FIN 571 Wk 1 – Practice: Wk 1 Practice Questions

In which type of organizational structure is the agency problem least likely to exist?

Multiple Choice

Limited Liability Corporation

Partnership

Professional Corporation

Sole Proprietorship

Which of the following is NOT a claim on the assets of a company?

Multiple Choice

Bond

Patent

Promissory Note

Stock

Which one of these determines the minimum acceptable rate of return on a capital investment?

Multiple Choice

• The alternative investment opportunities available to investors
• The profit margin of the existing firm
• The rate of return on the firm’s outstanding shares
• The rate of return on risk-free debt securities

You purchased a 6% annual coupon bond at face value and sold it one year later for $1,015.16. What was your rate of return on this investment if the face value at maturity was $1,000?

Multiple Choice

• 4.48%
• 6.15%
• 7.52%
• 6.07%

What are the conditions imposed on a debt issuer that are designed to protect bondholders ?

Multiple Choice

• Collateral agreements
• Vanilla wrappers
• Protective covenants
• Default provisions

What is the total return to an investor who buys a bond for $1,100 when the bond has a 9% annual coupon and 5 years until maturity, then sells the bond after 1 year for $1,085?

Multiple Choice

• 6.82%
• 6.91%
• 7.64%
• 9.00%

If the liquidation value of a corporation exceeds the market value of the equity, then the:

Multiple Choice

• firm has no value as a going concern.
• firm’s stock will sell for book value.
• firm is not taking advantage of available growth opportunities.
• dividend payout ratio has been too high.

If the price of a stock falls on 4 consecutive days of trading, then stock prices:

Multiple Choice

• cannot be following a random walk.
• can still be following a random walk.
• are almost certain to increase the following day.
• are almost certain to decrease the following day.

If The Wall Street Journal lists a stock’s dividend as $1, then it is most likely the case that the stock:

Multiple Choice

• pays $1 per share per quarter.
• paid $.25 per share per quarter for the past year.
• paid $1 during the past quarter, with no future dividends forecast.
• is expected to pay a dividend of $1 per share at the end of next year.

Jefferson’s recently paid an annual dividend of $1.31 per share. The dividend is expected to decrease by 4% each year. How much should you pay for this stock today if your required return is 16%?

Multiple Choice

• $6.29
• $5.74
• $10.48
• $11.57

Corporations that issue financial securities such as stock or debt obligations to the public do so primarily to:

Multiple Choice

increase sales.

become profitable.

increase their access to funds.

avoid double taxation of their profits.

Which of these duties are responsibilities of the corporate treasurer?

Multiple Choice

Financial statements and taxes

Cash management and tax reporting

Cash management and banking relationships

Raising capital and financial statements

Double taxation” refers to:

Multiple Choice

all partners paying equal taxes on profits.

corporations paying taxes on both dividends and retained earnings.

paying taxes on profits at the corporate level and dividends at the personal level.

the fact that marginal tax rates are doubled for corporations.

Which one of the following forms of compensation is most apt to align the interests of managers and shareholders?

Multiple Choice

A fixed salary

A salary that is linked to current company profits

A salary that is paid partly in the form of the company’s shares

A salary that is linked to the company’s market share

Which one of the following would ly differentiate general partners from limited partners in a limited partnership?

Multiple Choice

General partners have more job experience.

General partners have an ownership interest.

General partners are subject to double taxation.

General partners have unlimited personal liability.

Which one of the following would be considered a capital budgeting decision?

Multiple Choice

Planning to issue common stock rather than issuing preferred stock

Deciding to expand into a new line of products, at a cost of $5 million

Repurchasing shares of common stock

Issuing debt in the form of long-term bonds

How much should you be prepared to pay for a 10-year bond with a 6% coupon, semiannual payments, and a semiannually compounded yield of 7.5%?

Multiple Choice

$895.78

$897.04

$938.40

$1,312.66

Which one of these is included in the yield of a bond with a low credit rating but not included in a U.S. Treasury bond yield? Assume both bonds are selling at a premium.

Multiple Choice

Real rate of return

Inflation premium

Default premium

Loss of premium

What is the rate of return for an investor who pays $1,054.47 for a 3-year bond with an annual coupon payment of 6.5% and sells the bond 1 year later for $1,037.19?

Multiple Choice

4.53%

5.33%

5.16%

4.92%

What are the conditions imposed on a debt issuer that are designed to protect bondholders ?

Multiple Choice

Collateral agreements

Vanilla wrappers

Protective covenants

Default provisions

Periodic receipts of interest by the bondholder are known as:

Multiple Choice

the coupon rate.

principal payments.

coupon payments.

the default premium.

Which one of the following is  concerning real interest rates?

Multiple Choice

Real interest rates are constant.

Real interest rates must be positive.

Real interest rates must be less than nominal interest rates.

Real interest rates, if positive, increase purchasing power over time.

Which one of these statements is not ?

Multiple Choice

When a foreign government borrows dollars, investors worry that in some future crisis the government will not have sufficient dollars to repay the debt.

When the Japanese government borrows yen, investors worry that in some future crisis the government will not have sufficient yen to repay the debt.

When a Eurozone government borrows euros, investors worry that in some future crisis the government will not have sufficient euros to repay the debt.

When the U.S. government issues Treasury bonds, investors never need to worry that they will not be paid back.

Which statement is ?

Multiple Choice

It is much easier to judge whether the absolute level of stock prices is  rather than whether their relative levels are .

It is much easier to judge whether relative stock prices are  than to judge whether their absolute level is .

Most tests of market efficiency are concerned with the absolute level of stock prices.

If relative prices are , then absolute prices must be  also.

What is the expected constant-growth rate of dividends for a stock currently priced at $50, that just paid a dividend of $4, and has a required return of 18%?

Multiple Choice

3.41%

5.50%

9.26%

12.5%

If the price of a stock falls on 4 consecutive days of trading, then stock prices:

Multiple Choice

cannot be following a random walk.

can still be following a random walk.

are almost certain to increase the following day.

are almost certain to decrease the following day.

The growth of mature companies is primarily funded by:

Multiple Choice

issuing new shares of stock.

issuing new debt securities.

reinvesting company earnings.

increasing accounts payable.

Firms with valuable intangible assets are more likely to show a(n):

Multiple Choice

excess of book value over market value of equity.

high going-concern value.

low liquidation value.

low P/E ratio.

Which of the following is inconsistent with a firm that sells for very near book value?

Multiple Choice

Low current earnings

Few, if any, intangible assets

High future earning power

Low, unstable dividend payment

FIN 571 Wk 1 – Apply: The Stock Market and the Economy Summary

Research how financial markets and institutions influence the US and global economies.

Create an 8- to 12-slide presentation or 350- to 575-word summary to present your research.

Choose 4 financial markets or institutions. Briefly explain what each specializes in (mortgages, stocks, government securities, etc.).

Compare how each financial market you identified influences the US economy and global economy.

Cite references to support your assignment.

Format your citations according to APA guidelines.

Submit your assignment.

FIN 571 Wk 2 – Practice: Wk 2 Practice Questions

A firm has a debt-to-equity ratio of 1/4. The WACC is 18.6%, and the pretax cost of debt is 9.4%. What is the cost of common equity if the tax rate is 21%?

Multiple Choice

• 19.90%
• 20.90%
• 21.48%
• 22.73%

Changing the capital structure by adding debt will:

Multiple Choice

• reduce the return that shareholders require.
• reduce default risk.
• increase debtholder risk.
• reduce the cost of debt.

What return on equity do investors expect for a firm with a $55 share price, an expected dividend of $4.60, a beta of 0.9, and a constant growth rate of 3.5%?

Multiple Choice

• 9.87%
• 12.48%
• 13.95%
• 11.86%

What would you estimate as the cost of equity if a stock sells for $40, pays a $4.25 dividend, and is expected to grow at a constant rate of 5%?

Multiple Choice

• 17.46%
• 14.52%
• 12.69%
• 15.63%

Company X has 2 million shares of common stock outstanding with a book value of $2 per share. The stock trades for $3 per share. It also has $2 million in face value of debt that trades at 90% of face value. What is the debt ratio that should be used to calculate WACC?

Multiple Choice

• 13.91%
• 23.08%
• 31.03%
• 27.67%

Which one of the following statements is in?

Multiple Choice

• The equity component of WACC reflects the return expected by the company’s shareholders.
• Market values should be used in calculating WACC.
• Preferred equity is a separate component of WACC.
• There is a tax shield on the equity dividends paid.

The company cost of capital:

Multiple Choice

• measures the return that investors require from the company.
• depends on current profits and cash flows.
• is measured using security book values.
• depends on historical profits and cash flows.

According to CAPM estimates, what is the cost of equity for a firm with a beta of 1.5 when the risk-free interest rate is 6% and the expected return on the market portfolio is 15%?

Multiple Choice

• 19.5%
• 21.0%
• 22.5%
• 24.0%

Which one of the following changes offers the greatest chance of changing a project’s NPV from negative to positive?

Multiple Choice

• Substituting preferred stock for debt
• Selling the debt at less than par value
• Reducing the risk of the project
• Reducing the maturity of the debt

Capital structure decisions refer to the:

Multiple Choice

• dividend yield of the firm’s stock.
• blend of equity and debt used by the firm.
• capital gains available on the firm’s stock.
• maturity date for the firm’s securities.

An investor exercises the right to buy one additional share at $20 for every five shares held. How much should each share be worth after the rights issue if they previously sold for $50 each?

Multiple Choice

• $35.00
• $41.67
• $45.00
• $46.00

Roadshows:

Multiple Choice

• give companies an opportunity to thank investors who have bought the new issue.
• describe the meetings that managers have with investment bankers to select the underwriter to an issue.
• provide underwriters and the company’s management an opportunity to meet potential investors.
• describe the meetings that management has with the SEC to finalize the issue prospectus.

In return for providing funds, venture capitalists generally require:

Multiple Choice

• collateral equal in value to the funds provided.
• first right to all of the firm’s assets.
• an equity position in the firm.
• ownership of the entire fir

Who bears the bulk of the cost of underpricing an IPO?

Multiple Choice

• The underwriters
• The investors who purchase IPO shares
• All of the after-IPO shareholders
• The pre-IPO shareholders

An IPO was offered to the public at $18 a share with the issuing firm receiving $16.50 of that amount. The issuer incurred $750,000 in legal and administrative costs. At the end of the first trading day, the stock was priced at $22.40 a share. What was the total dollar cost, including both direct and indirect costs, of issuing the securities if 225,000 shares were offered?

Multiple Choice

• $1,687,500
• $1,540,000
• $2,077,500
• $1,087,500

If an underwriter charges the public $40 per share for a new issue after having promised the issuer $38 per share, the spread per share is:

Multiple Choice

• $1.
• $2.
• $38.
• $40.

Which one of the following is least likely to explain why entrepreneurs contribute their personal funds to start-up projects? Their contribution:

Multiple Choice

• acts as a signal to venture capitalists.
• repays debt held by the venture capitalist.
• retains a portion of the firm’s equity.
• provides incentive to expend effort.

In a firm commitment, the underwriter:

Multiple Choice

• encounters virtually no risk because the spread is fixed.
• is allowed to sell the shares at any price they choose.
• is protected against being stuck with unsold shares.
• is allowed to sell the shares at a price slightly higher than the price it paid to the company.

Assume the issuer incurs $2 million in other expenses to sell 4 million shares at $55 each to an underwriter and the underwriter sells the shares at $59 each. By the end of the first day’s trading, the issuing company’s stock price had risen to $68. What is the cost of underpricing?

Multiple Choice

$20 million

$32 million

$36 million

$40 million

Shelf registration was enacted to allow:

Multiple Choice

• the Department of Justice to prosecute those guilty of insider trading.
• the prospectus to be distributed after the sale of securities begins.
• underwriters to join together in syndication.
• a joint filing for multiple issues of a single security.

How much cash flow before tax and interest is necessary to support a project if $2 million is used to pay interest, the tax rate is 21%, and equity investors require annual income of $4 million?

Multiple Choice

$7.06 million

$7.86 million

$8.15 million

$8.85 million

Capital structure decisions refer to the:

Multiple Choice

dividend yield of the firm’s stock.

blend of equity and debt used by the firm.

capital gains available on the firm’s stock.

maturity date for the firm’s securities.

Al’s Market plans to close after 3 more years. The firm expects to have free cash flows of $148,000 next year, $128,000 in Year 2, and $65,000 in Year 3 after incurring the costs of closing. The firm’s cost of equity is 15.5% and its after-tax cost of debt is 6.2%. What is the present value of the firm if its debt to value ratio is 30%?

Multiple Choice

$312,020

$248,915

$277,467

$301,004

What proportion of a firm is equity financed if the WACC is 14%, the before-tax cost of debt is 10.77%, the tax rate is 21%, and the required return on equity is 18%?

Multiple Choice

54.00%

57.86%

70.26%

77.78%

Which one of the following statements is in?

Multiple Choice

The equity component of WACC reflects the return expected by the company’s shareholders.

Market values should be used in calculating WACC.

Preferred equity is a separate component of WACC.

There is a tax shield on the equity dividends paid.

A firm is considering expanding its current operations and has estimated the internal rate of return on that expansion to be 12.2%. The firm’s WACC is 11.8%. Given this, you know that the:

Multiple Choice

project will have a lower debt-equity ratio than the firm’s current operations.

appropriate discount rate for the project is between 11.8% and 12.2%.

project has slightly more risk than the firm’s current operations.

expansion should be undertaken as it has a positive net present value.

A firm is considering a project that will generate perpetual cash flows of $50,000 per year beginning next year. The project has the same risk as the firm’s overall operations. If the firm’s WACC is 12%, and its debt-to-equity ratio is 1.33, what is the most it could pay for the project and still earn its required rate of return?

Multiple Choice

$313,283

$375,094

$416,667

$554,167

For purposes of computing the WACC, if the book value of equity exceeds the market value of equity, then:

Multiple Choice

the book value of equity should be used.

the book value of equity less retained earnings should be used.

the market value of equity should be used.

the market value of equity less retained earnings should be used.

A project will generate a $1 million net cash flow annually in perpetuity. If the project costs $7 million, what is the break-even WACC?

Multiple Choice

13.33%

12.08%

14.29%

16.67%

What is the WACC for a firm with 50% debt and 50% equity that pays 12% on its debt, 20% on its equity, and has a 21% tax rate?

Multiple Choice

9.6%

12.0%

14.7%

16.0%

Assume the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each. By the end of the first day’s trading, the issuing company’s stock price had risen to $70. What is the total cost of issuing the securities?

Multiple Choice

$81 million

$91 million

$101 million

$111 million

A firm’s first offering of stock to the general public is known as:

Multiple Choice

first-stage financing.

an IPO.

a general cash offer.

a seasoned offering.

In a firm commitment, the underwriter:

Multiple Choice

encounters virtually no risk because the spread is fixed.

is allowed to sell the shares at any price they choose.

is protected against being stuck with unsold shares.

is allowed to sell the shares at a price slightly higher than the price it paid to the company.

Which one of the following is least likely to explain why entrepreneurs contribute their personal funds to start-up projects? Their contribution:

Multiple Choice

acts as a signal to venture capitalists.

repays debt held by the venture capitalist.

retains a portion of the firm’s equity.

provides incentive to expend effort

Which one of the following methods may be particularly cost-effective to smaller issuers of securities?

Multiple Choice

Seasoned offerings

Private placement

General cash offer

Best efforts underwriting

Stock that is sold through a rights issue:

Multiple Choice

is offered for cash to the general investing public.

will not affect the market price of the shares.

is limited to sales to existing shareholders.

must be sold on a firm commitment basis.

If a corporation’s management, with its superior knowledge of proposed investments, considers a security issue to be underpriced, it may react by:

Multiple Choice

forgoing the security issuance and investment.

lowering the price of the existing shares to equal the new shares.

increasing the number of shares to be sold.

adopting shelf registration, which automatically raises the issue price.

Plasti-tech Inc. has decided to go public and has sold 2 million of its shares to its underwriter for $20 per share. The underwriter then sold them to the public for $22 each. Plasti-tech also encountered $0.5 million in administrative fees. Soon after the issue, the stock price rose to $25. Find Plasti-tech Inc.’s total cost of this issue including any underpricing.

Multiple Choice

$4.5 million

$9.5 million

$10.5 million

$14.5 million

An investor can earn 20% on underpriced IPOs, but will lose 10% on overpriced IPOs. If he is awarded $2,000 worth of shares in an overpriced IPO, how much of the underpriced issue must he be awarded in order to gain $500 total?

Multiple Choice

$1,500

$2,500

$3,500

$10,000

Firms go public primarily to:

Multiple Choice

raise additional capital.

diversify public debt holders’ risk.

maintain ownership control.

increase their financial leverage.

FIN 571 Wk 2 – Apply: Signature Assignment: Investor Presentation

Select a Fortune 500 company or another company you are familiar with. Consider pharmaceuticals, computer hardware, retail, or automotive industries for your selection. If you choose a company that is not in the Fortune 500, ensure that enough financial information and key performance indicator results are available to complete the assignment.

Imagine your manager has asked you to help with a presentation on the company’s financial performance at the company’s annual meeting.

Research financial information and key performance indicators for the company.

Create a 10- to 16-slide presentation for investors to assess the company’s financial growth and sustainability.

Identify key performance indicators for the company you selected, including the following:

• The company and its ticker symbol
• Cash flow from operations
• Price-to-earnings ratio
• Stock dividends and the yield, if any
• Earnings per share ratio
• Revenue estimates for the next 12 months
• Revenue from the previous 3 years
• Statement of cash flows and identify net cash from operating, investing, and financing activities over the past 3 years
• Average trade volume.
• Current stock price, 52-week high, and 1-year estimated stock price
• Analysts’ recommendations for the stock (buy,sell, hold)
• Market cap for the company

Relate the stock price to price-to-earnings ratio.

Explain the market capitalization and what it means to the investor.

Evaluate trends in stock price, dividend payout, and total stockholders’ equity. Relate recent events or market conditions to the trends you identified.

Determine, based on your analysis, whether you think the organization is going to meet its financial goals, the outlook for growth and sustainability, and explain why you recommend this stock for purchase.

Cite references to support your assignment.

Format your citations according to APA guidelines.

Submit your assignment.

FIN 571 Wk 3 – Practice: Wk 3 Practice Questions

“Give me $5,000 today and I’ll return $10,000 to you in 5 years,” offers the investment broker. To the nearest percent, what annual interest rate is being offered?

Multiple Choice

• 12.29%
• 13.67%
• 14.87%
• 12.84%

If $120,000 is borrowed for a home mortgage, to be repaid at 9% interest over 30 years with annual payments of $11,680.36, how much interest (as opposed to return of capital) is paid in the last year of the loan?

Multiple Choice

• $918.25
• $942.51
• $978.43
• $964.43

What is the relationship between an annually compounded rate and the annual percentage rate (APR) which is calculated for truth-in-lending laws for a loan requiring monthly payments?

Multiple Choice

• The APR is lower than the annually compounded rate.
• The APR is higher than the annually compounded rate.
• The APR equals the annually compounded rate.
• The answer depends on the interest rate.

For mutually exclusive projects, the IRR can be used to select the best project:

Multiple Choice

• by calculating the modified internal rate of return.
• by calculating the IRR based on incremental cash flows.
• by using the discount rate to calculate the IRR.
• never. IRR cannot be utilized for mutually exclusive projects.

Firms that make investment decisions based on the payback rule may be biased toward rejecting projects:

Multiple Choice

• with short lives.
• with long lives.
• with late cash inflows.
• that have negative NPVs.

An investment costs $100,000 and provides a cash inflow of $17,000 per year. If the discount rate is 13%, how long must the cash inflows last for it to be an acceptable investment?

Multiple Choice

• 24 years
• 6 years
• 10 years
• 12 years

Which one of the following is least likely to influence the opportunity cost of an asset?

Multiple Choice

• Its current market value
• Alternative uses for the asset
• The current demand for the asset
• Its current book value

What effect is likely at the end of the life of a project that required a $20,000 investment in net working capital?

Multiple Choice

• The $20,000 must now be paid by the firm.
• The firm receives a $20,000 cash inflow.
• Taxable income is reduced by $20,000.
• No effects are expected because the $20,000 is now a sunk cost.

New projects can have multiple effects on a firm. Which one of the following appears to be a positive indirect effect?

Multiple Choice

• Additional working capital will be required at the start of the project.
• The sales force will need to be increased over the life of the project.
• Sales of replacement parts are expected in the future.
• The cost of employee benefits will increase due to new hires.

What is the effect on a firm’s net working capital if a new project requires a $30,000 increase in inventory, a $10,000 increase in accounts receivable, a $35,000 expenditure on machinery, and a $20,000 increase in accounts payable?

Multiple Choice

• −$5,000
• $10,000
• $20,000
• $55,000

What is the present value of a four-year annuity of $100 per year that makes its first payment 2 years from today if the discount rate is 9%?

Multiple Choice

$297.22

$323.97

$356.85

$272.68

What is the present value of $100 to be deposited today into an account paying 8%, compounded semiannually for 2 years?

Multiple Choice

$85.48

$100.00

$116.00

$116.99

What is the future value of $10,000 on deposit for 2 years at 6% simple interest?

Multiple Choice

$10,600

$11,236

$11,200

$13,382.26

An amortizing loan is one in which:

Multiple Choice

the principal remains unchanged with each payment.

accrued interest is paid regularly.

the maturity of the loan is variable.

the principal balance is reduced with each payment.

Prizes are often not “worth” as much as claimed. What is the value of a prize of $5,000,000 that is to be received in 20 equal yearly payments, with the first payment beginning today? Assume an interest rate of 7%.

Multiple Choice

$2,833,898.81

$2,911,015.68

$2,609,144.14

$2,738,304.13

What is the annually compounded rate of interest on an account with an APR of 10% and monthly compounding?

Multiple Choice

10.00%

10.47%

10.52%

11.05%

Occasionally projects may have positive initial cash flows. Such projects:

Multiple Choice

are like lending money.

are like borrowing money.

have no IRR.

their IRR increases as the cost of capital increases.

Given the various investment options listed, what investment criteria concept might make an investor select Project B over other projects?

Project    NPV       Profitability Index

A     $     1.3   mil  0.23

B     $     2.2   mil  0.54

C     $     3.5   mil  0.49

D     $     4.6   mil  0.38

________________________________________

Multiple Choice

The Gold Standard

The Rate of Return Rule

Capital rationing

Selection bias criteria

If the IRR for a project is 15%, then the project’s NPV would be:

Multiple Choice

negative at a discount rate of 10%.

positive at a discount rate of 20%.

negative at a discount rate of 20%.

positive at a discount rate of 15%.

The modified internal rate of return can be used to  for:

Multiple Choice

negative NPV calculations.

multiple internal rates of return.

undefined payback periods.

borrowing projects.

What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if the opportunity cost of capital is 14%?

Multiple Choice

$13,397.57

$14,473.44

$16,081.60

$33,748.58

A firm plans to use the profitability index to select between two mutually exclusive investments. If no capital rationing has been imposed, which project should be selected?

Multiple Choice

Select the project with the higher profitability index

Select the project with the lower profitability index

Without capital rationing, both projects can be selected

Without capital rationing, the NPV method must be used instead

When calculating a project’s payback period, cash flows are:

Multiple Choice

discounted at the opportunity cost of capital.

discounted at the internal rate of return.

discounted at the risk-free rate of return.

not discounted at all.

Bonus depreciation allows an increase:

Multiple Choice

in total depreciation over the asset’s life.

in depreciation in the first year only.

in real but not nominal depreciation expense.

in the asset’s depreciable cost basis.

When is it appropriate to include sunk costs in the evaluation of a project?

Multiple Choice

Whenever they are relatively large

If they improve the project’s NPV

If they are considered to be overhead costs

Never

Capital budgeting proposals should be evaluated as if the project were financed:

Multiple Choice

entirely by debt.

entirely by equity.

half by debt and half by equity.

with the highest cost source of funds, to be safe.

The present value of the depreciation tax shield at any given discount rate is:

Multiple Choice

equal for all depreciation methods.

higher with bonus depreciation than with straight-line depreciation.

higher for the 7-year recovery period than for the 5-year recovery period class.

likely to increase annually due to inflation.

A tax shield is equal to the reduction in a firm’s:

Multiple Choice

total tax liability resulting from a tax deductible expense.

taxable income resulting from depreciation.

taxable income resulting from a decrease in long-term debt.

net income caused by depreciation.

Which one of the following methods will provide a  analysis for capital budgeting purposes?

Multiple Choice

Discounting real cash flows with real rates.

Discounting real cash flows with nominal rates.

Discounting nominal cash flows with real rates.

Discounting nominal cash flows with either real or nominal rates.

If inflation is forecast to increase, which of the company’s following cash flows is most likely to change?

Multiple Choice

The depreciation tax shield.

Labor costs.

Costs of raw materials purchased on a fixed price contract.

Interest payments on its long-term debt.

FIN 571 Wk 3 – Apply: Wk 3 Quiz

Old Time Savings Bank pays 3% interest on its savings accounts. If you deposit $2,100 in the bank and leave it there: (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Revenues generated by a new fad product are forecast as follows:

Year Revenues

1     $60,000

2     40,000

3     30,000

4     20,000

Thereafter       0

________________________________________

Expenses are expected to be 40% of revenues, and working capital required in each year is expected to be 30% of revenues in the following year. The product requires an immediate investment of $70,000 in plant and equipment.

Required:

1. What is the initial investment in the product? Remember working capital.
2. If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight-line depreciation, and the firm’s tax rate is 20%, what are the project cash flows in each year? Assume the plant and equipment are worthless at the end of 4 years.
3. If the opportunity cost of capital is 10%, what is the project’s NPV?
4. What is project IRR?

A new furnace for your small factory is being installed right now, will cost $28,000, and will be completed in one year. At that point, it will require ongoing maintenance expenditures of $1,600 a year. But it is far more fuel-efficient than your old furnace and will reduce your consumption of heating oil by 2,500 gallons per year. Heating oil this year costs $3 a gallon; the price per gallon is expected to increase by $0.50 a year for the next 3 years and then to stabilize for the foreseeable future. The furnace will last for 20 years from initial use, at which point it will need to be replaced and will have no salvage value. (Specifically, the firm pays for the furnace at time 0, and then reaps higher net cash flows from that investment at the end of years 1 – 20.). The discount rate is 10%.

1. What is the net present value of the investment in the furnace? (Do not round intermediate calculations. Round your answer to the nearest whole dollar.)
2. What is the IRR? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
3. What is the payback period? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
4. What is the equivalent annual cost of the furnace? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
5. What is the equivalent annual savings derived from the furnace? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
6. Compare the PV of the difference between the equivalent annual cost and savings to your answer to part (a). Are the two measures the same or is one larger?

Talia’s Tutus bought a new sewing machine for $70,000 that will be depreciated over 5 years using double-declining-balance depreciation with a switch to straight-line.

Required:

1. Find the depreciation charge each year.
2. If the sewing machine is sold after 2 years for $44,000, what will be the after-tax proceeds on the sale if the firm’s tax bracket is 35%?

Find the interest rate implied by the following combinations of present and future values: (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Leave no cells blank – be certain to enter “0” wherever required.)

Johnny’s Lunches is considering purchasing a new, energy-efficient grill. The grill will cost $46,000 and will be depreciated straight-line over 3 years. It will be sold for scrap metal after 5 years for $11,500. The grill will have no effect on revenues but will save Johnny’s $23,000 in energy expenses. The tax rate is 30%.

Required:

1. What are the operating cash flows in each year?
2. What are the total cash flows in each year?
3. Assuming the discount rate is 12%, calculate the net present value (NPV) of the cash flow stream. Should the grill be purchased?

You can buy property today for $3.1 million and sell it in 6 years for $4.1 million. (You earn no rental income on the property.)

1. If the interest rate is 7%, what is the present value of the sales price? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places.)
2. Is the property investment attractive to you?

c-1. What is the present value of the future cash flows, if you also could earn $210,000 per year rent on the property? The rent is paid at the end of each year. (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places.)

c-2. Is the property investment attractive to you now?

The following are the cash flows of two projects:

Year Project A Project B

0     $     (230 )      $     (230 )

1          110             130

2          110             130

3          110             130

4          110

________________________________________

1. Calculate the NPV for both projects if the discount rate is 11%. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Compute the future value of a $150 cash flow for the following combinations of rates and times. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

1. r = 7%; t = 10 years
2. r = 7%; t = 20 years
3. r = 3%; t = 10 years
4. r = 3%; t = 20 years

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $3,600 and sell its old washer for $900. The new washer will last for 6 years and save $1,100 a year in expenses. The opportunity cost of capital is 20%, and the firm’s tax rate is 21%.

1. If the firm uses straight-line depreciation over a 6-year life, what are the cash flows of the project in years 0 to 6? The new washer will have zero salvage value after 6 years, and the old washer is fully depreciated. (Negative amounts should be indicated by a minus sign.)
2. What is project NPV? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
3. What is NPV if the firm investment is entitled to immediate 100% bonus depreciation? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Your landscaping company can lease a truck for $8,600 a year (paid at year-end) for 6 years. It can instead buy the truck for $42,000. The truck will be valueless after 6 years. The interest rate your company can earn on its funds is 7%.

1. What is the present value of the cost of leasing? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
2. Is it cheaper to buy or lease?
3. What is the present value of the cost of leasing if the lease payments are an annuity due, so the first payment comes immediately? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
4. Is it now cheaper to buy or lease?

The owner of a bicycle repair shop forecasts revenues of $188,000 a year. Variable costs will be $57,000, and rental costs for the shop are $37,000 a year. Depreciation on the repair tools will be $17,000.

1. Prepare an income statement for the shop based on these estimates. The tax rate is 20%.

1. Calculate the operating cash flow for the repair shop using the three methods given below:

Now calculate the operating cash flow.

1. Dollars in minus dollars out.
2. Adjusted accounting profits.

iii.   Add back depreciation tax shield.

1. The following are the cash flows of two projects:

Year Project A Project B

0     −$340              −$340

1     170           240

2     170           240

3     170           240

4     170

________________________________________

1. If the opportunity cost of capital is 10%, calculate NPV for both projects? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Project    NPV

A     $

B

________________________________________

1. Which of these projects is worth pursuing?

Both

The following are the cash flows of two projects:

Year: Project A;Project B

0:$(200);$(200)

1: $80; $100

2: $80;$100

3: $80; $100

4: $80

1. Calculate the NPV for both projects if the discount rate is 11%.

Suppose that you can choose only one of these projects. Which would you choose?

a)

NPVA = −$200 + [$80 × Annuity factor (11%, 4 periods)]

=−200+$80×[(1/0.11)−(1/(0.11×(1.11)4))]=$48.20

NPVB = −$200 + [$100 × Annuity factor (11%, 3 periods)]

=−200+$100×[(1/0.11)−(1/(0.11×(1.11)3))]=$44.37

1. b) Since you can only choose one project, select the one with the higher positive NPV.

Find the interest rate implied by the following combinations of present and future values:

Talia’s Tutus bought a new sewing machine for $85,000 that will be depreciated using the MACRS depreciation schedule for a 5-year recovery period.

1. Find the depreciation charge each year.

1. If the sewing machine is sold after 3 years for $35,000, what will be the after-tax proceeds on the sale if the firm’s tax bracket is 35%?

After-tax proceeds     $

rev: 04_19_2013_QC_29586

Bottoms Up Diaper Service is considering the purchase of a new industrial washer. It can purchase the washer for $6,900 and sell its old washer for $2,900. The new washer will last for 6 years and save $1,650 a year in expenses. The opportunity cost of capital is 16%, and the firm’s tax rate is 40%. What is the equivalent annual cost of the washer, if the firm uses straight-line depreciation? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Equivalent annual cost       $

If you insulate your office for $17,000, you will save $1,700 a year in heating expenses. These savings will last forever.

1. What is the NPV of the investment when the cost of capital is 8%? 10%?

1. What is the IRR of the investment? (Enter your answer as a whole percent.)

1. What is the payback period on this investment?

Johnny’s Lunches is considering purchasing a new, energy-efficient grill. The grill will cost $48,000 and will be depreciated according to the 3-year MACRS schedule. It will be sold for scrap metal after 3 years for $12,000. The grill will have no effect on revenues but will save Johnny’s $24,000 per year in energy expenses. The tax rate is 30%. Use MACRS depreciation schedule.

1. What are the operating cash flows in years 1 to 3? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Year Operating Cash Flows

1. What are total cash flows in years 1 to 3? (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places.)

Time          Total Cash Flows

1. If the discount rate is 10%, should the grill be purchased?

Yes

Johnny’s Lunches is considering purchasing a new, energy-efficient grill. The grill will cost $46,000 and will be depreciated straight-line over 3 years. It will be sold for scrap metal after 5 years for $11,500. The grill will have no effect on revenues but will save Johnny’s $23,000 in energy expenses. The tax rate is 30%.

Required:

1. What are the operating cash flows in each year?
2. What are the total cash flows in each year?
3. Assuming the discount rate is 12%, calculate the net present value (NPV) of the cash flow stream. Should the grill be purchased?

The following are the cash flows of two projects:

Year Project A Project B

0     $     (260 )      $     (260 )

1          140             160

2          140             160

3          140             160

4          140

________________________________________

1. Calculate the NPV for both projects if the discount rate is 11%. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

1. Suppose that you can choose only one of these projects. Which would you choose?

Project A

Project B

Neither

1. What is the present value of a 3-year annuity of $210 if the discount rate is 7%? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

1. What is the present value of the annuity in (a) if you have to wait an additional year for the first payment? (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

1. Revenues generated by a new fad product are forecast as follows:

Year Revenues

1     $54,000

2     30,000

3     20,000

4     10,000

Thereafter       0

________________________________________

Expenses are expected to be 50% of revenues, and working capital required in each year is expected to be 10% of revenues in the following year. The product requires an immediate investment of $50,000 in plant and equipment.

1. What is the initial investment in the product? Remember working capital.

Initial investment       $

1. If the plant and equipment are depreciated over 4 years to a salvage value of zero using straight-line depreciation, and the firm’s tax rate is 30%, what are the project cash flows in each year? (Enter your answers in thousands of dollars. Do not round intermediate calculations. Round your answers to 2 decimal places.)

Year Cash Flow

1. If the opportunity cost of capital is 12%, what is project NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

NPV    $

1. What is project IRR? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

IRR       %

Compute the future value of a $300 cash flow for the same combinations of rates and times: (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Future Value

1. r = 12%, t = 8 years $

1. r = 12%, t = 16 years

1. r = 6%, t = 8 years

1. r = 6%, t = 16 years

________________________________________

Compute the future value of a $125 cash flow for the following combinations of rates and times. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

1. r = 8%; t = 10 years
2. r = 8%; t = 20 years
3. r = 4%; t = 10 years
4. r = 4%; t = 20 years

Old Time Savings Bank pays 4% interest on its savings accounts. If you deposit $1,000 in the bank and leave it there (Do not round intermediate calculations. Round your answers to 2 decimal places.):

1. How much interest will you earn in the first year?

First year interest       $

1. How much interest will you earn in the second year?

Second year interest   $

1. How much interest will you earn in the tenth year?

Tenth year interest      $

A factory costs $460,000. You forecast that it will produce cash inflows of $150,000 in year 1, $210,000 in year 2, and $360,000 in year 3. The discount rate is 12%.

1. Calculate the PV of cash inflows. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Present value      $

1. Is the factory a good investment?

Yes

You can buy property today for $3.5 million and sell it in 4 years for $4.5 million. (You earn no rental income on the property.)

9. If the interest rate is 9.25%, what is the present value of the sales price? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places.)

Present value      $

million

1. Is the property investment attractive to you?

No

c-1.  What is the present value of the sales price, if you also could earn $250,000 per year rent on the property? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places.)

Present value      $

million

c-2.  Is the property investment attractive to you?

Your landscaping company can lease a truck for $7,100 a year (paid at year-end) for 7 years. It can instead buy the truck for $38,000. The truck will be valueless after 7 years. The interest rate your company can earn on its funds is 8%.

1. What is the present value of the cost of leasing? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
2. Is it cheaper to buy or lease?
3. What is the present value of the cost of leasing if the lease payments are an annuity due, so the first payment comes immediately? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
4. Is it now cheaper to buy or lease?

A new furnace for your small factory will cost $46,000 to install and will require ongoing maintenance expenditures of $4,000 a year. But it is far more fuel efficient than your old furnace and will reduce your consumption of heating oil by 4,300 gallons per year. Heating oil this year will cost $3 a gallon; the price per gallon is expected to increase by $0.50 a year for the next 3 years and then to stabilize for the foreseeable future. The furnace will last for 20 years, at which point it will need to be replaced and will have no salvage value. The discount rate is 10%.

1. What is the net present value of the investment in the furnace? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

NPV    $

1. What is the IRR? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

IRR     %

1. What is the payback period? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Payback period   years

1. What is the equivalent annual cost of the furnace? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Equivalent annual cost     $

1. What is the equivalent annual savings derived from the furnace? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Equivalent annual savings    $

FIN 571 Wk 4 – Practice: Wk 4 Questions

Pollution Busters Inc. is considering a purchase of 10 additional carbon sequesters for $110,000 apiece. The sequesters last for only 1 year before becoming saturated. Then the carbon is sold to the government.

1. Suppose the government guarantees the price of carbon. At this price, the payoff after 1 year is $126,500 for sure. How would you determine the opportunity cost of capital for this investment?

b-1. Suppose instead that the sequestered carbon has to be sold on the London Carbon Exchange. Carbon prices have been extremely volatile, but Pollution Busters’ CFO learns that average rates of return from investments on that exchange have been about 20%. She thinks this is a reasonable forecast for the future. What is the opportunity cost of capital in this case?

b-2.  If the expected return on the investment is still 15%, but instead depends on the price of carbon (so that it is no longer risk-free), then is the purchase of additional sequesters an attractive investment for the firm?

Suppose the government guarantees the price of carbon. At this price, the payoff after 1 year is $126,500 for sure. How would you determine the opportunity cost of capital for this investment?

Opportunity cost of capital for this investment is determined by U.S. Treasuries with 1 year to maturity

Suppose instead that the sequestered carbon has to be sold on the London Carbon Exchange. Carbon prices have been extremely volatile, but Pollution Busters’ CFO learns that average rates of return from investments on that exchange have been about 20%. She thinks this is a reasonable forecast for the future. What is the opportunity cost of capital in this case?

Opportunity cost of capital    20

If the expected return on the investment is still 15%, but instead depends on the price of carbon (so that it is no longer risk-free), then is the purchase of additional sequesters an attractive investment for the firm

radio button unchecked       Yes

radio button

No

Which of the following are investment decisions, and which are financing decisions?

Which of the following are real assets, and which are financial?

Choose the type of company in each case that best fits the description.

Which of the following statements always apply to corporations?  (You may select more than one answer. Single click the box with the question mark to produce a check mark for a  answer and double click the box with the question mark to empty the box for a wrong answer. Any boxes left with a question mark will be automatically graded as in.)

• Unlimited liabilityunchecked
• Limited lifeunchecked
• Ownership can be transferred without affecting operations
• Managers can be fired with no effect on ownership

Which of the following are  descriptions of large corporations? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a  answer and double click the box with the question mark to empty the box for a wrong answer. Any boxes left with a question mark will be automatically graded as in.)

• Managers no longer have the incentive to act in their own interests.
• The corporation survives even if managers are dismissed.
• Shareholders can sell their holdings without disrupting the business.
• Corporations, unlike sole proprietorships, do not pay tax; instead, shareholders are taxed on any dividends they receive.

Is limited liability always an advantage for a corporation and its shareholders?

Yes

No

Which of the following statements more accurately describes the treasurer than the controller? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a  answer and double click the box with the question mark to empty the box for a wrong answer. Any boxes left with a question mark will be automatically graded as in.)

• Monitors capital expenditures to make sure that they are not misappropriated
• Responsible for investing the firm’s spare cash
• Responsible for arranging any issue of common stock
• Responsible for the company’s tax affairs

We claim that the goal of the firm is to maximize current market value. Could the following actions be consistent with that goal?

Shareholders want managers to maximize the MARKET VALUE  of their investments. The firm faces a trade-off. Either it can invest its cash in REAL ASSETS  or it can give the cash back to shareholders  in the form of a dividend  and they can invest it in financial assets . Shareholders want the company to invest in real assets  only if the expected return  is higher  than they could earn for themselves. The return that shareholders could earn for themselves is therefore the opportunity cost of capital  for the firm.

Here is a simplified balance sheet for Locust Farming:

Locust Farming

Balance Sheet

($ in millions)

Current assets  $     42,532         Current liabilities   $     29,747

Long-term assets         46,848         Long-term debt           27,760

Other liabilities           14,333

Equity          17,540

Total       $     89,380         Total       $     89,380

________________________________________

Locust has 665 million shares outstanding with a market price of $91 a share.

1. Calculate the company’s market value added. (Enter your answers in millions.)

1. Calculate the market-to-book ratio. (Round your answer to 2 decimal places.)

1. How much value as the company created for its shareholders as a percent of shareholders’ equity, that is, the net capital contributed to the firm by its shareholders? (Enter your answer as a percentage rounded to the nearest whole number.)

Here are simplified financial statements for Watervan Corporation:

Home Depot entered fiscal 2014 with a total capitalization of $27,213 million. In 2014, debt investors received interest income of $830 million. Net income to shareholders was $6,345 million. (Assume a tax rate of 35%.)

Calculate the economic value added assuming its cost of capital is 10%.

economic value added = 4163.20

economic value added = after-tax operating income – (cost of capital * total capitalization)

after-tax operating income = (1 – tax rate) * interest expense + net income

(1 – .35) *830 + 6345 = 6884.50

6884.50 – (.10 * 27213) = 4163.20

Here are simplified financial statements for Phone Corporation in a recent year:

Here are simplified financial statements for Phone Corporation in a recent year:

INCOME STATEMENT

(Figures in $ millions)

Net sales  $     12,400

Cost of goods sold       3,660

Other expenses            4,137

Depreciation        2,278

Earnings before interest and taxes (EBIT)    $     2,325

Interest expense           645

Income before tax  $     1,680

Taxes (at 30%)            504

Net income     $     1,176

Dividends       $     796

________________________________________

BALANCE SHEET

(Figures in $ millions)

End of Year         Start of Year

Assets

Cash and marketable securities      $     796             $     150

Receivables          1,982                       2,330

Inventories          147                   198

Other current assets            827                   892

Total current assets $     3,037                 $     3,570

Net property, plant, and equipment            19,893                     19,835

Other long-term assets        4,136                       3,690

Total assets     $     27,066               $     27,095

Liabilities and shareholders’ equity

Payables  $     2,484                 $     2,960

Short-term debt           1,379                       1,533

Other current liabilities       771                   747

Total current liabilities   $     4,634                 $     5,240

Long-term debt and leases          9,010                       8,265

Other long-term liabilities          6,098                       6,069

Shareholders’ equity           7,324                       7,521

Total liabilities and shareholders’ equity       $     27,066               $     27,095

________________________________________

Calculate the following financial ratios for Phone Corporation: (Use 365 days in a year. Do not round intermediate calculations. Round your final answers to 2 decimal places.)

Chik’s Chickens has accounts receivable of $7,083. Sales for the year were $10,600. What is its average collection period?

In the past year, TVG had revenues of $2.98 million, cost of goods sold of $2.48 million, and depreciation expense of $172,960. The firm has a single issue of debt outstanding with book value of $1.12 million on which it pays an interest rate of 8%. What is the firm’s times interest earned ratio? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

In the past year, TVG had revenues of $3.09 million, cost of goods sold of $2.59 million, and depreciation expense of $133,760. The firm has a single issue of debt outstanding with book value of $1.09 million on which it pays an interest rate of 8%. What is the firm’s times interest earned ratio?

Salad Daze maintains an inventory of produce worth $560. Its total bill for produce over the course of the year was $80,000. How old on average is the lettuce it serves its customers?

Assume a firm’s inventory level of $18,000 represents 24 days’ sales. What is the inventory turnover ratio?

A firm has a long-term debt-equity ratio of .4. Shareholders’ equity is $1.03 million. Current assets are $230,000, and the current ratio is 2.0. The only current liabilities are notes payable. What is the total debt ratio?

Last year Electric Autos had sales of $100 million and assets at the start of the year of $150 million. If its return on start-of-year assets was 15%, what was its operating profit margin?

22.38%

Last year Electric Autos had sales of $100 million and assets at the start of the year of $150 million. If its return on start-of-year assets was 15%, what was its operating profit margin?

22.5%

A firm has a debt-to-equity ratio of .84 and a market-to-book ratio of 3.0. What is the ratio of the book value of debt to the market value of equity?

Torrid Romance Publishers has total receivables of $3,120, which represents 20 days’ sales. Total assets are $94,900. The firm’s operating profit margin is 5.5%. Find the firm’s ROA and asset turnover ratio.

Keller Cosmetics maintains an operating profit margin of 8% and asset turnover ratio of 2.

1. What is its ROA?

1. If its debt-equity ratio is 1, its interest payments and taxes are each $8,700, and EBIT is $23,500, what is its ROE?

FIN 571 Wk 4 – Apply: Signature Assignment: Shareholder Analysis

Continue your work with the company you selected in Wk 2.

Research your company’s financial reports for 2017.

Complete a 2- to 3-page FAQ/Shareholder Analysis.

Evaluate economic conditions that influence company performance. Consider political, environmental, currency (money), global economics, and government influences on economic conditions.

Compare market conditions with the company’s performance for 2017. Conclude how the market conditions that year influenced the company’s performance, such as interest rates, Federal Reserve Bank monetary policy changes, or other market conditions relevant to the company you selected.

Analyze year-over-year performance from 2016 and 2017. Consider key metrics or ratios such as trailing PE ratio, forward PE ratio, price to book, return on assets, and return on equity in your conclusions.

Cite references to support your assignment.

Format your citations according to APA guidelines.

Submit your assignment.

FIN 571 Wk 5 – Practice: Wk 5 Practice Questions

Periods of market decline are called:

Multiple Choice

• discount factors.
• bull markets.
• coupons.
• bear markets.

Over the past 4 years an investment returned 18%, −9%, −12%, and 15%. What is the standard deviation of returns?

Multiple Choice

• 9.2%
• 10.36%
• 11.2%
• 13.6%

The variance of an investment’s returns is a measure of the:

Multiple Choice

• volatility of the rates of return.
• probability of a negative return.
• historic return over long time periods.
• average value of the investment.

Risks that are peculiar to a single firm:

Multiple Choice

• are called market risks
• cannot be diversified away
• are called specific risks
• tend to cause stocks to move together

Which one of the following risks is most important to a well-diversified investor in common stocks?

Multiple Choice

• Market risk
• Specific risk
• Unsystematic risk
• Diversifiable risk

Suppose that the Treasury bill rate is 9% rather than 5%, as we assumed in Table 12.1, and the expected return on the market is 10%. Use the betas in that table to answer the following questions.

1. When you assume this higher risk-free interest rate, what makes sense for how you should modify your assumption about the rate of return on the market portfolio? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
2. Recalculate the expected return on the stocks in Table 12.1. (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
3. Suppose now that you continued to assume that the expected return on the market remained at 10%. Now what would be the expected returns on each stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
4. Ford offer a higher or lower expected return if the interest rate is 9% rather than 5%?
5. Walmart offer a higher or lower expected return if the interest rate is 9% rather than 5%?

If the expected rate of return on the market portfolio is 12% and T-bills yield 4%, what must be the beta of a stock that investors expect to return 9%? (Round your answer to 4 decimal places.)

A stock with a beta of 2.1 has an expected rate of return of 32%. If the market return this year turns out to be 13 percentage points below expectations, what is your best guess as to the rate of return on the stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

The Treasury bill rate is 4% and the market risk premium is 7%.

Project    Beta Internal Rate of Return, %

P          0.85      18

Q          0.00      14

R          2.00      18

S          0.25      15

T          1.50      20

________________________________________

1. What are the project costs of capital for new ventures with betas of 0.60 and 1.57? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

1. Which of the capital investments shown above have positive (non-zero) NPV’s? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a answer and double click the box with the question mark to empty the box for a wrong answer.)

check all that apply

• Project P
• Project Q
• Project S
• Project T
• Project RIn

You are a consultant to a firm evaluating an expansion of its current business. The cash-flow forecasts (in millions of dollars) for the project are as follows:

Years      Cash Flow

0     –     100

1-10 +     15

________________________________________

On the basis of the behavior of the firm’s stock, you believe that the beta of the firm is 1.34. Assuming that the rate of return available on risk-free investments is 5% and that the expected rate of return on the market portfolio is 14%, what is the net present value of the project? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in millions of dollars rounded to 2 decimal places.)

Which one of the following statements is in concerning stock indexes?

Multiple Choice

Indexes have been developed for foreign stocks.

Some indexes cover only a specific market sector.

Most indexes include all of the publicly-traded common stocks.

Some indexes are equally weighted.

“Dow up 14. Story at 6:00.” This means that:

Multiple Choice

the Dow was up 14% during today’s trading.

14 of the Dow’s 30 stocks increased in price today.

a share of Dow stock went up by $14 today.

the Dow index increased by 14 points in today’s trading.

Periods of market decline are called:

Multiple Choice

discount factors.

bull markets.

coupons.

bear markets.

When the annual rate of return on U.S. Treasury bills is historically high, investors expect the return on the stock market:

Multiple Choice

considerably lower than normal.

about average.

also to be high.

approximately equal to zero.

Sue purchased a stock for $25 a share, held it for one year, received a $1.34 dividend, and sold the stock for $26.45. What nominal rate of return did she earn?

Multiple Choice

11.16%

14.23%

12.09%

10.55%

If the toss of a coin comes down heads, you win a dollar. If it comes down tails, you lose fifty cents. How much would you expect to gain after 20 tosses?

Multiple Choice

$5.00

$7.50

$10.00

$15.00

In a year in which common stocks offered an average return of 12% and Treasury bills offered 3%. The risk premium for common stocks was:

Multiple Choice

1%.

3%.

12%.

9%.

A good way to reduce macro risk in a stock portfolio is to invest in stocks that:

Multiple Choice

have only specific risks.

have diversified away the macro risk.

have low exposure to business cycles.

pay guaranteed dividends.

A stock investor owns a diversified portfolio of 15 stocks. What will be the most likely effect on the portfolio’s standard deviation if one more stock is added?

Multiple Choice

A slight increase will occur.

A large increase will occur.

A slight decrease will occur.

A large decrease will occur.

The incremental risk to a portfolio from adding another stock:

Multiple Choice

is always greater than the average portfolio risk.

is always less than the average portfolio risk.

is always positive.

may be either positive or negative.

Individual stocks are:

Multiple Choice

exposed to the same amount of market risk.

exposed to differing amounts of market risk.

not exposed to market risk; only the general economy is subject to market risk.

exposed to differing amounts of market risk but the same amount of specific risk.

Which one of the following firms is likely to exhibit the least macro risk exposure?

Multiple Choice

Construction company

Airline company

Gold mining company

Auto manufacturer

Which statement is  concerning macro risk exposure?

Multiple Choice

All firms face equal macro risk exposure.

Only portfolios of stocks face macro risk exposure.

Macro risk exposure affects the cost of capital.

Macro risk exposure is less important to diversified investors than micro risk exposure.

A share of stock with a beta of 0.76 now sells for $51. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 3%, and the market risk premium is 7%.

1. Suppose investors believe the stock will sell for $53 at year-end. Calculate the opportunity cost of capital. Is the stock a good or bad buy? What will investors do? (Do not round intermediate calculations. Round your opportunity cost of capital calculation as a percentage rounded to 2 decimal places.)

1. At what price will the stock reach an “equilibrium” at which it is perceived as fairly priced today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Stock A has a beta of 0.5, and investors expect it to return 10%. Stock B has a beta of 1.5, and investors expect it to return 16%. Use the CAPM to calculate the market risk premium and the expected rate of return on the market. (Enter your answers as a whole percent.)

The risk-free rate is 5% and the expected rate of return on the market portfolio is 10%.

1. Calculate the required rate of return on a security with a beta of 1.23. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

1. If the security is expected to return 12%, is it overpriced or underpriced?

Underpriced

Overpriced

A stock with a beta of 1.9 has an expected rate of return of 28%. If the market return this year turns out to be 12 percentage points below expectations, what is your best guess as to the rate of return on the stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

Problem 12-12 CAPM and Cost of Capital (LO3)

The Treasury bill rate is 5% and the market risk premium is 8%.

Project    Beta Internal Rate of Return, %

P       0.70          12

Q      0        8

R       1.00          14

S       0.10          9

T       1.10          13

________________________________________

1. What are the project costs of capital for new ventures with betas of .45 and 1.45? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Beta            Cost of Capital

0.45             8.60 %

1.45          16.60 %

________________________________________

1. Which of the following capital investments have positive NPVs? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a answer and double click the box with the question mark to empty the box for a wrong answer.)

A project under consideration has an internal rate of return of 14% and a beta of .6. The risk-free rate is 4%, and the expected rate of return on the market portfolio is 14%.

You are considering the purchase of real estate that will provide perpetual income that should average $50,000 per year. How much will you pay for the property if you believe its market risk is the same as the market portfolio’s? The T-bill rate is 5%, and the expected market return is 12.5%.

Suppose that the S&P 500 with a beta of 1.0 has an

expected return of 13% and T Bills provide a risk free return

of 4%.

(a) what would be the expected return and beta of the

portfolios constructed from these two assets with weights

in the S&P500 of (i) 0; (ii) .25; (iii) .50; (iv) .75; (v) 1.0 ?

(b) On the bases of your answer to (a) what is the trade-off

between risk and return, that is how does expected return

vary with beta?

Suppose that the S&P 500, with a beta of 1.0, has an expected return

of 13 percent and T-bills provide a risk-free return of 5 percent.

1. What would be the expected return and beta of portfolios

constructed from these two assets with weights in the S&P 500 of (i)

0; (ii) .25; (iii) .5; (iv) .75; (v) 1.0?

1. Based on your answer to (a), what is the trade-off between risk and

return, that is, how does expected return vary with beta?

1. What does your answer to (b) have to do with the security market

line relationship?

A share of stock with a beta of 0.67 now sells for $51. Investors expect the stock to pay a year-end dividend of $3. The T-bill rate is 4%, and the market risk premium is 9%.

(a)

The opportunity cost of capital = 10.03%

The stock is a bad buy and the investors will sell the stock.

(b)

If CAPM holds, the fair price of the stock today= $50.90

Consider the following two scenarios for the economy and the returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D.

Rate of Return

Scenario  Market    Aggressive

Stock A   Defensive

Stock D

Bust    −8%           −10%         −6%

Boom  25            30            21

1. Find the beta of each stock. (Round your answers to 2 decimal places.)

Beta

Stock A

Stock D

1. If each scenario is equally likely, find the expected rate of return on the market portfolio and on each stock. (Round your answers to 2 decimal places.)

Expected

Rate of Return

Market portfolio %

Stock A      %

Stock D      %

1. If the T-bill rate is 5%, what does the CAPM say about the fair expected rate of return on the two stocks?(Do not round intermediate calculations. Round your answers to 2 decimal places.)

Expected

Rate of Return

Stock A      %

Stock D      %

1. Which stock seems to be a better buy on the basis of your answers to (a) through (c)?

Stock A

Stock D

The risk-free rate is 5% and the expected return on the market portfolio is 13%. A stock has a beta of 1.5, what is its expected return?

1. 17%
2. 12%
3. 19.5%
4. 24.5%

A stock has a beta of 0.9, the expected return on the market is 13 percent, and the   risk-free rate is 6 percent. What must the expected return on this stock be?

A stock has an expected return of 17 percent, the risk-free rate is 5.5 percent, and   the market risk premium is 8 percent. What must the beta of this stock be?

2. Problem 11-3 Real versus Nominal Returns (LO2)

You purchase 100 shares of stock for $25 a share. The stock pays a $2 per share dividend at year-end. What is the rate of return on your investment for the end-of-year stock prices listed below? What is your real (inflation-adjusted) rate of return? Assume an inflation rate of 5%. (Leave no cells blank – be certain to enter “0” wherever required. Negative values should be indicated by a minus sign. Do not round intermediate calculations. Round your “Real Rate of Return” answers to 2 decimal places.)

Rate of Return       Real Rate of Return

4. $23 0 %       -4.76 %
5. $25 8 %       2.86 %
6. $28 20 %     14.29 %

________________________________________

3.

Here are stock market and Treasury bill percentage returns between 2006 and 2010:

Year Stock Market Return      T-Bill Return

2006       16.47             5.30

2007       6.41               5.16

2008       −37.93           1.80

2009       28.90             0.60

2010       17.96             0.62

________________________________________

.      What was the risk premium on common stock in each year? (Negative values should be indicated by a minus sign. Round your answers to 2 decimal places.)

1. What was the average risk premium? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Average risk premium       3.67 %

1. What was the standard deviation of the risk premium? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Standard deviation of the risk premium    23.41 %

4.

1. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms?

Yes

1. Calculate the expected rate of return and standard deviation for each investment. (Do not round intermediate calculations. Round your answers to 1 decimal place.)

Expected Rate

of Return Standard

Deviation

Stocks 15.0 %         15.5 %

Bonds  12.6 %         5.5 %

________________________________________

1. Which investment would you prefer?

Stocks

5.

roblem 11-18 Portfolio Analysis (LO3)

Rate of Return

Scenario     Probability     Stocks     Bonds

Recession    .30   −7   %    +18  %

Normal economy       .60   +20       +10

Boom  .10   +26       +3

________________________________________

Consider a portfolio with weights of .7 in stocks and .3 in bonds.

1. What is the rate of return on the portfolio in each scenario? (Do not round intermediate calculations. Round your answers to 1 decimal place.)

Scenario         Rate of Return

Recession    0.5 %

Normal economy       17.0 %

Boom  19.1 %

________________________________________

1. What are the expected rate of return and standard deviation of the portfolio? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Expected rate of return      12.26 %

Standard deviation     7.72 %

________________________________________

1. Which investment would you prefer?

Portfolio

6.

Problem 11-22 Risk and Return (LO2, 4)

A stock will provide a rate of return of either −21% or +32%.

1. If both possibilities are equally likely, calculate the expected return and standard deviation. (Do not round intermediate calculations. Round your answers to 1 decimal place.)

Expected return  5.5 %

Standard deviation     26.5 %

________________________________________

5. If Treasury bills yield 5.5% and investors believe that the stock offers a satisfactory expected return, what must the market risk of the stock be?

Market risk 0%

7

Problem 12-7 CAPM and Expected Return (LO2)

The risk-free rate is 6% and the expected rate of return on the market portfolio is 13%.

1. Calculate the required return of a security with a beta of 1.34 and an expected rate of return of 17%. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Required return  15.38 %

1. Is the security overpriced or underpriced?

Underpriced

8.

Problem 12-12 CAPM and Cost of Capital (LO3)

The Treasury bill rate is 5% and the market risk premium is 8%.

Project    Beta Internal Rate of Return, %

P       0.70          12

Q      0        8

R       1.00          14

S       0.10          9

T       1.10          13

________________________________________

1. What are the project costs of capital for new ventures with betas of .45 and 1.45? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Beta            Cost of Capital

0.45             8.60 %

1.45          16.60 %

________________________________________

1. Which of the following capital investments have positive NPVs? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a answer and double click the box with the question mark to empty the box for a wrong answer.)

P

Q

T

R

S

9. Problem 12-19 CAPM and Valuation (LO3)

You are considering the purchase of real estate that will provide perpetual income that should average $65,000 per year. How much will you pay for the property if you believe its market risk is the same as the market portfolio’s? The T-bill rate is 5%, and the expected market return is 8.0%.

If the systematic risk were comparable to that of the market, the discount rate would be 8.0%.

10.

Problem 12-22 CAPM and Expected Return (LO2)

Stock A has a beta of .2, and investors expect it to return 5%. Stock B has a beta of 1.8, and investors expect it to return 17%. Use the CAPM to find the expected rate of return and the market risk premium on the market. (Do not round intermediate calculations. Round your answers to 1 decimal place.)

Expected rate of return      11.0 %

Market risk premium  7.5 %

________________________________________

11.

Problem 12-29 CAPM (LO2)

We Do Bankruptcies is a law firm that specializes in providing advice to firms in financial distress. It prospers in recessions when other firms are struggling. Consequently, its beta is negative, −.2.

1. If the interest rate on Treasury bills is 6% and the expected return on the market portfolio is 16%, what is the expected return on the shares of the law firm according to the CAPM?

Expected return  4 %

1. Suppose you invested 80% of your wealth in the market portfolio and the remainder of your wealth in the shares in the law firm. What would be the beta of your portfolio? (Round your answer to 2 decimal places.)

Portfolio beta     .76

12.

Problem 13-1 Cost of Debt (LO2)

Micro Spinoffs, Inc., issued 10-year debt a year ago at par value with a coupon rate of 8%, paid annually. Today, the debt is selling at $1,180. If the firm’s tax bracket is 40%, what is its after-tax cost of debt? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

After-tax cost of debt 3.25 %

13.

Problem 13-2 Cost of Preferred Stock (LO2)

Micro Spinoffs has preferred stock outstanding. The stock pays a dividend of $4 per share, and the stock sells for $40. What is the return on preferred stock?

Return on preferred stock  10 %

Micro Spinoffs, Inc., issued 10-year debt a year ago at par value with a coupon rate of 6%, paid annually. Today, the debt is selling at $1,060. The firm’s tax bracket is 30%.

Micro Spinoffs also has preferred stock outstanding. The stock pays a dividend of $6 per share, and the stock sells for $40.

Micro Spinoffs’s cost of equity is 17%. What is its WACC if equity is 60%, preferred stock is 10%, and debt is 30% of total capital? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

WACC 12.78 %

15. Problem 13-5 Calculating WACC (LO3)

Reactive Industries has the following capital structure. Its corporate tax rate is 30%.

Security  Market Value  Required Rate

of Return

Debt    $20 million             2%

Preferred stock   30 million       4

Common stock   50 million       8

________________________________________

What is its WACC? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

WACC 5.48 %

16. Problem 13-14 Cost of Equity (LO2)

Bunkhouse Electronics is a recently incorporated firm that makes electronic entertainment systems. Its earnings and dividends have been growing at a rate of 20%, and the current dividend yield is 2%. Its beta is 1.1, the market risk premium is 9%, and the risk-free rate is 4%.

a-1.  Calculate the firm’s cost of equity by using the Dividend Discount Model.

Cost of equity     22 %

a-2.  Calculate the firm’s cost of equity by using the CAPM. (Do not round intermediate calculations. Round your answer to 1 decimal place.)

Cost of equity     13.9 %

1. Which estimate seems more reasonable to you?

CAPM

FIN 571 Wk 5 – Apply: Wk 5 Quiz

Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $42. The stock will pay a dividend at year-end of $4.00. Assume that risk-free Treasury securities currently offer an interest rate of 1.7%.

Average rates of return on Treasury bills, government bonds, and common stocks, 1900–2017 (figures in percent per year) are as follows.

Portfolio Average Annual

Rate of Return (%) Average Premium (Extra return

versus Treasury bills) (%)

Treasury bills       3.8

Treasury bonds            5.3              1.5

Common stocks           11.5            7.7

________________________________________

1. What is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places.)

Assume these are the stock market and Treasury bill returns for a 5-year period:

Year      Stock Market Return (%)      T-Bill Return (%)

2013                  32.10                 0.05

2014                  11.30                 0.05

2015                  −2.00                 0.05

2016                  13.40                 0.23

2017                  21.70                 0.25

________________________________________

Required:

1. What was the risk premium on common stock in each year?
2. What was the average risk premium?
3. What was the standard deviation of the risk premium? (Ignore that the estimation is from a sample of data.)

A stock is selling today for $75 per share. At the end of the year, it pays a dividend of $6 per share and sells for $87.

Required:

1. What is the total rate of return on the stock?
2. What are the dividend yield and percentage capital gain?
3. Now suppose the year-end stock price after the dividend is paid is $72. What are the dividend yield and percentage capital gain in this case?

You purchase 100 shares of stock for $40 a share. The stock pays a $4 per share dividend at year-end.

1. What is the rate of return on your investment if the end-of-year stock price is (i) $36; (ii) $40; (iii) $44? (Leave no cells blank – be certain to enter “0” wherever required. Enter your answers as a whole percent.)

Consider the following scenario analysis:

Rate of Return

Scenario  Probability     Stocks     Bonds

Recession       0.20 −8   %    16    %

Normal economy    0.50 19    %    9     %

Boom      0.30 25    %    6     %

________________________________________

1. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms?

multiple choice

• No
• Yes

1. Calculate the expected rate of return and standard deviation for each investment. (Do not round intermediate calculations. Enter your answers as a percent rounded to 1 decimal place.)

In a recent 5-year period, mutual fund manager Diana Sauros produced the following percentage rates of return for the Mesozoic Fund. Rates of return on the market index are given for comparison.

1     2     3     4     5

Fund       −1.5 +23.3      +41.2      +10.2      +0.2

Market index  −0.7 +14.0      +30.7      +11.5      −0.5

________________________________________

1. Calculate (a) the average return on both the Fund and the index, and (b) the standard deviation of the returns on each. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
2. Did Ms. Sauros do better or worse than the market index on these measures?

Consider the following scenario analysis:

Rate of Return

Scenario  Probability     Stocks     Bonds

Recession       0.3   -6    %    18    %

Normal economy    0.4   19         8

Boom      0.3   22         5

________________________________________

Assume a portfolio with weights of 0.60 in stocks and 0.40 in bonds.

1. What is the rate of return on the portfolio in each scenario? (Enter your answer as a percent rounded to 1 decimal place.)

1. What are the expected rate of return and standard deviation of the portfolio? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Here are the returns on two stocks.

Digital Cheese Executive Fruit

January              +19             +8

February            −3              +1

March                +5              +4

April                  +7              +17

May            −4              +2

June            +3              +4

July            −2              −3

August               −8              −2

________________________________________

Required:

a-1. Calculate the variance and standard deviation of each stock.

a-2. Which stock is riskier if held on its own?

1. Now calculate the returns in each month of a portfolio that invests an equal amount each month in the two stocks.
2. Is the variance more or less than halfway between the variance of the two individual stocks?

A stock with a beta of 2.0 has an expected rate of return of 21%. If the market return this year turns out to be 8 percentage points below expectations, what is your best guess as to the rate of return on the stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

The risk-free rate is 8% and the expected rate of return on the market portfolio is 13%.

1. Calculate the required rate of return on a security with a beta of 1.13. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

1. If the security is expected to return 16%, is it overpriced or underpriced?

multiple choice

• Underpriced

Overpriced

Consider the following two scenarios for the economy and the expected returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D.

Rate of Return

Scenario       Market         Aggressive

Stock A        Defensive

Stock D

Bust            –8    %               –11  %               –6    %

Boom                 30                     40                     24

________________________________________

Required:

1. Find the beta of each stock.
2. If each scenario is equally likely, find the expected rate of return on the market portfolio and on each stock.
3. If the T-bill rate is 3%, what does the CAPM say about the fair expected rate of return on the two stocks?
4. Which stock seems to be a better buy on the basis of your answers to (a) through (c)?

A share of stock with a beta of 0.69 now sells for $44. Investors expect the stock to pay a year-end dividend of $4. The T-bill rate is 6%, and the market risk premium is 9%. If the stock is perceived to be fairly priced today, what must be investors’ expectation of the price of the stock at the end of the year? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Suppose that the S&P 500, with a beta of 1.0, has an expected return of 13% and T-bills provide a risk-free return of 6%.

1. What would be the expected return and beta of portfolios constructed from these two assets with weights in the S&P 500 of (i) 0; (ii) 0.25; (iii) 0.50; (iv) 0.75; (v) 1.0? (Leave no cells blank – be certain to enter “0” wherever required. Do not round intermediate calculations. Enter the value of Expected return as a percentage rounded to 2 decimal places and value of Beta rounded to 2 decimal places.)

1. How does expected return vary with beta? (Do not round intermediate calculations.)

The Treasury bill rate is 6%, and the expected return on the market portfolio is 14%. According to the capital asset pricing model:

1. What is the risk premium on the market?
2. What is the required return on an investment with a beta of 1.4? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
3. If an investment with a beta of 0.6 offers an expected return of 8.4%, does it have a positive or negative NPV?
4. If the market expects a return of 11.6% from stock X, what is its beta? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

A project under consideration has an internal rate of return of 15% and a beta of 0.8. The risk-free rate is 5%, and the expected rate of return on the market portfolio is 15%.

1. What is the required rate of return on the project? (Do not round intermediate calculations. Enter your answer as a whole percent.)
2. Should the project be accepted?
3. What is the required rate of return on the project if its beta is 1.80? (Do not round intermediate calculations. Enter your answer as a whole percent.)
4. If project’s beta is 1.80, should the project be accepted?

The Treasury bill rate is 4% and the market risk premium is 8%.

Project    Beta Internal Rate of Return, %

P          1.10      16

Q          0.00      12

R          2.00      20

S          0.50      13

T          1.60      22

________________________________________

1. What are the project costs of capital for new ventures with betas of 0.85 and 1.78? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

1. Which of the capital investments shown above have positive (non-zero) NPV’s? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a answer and double click the box with the question mark to empty the box for a wrong answer.)

check all that apply

• Project P
• Project Q
• Project S
• Project T
• Project R

You are considering the purchase of real estate that will provide perpetual income that should average $55,000 per year. How much will you pay for the property if you believe its market risk is the same as the market portfolio’s? The T-bill rate is 5%, and the expected market return is 11.0%.

FIN 571 Wk 6 – Practice: Wk 6 Questions

Which one of the following is not a reason for compiling financial plans?

Multiple Choice

• Considering options
• Contingency planning
• Calculating the optimal plan
• Forcing consistency

Assume a firm wants to hold its current long-term debt-to-equity ratio constant at 0.55 and its payout ratio constant at 35%. The firm neither issues nor repurchases shares. If the firm generates $326,000 of net income, what is the maximum amount that the firm can increase its long-term debt?

Multiple Choice

• $116,545
• $95,355
• $122,615
• $0

Planners have determined that sales will increase by 20% next year, and the profit margin will remain at 10% of sales. Which one of the following statements is  if the payout ratio remains at 30%?

Multiple Choice

• Net income will increase by 10% next year.
• The addition to retained earnings will increase by 20% next year.
• The dividend will increase by 6% next year.
• The addition to retained earnings will equal 6% of the sales increase next year.

The sustainable growth rate is the maximum growth rate that the firm can achieve

Multiple Choice

• without external financing.
• while maintaining its debt ratio.
• without investing in additional fixed assets.
• without excessive strains on management.

What is the internal growth rate for a firm with an ROE of 20%, a dividend payout ratio of 40%, and an equity-to-debt ratio of 60%?

Multiple Choice

• 4.50%
• 5.39%
• 8.00%
• 12.00%

Before settling on a final short-term financial plan, the manager needs to ask several questions. Which question is the manager least likely to ask?

Multiple Choice

• Does the plan yield satisfactory financial ratios?
• Would the firm do better to arrange long-term financing to cover any cash shortage?
• Has the firm estimated its EVA ly?
• Does the company need a larger reserve of cash or marketable securities to cover emergencies?

Firms that continually invest in nontrivial amounts of marketable securities may be guilty of:

Multiple Choice

• excessive short-term borrowing.
• not matching their sources and uses of cash.
• holding excessive current liabilities.
• incurring extra taxes.

A firm starts the week with payables of $172,000. It pays $80,000 of outstanding bills, and purchases $44,000 of raw materials on one month’s credit. What is the level of payables at the end of the week?

Multiple Choice

• $136,000.
• $208,000.
• $96,000.
• $216,000.

The Boat Works started the month with $3.21 million in accounts receivable. Sales for the month were $7.84 million. The firm collects 18% of its sales in the month of sale with the remainder paid the following month. What is the accounts receivable balance at month end?

Multiple Choice

• $4,621,200
• $6,428,800
• $9,061,000
• $1,411,200

A firm has a need for cash in a specific quarter. Which of the following is least likely to be part of a short-term financial plan to raise cash?

Multiple Choice

Bank loan

New equity

Securities sold

Stretched payables

If a firm’s sales increase by 12%, and it has no spare capacity, it must increase fixed assets by at least:

Multiple Choice

0%.

6%.

9%.

12%.

All of the following are part of the financial planning process except:

Multiple Choice

deciding which risks are worth taking.

analyzing investment and financing options.

projecting the future.

minimizing risk.

Contingency planning is:

Multiple Choice

forecasting the most likely outcomes.

working through the implications of the most likely outcomes.

working through the consequences of the plan under different scenarios.

formulating responses to inevitable surprises.

A financial planning model will generally include all of the following except the:

Multiple Choice

listing of the firm’s goals.

required increase in fixed assets.

projected sales.

forecast increase in retained earnings.

A firm has current sales of $2.4 million and fixed assets of $1.65 million. The firm is currently operating at 88% of capacity. How high can the firm’s sales go without requiring any additional fixed assets?

Multiple Choice

$2.423 million

$2.509 million

$2.727 million

$2.836 million

A firm wants to limit its new debt issue to $10 mil and has no interest in adding new equity. Net income is forecasted at $30 mil and new assets of $22 mil will be needed to sustain the growth of the company. What dividend will the company pay to maintain its objectives?

Multiple Choice

$10 million

$14 million

$18 million

$24 million

A firm’s internal growth rate is all of the following except:

Multiple Choice

the rate below which external financing is needed.

the ratio of reinvested earnings to assets.

the maximum growth rate without requiring external sources of new capital.

the product of the plowback ratio, ROE, and the ratio of equity to assets.

Calculate the rate at which a firm can grow without changing its leverage if its payout ratio is 70%, equity outstanding at the beginning of the year is $940,000, and its net income for the year is $162,000.

Multiple Choice

5.17%

11.67%

14.00%

16.67%

What is the sustainable growth rate for a firm with $250,000 in net income, $100,000 in common stock dividends, and equity of $1 million?

Multiple Choice

8%

10%

15%

17%

If the projected growth rate is less than the firm’s sustainable growth rate:

Multiple Choice

it should increase its projected growth rate.

the firm will be required to decrease its plowback ratio.

its debt-equity ratio will decrease.

the firm will be required to increase borrowing.

Before settling on a final short-term financial plan, the manager needs to ask several questions. Which question is the manager least likely to ask?

Multiple Choice

Does the plan yield satisfactory financial ratios?

Would the firm do better to arrange long-term financing to cover any cash shortage?

Has the firm estimated its EVA ly?

Does the company need a larger reserve of cash or marketable securities to cover emergencies?

Which one of these is most associated with a disadvantage of the relaxed strategy of long- versus short-term financing?

Multiple Choice

Transaction costs are required to continually obtain financing.

Short-term investment income is often unattractive.

Investment opportunities must frequently be ignored.

Long-term financing has burdensome tax consequences.

Which of these assets is likely to be the least liquid?

Multiple Choice

receivables

marketable securities

inventories of work in progress

inventories of finished goods

For a recent period, a firm collected $38,200 on accounts receivable, paid $19,700 to suppliers on trade credit, paid $12,000 in cash expenses, purchased for cash a $42,000 piece of equipment that will be depreciated straight-line to zero over 4 years, and had $59,000 of sales of which 15% were cash sales. The firm also paid $13,500 in taxes and interest. The beginning cash balance was $11,300. How much did the firm need to borrow in order to maintain a minimum cash balance of $10,000?

Multiple Choice

$38,850

$37,550

$7,350

$30,000

A firm starts the week with payables of $172,000. It pays $80,000 of outstanding bills, and purchases $44,000 of raw materials on one month’s credit. What is the level of payables at the end of the week?

Multiple Choice

$136,000.

$208,000.

$96,000.

$216,000.

Managers are alerted to projected cash shortages by means of the:

Multiple Choice

statement of sources and uses of cash.

pro forma balance sheet.

cash budget.

monthly bank statements.

The Boat Works started the month with $1.28 million in accounts receivable. Sales for the month were $3.4 million. The firm collects 35% of its sales in the month of sale with the remainder paid the following month. What is the accounts receivable balance at month end?

Multiple Choice

$2.21 million

$1.19 million

$3.49 million

$2.71 million

A firm has a need for cash in a specific quarter. Which of the following is least likely to be part of a short-term financial plan to raise cash?

Multiple Choice

Bank loan

New equity

Securities sold

Stretched payables

Avatar Corp solves its cash shortage by paying its bills a week late but loses a 1% discount by doing so. This is equivalent to borrowing at an annual interest rate of:

Multiple Choice

52.0%.

12.8%.

68.6%.

1.0%.

A firm must decide between borrowing from a bank at 12% interest or stretching its payables for one quarter. If it stretches the payables it will forgo a 2% discount for timely payment. Based solely on cash flows, which is the cheaper solution?

Multiple Choice

Stretching saves the firm approximately 8% per year.

Use the bank loan; forgoing a cash discount is costly.

Stretch the payables and finance at a savings of approximately 3.75% annually.

Use the bank loan because it represents simple interest.

FIN 571 Wk 6 – Apply: Signature Assignment: Financial Plan

Prepare a financial plan for the company you select for your business plan. This financial plan will be included in your final business plan in your capstone course.

Describe the business, including the type of business.

Create the business case.

• Determine why funding is needed for the company.
• Determine the sources of funding. Considerself-funding, borrowing, equity, venture capital, etc.
• Evaluate the requirements of each funding source you determined appropriate.
• Analyze the associated risks of each funding source.
• Decide which sources are the best fit for your company based on the requirements of each. Justify your decision.
• Estimate the cost of capital for both short-term and long-term funding sources. Research current estimated APRs for your selected sources of funding. Consider creating a table or chart to display this information.

Create a profit-and-loss statement for a 3-year period. Project revenue, stating realistic assumptions, such as growth per year, in your projections.

Estimate direct costs, including capital, marketing, labor, and supply costs.

Cite references to support your assignment.

Format your citations according to APA guidelines.

Submit your assignment.