Exam 2 - Fin Mmg Theory Pol

Lesco's is evaluating a project that has a different level of risk than the overall firm. This project should be evaluated:

using a beta commensurate with the project's risks.

An analysis of what happens to the estimate of net present value when only one input variable is changed is called _____ analysis.

Sensitivity

Sensitivity analysis is primarily designed to determine the:

degree to which the net present value reacts to changes in a single variable.

Conducting scenario analysis helps mangers see the:

expected range of outcomes from a proposed project.

Variable costs:

change in direct relationship to the quantity of output produced.

As of 2018, U.S. tax law limits the tax deduction for interest payments to 30 percent of:

EBIT.

What are the portfolio weights for a portfolio that has 145 shares of Stock A that sell for $47 per share and 130 shares of Stock B that sell for $86 per share? Stock A Stock B

Stock A = 0.3787 Stock B = 0.6213 Portfolio value = 145($47) + 130($86) Portfolio value = $17,995 WeightA = 145($47)/$17,995 WeightA = .3787 WeightB = 130($86)/$17,995 WeightB = .6213

Watters Umbrella Corp. issued 15-year bonds two years ago at a coupon rate of 6.2 percent. The bonds make semiannual payments. If these bonds currently sell for 98 percent of par value, what is the YTM?

YTM = 6.43% (2*3.215%) Solve for i/y on calculator, where: N=26 (15-2=13*2) PMT=31 (62/2) PV=-980 (98%*1000) FV=1,000 i/y= CPT = 3.215*2 = 6.43%

You have plotted the monthly returns for two securities for the past five years on the same graph. The pattern of the movements of each of the two securities generally rose and fell to the same degree in step with each other. This indicates the securities have:

a strong positive correlation.

The Rose Co. has earnings of $3.41 per share. The benchmark PE for the company is 18. a. What stock price would you consider appropriate? b. What if the benchmark PE were 21?

a. 61.38 b. 71.61 a. P = Benchmark PE ratio × EPS P = 18($3.41)P = $61.38 b. P = 21($3.41) P = $71.61

When computing WACC, you should use the:

aftertax cost of debt because interest is partially, if not fully, tax deductible.

A firm's WACC can be correctly used to discount the expected cash flows of a new project when that project will:

have the same level of risk as the firm's current operations.

You are considering purchasing Stock S. This stock has an expected return of 12 percent if the economy booms, 8 percent if the economy is normal, and 3 percent if the economy goes into a recessionary period. The overall expected rate of return on this stock will:

increase as the probability of a boom economy increases.

A project with a life of one year has an accounting break-even point of 2,962 units. The fixed costs are $46,308 and the depreciation expense is $22,147. The projected variable cost per unit is $23.10. What is the projected sales price?

$46.21 Total variable costs = 23.10*2962=68,422.20 Fixed costs = 46,308 Depreciation expense = 22,147 At breakeven, Total sales = Total cost S.P/unit = Total cost/units = 68,422.20+46,308+22,147/2962units = 46.21

Even though most corporate bonds in the United States make coupon payments semiannually, bonds issued elsewhere often have annual coupon payments. Suppose a German company issues a bond with a par value of €1,000, 15 years to maturity, and a coupon rate of 5.1 percent paid annually. If the yield to maturity is 4.3 percent, what is the current price of the bond?

1,087.11 Bond price Solve for PV on calculator, where: N= 15 i/y=4.3% PMT=51 FV=1,000 PV= CPT = 1087.11

Which one of the following statements is correct concerning the expected rate of return on an individual stock given various states of the economy?

The expected return is a weighted average where the probabilities of the economic states are used as the weights.

Titan Mining Corporation has 6.4 million shares of common stock outstanding and 175,000 6.2 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $53 per share and has a beta of 1.15; the bonds have 25 years to maturity and sell for 106 percent of par. The market risk premium is 6.8 percent, T-bills are yielding 3.1 percent, and the company's tax rate is 22 percent. a. What is the firm's market value capital structure? b. If the company is evaluating a new investment project that has the same risk as the firm's typical project, what rate should the firm use to discount the project's cash flows?

a. debt = 0.3535 equity = 0.6465 b. Discount rate (WACC) = 8.64% a. Bonds =175,000(1,060)=185,500,000 Stock =6,400,000(53)=339,200,000 Total Market Value =185500000+339200000 =524,700,000 B/V = 185.5M/524.7M=.3535 S/V = 339.2M/524.7M=.6465 b. CAPM = .031+1.15(.068) CAPM = 10.92% YTM = N=50,PV=-1060,FV=1000,PMT=31, CPT i/y = 2.872%*2 = 5.74% WACC = .6465(10.92%)+.3535(5.74%)(1-22%) WACC = 8.64%

Microhard has issued a bond with the following characteristics: Par: $1,000 Time to maturity: 15 years Coupon rate: 7 percent Semiannual payments Calculate the price of this bond if the YTM is: a. 7% b. 9% c. 5%

a. $1,000 b. $837.11 c. $1,209.30 solve for PV on calculator, where: N=30 (15*2) i/y= 3.5%(7/2),4.5%(9/2),2.5%(5/2) PMT=35 (70/2) FV=1000 PV=CPT for all 3 rates or Bond price = PV annuity + PV lumpsum Coupon*({1-[1/(1+r)^t]}/r)+FV/(1+r)^t

A Japanese company has a bond outstanding that sells for 91.53 percent of its 100,000 par value. The bond has a coupon rate of 3.4 percent paid annually and matures in 16 years. What is the yield to maturity of the bond? (YTM,RROR)

4.13% YTM Solve in excel using =YIELD(settlement,maturity,rate,pr,redemption,frequency)

Rhiannon Corporation has bonds on the market with 11.5 years to maturity, a YTM of 6.8 percent, a par value of $1,000, and a current price of $1,055. The bonds make semiannual payments. What must the coupon rate be on these bonds?

7.50% Coupon rate Solve for PMT on calculator, where: N=23 (11.5*2) i/y=3.4% (6.8/2) PV=-1,055 FV=1,000 PMT= CPT = 37.49*2 = $74.97/1,000 = 0.0749

The Change Corporation has two different bonds currently outstanding. Bond M has a face value of $40,000 and matures in 20 years. The bond makes no payments for the first six years, then pays $2,500 every six months over the subsequent eight years, and finally pays $2,800 every six months over the last six years. Bond N also has a face value of $40,000 and a maturity of 20 years; it makes no coupon payments over the life of the bond. The required return on both these bonds is 8 percent compounded semiannually. What is the current price of Bond M and Bond N?

Bond M = 35,289.73 Bond N = 8,331.56 Bond M use CFs on calculator, where: CFo=0 C01=0 F01=12 C02=2,500 F02=16 C03=2,800 F03=11 C04=42,800 F04=1 I = 4% (8/2) NPV CPT = 35,289.73 Bond N find PV on calculator, where N=40 (20*2) i/y=4% (8/2) PMT=0 FV=40,000 PV= CPT = 8,331.56

What is the price of a 20-year, zero coupon bond paying $1,000 at maturity, assuming semiannual compounding, if the YTM is: a. 6 percent b. 8 percent c. 10 percent

a. $306.56 b. $208.29 c. $142.05 solve for PV on calculator, where N=40 i/y=3%(6/2)/4%(8/2)/5%(10/2) PMT=0 FV=1,000 PV=CPT for all 3 rates or a. P = $1,000/(1 + .06/2)40 = $306.56 b. P = $1,000/(1 + .08/2)40 = $208.29 c. P = $1,000/(1 + .10/2)40 = $142.05

The newspaper reported last week that Bennington Enterprises earned $17.5 million this year. The report also stated that the firm's return on equity is 13 percent. The firm retains 80 percent of its earnings. a. What is the firm's earnings growth rate? b. What will next year's earnings be?

a. 10.40% b. 19,320,000 a. g = ROE × bg = .13(.80) g =.1040, or 10.40% b. Next year's earnings = Current earnings(1 + g) Next year's earnings = $17,500,00(1 +.1040) Next year's earnings = $19,320,000

The Nearside Co. just paid a dividend of $2.07 per share on its stock. The dividends are expected to grow at a constant rate of 4.3 percent per year, indefinitely. Investors require a return of 11 percent on the stock. a.What is the current price? b.What will the price be in 3 years? c.What will the price be in 15 years?

a. 32.22 b. 36.56 c. 60.60 a. P0 = D0(1 + g)/(R − g) P0 = $2.07(1.043)/(.11 − .043) P0 = $32.22 b. P0 = D0(1 + g)^4/(R − g) P3 = $2.07(1.043)^4/(.11 − .043) P3 = $36.56 c. P15 = D0(1 + g)^16/(R − g) P15 = $2.07(1.043)^16/(.11 − .043) P15 = $60.60

One Step, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 17 years to maturity that is quoted at 95 percent of face value. The issue makes semiannual payments and has a coupon rate of 6 percent. a. What is the company's pretax cost of debt? If the tax rate is 21 percent? b. What is the after-tax cost of debt? c. Which is more relevant, the pretax or the aftertax cost of debt?

a. 6.49% Pre-tax b. 5.13% After-tax c. Aftertax cost of debt Solve for Pre-tax i/y on calc, where N=34 (17*2) PV=-950 FV=1000 PMT=30 (60/2) i/y= CPT = 3.2450*2= 6.49 After-tax = 6.49%*(1-21%) = .0513, or 5.13%

The YTM on a bond is the interest rate you earn on your investment if interest rates don't change. If you actually sell the bond before it matures, your realized return is known as the holding period yield (HPY). a. Suppose that today you buy a bond with an annual coupon of 9 percent for $1,180. The bond has 17 years to maturity. What rate of return do you expect to earn on your investment? b-1. Two years from now, the YTM on your bond has declined by 1 percent and you decide to sell. What price will your bond sell for? b-2. What is the holding period yield (HPY) on your investment?

a. 7.14%, b-1. $1,275.25, b-2. 11.44 a. Solve for i/y on calculator, where N=17 PMT=90 PV=-1,180 FV=1,000 i/y= CPT = 7.14% b-1. Solve for PV on calculator, where N=15 (17-2) i/y=6.14% (7.14-1.00) PMT=90 FV=1,000 PV= CPT = 1,275.41 b-2. Solve for i/y on calculator, where N=2 (17-15) PMT=90 PV=-1,180 FV=1,275.41 i/y= CPT =11.45%

A stock has a beta of 1.08 and an expected return of 11.6 percent. A risk-free asset currently earns 3.6 percent. a. What is the expected return on a portfolio that is equally invested in the two assets? b. If a portfolio of the two assets has a beta of .50, what are the portfolio weights? c. If a portfolio of the two assets has an expected return of 10.5 percent, what is its beta? d. If a portfolio of the two assets has a beta of 2.16, what are the portfolio weights?

a. 7.60% b. stock weight = 0.4630 b. risk-free weight = 0.5370 c. 0.932 d. stock weight = 2 d. risk-free weight = -1 a. E(RP) = (.116 + .036)/2 E(RP) = .0760, or 7.60% b. XS = .50/1.08 = .4630 XRf = 1 − .4630 = .5370 c. E(RP) = .105 = .116XS + .036(1 − XS) .105 = .116XS + .036 − .036XS 0.069 = 0.08XS XS = .8625 βP = .8625(1.08) + (1 − .8625)(0) βP = .932 d. XS = 2.16/1.08 = 2 XRf = 1 − 2 = -1

Bond P is a premium bond with a coupon rate of 8 percent. Bond D has a coupon rate of 3 percent and is selling at a discount. Both bonds make annual payments, have a YTM of 5 percent, and have ten years to maturity. a. What is the current yield for Bond P and Bond D? b. If interest rates remain unchanged, what is the expected capital gains yield over the next year for Bond P and Bond D?

a. Bond P = 6.50% , Bond D = 3.55% b. Bond P = -1.50% , Bond D = 1.45% Bond P Solve for PV, where N=10 / N=9 i/y=5% PMT=80 FV=1,000 PV= CPT n=10 $1,231.65 , n=9 $1,213.23 Current yield = 80/1,231.65=.0650 Capital gains yield = (1,213.23-1,231.65)/1,231.65 = -.0150 Bond D Solve for PV, where N=10 / N=9 i/y=5% PMT=30 FV=1,000 PV= CPT n=10 $845.57 , n=9 $857.84 Current yield = 30/845.57 = .0355 Capital gains yield = (857.84-845.57)/845.57 = .0145

You own a stock portfolio invested 20 percent in Stock Q, 30 percent in Stock R, 15 percent in Stock S, and 35 percent in Stock T. The betas for these four stocks are .75, 1.90, 1.38, and 1.16, respectively. What is the portfolio beta?

1.33 βP = .20(.75) + .30(1.90) + .15(1.38) + .35(1.16) βP = 1.33

The next dividend payment by Skippy, Inc., will be $2.95 per share. The dividends are anticipated to maintain a growth rate of 4.8 percent, forever. The stock currently sells for $53.10 per share. What is the required return?

10.35% R = (D1/P0) + g R = ($2.95/$53.10) + .048 R = .1036, or 10.36%

You own a portfolio that has $3,100 invested in Stock A and $4,600 invested in Stock B. If the expected returns on these stocks are 9.8 percent and 12.7 percent, respectively, what is the expected return on the portfolio?

11.53% Portfolio value = $3,100 + 4,600 Portfolio value = $7,700 So, the expected return of this portfolio is: E(RP) = ($3,100/$7,700)(.098) + ($4,600/$7,700)(.127) E(RP) = .1153, or 11.53%

A stock has a beta of 1.15, the expected return on the market is 11.1 percent, and the risk-free rate is 3.8 percent. What must the expected return on this stock be?

12.20% CAPM = rf + Beta * ( Rm - rf ) CAPM = 3.8%+1.15(11.1%-3.8%) CAPM = .1220 or 12.20%

You own a portfolio that is 20 percent invested in Stock X, 45 percent in Stock Y, and 35 percent in Stock Z. The expected returns on these three stocks are 10.5 percent, 16.1 percent, and 12.4 percent, respectively. What is the expected return on the portfolio?

13.69% E(RP) = .20(.105) + .45(.161) + .35(.124) E(RP) = .1369, or 13.69%

FFDP Corp. has yearly sales of $48 million and costs of $15 million. The company's balance sheet shows debt of $64 million and cash of $23 million. There are 1.95 million shares outstanding and the industry EV/EBITDA multiple is 6.4. What is the company's enterprise value? What is the stock price per share?

211,200,000 enterprise value 87.28 stock price EBITDA = Sales − Costs EBITDA = $48,000,000 − 15,000,000 EBITDA = $33,000,000 Enterprise value = $33,000,000(6.4) Enterprise value = $211,200,000 Equity value = Enterprise value − Debt + Cash Equity value = $211,200,000 − 64,000,000 + 23,000,000 Equity value = $170,200,000 Stock price = $170,200,000/1,950,000 Stock price = $87.28

Bretton, Inc., just paid a dividend of $3.15 on its stock. The growth rate in dividends is expected to be a constant 4 percent per year, indefinitely. Investors require a 15 percent return on the stock for the first three years, a 13 percent return for the next three years, and then an 11 percent return thereafter. What is the current share price for the stock?

40.67 P6 = D0(1 + g)^7/(R - g) P6 = $3.15(1.04)^7/(.11 − .04) P6 = $59.22 P3 = $3.15(1.04)^4/1.13 + $3.15(1.04)^5/1.13^2 + $3.15(1.04)^6/1.13^3 + $59.22/1.13^3 P3 = $50.07 P0 = $3.15(1.04)/1.15 + $3.15(1.04)^2/(1.15)^2 + $3.15(1.04)^3/(1.15)^3 + $50.07/(1.15)^3 P0 = $40.67

Gruber Corp. pays a constant $8.50 dividend on its stock. The company will maintain this dividend for the next 11 years and will then cease paying dividends forever. The required return on this stock is 9.5 percent. What is the current share price?

56.50 ( PVIFA = (1-(1+r)^-t)/r P0 = $8.50(PVIFA9.5%,11) P0 = $56.50

Saine Corporation will pay a $3.25 per share dividend next year. The company pledges to increase its dividend by 5 percent per year, indefinitely. If you require a return of 10.5 percent on your investment, how much will you pay for the company's stock today?

59.09 P0 = D1/(R − g) P0 = $3.25/(.105 − .05) P0 = $59.09

Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next 9 years, because the firm needs to plow back its earnings to fuel growth. The company will pay a dividend of $15.75 per share in 10 years and will increase the dividend by 4.8 percent per year thereafter. If the required return on this stock is 12 percent, what is the current share price?

78.88 P9 = D10/(R − g) P9 = $15.75/(.12 − .048) P9 = $218.75 P0 = $218.75/1.12^9 P0 = $78.88

Mullineaux Corporation has a target capital structure of 70 percent common stock and 30 percent debt. Its cost of equity is 10.9 percent and the cost of debt is 5.7 percent. The relevant tax rate is 23 percent. What is the company's WACC?

8.95% WACC = .70(.109) + .30(.057)(1 − .23) WACC = .0895, or 8.95%

Antiques R Us is a mature manufacturing firm. The company just paid a dividend of $12, but management expects to reduce the payout by 4 percent per year, indefinitely. If you require a return of 9 percent on this stock, what will you pay for a share today?

88.62 P0 = D0(1 + g)/(R − g) P0 = $12(1 − .04)/[.09 − (−.04)] P0 = $88.62

The Nixon Corporation's common stock has a beta of .95. If the risk-free rate is 2.7 percent and the expected return on the market is 10 percent, what is the company's cost of equity capital?

9.64% Re = .027+.95(.10-.027) Re = .0964, or 9.64%

Which one of these is a correct means of calculating an expected rate of growth?

ROE × Retention ratio

Hero Manufacturing has 7.6 million shares of common stock outstanding. The current share price is $67 and the book value per share is $4. The company also has two bond issues outstanding, both with semiannual coupons. The first bond issue has a face value of $80 million and a coupon rate of 6.8 percent and sells for 109.5 percent of par. The second issue has a face value of $65 million and a coupon rate of 7.1 percent and sells for 112.4 percent of par. The first issue matures in 9 years, the second in 25 years. a.What are the company's capital structure weights on a book value basis? b.What are the company's capital structure weights on a market value basis? c. Which are more relevant?

a. Equity/Value = 0.1733 a. Debt/Value = 0.8267 b. Equity/Value = 0.7602 b. Debt/Value = 0.2398 c. Market value weights a. Equity = 7,600,000($4) Equity = $30,400,000 Debt = $80,000,000 + 65,000,000 Debt = $145,000,000 Book value = $30,400,000 + 145,000,000 Book value = $175,400,000 Equity/Value = $30,400,000/$175,400,000Equity/Value = .1733 Debt/Value = 1 − Equity/Value = .8267 b. S = 7,600,000($67) S = $509,200,000 B = 1.095($80,000,000) + 1.124($65,000,000) B = $160,660,000 V = $509,200,000 + 160,660,000 V = $669,860,000 S/V = $509,200,000/$669,860,000 S/V = .7602 B/V = 1 − S/V = .2398

Fixed costs:

are constant over the short-run regardless of the quantity of output produced.

Which one of the following is the best example of systematic risk? a. The price of lumber declines sharply b. The airline pilots of a firm go on strike c. The Federal Reserve increases interest rates d. A hurricane hits a tourist destination e. People become diet conscious and avoid fast food restaurants

c. The Federal Reserve increases interest rates

Which one of the following is an example of unsystematic risk? a. the inflation rate increases unexpectedly b. the federal government lowers income tax c. an oil tanker runs aground and spills its cargo d. interest rates decline by .5 percent e. the GDP rises by .5 percent more than anticipated

c. an oil tanker runs aground and spills its cargo

The weighted average cost of capital for a firm is the:

overall rate which the firm must earn on its existing assets to maintain the value of its stock.

The discount rate applied to an individual project should be based on the:

risks associated with the project's cash flows.