Return Pete Corp 1.35 0.132 Repete Co. 0.80 0.101

Assume these securities are correctly priced. Based on the CAPM, what is the expected  return on the market? What is the risk-free rate?The market risk premium is 8 percent, and the risk-free rate is 4 percent. Which stock  has the most systematic risk? Which one has the most unsystematic risk? Which stock is  “riskier”? Explain. #6:  #6: Suppose you observe the following situation: Suppose you observe the following situation: Security Beta Expected Return Pete Corp 1.35 0.132 Repete Co. 0.80 0.101

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Assume these securities are correctly priced. Based on the CAPM, what is the expected  Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the  return on the market? What is the risk-free rate?market? What is the risk-free rate? #7: You are managing a portfolio of 6 stocks, which are held in equal dollar amounts. The current beta of  the portfolio is 1.4, and the beta’s of Stock A is 1.8 and of Stock B is 2.0, respectively. If Stock A and  Stock B are sold and the proceeds used to purchase 2 replacement stocks, what does the average beta of  these 2 replacement stocks have to be to reduce the portfolio beta to 1.25? Tutorial 6 #1:  A substantial percentage of the companies listed on the NYSE and NASDAQ don’t pay dividends, but  investors are nonetheless willing to buy shares in them. How is this possible? #2:  Suppose a company has a preferred stock issue and a common stock issue. Both have just paid a \$2  dividend. Which do you think will have a higher price, a share of the preferred or a share of the  common? #3:  The Jackson-Timberlake Wardrobe Co. just paid a dividend of \$1.95 per share on its stock. The  dividends are expected to grow at a constant rate of 6 percent per year, indefinitely. If investors require  an 11 percent return on The Jackson-Timberlake Wardrobe Co. stock, what is the current price? What  will the price be in three years? In 15 years? #4:  Great Pumpkin Farms (GPF) just paid a dividend of \$3.50 on its stock. The growth rate in dividends is  expected to be a constant 5 percent per year, indefinitely. Investors require a 14% return on the stock for  the first three years, a 12 percent return for the next three years, and then a 10 percent return thereafter.  What is the current share price? #5:  Far Side Corporation is expected to pay the following dividends over the next four years: \$11, \$8, \$5,  and \$2. Afterwards, the company pledges to maintain a constant 5 percent growth rate in dividends,  forever. If the required return on the stock is 12 percent, what is the current share price? #6:  Antiques R Us is a manufacturing firm. The company just paid a \$10.46 dividend, but management  expects to reduce the payout by 4 percent per year indefinitely. If you require an 11.5 percent return on  this stock, what will you pay for a share today? #7:  Consider four different stocks, all of which have a required return of 19 percent and a most recent  dividend of \$4.50 per share. Stocks W, X, and Y are expected to maintain constant growth rates in  dividends for the foreseeable future of 10 percent, 0 percent, and -5 percent per year, respectively. Stock  Z is a growth stock that will increase its dividend by 20 percent for the next two years and then maintain  a constant 12 percent growth rate, thereafter. What is the dividend yield for each of these four stocks?  What is the expected capital gains yield? Discuss the relationship among the various returns that you find  for each of these stocks. #8: The risk-free rate is an annual rate of 6 percent, and the market return is an annual rate of 12 percent.  Stock A is expected to generate a constant dividend of \$5.20 per share. A toxic spill results in a lawsuit  and potential fines, and the beta of the stock increases by 25%. Consequently, the equilibrium price of  the stock falls by 12%. Assume that dividends remain unchanged, what is the new equilibrium price of  the Stock A? Tutorial 7 #1:  Tutorial 7 Suppose a project has conventional cash flows and a positive NPV. What do you know  Tutorial 7 about its payback? Its discounted payback? Its profitability index? Its IRR? Explain.  #1:  #1:  Suppose a project has conventional cash flows and a positive NPV. What do you know  Suppose a project has conventional cash flows and a positive NPV. What do you know about its  #2:  about its payback? Its discounted payback? Its profitability index? Its IRR? Explain.  payback? Its discounted payback? Its profitability index? Its IRR? Explain. Mahjong, Inc., has identified the following two mutually exclusive projects:  #2:  Mahjong, Inc., has identified the following two mutually exclusive projects:   #2: Year Mahjong, Inc., has identified the following two mutually exclusive projects:Cash Flow (A) Cash Flow (B) 0 -\$43,000 -\$43,000

Year 1 Cash Flow (A) 23,000

Cash Flow (B)  7,000

0 -\$43,000

-\$43,000 2 17,900

13,800

1 23,000

7,000 3 12,400

24,000

2 17,900

13,800 4 9,400

26,000

3 12,400

24,000

4 9,400 a. What is the IRR for each of these projects? Using the IRR decision rule, which 26,000

project should the company accept? Is this decision necessarily correct?  a. What is the IRR for each of these projects? Using the IRR decision rule, which  a. What is the IRR for each of these projects? Using the IRR decision rule, which project should  b. If the required return is 11%, what is the NPV for each of these projects? Which  project should the company accept? Is this decision necessarily correct?  the company accept? Is this decision necessarily correct?  project will you choose if you apply the NPV decision rule?  b. If the required return is 11%, what is the NPV for each of these projects? Which  b. If the required return is 11%, what is the NPV for each of these projects? Which project will  c. Over what range of discount rates would you choose Project A? Project B? At what  project will you choose if you apply the NPV decision rule?  you choose if you apply the NPV decision rule? discount rate would you be indifferent between these two projects? Explain.  c. Over what range of discount rates would you choose Project A? Project B? At what  c. Over what range of discount rates would you choose Project A? Project B? At what discount  discount rate would you be indifferent between these two projects? Explain.  rate would you be indifferent between these two projects? Explain.  #3:  #3:  Consider the following two mutually exclusive projects:  #3:  Consider the following two mutually exclusive projects: Consider the following two mutually exclusive projects: Year Cash Flow (A) Cash Flow (B) Year 0 Cash Flow (A) -\$300,000 -\$40,000 Cash Flow (B)   0 1 -\$300,000 20,000

19,000 -\$40,000

1 2 20,000 50,000

12,000 19,000

2 3 50,000 50,000

18,000 12,000

3 4 50,000 390,000

10,500 18,000

4 390,000 10,500

Whichever project you choose, if any, you require a 15% return on your investment.  Whichever project you choose, if any, you require a 15% return on your investment. a. If you apply the payback criterion, which investment will you choose? Why?  a. If you apply the payback criterion, which investment will you choose? Why?  Whichever project you choose, if any, you require a 15% return on your investment.  b. If you apply the discounted payback criterion, which investment will you choose?  b. If you apply the discounted payback criterion, which investment will you choose? Why?  a. If you apply the payback criterion, which investment will you choose? Why?  Why?  c. If you apply the NPV criterion, which investment will you choose? Why?  b. If you apply the discounted payback criterion, which investment will you choose?  c. If you apply the NPV criterion, which investment will you choose? Why?  d. If you apply the IRR criterion, which investment will you choose? Why?  Why?  e. If you apply the profitability index criterion, which investment will you choose? Why?  d. If you apply the IRR criterion, which investment will you choose? Why? c. If you apply the NPV criterion, which investment will you choose? Why?  d. If you apply the IRR criterion, which investment will you choose? Why?  f. Based on your answers in (a) through (e), which project will you finally choose? Why?  e. If you apply the profitability index criterion, which investment will you choose?  Why?  f. Based on your answers in (a) through (e), which project will you finally choose?  Why?  #4:  #4:  Slow Ride Corp. is evaluating a project with the following cash flows:  Slow Ride Corp. is evaluating a project with the following cash flows: Year Cash Flow 0 -\$16,000 1 6,100 2 7,800 3 8,400 4 6,500 5 -5,100

The company uses a 10 percent interest rate on all of its projects. Calculate the MIRR of  The company uses a 10 percent interest rate on all of its projects. Calculate the MIRR of the  the project using the combination approach.  project using the combination approach. #5:  #5:  The Yurdone Corporation wants to set up a private cemetery business. According to the  The Yurdone Corporation wants to set up a private cemetery business. According to the CFO,  CFO, Barry M. Deep, business is “looking up.” As a result, the cemetery project will  Barry M. Deep, business is “looking up.” As a result, the cemetery project will provide a net cash  provide a net cash inflow of \$85,000 for the firm during the first year, and the cash flows  inflow of \$85,000 for the firm during the first year, and the cash flows are projected to grow at a  are projected to grow at a rate of 6 percent per year forever. The project requires an  rate of 6 percent per year forever. The project requires an initial investment of \$1,400,000. initial investment of \$1,400,000.  a. If Yurdone requires a 13% return on such undertakings, should the cemetery business be  started?  a. If Yurdone requires a 13% return on such undertakings, should the cemetery business  b. The company is somewhat unsure about the assumption of a 6% growth rate in its cash flows.  be started?  At what constant growth rate would the company just break even if it still required a 13%  b. The company is somewhat unsure about the assumption of a 6% growth rate in its  return on investment?  cash flows. At what constant growth rate would the company just break even if it still  required a 13% return on investment?  #6:  What is the NPV of a publicly listed common stock? Of a bond? Given your answers, would you  #6:  purchase a common stock and/or a bond? What is the NPV of a publicly listed common stock? Of a bond? Given your answers,  would you purchase a common stock and/or a bond? #7: Joe is considering a project that requires \$90,000 for initial investment. The project generates  revenues of \$X every year for 6 years. The payback for the project is 4.5 years. The NPV for the  project is \$2,457.59. What is the discounted payback for this project?
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