FINA 3004
You are considering the purchase of an investment that would pay you $5,000 per year for Years 1-5, $3,000 per year for Years 6-8, and $2,000 per year for Years 9 and 10. If you require a 14% rate of return, and the cash flows occur at the end of each year, then how much should you be willing to pay for this investment?
$21,937.26
The CEO of Tom and Sue's wants the company to earn a net income of $3.25 million in 2010. Cost of goods sold is expected to be 60 percent of net sales, depreciation expense is $2.9 million, interest expense is expected to increase to $1.050 million, and the firm's tax rate will be 30 percent. Calculate the net sales needed to produce net income of $3.25 million.
$21.48 million
Costner Inc. would like to introduce its new haircutting machine, the terminator. The machine will cost $15,000 today. As a result of purchasing the machine, Costner expects to give 5,000 more haircuts for $8 each. In the first year, Costner will give 2,000 more haircuts, and in the second year Costner will give 3,000 more haircuts. What is the net present value (NPV) associated with purchasing the terminator if Costner's cost of capital is 9%?
+$19,87
A $2 million deposit earns 7% for 13 years. If the account earns 9% per year forever after that, how long will it take to grow to $5 million
0.43 years
The current price of a 10-year, $1,000 par value bond is $1,158.91. Interest on this bond is paid every 6 months, and the nominal annual yield is 14%. Given these facts, what is the annual coupon rate on this bond?
17%
Which of the following is NOT true when developing a time line?
Cash outflows are designated with a positive number
This index tracks 500 companies which allows for a great deal of diversification.
S&P 500
Corporate bonds usually have which of the following?
all of the above
Comparing net present value and internal rate of return analysis ___________ .
both b and c are correct
If a bond is selling at par value, which of the following statements is correct?
both statements are correct
Value stocks usually have
low P/E ratios and high growth rates.
The initial cash flows and operating cash inflows are referred to as the .
relevant cash flows
The _______ is a graphical representation of the term structure of interest rates.
yield curve
In three years you will begin receiving an annual payment of $600 that will be made for two years. If the annual interest rate is 12%, what will be the balance in your account at the end of the fourth year?
$1,272
What is the value of a 25-year bond with a $1,000 par value and an 8% coupon rate that yields 4%?
$1,624.88
Your company is considering the purchase of a new machine. The original cost of the old machine was $100,000; it is now 5 years old, and it has a current market value of $40,000. The old machine is being depreciated over a 10-year life toward a zero estimated salvage value on a straight-line basis, resulting in a current book value of $50,000 and an annual depreciation expense of $10,000. The old machine can be used for 6 more years but has no market value after its depreciable life is over. Management is contemplating the purchase of a new machine whose cost is $80,000 and whose estimated salvage value is zero. Expected before-tax cash savings from the new machine are $13,000 a year over its full MACRS depreciable life. Depreciation is computed using MACRS over a 5-year life, and the cost of capital is 10 percent. Assume a 40 percent tax rate. What will the year 1 operating cash flow for this project be?
$10,200
Lemmon Inc. lists fixed assets of $100 on its balance sheet. The firm's fixed assets have recently been appraised at $140. The firm's balance sheet also lists current assets at $15. Current assets were appraised at $16.5. Current liabilities book and market values stand at $12 and the firm's long-term debt is $40. Calculate the market value of the firm's stockholders' equity.
$104.50
Loan Balance Hank purchased a $20,000 car two years ago using an 8 percent, 5-year loan. He has decided that he would sell the car now, if he could get a price that would pay off the balance of his loan. What's the minimum price Hank would need to receive for his car?
$12,941.12
Interest Payments Determine the interest payment for the following three bonds: 2½ percent coupon corporate bond (paid semi-annually), 3.15 percent coupon Treasury note, and a corporate zero coupon bond maturing in 10 years. (Assume a $1,000 par value.
$12.50, $15.75, $0, respectively
Marla borrows $4500 at 12 percent annually compounded interest to be repaid in four equal annual installements. The actual end of year payment is
$1482
Donna makes annual end of year payments of $5403.71 on a four year loan with an interest rate of 13 percent. The original principal amount was
$15000
You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $75,000. The truck falls into the MACRS three-year class, and it will be sold after three years for $13,000. Use of the truck will require an increase in NWC (spare parts inventory) of $5,000. The truck will have no effect on revenues, but it is expected to save the firm $20,000 per year in before-tax operating costs, mainly labor. The firm's marginal tax rate is 40 percent. What will the operating cash flow for this project be during year 3?
$16,443.00
Your current $155,000 mortgage calls for monthly payments over 25 years at an annual rate interest rate of 6%. If you pay an additional $50 each month beginning with the first payment, how much interest expense do you save by pre-paying?
$17,152.22
Future Value of an Annuity What is the future value of an $800 annuity payment over 15 years if the interest rates are 6 percent
$18,620.78
interest Payments Determine the interest payment for the following three bonds: 4 percent coupon corporate bond (paid semi-annually), 4.75 percent coupon Treasury note, and a corporate zero coupon bond maturing in 15 years. (Assume a $1,000 par value.)
$20.00, $23.75, $0, respectively
Suppose you sell a fixed asset for $99,000 when its book value is $75,000. If your company's marginal tax rate is 39%, what is the gain or loss on the sale of the asset?
$24,000
TIPS Capital Return Consider a 3.25% TIPS with an issue CPI reference of 186.7. At the beginning of this year, the CPI was 197.5 and was at 202.4 at the end of the year. What was the capital gain of the TIPS in dollars? (Assume semi-annual interest payments and $1,000 par value.)
$26.25
Approximately how much must Tiffany invest today to accumulate $10,000 in ten years if she can earn 10% compounded annually
$3,855
Future Value Compute the future value in year 10 of a $1,000 deposit in year 1 and another $1,500 deposit at the end of year 4 using an 8% interest rate
$4,379.31
Zero Coupon Bond Price Calculate the price of a zero coupon bond that matures in 10 years if the market interest rate is 6 percent. (Assume semi-annual compounding and $1,000 par value.)
$553.68
What is the present value of a $600 payment in one year when the discount rate is 8%?
$555.56
Your firm needs a computerized machine tool lathe which costs $50,000, requires $10,000 in installation, $5,000 in freight charges and another $12,000 in maintenance for each year of its 3-year life. After 3 years, this machine will be replaced. The machine falls into the MACRS 3-year class life category. Assume a tax rate of 30% and a discount rate of 12%. If the lathe can be sold for $7,000 at the end of year 3, what is the after-tax salvage value?
$6,344.95
What is the present value of a $50 perpetuity if interest rates are 7%?
$714.29
How much should an investor pay for a bond that returns $10,000 at the end of five years if market interest rates are 4%?
$8,218.95
KADS, Inc. has spent $400,000 on research to develop a new computer game. The firm is planning to spend $250,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated; they total $50,000. The machine has an expected life of 3 years, a $75,000 estimated resale value, and falls under the MACRS 7-Year class life. Revenue from the new game is expected to be $600,000 per year, with costs of $250,000 per year. The firm has a tax rate of 35 percent, an opportunity cost of capital of 15 percent, and it expects net working capital to increase by $100,000 at the beginning of the project. What will the year 0 free cash flow for this project be?
-400,000
How many possible IRRs could you find for the following set of cash flows?
1
Interest rates A corporation's 10-year bonds have an equilibrium rate of return of 7 percent. For all securities, the inflation risk premium is 1.50 percent and the real interest rate is 3.0 percent. The security's liquidity risk premium is 0.15 percent and maturity risk premium is 0.70 percent. The security has no special covenants. What is the bond's default risk premium?
1.65%
Compound Frequency Payday loans are very short-term loans that charge very high interest rates. You can borrow $500 today and repay $550 in two weeks. What is the compound annual rate implied by this 10 percent rate charged for only two weeks?
1091.78%
CJ Co stock has a beta of 0.9, the current risk-free rate is 5.6, and the expected return on the market is 13 percent. What is CJ Co's cost of equity?
12.26%
What will be the monthly payment on a loan of $692, amortized over 8 years, at an annual interest rate of 17%
13.23 ± 2%
Compute the IRR statistic for Project X and note whether the firm should accept or reject the project with the cash flows shown below if the appropriate cost of capital is 10 percent.
13.26%, accept
Expected Return A company's current stock price is $65.40 and it is likely to pay a $2.25 dividend next year. Since analysts estimate the company will have a 11.25% growth rate, what is its expected return?
14.69%
Suppose the present value of a 5-year ordinary annuity is $528. If the discount rate is 14%, what must the annual cash flow be?
153.80 ± 2%
The Wall Street Journal reports that the rate on 4-year Treasury securities is 7.50% and the rate on 5-year Treasury securities is 9.15%. According to the unbiased expectations hypotheses, what does the market expect the 1-year Treasury rate to be four years from today, E( 5r 1)?
16.0%
Universal Forest's current stock price is $154.00 and it is likely to pay a $5.23 dividend next year. Since analysts estimate Universal Forest will have a 13.0% growth rate, what is its required return?
16.40%
A firm has 5,000,000 shares of common stock outstanding, each with a market price of $10.00 per share. It has 55,000 bonds outstanding, each selling for $990 with a $1000 face value. The bonds mature in 15 years, have a coupon rate of 8%, and pay coupons semi-annually. The firm's equity has a beta of 2.0, and the expected market return is 15%. The tax rate is 35% and the WACC is 16%. Calculate the risk-free rate.
2.32%
Sharif's portfolio generated returns of 12%, 15%, -15%, 19% and -12% over 5 years. What was his average return over this period?
3.8%
A firm is expected to pay a $4.00 dividend per share. The stock is selling in the market place for $55.00 per share. If investors are demanding 12% on this stock, what is this stock's growth rate?
4.73%
You deposit $20,000 in an account that doubles in 7 years. How many years will it take the account to be reduced to its original value if it loses 12% per year?
5.42 years
Suppose that Hanna Nails, Inc.'s capital structure features 45 percent equity, 55 percent debt, and that its before-tax cost of debt is 5 percent, while its cost of equity is 9 percent. If the appropriate weighted average tax rate is 40 percent, what will be Hanna Nails' WACC?
5.70%
A 5.5% coupon municipal bond has 16 years left to maturity and has a price quote of 92.55. The bond can be called in 9 years. The call premium is one year of coupon payments. Compute the bond's current yield. Assume interest payments are paid semi-annually and a par value of $5,000.
5.94%
If a 53-year ordinary annuity has a present value of $658, and if the interest rate is 11%, what is the amount of each annuity payment?
72.67 ± 2%
If it were evaluated with an interest percent of 0%, a ten year regular annuity would have a PRESENT VALUE of $3,755.50. If the FUTURE COMPOUNDED VALUE of this annuity, evaluated at Year 10, is $5,440.22, what effective annual interest rate must the analysist be using to find the future value?
8%
CAPM Required Return A company has a beta of 0.50. If the market return is expected to be 12 percent and the risk-free rate is 5 percent, what is the company's required return?
8.5%
The Ace Company is considering investing in a piece of property which cost $105,000. The property will return a constant cash flow forever. If the firm's cost of capital is 9% and the corporate tax rate is 40%, what is the minimum after-tax cash flow that would make the investment acceptable to Ace?
9,450
Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has 4 divisions, A through D, with average betas for each division of 0.5, 1.0, 1.3 and 1.6, respectively. If all current and future projects will be financed with half debt and half equity, and if the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 7%) is 14% and the after-tax yield on the company's bonds is 8%, what are the WACCs for divisions A through D?
9.25%; 11.00%; 12.05%; 13.10%
A 7.5% coupon bond with 16 years left to maturity is offered for sale at $834.92. What yield to maturity is the bond offering? (Assume interest payments are paid semi-annually and par value is $1,000.)
9.54%
Suppose that TipsNToes, Inc.'s capital structure features 40 percent equity, 60 percent debt, and that its before-tax cost of debt is 9 percent, while its cost of equity is 15 percent. If the appropriate weighted average tax rate is 34 percent, what will be TipsNToes' WACC?
9.56%
Which of the following statements is incorrect?
A NPV profile plots the relationship between the riskiness of a project and the associated NPVs.
Which of the following statements is correct?
Accountants are focused on what happened in the past.
Between corporate managers and stockholders, this can create ethical dilemmas.
Agency relationship
Among the services provided by financial markets are
All of the above
Which of the following does not need to be considered when assessing the impact of financial decision?
All of the above must be considered
Which of the following statements is true?
Competitive financial markets allocate scarce funds to borrowers who have the most profitable opportunities and are willing to pay market interest rates.
From a taxation perspective, the form of business organization with the highest business level taxes is the __________.
Corporation
You can deposit your savings at the Darlington National Bank, which offers to pay 12.6 percent interest compounded monthly, or at the Barlett Bank, which will pay interest of 11.5 percent compounded daily. (Assume 365 days in a year.) Which bank offers the higher effective annual rate?
Darlington National Bank
Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has 4 divisions, A through D, with average betas for each division of 0.5, 1.2, 1.5 and 1.8, respectively. If all current and future projects will be financed with half debt and half equity, and if the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 5 percent, market premium of 10 percent) is 15 percent and the after-tax yield on the company's bonds is 7 percent, what will the WACCs be for each division?
Division A: 5 + 10(.5) = 10%Division B: 5 + 10(1.2) = 17%Division C: 5 + 10(1.5) = 20%Division D: 5 + 10(1.8) = 23%WACC:Division A: .5 x 7% + .5 x 10% = 8.5%Division B: .5 x 7% + .5 x 17% = 12%Division C: .5 x 7% + .5 x 20% = 13.5%Division D: .5 x 7% + .5 x 23% = 15%
Consider the following annual returns of Estee Lauder and Lowe's Companies:
Estee Lauder: 9.02%; 30.69%; 3.4 Lowe's Companies: 10.66%; 25.46%; 2.39
Section 179 allows a business, with certain restrictions, to do which of the following?
Expense the asset immediately in the year of purchase
Assume your firm produces a good which has high sales when the economy is expanding and low sales during a recession. Your risk will be higher if you invest in another product which is countercyclical.
False
Which of the following statements is not true with respect to the study of finance?
Few positions today require an understanding of the basic financial principles.
The cost of common stock equity may be estimated by using the
Gordon model
Which of the following is not a way in which transaction costs are minimized?
Granting access to the financial markets to any investor who wishes to trade.
IBM has a beta of 1.0 and Apple Computer has a beta of 3.0. Which of the following statements must be correct?
If investors become more risk averse, the expected return of Apple will increase more than the expected return on IBM.
Explain the Rule of Signs as it pertains to IRR.
If management insists on using IRR for non-normal cash flows, some trial and error to find all the possible IRRs will be needed. It will help to know how many there might possibly be. According to the Rule of Signs, one can end up with no more different positive IRRs than the number of sign changes in the cash flows - that is, inflows to outflows, or outflows to inflows.
Which of these statements is true regarding calculating weights for WACC?
If we are calculating WACC for the firm, then equity, preferred stock and debt would be the entire market value of each source of capital.
Which financial statement shows the total revenues that a firm earns and the total expenses the firm incurs to generate those revenues over a specific period of time—generally one year?
Income Statement
Which of the following will not increase a present value?
Increase the interest rate.
A local bank is contemplating adding a new ATM to their lobby. They will need another phone line to provide communications which has a monthly cost of $50 per month. This is an example of _____________.
Incremental cash flow
You are trying to pick the least-expensive machine for your company. You have two choices: machine A, which will cost $100,000 to purchase and which will have OCF of -$7,000 annually throughout the machine's expected life of three years; and machine B, which will cost $125,000 to purchase and which will have OCF of -$2,600 annually throughout that machine's four-year life. Both machines will be worthless at the end of their life. If you intend to replace whichever type of machine you choose with the same thing when its life runs out, again and again out into the foreseeable future, and if your business has a cost of capital of 15 percent, which one should you choose?
Machine B
The interest on your home mortgage is tax deductible. Why are the early years of the mortgage more helpful in reducing taxes than the later years?
More interest is paid in the early years.
Which of the following statements is correct?
None of these statements are correct.
Is the set of cash flows depicted below normal or non-normal? Explain
Normal. When initial cash flows are negative, representing initial cash expenditures, and all subsequent cash flows are positive, representing returns on the expenditures, we typically call these cash flow relationships "normal."
All of the following are functions of the board of directors except ________.
Provide reports to the auditors
Which of the following factors does not promote market efficiency?
Security prices are set by the governing board of the New York Stock Exchange.
which of the following indices best reflects the ten sectors of the economy?
Standard & Poor's 500
________is a guide to the firm's value if it is assumed that investors value the earnings of a given firm in the same way they do the average firm in the industry.
The P/E multiple
Which of the following will decrease the present value of an annuity?
The discount rate increases
Describe the diversification potential of two assets with a -0.7 correlation. What is the potential if the correlation is + 0.7?
The diversification potential is very good with two assets that have a −0.7 correlation. Since these two assets tend to move in opposite directions, the combination will greatly reduce the risk or volatility an investor would experience with only one of the assets. There is not much diversification potential for two assets with a correlation close to one, like + 0.7.
Low Financing or Cash Back? A car company is offering a choice of deals. You can receive $2,000 cash back on the purchase, or a 2 percent APR, 3-year loan. The price of the car is $17,000 and you could obtain a 3-year loan from your credit union, at 7 percent APR. Which deal is cheaper?
The rebate with the credit union's 7 percent 3-year loan
One-year interest rates are 3%. The market expects one-year rates to be 5% one year from now. The market also expects one-year rates to be 7% two years from now. Assume that the unbiased expectations theory holds. Which of the following is correct?
The yield curve is upward sloping.
Which of the following is the correct ranking from least risky to most risky?
Treasury Bills, Long-term Treasury Bonds, Stocks
A stock's beta is more relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only one stock.
True
In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are interested in ex ante (future) data.
True
The biggest disadvantage of the sole proprietorship is _________________.
Unlimited liability
Which of the following will impact the cost of equity component in the weighted average cost of capital?
all of the above
The board of directors _____________.
are elected by shareholders
This model includes an equation that relates a stock's required return to an appropriate risk premium
asset pricing
As a new investor, you find that the expected return on an asset is 13% and the required return is 12%. You should probably
buy the asset now.
The real interest rate
cannot be directly observed for loans made today that mature in one year.
We call the process of earning interest on both the original deposit and on the earlier interest payments _______________.
compounding
Greater risk aversion results in lower required returns for each level of risk, whereas a reduction in risk aversion would cause the required return for each level of risk to increase.
false
If a firm has unlimited funds to invest, then all the mutually exclusive projects that meet its minimum investment criteria will be implemented.
false
One of the disadvantages of the payback method (either regular or discounted) is that it considers all cash flows throughout the entire life of a project.
false
One of the disadvantages of the payback methods (either regular or discounted) is that it considers all cash flows throughout the entire life of a project.
false
Operating leverage is concerned with the relationship between the firm's sales revenue and its operating expenses.
false
Other things held constant, an increase in the cost of capital discount rate will result in a decrease of a projects IRR.
false
The book value of an asset is equal to the assets after-tax proceeds that are provided after the asset has been sold.
false
The marginal cost of capital (MCC) is the cost of the last dollar of new capital that the firm raises, and the marginal cost declines as more and more of a specific type of capital is raised during a given period.
false
When valuing common stock, capital gains determine a majority of the stock's current value.
false
Investment grade bonds include those bonds with ratings _____________.
from AAA to BBB
When residual cash flows are high, stock values will be
high
Under shareholder wealth maximization, the directive to managers is to ____________ the firm's cash flows while _____________ risk.
increase; minimizing
In the U.S., these financial institutions arrange most primary market transactions for businesses.
investment banks
Unsystematic risk is not relevant, because
it can be eliminated through diversification.
You are an investor in common stock, and you currently hold a well-diversified portfolio which has an expected return of 12%, a beta of 1.2, and a total value of $9,000. You plan to increase your portfolio by buying 100 shares of AT&E at 10 a share. AT&E has an expected return of 20% with a beta of 2.0. What will be the expected return and the beta of your portfolio after you purchase the new stock?
k(p)=12.8%; b(p)=1.28
The ultimate goal of capital budgeting analysis is to select projects that
maximize shareholder wealth
Managers of corporations should act in ways that
maximize shareholder wealth.
A capital budgeting technique that converts a project's cash flows using a more consistent reinvestment rate prior to applying the Internal Rate of Return, IRR, decision rule.
modified internal rate of return
In comparing the internal rate of return and net present value methods of evaluation,
net present value is theoretically superior, but financial mangers prefer to use Internal Rate of Return
The total risk of the S&P500 Index is equal to ____________________.
nondiversifiable risk
In the capital asset pricing model, the beta coefficient is a measure of ___________ risk and an index of the degree of movement of an asset's return in response to a change in _______.
nondiversifiable; the market return
A dollar paid (or received) in the future is
not worth as much as a dollar paid (or received) today.
Bond prices are quoted in terms of which of the following?
percent of par value
The efficient frontier portfolios are __________________________.
portfolios that dominate all others
An average of which of the following will give a fairly accurate estimate of what a project's beta will be?
proxy beta
Investors buy stock at the
quoted ask price
Which of the following terms means the chance that future interest payments will have to be reinvested at a lower interest rate?
reinvestment rate risk
A potential future negative impact to value and/or cash flows is often discussed in terms of probability of loss and the expected magnitude of the loss. This is called _________.
risk
Opportunity costs may be defined as
the highest return an investor could have earned from investing in the next-best alternative.
Holding the market yield and the coupon rate of a bond constant, as the time to maturity increases
the sum of the present value of the coupon payments represents a larger share of the total bond value than the present value of the principal
A firm may face increases in the weighted average cost of capital either when retained earnings have been exhausted or due to increases in debt, preferred stock, and common equity costs as additional new funds are required.
true
A portfolio combining two assets with less than perfectly positive correlation can reduce total risk to a level below that of either of the components.
true
According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the isolated risk of individual stocks. Thus, the relevant risk is an individual stock's contribution to the overall riskiness of the portfolio.
true
Any action that increases the risk of an asset will also increase that assets required return.
true
At the operating breakeven point, the sales revenue is equal to the sum of the fixed and variable operating costs
true
Combining stocks together in portfolios reduces risk as long as the correlation between the returns on the securities is not perfect (i.e. r= -1.0 or r=+1.0.)
true
If a firm is considering purchasing an asset whose beta is greater than the current beta of the firm, it should use a discount rate greater than the firms current cost of capital to evaluate the possible investment.
true
If the required rate of return on a bond is greater than its coupon interest rate (and K(d) remains above the coupon rate), the market value of that bond will always be below its par value until the bond matures, at which time its market value will equal its par value. (Accrued interest between interest payment dates should not be considered when answering this question.)
true
In its most general sense, capital budgeting is concerned both with the demand for and the supply of funds for long-term investment.
true
Net incremental cash flow is calculated by adding back the change in depreciation to the change in income after taxes.
true
Net working capital is the amount by which a firms current assets exceed its current liabilities.
true
One advantage of the payback period method of evaluating fixed asset investment possibilities is that it provides a rough measure of a project's liquidity and risk.
true
The NPV assumes that periodic cash inflows are invested at a rate equal to the firms cost of capital.
true
The breakeven cash inflow is the minimum level of cash inflow necessary for a project to be acceptable.
true
The relevant cash flows for a proposed Project Are the incremental after-tax cash outflows and the resulting cash inflows.
true
The risk of an asset may be found by subtracting the worst outcome from the best outcome.
true
The salvage value of an asset should be net of any removal or cleanup costs associated with the termination of a project.
true
The steeper the slope of the line relating EBIT to EPS, the greater the financial risk.
true
The value of all financial assets are found the same way. The current value is the present value of all future cash flows
true
