FIN 350 Exam 1 Notes

A 10-year bond, $1,000 face value bond with a 11% coupon rate and semi-annual coupons has a yield to maturity of 8%. The bond should be trading at a price of

$1203.85 (Round to the nearest cent.

Your firm is preparing to open a new retail strip mall and you have multiple businesses that would like lease space in it. Each business will pay a fixed amount of rent each month plus a percentage of the gross sales generated each month. The NPVs from each of the businesses has approximately the same amount of risk. The business names, square footage requirements, and monthly expected NPVs for each of the businesses that would like to lease space in your strip mall are provided below Business Name Square Feet Required Expected Monthly NPV Videos Now 4,000 70,000 Gords Gym 3,500 52,500 Pizza Warehouse 2,500 52,500 Super Clips 1,500 25,500 30 1/2 Flavors 1,500 28,500 S-Mart 12,000 180,000 WalVerde Drugs 6,000 147,000 Multigular Wireless 1,000 22,250 If your new strip mall will have 15,000 square feet of retail space available to be leased, what is the maximum monthly NPVs to be generated?

$320,250 check hw 6 to see how to do it

You just purchased a car for $24,000 and the auto loan is 60-month fixed rate loan with annual interest of 2.4%. What is your monthly payment?

$425

You bought a house worth $900,000 and the loan is a 30-year fixed rate mortgage with 4.5% annual interest rate. What is your monthly payment?

$4560

Assume Evco, Inc., has a current stock price of $60 and will pay a $2.20 dividend in one year; its equity cost of capital is 19%. What price must you expect Evco stock to sell for immediately after the firm pays the dividend in one year to justify its current price?

$69.20 (round to the nearest cent)

You are 22 years old and decide to start saving for your retirement. You plan to save $6,000 at the end of each year (so the first deposit will be one year from now), and will make the last deposit when you retire at age 65. Suppose you earn 6% per year on your retirement savings. How much will you have saved for retirement right at age 65?

1125045

Krell Industries has a share price of $20.50 today. If Krell is expected to pay a dividend of $1.00 this year, and its stock price is expected to grow to $25 at the end of the year, what is Krell's dividend yield and equity cost of capital?

(a) Krell's dividend yield is Answer 4.88%. (Round to two decimal places.) (b) Krell's equity cost of capital is Answer 26.83%. (Round to two decimal places.) see hw to see how to do

Use the following information to answer the questions from 1 to 6 below. Suppose that the market portfolio is equally likely to increase by 24% or decrease by 8%. Security "X" goes up on average by 29% when the market goes up and goes down by 11% when the market goes down. Security "Y" goes down on average by 16% when the market goes up and goes up by 16% when the market goes down. Security "Z" goes up on average by 4% when the market goes up and goes up by 4% when the market goes down The beta for security "X" is closest to

1.25

Identify each of the following risks as most likely to be systematic risk or diversifiable risk:

(a) The risk that your main production plant is shut down due to an accident. The risk is diversifiable . (b) The risk that the economy slows, decreasing demand for durable goods. The risk is systematic . (c) The risk that your best employees will quit. The risk is diversifiable . (d) The risk that the new product you expect your R&D division to produce will not materialize. The risk is diversifiable

A project costs $200 million and is expected to generate cash flows of $25 million per year, starting at the end of the first year and lasting forever. What is the internal rate of return?

12.5% Note that the cash flow stream is a perpetuity. So its present value is: C / r NPV = -$200 + $25 ÷ IRR. Set NPV = 0, solve for IRR, IRR=12.5%

Anle Corporation has a current price of $21, is expected to pay a dividend of $2 in one year, and its expected price right after paying that dividend is $22

(a) What is Anle's expected dividend yield? Answer 9.52%. (Round to two decimal places.) (b) What is Anle's expected capital gain rate? Answer 4.76%. (Round to two decimal places.) (c) What is Anle's equity cost of capital? Answer 14.29%. (Round to two decimal places.)

The last four years of returns for a stock are as follows: 1 2 3 4 -3.5% +28.5% +12.5% +4.5%

(a) What is the average annual return? 10.5%. (Round to two decimal places.) (b) What is the variance of the stock's returns? 0.01867 (Round to five decimal places.) (c) What is the standard deviation of the stock's returns? 13.66% (Round to two decimal places.)

A bond will make payments every six months as shown on the following timeline (using six-month periods): t=0 t=1 t=2 t=27 t=28 |----------------|----------------|--------- ··········-----|----------------| $60 $60 $60 $1,060

(a) What is the maturity of the bond (in years)? 14 years. (b) What is the face value? $1000 . (c) What is the coupon rate (in percent)? 12%. (Round to two decimal places.)

Andrew Industries is contemplating issuing a 30-year bond with a coupon rate of 7.50% (annual coupon payments) and a face value of $1,000. Andrew believes it can get a rating of A from Standard Poor's. However, due to recent financial difficulties at the company, Standard and Poor's is warning that it may downgrade Andrew Industries bonds to BBB. Yields on A-rated long-term bonds are currently 7.00%, and yields on BBB-rated bonds are 7.40%

(a) What is the price of the bond if Andrew maintains the A rating for the bond issue? $Answer . (Round to the nearest cent.) (b) What will the price of the bond be if it is downgraded? $1012.53 . (Round to the nearest cent.)

Suppose the current, zero-coupon, yield curve for risk-free bonds is as follows: Maturity (years) 1 2 3 4 5 Yield to Maturity 4.70% 5.20% 5.45% 5.65% 5.80%

(a) What is the price per $100 face value of a 3-year, zero-coupon risk-free bond? The price is $85.28 . (Round to two decimal places.) (b) What is the price per $100 face value of a 5-year, zero-coupon, risk-free bond? The price is $75.43 . (Round to two decimal places.) (c) What is the risk-free interest rate for 3-year term? The risk-free interest rate for 3-year maturity is 5.45%. (Round to two decimal places.)

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The beta for security "Y" is closest to

-1

The beta for security "Z" is closest to

0

You have decided to form a new start-up company developing applications for the iPhone. Match each example listed below with the type of decision you would make as a Chief Financial Offer. 1 Determining which types of iPhone application projects will offer your company the best value and therefore which project your company should develop. 2 Ensuring that your company has the necessary funds to make investments, pay interest on loans, and pay your employees 3 Determining how to fund your iPhone application investments what what mix of bonds and stocks will sell.

1 Investment decision ( decisions to spend money) 2 Cash management (decisions to manage day-today-cash needs) 3 financing decisions (decisions to raise money)

You are 20 years old and decide to start saving for your retirement. You plan to save $4,000 at the end of the first year and then increase your savings by 3% per year until you make the very last deposit at age 65. Suppose you earn 6% per year on your retirement savings. How much will you have saved for retirement right at age 65?

1331069 (Round to the nearest dollar.)

When you purchased your house, you took out a 30-year mortgage with an interest rate of 4.8% per year. The monthly payment on the mortgage $1,500. You have just made a payment and have now decided to pay the mortgage off by repaying the outstanding balance. What is the payoff amount if you have lived in the house for 18 years (so there are 12 years left on the mortgage)? Payoff amount is $____

163,954

Your oldest daughter is about start kindergarten in a private school. Tuition is $20,000 per year, payable at the beginning of the school year. You expect to keep your daughter in private school through high school. You expect tuition to increase at a rate of 3% over the 13 years of her schooling. What is the present value of your tuition payments if the interest rate is 8% per year? That is, you would need to have $

198730 (Round to the nearest dollar.) PV = $20,000 + PV(growing annuity) = $20,000 + [$20,000 ×(1+0.03)] ÷ (0.08 - 0.03) × [1 - (1.03/1.08)12]

Consider a project with the following cash flows: Year Cash Flow 0 -10,000 1 4,000 2 4,000 3 4,000 4 4,000 Assume the appropriate discount rate for this project is 15%. The payback period for this project is closest to:

3 Payback = 10000 / 4000 = 2.5, Round upward to 3

The risk-free rate is closest to

4%

Consider a project with the following cash flows: Year Cash Flow 0 -10,000 1 14,000 Assume the appropriate discount rate for this project is 15%. The IRR for this project is closest to:

40% $10,000 = $14,000÷ (1+IRR), solve for IRR, IRR = 40%

Your grandmother has been putting $2,000 into a savings account on every birthday since your first (that is, when you turned 1). The account pays an interest rate of 5%. How much money will be in the account on your 18th birthday immediately after your grandmother makes the deposit on that birthday? The amount in the account upon your 18th birthday is $____

56264

Your firm has a risk-free investment opportunity where it can invest $160,000 today and receive $171,000 in one year. For what level of interest rate is this project attractive? The project will be attractive when the interest rate is any positive value less than or equal to

6.88 // hint: Under what interest rate would an investment of $160,000 grow to $171,000 in one year

You run a construction firm. You have just won a contract to build a government office building. Building it requires an investment of $10.4 million today, and $5.0 million in one year. The government will pay you $24.0 million in one year upon the building's completion. Suppose the cash flows and their times of payment are certain, and the risk-free interest rate is 9%. The NPV of this opportunity is

7.03 milion (round to two decimal places)

The expected return on the market portfolio is closest to

8%

The expected return on security with a beta of 1.2 is closest to

8.8%

You are a risk-averse investor considering investing in one of two economies. The expected return and volatilities of all stocks in both economies are the same. In the first economy, all stocks move together - in good times all prices go up together, and in bad times they fall together. In the second economy, stocks returns are independent - one stock increasing in price has no effect on the prices of other stocks. Which economy would you choose to invest in?

A risk-averse investor would choose the economy in which stock returns are independent because risk can diversified away in a large portfolio.

The promised cash flows of three securities are listed below. If the cash flows are risk-free, and the risk-free interest rate is 6.0%, determine the no-arbitrage price of each security before the first cash flow is paid Security // Cash flow today // cash flow in one year A 700 700 B 0 1400 C 1400 0 The no-arbitrage price of Security A is The no-arbitrage price of Security B is The no-arbitrage price of Security C is

A) 1360.38 (round to the nearest cent) B) 1320.75 (round to the nearest cent) C) 1400 (round to the nearest cent) ------ cash flow today + cash flow in 1 year divided by (1+ interest rate) for A its: 700+ 700/1.06 700+660.3773585 =1360.38 when rounded

Your firm has identified three potential investment projects. The projects and their cash flows are shown below: project // cash flow today // cash flow in one year A -$7 $15 B $7 $4 C $19 -$6 Suppose all cash flows are certain and the risk-free interest rate is 9% The NPV of Project A is The NPV of Project B is The NPV of Project C is If the firm can choose only one of these projects, which should it choose based on the NPV decision rule?

A) 6.76 (rounded to two decimal places) B) 10.67 (rounded to two decimal places) C) 13.50 (rounded to two decimal places) D) project C and project B

You are a shareholder in a C corporation. The corporation earns $1 per share before taxes. Once it has paid taxes, it will distribute the rest of its earnings to you as a dividend. The corporate tax rate is 39%, and the personal tax rate on dividend income is 25%. How much is left for you after all taxes are paid? The amount that remains is $ ____ per share. (Round to 2 decimals.)

After-tax earnings = $1 × (1-39%) × (1-25%) =$0.4575. The correct answer is: 0.46

Who has the ultimate decision making authority in a corporation?

Board of Directors

Which form of business accounts for the largest share in revenues in United States?

Corporations

Your buddy in mechanical engineering has invested a machine. It takes one year for the machine to manufacture $400 worth of goods. Once built, the machine will last forever and will require no maintenance. The machine can be built immediately and will cost $4,000 to build.

If the interest rate is 3.5%, the NPV of the machine is $7429

Which of the following statements is false? hw10

If we assume that the market portfolio (or the S&P 500) is efficient, then changes in the value of the market portfolio represent unsystematic shocks to the economy.

Explain why the risk premium of a stock does not depend on its diversifiable risk.

Investors, without cost, can remove diversifiable risk from their portfolios by diversifying. They therefore do not demand a risk premium for it

What is the relationship between the average return and the historical volatility of individual stocks versus large, well-diversified, portfolios?

Large portfolios with lower returns have lower volatilities. For individual stocks, no clear relationship exists.

What is the goal of a corporation?

Maximize Shareholder Value

You make monthly payments of $1,700 on a house mortgage loan. You have just made a payment. The mortgage has 26 years remaining. Show the timeline of the loan from the bank's perspective.

Month: 0 1 2 3 4 312 |---- |--------|------|------| Cash Flow: $1700 $1700 $1700 $1700 $1700

Which is the second largest stock market in the world?

NASDAQ

Which of the following statements is false?

NPV is positive only for discount rates greater than the internal rate of return.

Which of the followings about the Capital Market Line is false?

One should not invest in the risk free security if he seeks high return

You are a shareholder in an S corporation. The corporation earns $2.6 per share before taxes. Once it has paid any applicable taxes it will distribute the rest of its earnings to you as a dividend. The corporate tax rate is 9.5%, and the personal tax rate on income is 1.6%. How much is left for you after all taxes are paid? The amount that remain is $ ____ per share. (Round to two decimal places.)

S corporations are only subject to income tax. After-tax income = $2.6 × (1 - 1.6%) = $2.5584. The correct answer is: 2.56

Which of the followings does not help alleviate the agency problem in a corporate?

Separation of ownership and control

Which of the following investments has had the highest overall return over the past eighty years?

Small Stocks

Which of the following investments has had the largest volatility in overall return over the past eighty years?

Small Stocks

Which form of business accounts for the largest number of entities in United States

Sole Proprietorship

A rich relative has bequeathed you a growing perpetuity. The first payment will occur in one year and will be $4,000 each. Each year after that, you will receive a payment on the anniversary of the last payment that is 4% larger than the last payment. This pattern of payments will go on forever. If the interest rate is 11% per year, what is the present value of the bequest?

The PV of the growing perpetuity is $57143

Which of the following statements is false? hw10 pt2

The beta is the expected percentage change in the excess return of the market portfolio for a 1% change in the excess return of a security

Your buddy in mechanical engineering has invested a machine. It takes one year for the machine to manufacture $900 worth of goods. Once built, the machine will last forever and will require no maintenance. The machine will take one year to build and will cost $9,000 today. If the interest rate is 11%, the NPV of the machine is $

The cost of building the machine is $9,000 paid today. It takes one year just to build the machine and it takes the machine another year to manufacture $900, so the very first cash flow (+) will arrive at t=2.The stream of cash flow above can be decomposed into two parts: a single cash flow of - $9,000 at t=0, and a standard perpetuity if you stand at t=1. For the perpetuity portion, we first need to compute the present value at t=1, PVt=1. Then we will bring PVt=1 backward in time for one period, PV = PVt=1 ÷ (1+r) Thus, PV =CF0 + PVt=1(perpetuity) ÷ (1+r) = -$9000 + (C / r) ÷ (1+r) = - $9,000+ ($900 / 0.11) ÷ (1+0.11)

Your lender now offers you a 30-year fixed-rate home mortgage with 3.6% interest per year. If you can afford a monthly payment of $3,000, what is maximum price of a house that you can afford?

The maximum house price is $659,855 (Round to the nearest dollar.)

What is the present value of $5,000 paid at the beginning of each of the next 78 years if the interest rate is 9% per year?

The present value is $60483 Hint: The cash flow at t=0 is $5,000 and the last cash flow stops at the end of 77 years (that is, the beginning of 78 years). Therefore, the stream is not a standard annuity model. The timeline can be split into two parts: $5,000 cash flow at t=0 and a 77-year annuity of $5,000 cash flows. Total PV = $5,000 today + PV (77-year Annuity)

What is the present value of $5,000 paid at the end of each of the next 78 years if the interest rate is 9% per year?

The present value is 55489 (round to the nearest dollar) Hint: The stream of cash flows described above is a standard Annuity. Therefore, you can apply directly the Present Value formula for Annuity. Identify C, r and n, and use PV = C/r × [ 1 - 1/(1+r)n ]

Summit Systems will pay a dividend of $1.40 in one year. If you expect Summit's dividend to grow by 5.0% per year, what is its share price if its equity cost of capital is 10%?

The price per share is $28 (Round to the nearest cent.)

Which of the following investments has had the lowest return over the past eighty years?

Treasury Bills

Which of the following investments has had the smallest fluctuations in overall return over the past eighty years?

Treasury bills

Which of the following statements is false? hw10 pt 3

We call a portfolio that contains only unsystematic risk an efficient portfolio

You have just taken out a five-year loan from a bank to buy an engagement ring. The ring costs $7,000. You plan to put down $2,000 and borrow $5,000. You will need to make annual payments of $1,100 at the end of each year. Show the timeline of the loan from your perspective.

Year 0 1 2 3 4 5 cash flow 5000 -1100 -1100 -1100 -1100 -1100 Hint: from your perspective on the loan, you received $5,000 today and you will make 5 installments of $1,100 at the end of each of the next five years.

March 14th March 21stBest Ask: 30.24 Best Ask: 30.42Best Bid: 30.21 Best Bid: 30.39 Suppose you purchase 1992 shares of ABC stock on March 14th and then sell them one week later on March 21st. What are your net proceeds?

You buy at the asking price and sell to the biding price. You bought at $30.24 on March 14th and you sold at $30.39 on March 21st. You made a profit of ($30.39 - $30.24=) $0.15 per share. The correct answer is: 298.80

Your daughter is currently 6 years old. You anticipate that she will be going to college in 12 years. You would like to have $144,000 in a savings account to fund her education at that time. If the account promises to pay a fixed interest rate of 7% per year, how much money do you need to put into the account today to ensure that you will have $144,000 in 12 years?

Your deposit today should be $63938 (round to the nearest dollar) Hint: FV = PV × (1+r)n

You have been offered a unique investment opportunity. If you invest $20,000 today, you will receive $1,000 one year from now, $3,000 two years from now, and $20,000 ten years from now. (a) The NPV of the opportunity if the interest rate is 10% per year is (b) Should you take the opportunity? (c) The NPV of the opportunity if the interest rate is 6% per year is (d) Should you take the opportunity

a) -8901 b) Reject it because the NPV is less than 0 c) -5219 d)Reject it because the NPV is less than 0 Hint: NPV = PV (All Cash Flows)

Calculate the future value of $2,000 in (a) 5 years at an interest rate of 8% per year. (b) 10 years at an interest rate of 8% per year. (c) 5 years at an interest rate of 16% per year. (d) Why is the amount of interest earned in part (a) less than half the amount of interest earned in part (b)?

a) 2939 (round to the nearest dollar) b) 4318 (round to the nearest dollar) c) 4201 (round to the nearest dollar) d) This is because you earn interest on past interest. Since the beginning of the second 5 year starts off with more money than the beginning of the first 5 years, the money grows faster. FV = PV × (1+r)n

What is the present value of $14,000 received (a) 12 years from today when the interest rate is 4% per year. (b) 20 years from today when the interest rate is 5% per year (c) 6 years from today when the interest rate is 2% per year

a) 8744 (round to the nearest dollar) b) 5277 (round to the nearest dollar) c) 12432 (round to the nearest dollar) Hint: PV = FV ÷ (1+r)n

You are thinking of retiring. Your retirement plan will pay you either $250,000 immediately on retirement or $350,000 five years after the date of your retirement. (a) If the interest rate is 0% per year, which alternative should you choose? (b)If the interest rate is 8% per year, which alternative should you choose? (c) If the interest rate is 20% per year, which alternative should you choose?

a) Waiting until 5 years after retirement. b) Take the money now c) Take the money now Hint: PV = FV ÷ (1+r)n

Suppose the risk-free interest rate is 5% a.) Having $400 today is equivalent to having $______ b.)Having $400 in one year is equivalent to having$_____ c.) Which would you prefer, $400 today or $400 in one year? d.) Does your answer depend on when you need the money? Why or why not?

a.) 420 b.) 380.95 c.) 400 today d.)No, because if you didn't need it then the $400 could be invested and would be worth more than $400 in one year.

Shareholders of a corporation can exercise control by all of the following except

electing the chief executive officer