FIN Quiz 2
You expect KStreet Co's trade at $100 per share right after paying a $2.00 dividend per share in one year. What is the most you would pay to buy the stock now if you want to earn at least a return of 15%?
0.15=$2.00+($100-P)/P 0.15P=$102-P 1.15P=$102 P=$102/1.15=$88.70
This year, FCF Inc. has earnings before interest and taxes of $10 million, depreciation expenses of $1 million, capital expenditures of $1.5 million, and has increased its net working capital by $500,000. If its tax rate is 35%, what is its free cash flow?
Free Cash Flow=$10,000,000×(1−0.35)+$1,000,000−$1,500,000−$500,000= $5,500,000
You have forecast pro forma earnings of $1,000,000. This includes the effect of $200,000 in depreciation. You also forecast a decrease in working capital of $100,000 that year. What is your forecast of free cash flows for that year?
Free Cash Flows=$1,000,000+$200,000−(-$100,000) =$1,300,000
Portage Bay Enterprises has $1 million in excess cash, no debt, and is expected to have free cash flow of $10 million next year. Its FCF is then expected to grow at a rate of 3% per year forever. If Portage Bay's equity cost of capital is 11% and it has 5 million shares outstanding, what should be the price of Portage Bay stock?
V0=$10,000,000/ (0.11−0.03)= $125,000,000 P0=($10,000,000+ $1,000,000−$0)/ 5,000,000 shares= $25.20
Daily Enterprises is purchasing a $10.0 million machine. It will cost $50,000 to transport and install the machine. The machine has a depreciable life of five years and will have no salvage value. The machine will generate incremental revenues of $4.0 million per year along with incremental costs of $1.2 million per year. If Daily's marginal tax rate is 35%, what are the incremental earnings (net income) associated with the new machine?
Annual incremental earnings=($4,000,000-$1,200,000−($10,000,000+$50,000)/5)×(1−0.35)= $513,500
You have a depreciation expense of $500,000 and a tax rate of 35%. What is your depreciation tax shield?
Depreciation Tax Shield=$500,000×35%= $175,000
You notice that Coca-Cola has a stock price of $41.09 and EPS of $1.89. Its competitor PepsiCo has EPS of $3.90. But, Jones Soda, a small batch Seattle-based soda producer has a P/E ratio of 35. Based on this information, what is one estimate of the value of a share of PepsiCo stock?
Coca-Cola's P/E ratio= $41.09/$1.89=21.741 Pepsi's stock value=$3.90×21.741 =$84.79
Daily Enterprises is purchasing a $10.0 million machine. It will cost $50,000 to transport and install the machine. The machine has a depreciable life of five years and will have no salvage value. If Daily uses straight-line depreciation, what are the depreciation expenses associated with this machine?
Depreciation Expenses= ($10,000,000+$50,000)/ 5 years=$2,010,000 per year
You purchased a machine for $1.00 million three years ago and have been applying straight-line depreciation to zero for a seven-year life. Your tax rate is 35%. If you sell the machine today (after three years of depreciation) for $700,000, what is your incremental cash flow from selling the machine?
Depreciation= $1,000,000/ 7 years=$142,857.14 per year Book Value=$1,000,000−3 years×$142,857.14 per year=$571,428.58 Taxable Income=$700,000−$571,428.58=$128,571.42 Taxes=$128,571.42×0.35=$45,000.00 Incremental Cash Flow=$700,000−$45,000.00=$655,000.00
You are upgrading to better production equipment for your firm's only product. The new equipment will allow you to make more of your product in the same amount of time. Thus, you forecast that total sales will increase next year by 20% over the current amount of 100,000 units. If your sales price is $20 per unit, what are the incremental revenues next year from the upgrade?
Incremental Revenues=100,000 units×20%×$20 per unit= $400,000
You have an opportunity to invest $104,000 now in return for $79,400 in one year and $29,100 in two years. If your cost of capital is 8.5%, what is the NPV of this investment?
NPV=$79,400/1+0.085 + $29,100/(1+0.085)^2−$104,000= −$6,101.13
You have an opportunity to invest $50,000 now in return for $60,000 in one year. If your cost of capital is 8.0%, what is the NPV of this investment?
NPV=($60,000/1+0.080)−$50,000=$5,555.56
Chutes & Co. has interest expense of $1.00 million and an operating margin of 10.0% on total sales of $30.0 million. What is Chutes' interest coverage ratio?
Operating Income=$30.0 million×10.0%=$3.00 million Interest Coverage Ratio= $3.00 million/$1.00 million=3.0 times
Summit Systems will pay a dividend of $1.50 this year. If you expect Summit's dividend to grow by 6.0% per year, what is its price per share if the firm's equity cost of capital is 11.0%?
P0=$1.50/(0.110−0.060)=$30
See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. a. By what percentage did Mydeco's revenues grow each year from 2016 to 2019? b. By what percentage did net income grow each year? c. Why might the growth rates of revenues and net income differ?
Revenues Growth= (Revenues t/Revenues t−1)−1
You are choosing between two projects. The cash flows for the projects are given in the following table ($ million): Project A-Year 0 -$50 Project B-Year 0 -$100 Project A-Year 1 $25 Project B-Year 1 $20 Project A-Year 2 $20 Project B-Year 2 $40 Project A-Year 3 $20 Project B-Year 3 $50 Project A-Year 4 $15 Project B-Year 4 $60 a. What are the IRRs of the two projects? b. If your discount rate is 5.0%, what are the NPVs of the two projects? c. Why do IRR and NPV rank the two projects differently?
a) 24%, 21% b) $21.56 million, $47.88 million c) NPV is measuring value creation, while IRR is measuring return on investment. Because returns do not scale with different levels of investment, the two measures may give different rankings when the initial investments are different.
You are preparing to produce some goods for sale. You will sell them in one year and you will incur costs of $80,000 immediately. If your cost of capital is 7%, what is the minimum dollar amount you need to sell the goods for in order for this to be a non-negative NPV?
FV=$80,000×(1+0.07)=$85,600
You buy 100 shares of Tidepool Co. for $40 each and 200 shares of Madfish, Inc., for $15 each. What are the weights in your portfolio?
P=$40 per shares×100 shares+$15 per share×200 shares=$7,000 w1=$40 per share×100 shares/ $7,000=57.1% w2=$15 per share×200 shares/ $7,000=42.9%
You bought a stock one year ago for $50.00 per share and sold it today for $55.00 per share. It paid a $1.00 per share dividend today. What was your realized return?
R1=$1.00+($55.00−$50.00)/ $50.00=12.0%
You bought a stock one year ago for $50.00 per share and sold it today for $55.00 per share. It paid a $1.00 per share dividend today. How much of the return came from dividend yield and how much came from capital gain?
R1=$1.00/$50.00=2.0% R1=($55.00−$50.00)/$50.00=10.0%
Achi Corp. has preferred stock with an annual dividend of $3.00. If the required return on Achi's preferred stock is 8.0%, what is its price? (Hint: For a preferred stock, the dividend growth rate is zero.)
P0=$3.00/0.08=$37.50
Fremont Enterprises has an expected return of 15% and Laurelhurst News has an expected return of 20%. If you put 70% of your portfolio in Laurelhurst and 30% in Fremont, what is the expected return of your portfolio?
ERP=0.7×20%+0.3×15%=18.50%
Suppose the risk-free return is 4.0% and the market portfolio has an expected return of 10.0% and a standard deviation of 16%. Johnson & Johnson Corporation stock has a beta of 0.32. What is its expected return?
ERi=4.0%+0.32×(10.0%−4.0%)=5.92%
Assume Evco, Inc. has a current stock price of $50.00 and will pay a $2.00 dividend in one year; its equity cost of capital is 15%. 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?
$50.00=$2.00+P1/1+0.15 Solving for the expected price, Upper P 1: P1=($50.00×1.15)−$2.00=$55.50
You observe a portfolio for five year and determine that its average return is 12.0% and the standard deviation of its returns in 20.0%. Would a 30% loss next year be outside the 95% confidence interval for this portfolio?
12.0%−(2×20.0%), or −28.0%.
See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. Suppose Mydeco repurchases 2 million shares each year from 2016 to 2019. What would be its earnings per share in 2019? (Assume Mydeco pays for the shares using its available cash and that Mydeco earns no interest on its cash balances.)
2019 shares outstanding=55 million−4×2 million=47 million, EPS=$21.7 million/47 million=$0.46.
Suppose Autodesk stock has a beta of 2.16, whereas Costco stock has a beta of 0.69. If the risk-free interest rate is 4% and the expected return of the market portfolio is 10.0%, what is the expected return of a portfolio that consists of 60% Autodesk stock and 40% Costco stock, according to the CAPM?
Autodesk 2.16 x 60=1.296 0.69 x 40=0.276 total=1.572 E RPft=4%+1.572×(10.0%−4%)=13.43%
Ovit, Inc. has preferred stock with a price of $20.00 and a dividend of $1.50 per year. What is its dividend yield?
Dividend yield=$1.50/$20.00=0.075 7.5%
HNL has an expected return of 18% and KOA has an expected return of 22%. If you create a portfolio that is 60% HNL and 40% KOA, what is the expected return of the portfolio?
ERP=(0.60)(18%)+(0.40)(22%)=19.60%
Using the data from the following table, Date-Stock price-Dividend Jan 1-$50 March 31-$51-$0.55 Jun 30-$49.47-$0.55 Sep 30-$51.94-$0.75 Dec 31-$52.46-$0.75 calculate the return for investing in this stock from January 1 to December 31. Prices are after the dividend has been paid.
R1=$51.00+$0.55/ $50.00−1=0.03100 R2=$49.47+$0.55/$51.00 −1=−0.01922 R3=$51.94+$0.75/$49.47 −1=0.06509 R4=$52.46+$0.75/$51.94 −1=0.02445 Ryear=[(1+0.03100)(1−0.01922)(1+0.06509)(1+0.02445)]−1=0.1033=10.33%
Using the data in the following table, estimate the average return and volatility for each stock. Realized returns: Year-Stock A-Stock B 2008 -10% 21% 2009 20% 30% 2010 5% 7% 2011 -5% -3% 2012 2% -8% 2013 9% 25%
RA=1/6×(−10%+20%+5%−5%+2%+9%)=3.5% RB=1/6×(21%+30%+7%−3%−8%+25%)=12.00% Var (R)=1/5×((−10%−3.5%)^2+(20%−3.5%)^2+(5%−3.5%)^2+(−5%−3.5%)^2=+(2%−3.5%)^2+(9%−3.5%)^2)=0.01123 Var (R)=1/5×((21%−12.00%)^2+(30%−12.00%)^2+(7%−12.00%)^2+(−3%−12.00%)^2+(−8%−12.00%)^2+(25%−12.00%)^2=0.02448 SD (R)=square root(0.01123)=0.10597 10.6% SD (R)=square root(0.02448)=0.15646 15.65%
You are thinking of buying a stock priced at $100 per share. Assume that the risk-free rate is about 4.5% and the market risk premium is 6.0%. If you think the stock will rise to $117 per share by the end of the year, at which time it will pay a $1.00 dividend, what beta would it need to have for this expectation to be consistent with the CAPM?
Rt+1=$1.00+$117−$100/ $100=18.00% E Ri=18.00%=4.5%+β×6.0% β=18.00%−4.5%/6.0%=2.25
AFW Industries has 200 million shares outstanding and expects earnings at the end of this year of $700 million. AFW plans to pay out 60% of its earnings in total, paying 40% as a dividend and using 20% to repurchase shares. If AFW's earnings are expected to grow by 8.0% per year and these payout rates remain constant, determine AFW's share price assuming an equity cost of capital of 12.0%.
Total payout=$700 million×60%=$420.0 million PV=$420.0 million/ (0.120−0.080)=$10.500 million P0=$10.500 billion /200 million=$52.50
In December 2015, Apple had cash of $38.07 billion, current assets of $76.22 billion, and current liabilities of $76.09 billion. It also had inventories of $2.45 billion. a. What was Apple's current ratio? b. What was Apple's quick ratio? c. In January 2016, Hewlett-Packard had a quick ratio of 0.66 and a current ratio of 0.90. What can you say about the asset liquidity of Apple relative to Hewlett-Packard?
a) Current Ratio= $76.22 billion/$76.09 billion=1.00 b)Quick Ratio= ($76.22 billion−$2.45 billion)/ $76.09 billion=0.97 c)Apple's higher current and quick ratios demonstrate that it has much higher asset liquidity than does Hewlett-Packard. This means that in a pinch, Apple has more liquidity to draw on than does Hewlett-Packard.
In December 2015, General Electric (GE) had a book value of equity of $98.0 billion, 9.4 billion shares outstanding, and a market price of $31.00 per share. GE also had cash of $$102.0 billion, and total debt of $199.0 billion. a. What was GE's market capitalization? What was GE's market-to-book ratio? b. What was GE's book debt-equity ratio? What was GE's market debt-equity ratio? c. What was GE's enterprise value?
a) Market Capitalization=9.4 billion shares×$31.00 per share=$291.4 billion Market-to-Book Ratio= $291.4 billion/$98.0 billion=2.97 b) Book Debt-Equity Ratio= $199.0 billion/$98.0 billion=2.03 Market Debt-Equity Ratio=$199.0 billion/$291.4 billion=0.68 c) Enterprise Value=$291.4 billion+$199.0 billion−$102.0 billion=$388.4 billion
You have been offered a unique investment opportunity. If you invest $10,000 today, you will receive $500 one year from now, $1,500 two years from now, and $10,000 ten years from now. a. What is the NPV of the opportunity if the cost of capital is 6.0% per year? Should you take the opportunity? b. What is the NPV of the opportunity if the cost of capital is 2.0% per year? Should you take it now?
a) NPV=−$10,000 + $500/(1+0.060) +$1,500/(1+0.060)^2+$10,000 (1+0.060)^10= −$2,609.36 b) NPV=−$10,000 + $500/(1+0.020) + $1,500/(1+0.020)^2+$10,000/ (1+0.020)^10= $135.43
Suppose Acap Corporation will pay a dividend of $2.80 per share at the end of this year and $3.00 per share next year. You expect Acap's stock price to be $52.00 in two years. Assume that Acap's equity cost of capital is 10.0%. a. What price would you be willing to pay for a share of Acap stock today, if you planned to hold the stock for two years? b. Suppose instead you plan to hold the stock for one year. For what price would you expect to be able to sell a share of Acap stock in one year? c. Given your answer in (b), what price would you be willing to pay for a share of Acap stock today if you planned to hold the stock for one year? How does this compare to your answer in (a)?
a) P0=$2.80/(1+0.100)+($3.00+$52.00)/ (1+0.100)^2=$48.00 b)P1=($3.00+$52.00)/ (1+0.100)=$50.00 c)P0=$2.80+$50.00/ (1+0.100)=$48.00 d)The price in part (a) is the same as the price in part (c)
Your portfolio consists of 100100 shares of CSH and 50 shares of EJH, which you just bought at $20 and $30 per share, respectively. a. What fraction of your portfolio is invested in CSH? In EJH? b. If CSH increases to $23 and EJH decreases to $25, what is the return on your portfolio?
a) P=$20 per share×100 shares+$30 per share×50 shares=$3,500 w1=$20 per share×100 shares/$3,500=57.1% w2=$30 per share×50 shares/$3,500=42.9% b)R1=$23−$20/$20=15% R1=$25−$30/$30=−16.7% R=0.571×15%+0.429×(−16.7%)=1.4%
You run a construction firm. You have just won a contract to build a government office complex. Building it will require an investment of $10.0 million today and $5.0 million in one year. The government will pay you $20.0 million in one year upon the building's completion. Suppose the interest rate is 10.0%. a. What is the NPV of this opportunity? b. How can your firm turn this NPV into cash today?
a) PV=$20.0 million/(1+0.100)=$18.18 million PV=$5.0 million/(1+0.100)= $4.55 million NPV=$18.18 million−$10.0 million−$4.55 million=$3.63 million b) The firm can borrow $18.18 million today and pay it back with 10.0% interest using the $20.0 million it will receive from the government
The last four years of returns for a stock are as shown here: Year 1-4% Year 2-28% Year 3-12% Year 4-4% a. What is the average annual return? b. What is the variance of the stock's returns? c. What is the standard deviation of the stock's returns? Note: Notice that the average return and standard deviation must be entered in percentage format. The variance must be entered in decimal format.
a) R=1/4×(−4.0%+28.0%+12.0%+4.0%)= 10.00% b)Var=1/3×((−4.0%−10.00%)^2+(28.0%−10.00%)^2+(12.0%−10.00%)^2+(4.0%−10.00%)^2)=0.01867 c)SD=square root (0.01867)=13.66%
Summit Systems has an equity cost of capital of 11.0%, will pay a dividend of $1.50 in one year, and its dividends had been expected to grow by 6.0% per year. You read in the paper that Summit Systems has revised its growth prospects and now expects its dividends to grow at a rate of 3.0% per year forever. a. What is the drop in value of a share of Summit Systems stock based on this information? b. If you tried to sell your Summit Systems stock after reading this news, what price would you be likely to get? Why?
a) Value of a Share= $1.50/0.110−0.060= $30.00 per share Value of a Share= $1.50/0.110−0.030= $18.75 per share Drop in Price=$30.00−$18.75= $11.25 b)Value of a Share= $1.50/0.110−0.030= $18.75 per share
You are considering how to invest part of your retirement savings.You have decided to put $200,000 into three stocks: 50% of the money in GoldFinger (currently $25/share), 25% of the money in Moosehead (currently $80/share), and the remainder in Venture Associates (currently $2/share). Suppose GoldFinger stock goes up to $30/share, Moosehead stock drops to $60/share, and Venture Associates stock rises to $3 per share. a. What is the new value of the portfolio? b. What return did the portfolio earn? c. If you don't buy or sell any shares after the price change, what are your new portfolio weights?
a) nG=0.50×$200,000/$25=4,000 shares nM=0.25×$200,000/$80=625 shares nV=0.25×$200,000/$2=25,000 shares P=$30×4,000+$60×625+$3×25,000=$232,500 b) Return=$232,500/$200,000−1=16.25% c)Portfolio weight of Goldfinger= 4,000×$30/$232,500=51.61% Portfolio weight of Moosehead= 625×$60/$232,500=16.13% Portfolio weight of Venture= 25,000×$3/$232,500=32.26%
You are deciding between two mutually exclusive investment opportunities. Both require the same initial investment of $10.0 million. Investment A will generate $2.00 million per year (starting at the end of the first year) in perpetuity. Investment B will generate $1.50 million at the end of the first year, and its revenues will grow at 2.0% per year for every year after that. a. Which investment has the higher IRR? b. Which investment has the higher NPV when the cost of capital is 7.0%? c. In this case, when does picking the higher IRR give the correct answer as to which investment is the best opportunity?
a. Which investment has the higher IRR? The IRR of investment A is 20%. (Round to two decimal places.) The IRR of investment B is 17%. (Round to two decimal places.) Based on the IRR, you would pick investment A b. Which investment has the higher NPV when the cost of capital is 7.0%? If the cost of capital is 7.0%, the NPV of investment A is $18.57 million. If the cost of capital is 7.0%, the NPV of investment B is $20 million. The NPV rule requires you to choose B c. In this case, when does picking the higher IRR give the correct answer as to which investment is the best opportunity? The best investment opportunity when picking the higher IRR occurs for all discount rates higher than 8%.
You just purchased a share of SPCC for 100. You expect to receive a dividend of $5 in one year. If you expect the price after the dividend is paid to be $110, what total return will you have earned over the year? What was your dividend yield? Your capital gain rate?
r=$5+($110−$100)/ $100=0.1500=15.00% Dividend yield= $5/$100=0.0500=5.00% Capital gain rate=($110−$100)/ $100=0.1000=10.00%
Assume Coleco pays an annual dividend of $1.50 and has a share price of $37.50. It announces that its annual dividend will increase to $1.75. If its dividend yield stays the same, what should be its new share price?
rE=$1.50/$37.50=4% P0=$1.75/0.04=$43.75
Cooperton Mining just announced it will cut its dividend from $4.00 to $2.50 per share and use the extra funds to expand. Prior to the announcement, Cooperton's dividends were expected to grow at a 3.0% rate, and its share price was $50.00. With the planned expansion, Cooperton's dividends are expected to grow at a 5.0% rate. What share price would you expect after the announcement? (Assume that the new expansion does not change Cooperton's risk.) Is the expansion a good investment?
rE=($4.00/$50.00) + 0.03=0.11=11.0% P0=$2.50/(0.11−0.05)=$41.67 No, it is not
