FIRE-311 Module 4&5 Notes

A chemical company is planning to release a new brand of insecticide that will kill many insect pests but not harm useful pollinators. Buying new equipment to manufacture the product will cost $15 million. The equipment is expected to have a lifetime of nine years and will be depreciated by the straight-line method over its lifetime. The firm expects that they should be able to sell 1,500,000 gallons per year at a price of $53 per gallon. It will take $36 per gallon to manufacture and support the product. If the company's marginal tax rate is 40%, what are the incremental earnings after tax in year 3 of this project? $9.5 million / $15.3 million / $12.7 million / $25.5 million / $14.3 million / $23.8 million

(work in Excel "Incremental Earnings Forecast") Answer = $14.3 million

Since your first birthday, your grandparents have been depositing $1200 into a savings account on every one of your birthdays. The account pays 6% interest annually. Immediately after your grandparents make the deposit on your 18th birthday, the amount of money in your savings account will be closest to ________. $21,600.00 / $12,993.12 / $44,504.14 / $22,252.07 / $37,086.78

18th birthday - 1st birthday = 17 years N=17, I/Y=6, PV=-1200, PMT=-1200 FV = $37,086.78

Temporary Housing Services Incorporated​ (THSI) is considering a project that involves setting up a temporary housing facility in an area recently damaged by a hurricane. THSI will lease space in this facility to various agencies and groups providing relief services to the area. THSI estimates that this project will initially cost $6 million to set up and will generate $25 million in revenues during its first and only year in operation​ (paid in one​ year). Operating expenses are expected to total $12 million during this year and depreciation expense will be another $2 million. THSI will require no working capital for this investment. ​ THSI's tax-rate is​ 20% Assume that​ THSI's cost of capital for this project is​ 15%. The net present value​ (NPV) of this temporary housing project is closest​ to:

25-12=13 mil gross profit 13-2=11 mil ebit 11 mil * 0.2 = 2,200,000 = 2.2 mil tax 11-2.2=8.8 net profit 8.8+2=10.8 cash flow npv = (10.8/(1+0.15))-6 = 3.391304

Amazon.com stock prices gave a realized return of 5%, -5%, 11%, and -11% over four successive quarters. What is the annual realized return for Amazon.com for the year? 1.46% / -1.46% / 2.91% / -2.91% / 0.99% / 0.00%

Annualized return = Rannual Rannual = ((1 + R1) * (1 + R2) * (1 + R3) * (1 + R4)) - 1 = (1+0.05) * (1-0.05) * (1+0.11) * (1-0.11) - 1 = −0.01457 = -1.46%

Which of the following statements regarding bonds and their terms is FALSE? -Bonds typically make two types of payments to their holders. -By convention, the coupon rate is expressed as an effective annual rate. -Bonds are securities sold by governments and corporations to raise money from investors today in exchange for a promised future payment. -Annual coupon is determined by the coupon rate and the face value. -The time remaining until the repayment date is known as the term of the bond.

Answer: By convention, coupon rate's expressed as an effective annual rate.

Dewyco has preferred stock trading at $45 per share. The next preferred dividend of $6 is due in one year. What is​ Dewyco's cost of capital for preferred​ stock?

Cost of preferred stock capital = Divpfd / Ppfd aka = (preferred dividend) / (preferred stock price) = 6 / 45 = 0.133333 = 13.33%

Historically, stocks have delivered a​ ________ return on average compared to Treasury bills but have experienced​ ________ fluctuations in values. A. ​higher, lower B. ​lower, higher C. ​lower, lower D. ​higher, higher

D. ​higher, higher

BHT Company evaluates a project for a potential inclusion in its capital budget. In the first year of the project, it expects incremental net income of $29 million, depreciation expenses of $10 million and an increase in net working capital of $3 million. What is the estimated incremental free cash flow in the first year of the project? $36 mil / $42 mil / $39 mil / $19 mil / $22 mil / $29 mil

In Excel "Incremental Earnings Forecast" Answer: $36 mil

Your sibling asks you to borrow money from you that she can repay in four equal annual payments of $1,000 at the end of each of the next four years. If you charge 3% interest rate on the loan to your sibling, and that is the competitive interest rate, what would be the amount that you can lend to her today? $3,717.10 / $4,310.13 / $3,956.72 / $3,828.61 / $3,549.95

N=4, I/Y=3, PMT=1,000, FV=0 PV = $3,717.10

You have just been offered a contract worth $1.19 million per year for 6 years.​ However, to take the​ contract, you will need to purchase some new equipment. Your discount rate for this project is 11.9%. You are still negotiating the purchase price of the equipment. What is the most you can pay for the equipment and still have a positive NPV​?

PV = (CF / r) * (1 - (1 / (1 + r)^n)) PV = (1190000 / 0.119) * (1 - (1 / (1 + 0.119)^6)) PV = 4,906,462.817481 Most you can pay = $4.91 million

The average annual return for the S&P 500 from 1886 to 2006 is 5%, with a standard deviation of 15%. Based on these numbers, what is a 95% confidence interval for 2007's returns? a. -10%, 20% b. -25%, 25% c. -5%, 25% d. -25%, 35% e. -15%, 25% f. -12.5%, 17.5%

Prediction interval = \R +/- (2 * SD(R)) or = average annual return +/- (2 * standard deviation) Higher interval = 0.05 + (2 * 0.15) = 0.35 Lower interval = 0.05 - (2 * 0.15) = −0.25 Answer: d. -25%, 35%

An investor has the opportunity to invest in three new retail stores. The amount that can be invested in each​ store, along with the expected cash flow at the end of the first​ year, the growth rate of the​ concern, and the cost of capital is shown for each case. It is assumed each investment will operate in perpetuity after the initial investment. Which investment should the investor choose if the projects are mutually​ exclusive? A. Initial​ investment: $1.2​ million; Cash flow in year​ 1: $150,000; Annual Growth​ Rate: 2%; Cost of​ Capital: 7​% B. Initial​ investment: $1.1​ million; Cash flow in year​ 1: $160,000; Annual Growth​ Rate: 2%; Cost of​ Capital: 9​% C. Initial​ investment: $1.3​ million; Cash flow in year​ 1: $160,000; Annual Growth​ Rate: 1%; Cost of​ Capital: 5.6​%

Step 1: calculate NPV since & choose the highest since it's a better predictor of value than IRR. Multiyear NPV = (-immediate cost) + (benefit/(1+r)) + (benefit/(1+r)^2) + (benefit/(1+r)^3) + ... A: -1200000+ (150000/1.02) = -1052941.176471 B: -1100000 + (160000/1.02) = -943137.254902 C: -1300000 + (160000/1.01) = -1141584.158416 NPV = (CF1) / (r - g) - initial investment & rank A: 150000/(0.07-0.02) - 1200000 = 1,800,000 B: 160000/(0.09-0.02) - 1100000 = 1,185,714.285714 C: 160000/(0.056-0.01) - 1300000 = 2,178,260.869565 = C. Initial​ investment: $1.3​ million; Cash flow in year​ 1: $160,000; Annual Growth​ Rate: 1%; Cost of​ Capital: 5.6​%

Your factory has been offered a contract to produce a part for a new printer. The contract would last for three​ years, and your cash flows from the contract would be $5.02 million per year. Your upfront setup costs to be ready to produce the part would be $8.04 million. Your discount rate for this contract is 7.7%. a. What is the​ IRR? b. The NPV is $4.97 ​million, which is positive so the NPV rule says to accept the project. Does the IRR rule agree with the NPV​ rule?

a. Plug into IRR calc IRR = 39.377% = 39.38% b. The IRR rule agrees with the NPV rule.

(a) Assume Dominion Energy is discussing new ways to recapitalize the firm and raise additional capital. The market values of its capital sources are $63.1 billion in equity, $39.7 billion in debt and $2.4 billion in preferred stock . The cost of equity capital is 4.3%, the cost of preferred stock is 3.7%, and the pretax cost of debt is 3.1%. What is the weighted average cost of capital for Dominion Energy if its marginal tax rate is 25%? 3.83% / 3.96% / 3.46% / 3.54% / 3.77% / 4.15% (b) Assume Dominion Energy is discussing new ways to recapitalize the firm and raise additional capital. The market values of its capital sources are $70.1 billion in equity, $37.9 billion in debt and $2.4 billion in preferred stock . The cost of equity capital is 3.4%, the cost of preferred stock is 3.2%, and the pretax cost of debt is 1.9%. What is the weighted average cost of capital for Dominion Energy if its marginal tax rate is 25%? 2.88% / 3.13% / 3.21% / 3.34% / 2.57% / 2.72%

(a) rwacc with preferred stock = (rE * E%) + (rpfd * P%) + (rD * (1 - TC) * D%) which = (cost of equity * equity weight) + (preferred capital * preferred stock weight) + (debt capital * (1 - corporate tax rate) * debt weight) Step 1: calculate weights of equity, debt, & preferred (63100000000 + 39700000000 + 2400000000) = 105,200,000,000 Equity = 63.1 / total = 0.59981 Preferred = 2.4 / total = 0.022814 Debt = 39.7 / total = 0.377376 Step 2: calculate rWACC = (0.59981 * 0.043) + (0.022814 * 0.037) + (0.377376 * (1 - 0.25) * 0.031) = 0.03541 = 3.54% (b) rwacc = (cost of equity * equity weight) + (preferred capital * preferred stock weight) + (debt capital * (1 - corporate tax rate) * debt weight) Step 1: calculate weights of equity, debt, & preferred (70.1 + 37.9 + 2.4) = 110.4 billion total MV of assets Equity = 70.1 / 110.4 = 0.634964 Preferred = 2.4 / 110.4 = 0.021739 Debt = 37.9 / 110.4 = 0.343297 Step 2: calculate rWACC = (0.034 * 0.634964) + (0.032 * 0.021739) + (0.019 * (1 - 0.25) * 0.343297) = 0.027176 = 2.72%

Cellular​ Access, Inc., a cellular telephone service​ provider, reported net income of $250.0 million for the most recent fiscal year. The firm had depreciation expenses of $100.0 ​million, capital expenditures of $200.0 ​million, and no interest expenses. Net working capital increased by $10.0 million. Calculate the free cash flow for Cellular Access for the most recent fiscal year.

(work in Excel "Incremental Earnings Forecast") Answer = $140 million

RiverRocks​ (whose WACC is 11.4%​) is considering an acquisition of Raft Adventures​ (whose WACC is 14.3%​). What is the appropriate discount rate for RiverRocks to use to evaluate the​ acquisition? Why?

-The cost of capital for a project, in this case an acquisition, is determined by the riskiness of the project that we are investing in. In this case, that riskiness is captured by the target's WACC of 14.3%. -Raft​ Adventures' WACC is the most appropriate discount rate to account for the risk of Raft​ Adventures' cash flows.

Which of the following bonds will be most sensitive to a change in interest rates if all bonds have the same initial yield to maturity? a. a 20-year bond with a $1,000 face value whose coupon rate is 5.8% APR paid semiannually b. a ten-year bond with a $1,000 face value whose coupon rate is 5.8% APR paid semiannually c. a 20-year bond with a $1,000 face value whose coupon rate is 7.4% APR paid semiannually d. a ten-year bond with a $1,000 face value whose coupon rate is 7.4% APR paid semiannually e. a 20-year bond with a $1,000 face value whose coupon rate is 8.7% APR paid semiannually

-the longer the bond, the more sensitive it is -the smaller the coupon rate change, the more sensitive Answer: a. a 20-year bond with a $1,000 face value whose coupon rate is 5.8% APR paid semiannually

Which of the following statements is​ FALSE? A. Investments in​ plant, property, and equipment are directly listed as expense when calculating earnings. B. The opportunity cost of using a resource is the value it could have provided in its best alternative use. C. The marginal corporate tax rate is the tax rate the firm will pay on an incremental dollar of pre−tax income. D. We begin the capital budgeting process by determining the incremental earnings of a project.

A. Investments in​ plant, property, and equipment are directly listed as expense when calculating earnings.

Which of the following statements about evaluating a single project where costs occur before benefits is FALSE? (A) In general, the difference between the cost of capital and the internal rate of return (IRR) is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision. (B) If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive. (C) In an NPV profile that shows how NPV changes when cost of capital changes, NPV equals zero when the project discount rate equals IRR. (D) The internal rate of return (IRR) can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital. (E) If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate.

A. true B. false: if cost of capital > IRR, NPV will be negative C. true D. true E. true Answer: (B) If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive.

In an effort to maintain price stability, it is expected that the European Central Bank will raise interest rates in the future. Which of the following is the most likely effect of such an action on short-term and long-term interest rates in Europe? -The yield curve is expected to become inverted. -Both long- and short-term interest rates would be expected to fall sharply. -No relative change in short- and long-term interest rates could be predicted. -Long-term interest rates will be about the same as short-term interest rates. -Long-term interest rates will tend to be higher than short-term interest rates.

Answer: Long-term interest rates tend to be higher than short-term rates.

The probability mass between two standard deviations around the mean for a normal distribution is​ ________. A. ​75% B. ​95% C. ​90% D. ​66%

B. 95%

You are given two choices of​ investments, Investment A and Investment B. Both investments have the same future cash flows. Investment A has a discount rate of​ 5%, and Investment B has a discount rate of​ 4%. Which of the following is​ true? A. The present value of cash flows in Investment A is higher than the present value of cash flows in Investment B. B. The present value of cash flows in Investment A is lower than the present value of cash flows in Investment B. C. The present value of cash flows in Investment A is equal to the present value of cash flows in Investment B. D. No comparison can be made—we need to know the cash flows to calculate the present value.

B. The present value of cash flows in Investment A is lower than the present value of cash flows in Investment B.

The relative proportion of​ debt, equity, and other securities that a firm has outstanding constitute its​ ________. A. current ratio B. capital structure C. retained earnings D. asset ratio

B. capital structure

A company planning to market a new model of motor scooter analyzes the effect of changes in the selling price of the motor scooter, the number of units that will be sold, the cost of making the motor scooter, the effect on Net Working Capital, and the cost of capital on the project's NPV. They predict that the break-even point for sales price for the motor scooter is $2,480. What does this mean? a. If the motor scooter is sold for $2,480, then the project will make a profit b. The predicted selling price of the motor scooter is $2,480. c. At the price of $2,480, the revenue for the scooter will exactly equal its production cost. d. If the motor scooter is sold for $2,480, then the net present value (NPV) for the product will be zero. e. The maximum that the motor scooter can sell for and still make the project have a positive net present value (NPV) is $2,480.

Break-even point is the level of a parameter where an investment has an NPV of 0. So...answer: d. If the motor scooter is sold for $2,480, then the net present value (NPV) for the product will be zero.

Suppose Capital One is advertising a 60​-month, 5.99% APR motorcycle loan. If you need to borrow $8,000 to purchase your dream​ Harley-Davidson, what will be your monthly​ payment?​ (Note: Be careful not to round any intermediate steps less than six decimal​ places.)

Calculate PMT. 1. Convert: 5.99% APR / 12 months per year = 0.499167 2. In calc: n=60, i/y=0.499167, pv=8000, fv=0 PMT = $154.63

Which of the following accounts offers the highest interest rate? -one that pays 12.32% per year -one that pays 25.55% every two years -one that pays 3.05% every three months -one that pays 6.11% every six months -one that pays 1.00% per month

Convert all to annual % where (1 + EAR) ^n - 12/3=4, (1 + 0.0305)^4 = 1.127696 = 12.77% - 12.32% = 12.32% - 12 months, (1 + 0.01)^12 = 1.126825 = 12.68% - 1/2, (1 + 0.2555)^1/2 = 1.120491 = 12.05% - 12/6=2, (1 + 0.0611)^2 = 1.125933 = 12.59% Answer: one that pays 3.05% every three months

Assume preferred stock of Ford Motors pays a dividend of $1.55 each year and trades at a price of $26.82. What is the cost of preferred stock capital for Ford? 3.75% / 4.16% / 4.42% / 5.17% / 5.78% / 5.36% Assume preferred stock of Ford Motors pays a dividend of $4 each year and trades at a price of $47. What is the cost of preferred stock capital for Ford? 7.36% / 12.6% / 11.4% / 9.17% / 8.51% / 13.7%

Cost of preferred stock capital = Divpfd / Ppfd aka = (preferred dividend) / (preferred stock price) = 1.55 / 26.82 = 0.057793 = 5.78% Cost of preferred stock capital = Divpfd / Ppfd aka = (preferred dividend) / (preferred stock price) = 4 / 47 = 0.085106 = 8.51%

Your company currently has $1,000 ​par, 6% coupon bonds with 10 years to maturity and a price of $1,078. If you want to issue new​ 10-year coupon bonds at​ par, what coupon rate do you need to​ set? Assume that for both​ bonds, the next coupon payment is due in exactly six months.

Coupon rate same as YTM = par Step 1: Current YTM = (face value / price) ^1/n - 1 = (1000 / 1078)^1/10 - 1 = -0.907236 = -90.72% Find I/Y in calculator (10*2=20 periods) (0.06*1000/2=30)(n=20, pv=-1078, pmt=30, fv=1000) I/Y = 2.5% Step 2: the bond trades at par when its coupon rate is equal to YTM, however the coupon rate we just found is the semiannual rate, double it to find the matching APR. = 2.5 * 2 = 5% Answer: 5%

Andyco, Inc., has the following balance sheet and an equity​ market-to-book ratio of 1.7. Assuming the market value of debt equals its book​ value, what weights should it use for its WACC​ calculation? Assets Liabilities&Equity $1,080 Debt=$450 Equity=$630

Debt = $450 Equity = book value of equity * ratio = 630 * 1.7 = 1071 Total = MV of debt + MV of equity = 450 + 1071 = 1521 Debt weight = 450 / 1521 = 0.295858 = 29.59% Equity weight = 1071 / 1521 = 0.704142 = 70.41%

When we use the WACC to assess a project, we assume that the ________ ratio does not change. -reward to systematic risk -debt to equity -volatility to systematic risk -risk to reward -sales to assets -market to book

Debt to equity

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? Suppose you invested $100 in the Ishares High Yield Fund (HYG) a month ago. It paid a dividend of $2 today and then you sold it for $95. What was your dividend yield and capital gains yield on the investment? a. 2%, -5% b. -5%, -2% c. 5%, 2% d. -2%, -5% e. -2%, 5% f. 2%, 5%

Dividend yield = Div1 / P0 = 5 / 100 = 0.05 = 5% Capital gain rate = (P1 - P0) / P0 = (110 - 100) / 100 = 0.1 = 10% Expected return rE = ((Div1 + P1) / P0) - 1rE = ((5 + 110) / 100) - 1 = 0.15 = 15% Dividend yield = Div1 / P0 = ((Div0 * (1 + g)) / current price) + g = ((2 * (1 + 0)) / 95 = 2/95 = 0.021053 = 2.1% Capital gain rate = (P1 - P0) / P0 = (95 - 100) / 100 = -0.05 = -5% Answer: a. 2%, -5%

Outstanding debt of Kroger trades with a yield to maturity of 3.53%. The tax rate of Kroger is 23.2%. What is the effective cost of debt of Kroger? 3.53% / 2.71% / 3.16% / 4.35% / 0.82% / 19.67% Outstanding debt of Home Depot trades with a yield to maturity of 8%. The tax rate of Home Depot is 20%. What is the effective cost of debt of Home Depot? 5.60% / 8.00% / 6.40% / 1.60% / 9.60% / 5.88%

Effective cost of debt = pretax cost of debt * (1 - corp r) Corporate tax rate = 23.2% YTM = pretax cost of debt = 3.53% Effective cost of debt = 0.0353 * (1 - 0.232) = 0.02711 =2.71% Effective cost of debt = pretax cost of debt * (1 - corp r) Corporate tax rate = 20% YTM = pretax cost of debt = 8% Effective cost of debt = 0.08 * (1 - 0.2) = 0.064 = 6.4%

Laurel, Inc., has debt outstanding with a coupon rate of 5.9% and a yield to maturity of 7.2%. Its tax rate is 35%. What is​ Laurel's effective​ (after-tax) cost of​ debt? ​NOTE: Assume that the debt has annual coupons and that the firm will always be able to utilize its full interest tax shield.

Effective cost of debt = pretax cost of debt * (1 - corp r) Corporate tax rate = 35% YTM = pretax cost of debt = 7.2% Effective cost of debt = 0.072 * (1 - 0.35) = 0.0468 = 4.68%

The​ risk-free rate is 3​% and you believe that the​ S&P 500's excess return will be 10​% over the next year. If you invest in a stock with a beta of 1.2 ​(and a standard deviation of 30​%), what is your best guess as to its expected excess return over the next​ year?

Expected excess return = excess return * beta 0.1 * 1.2 = 0.12 = 12%

Suppose you invested $60 in the Ishares Dividend Stock Fund (DVY) a month ago. It paid a dividend of $0.63 today and then you sold it for $65. What was your return on the investment? 8.66% / 6.57% / 10.32% / 9.38% / 7.51% / 8.33%

Expected return rE = ((Div1 + P1) / P0) - 1rE = ((0.63 + 65) / 60) - 1 = 0.093833 = 9.38%

Stocks have both diversifiable risk and undiversifiable​ risk, but only diversifiable risk is rewarded with higher expected returns. -True -False

False

Martin is offered an investment where for $6,000 ​today, he will receive $6,180 in one year. He decides to borrow $6,000 from the bank to make this investment. What is the maximum interest rate the bank needs to offer on the loan if Martin is at least to break even on this​ investment? Martin is offered an investment where for $4,000 ​today, he will receive $4,120 in one year. He decides to borrow $4,000 from the bank to make this investment. What is the maximum interest rate the bank needs to offer on the loan if Martin is at least to break even on this​ investment? A. 2​% B. 4​% C. 1​% D. 3​%

Find rate in calc n=1, pv=-6000, pmt=0, fv=6180 I/Y = 3% Find rate in calc n=1, pv=-4000, pmt=0, fv=4120 I/Y = 3%

The local electronics store is offering a promotion​ "1-year: same as​ cash," meaning that you can buy a TV​ now, and wait a year to pay​ (with no​ interest). So, if you take home a $1,000 TV​ today, you will owe them $1,000 in one year. If your bank is offering 4% ​interest, what is the true cost of the TV to you​ today?

Find the present value in calc: N=1, I/Y=4, PMT=0, FV=1000 PV = $961.54

If $17,000 is invested at 10% per year, in how many years will the investment double? 13.2 years / 8.4 years / 11.0 years / 9.1 years / 7.3 years

I/Y=10, PV=17,000, PMT=0, FV=34,000 N = 7.273 = 7.3 years

Hardware Industries is purchasing a new chemical vapor depositor in order to make silicon chips. It will cost $5,000,000 to buy the machine and $10,000 to have it delivered and installed. The machine is expected to work for six years and raise gross profits by $4,500,000 per year, starting at the end of the first year. Other general expenses associated with using the machine are estimated at $1 million for each of those years. The machine will be depreciated over six years using the straight-line method. The marginal tax rate is 40%. What are the incremental free cash flows associated with the new machine in year 2 of the project? Assume the machine is purchased in year zero and starts depreciating in year 1 of the project. $2,100,000 / $2,665,000 / $1,599,000 / $2,434,000 / $831,667 / $835,000 What are the incremental free cash flows associated with the new machine in year 0 of the project? -$5,000,000 / -$5,010,000 / -$5,500,000 / -$4,500,000 / -$835,000 / -$3,006,000

In Excel "Incremental Earnings Forecast" Answer: $2,434,000 In Excel "Incremental Earnings Forecast" Answer: -$5,010,000

You are considering adding a microbrewery onto one of your firm's existing restaurants. This will entail an investment of $47,000 in new equipment. This equipment will be depreciated straight-line over five years. If your firm's marginal corporate tax rate is 35%, then what is the value of the microbrewery's depreciation tax shield in the first year of operation? $9,400 / $16,450 / $6,110 / $30,550 / $3,290 / $47,000

Investment Cost = 47000 Equipment Life = 5 years Corporate tax rate = 0.35 Depreciation value = 47000 / 5 = 9400 Tax shield = dep*tax rate = 9400*0.35 = $3,290

Time Warner shares have a market capitalization of $50 billion. The company is expected to pay a dividend of $0.35 per share and each share trades for $40. The growth rate in dividends is expected to be 8% per year. ​ Also, Time Warner has $20 billion of debt that trades with a yield to maturity of 7​%. If the​ firm's tax rate is 25​%, what is the​ WACC? A. 7.84​% B. 7.45​% C. 8.62​% D. 6.66​% Time Warner shares have a market capitalization of $40 billion. The company is expected to pay a dividend of $0.25 per share and each share trades for $20. The growth rate in dividends is expected to be 8​% per year. ​ Also, Time Warner has $15 billion of debt that trades with a yield to maturity of 7​%. If the​ firm's tax rate is 25​%, what is the​ WACC? A. 6.94​% B. 7.75​% C. 8.98​% D. 8.16​% The market value of​ Fords' equity, preferred stock and debt are $6 ​billion, $3billion and $10billion respectively. Ford has a beta of 1.4​, the market risk premium is 8​% and the​ risk-free rate of interest is 4​%. ​ Ford's preferred stock pays a dividend of $5 each year and trades at a price of $30 per share. ​ Ford's debt trades with a yield to maturity of 9​%. What is​ Ford's weighted average cost of capital if its tax rate is 25​%?

MV of debt = 20 billion & MV of equity = 50 billion Step 1: MV of assets = MV of equity + MV of debt = 50 billion + 20 billion = 70 billion Step 2: Weight = mv of debt or equity / total mv of firm Debt: weight = 20 billion/70 billion = 0.285714 = 28.57% Equity: weight = 50 billion/70 billion = 0.714286 = 71.43% Step 3: Cost of equity = (Div1 / current price) + g = (0.35 / 40) + 0.08 = 0.08875 Step 4: Debt capital = YTM = 7% = 0.07 Step 5: rwacc = (cost of equity * equity weight) + (debt capital * (1 - corporate tax rate) * debt weight) = (0.08875*0.714286) + (0.07*(1-0.25)*0.285714) = 0.078393 = 7.84% Answer: A. 7.84% MV of debt = 15 billion & MV of equity = 40 billion Step 1: MV of assets = MV of equity + MV of debt = 40 billion + 15 billion = 55 billion Step 2: Weight = mv of debt or equity / total mv of firm Debt: weight = 15 billion/55 billion = 0.272727 Equity: weight = 40 billion/55 billion = 0.727273 Step 3: Cost of equity = (Div1 / current price) + g = (0.25 / 20) + 0.08 = 0.0925 Step 4: Debt capital = YTM = 7% = 0.07 Step 5: rwacc = (cost of equity * equity weight) + (debt capital * (1 - corporate tax rate) * debt weight) = (0.0925*0.727273) + (0.07*(1-0.25)*0.272727) = 0.081591 = 8.16% Answer: 8.16% MV of debt = 10 billion & MV of equity = 6 billion * preferred = 3 billion Step 1: MV of assets = MV of equity + MV of debt = 10+6+3 = 19 billion Step 2: Weight = mv of debt or equity / total mv of firm Debt: weight = 10/19 = 0.526316 Equity: weight = 6/19 = 0.315789 Preferred weight = 3/19 = 0.157895 Step 3: rE = risk-free rate + equity beta * market risk premium = 0.04 + 1.4 * 0.08 = 0.152 rpfd = dividends / price of preferred stock = 5/ 30= 0.166667 = (0.152*0.315789)+(0.166667*0.157895)+(0.09*(1-0.25)*0.526316) = 0.109842 = 10.98%

Assume that at the end of 2019, Global Corporation had 3.6 million shares outstanding which traded at $10 per share on a stock exchange. If the company reported $170.1 mil. in assets, $147.9 mil. in liabilities, and $22.2 in stockholder equity on its end-of-2019 balance sheet, what was the company's market-to-book ratio at the end of 2019? $22.2 mil / 0.21 / $36 mil / 0.62 / 4.09 / 1.62

MV of equity = $10 * 3.6 mil shares = $36 million Global's 2019 BV of equity = 22.2 M-to-B ratio = 36 mil / 22.2 = 1.62

For each 1% change in the market portfolio's excess return, the investment's excess return is expected to change by ________ due to risks that it has in common with the market. a. alpha percent b. 0% c. risk-free rate d. 1% e. delta percent f. beta percent

f. beta percent

If in 2006 Luther has 10.2 million shares outstanding and these shares are trading at​ $16 per​ share, then​ Luther's market-to-book ratio would be closest​ to: (Total equity on book = 126.8 million) If in 2006 Luther has 10.2 million shares outstanding and these shares are trading at​ $16 per​ share, then​ Luther's market-to-book ratio would be closest​ to: (Total equity on book = 125.4 million)

Market capitalization = price per share * # of shares = $16 * 10.2 mil shares = $163200000 Market-to-book ratio = MV of equity / BV of equity = 163200000 / 126800000 = 1.287066 = 1.29% Market capitalization = price per share * # of shares = $16 * 10.2 mil shares = $163200000 Market-to-book ratio = MV of equity / BV of equity = 163200000 / 125400000 = 1.301435 = 1.3%

An auto-parts company is deciding whether to sponsor a racing team for a cost of $1 million. The sponsorship would last for three years and is expected to increase cash flows by $590,000 per year. If the discount rate is 6.9%, what will be the change in the value of the company if it chooses to go ahead with the sponsorship? $551,180 / $499,482 / $846,622 / $626,107 / $796,588 / $710,000 An auto-parts company is deciding whether to sponsor a racing team for a cost of $1 million. The sponsorship would last for three years and is expected to increase cash flows by $570,000 per year. If the discount rate is 6.9%, what will be the change in the value of the company if it chooses to go ahead with the sponsorship? $847,615 / $498,597 / $710,000 / $547,896 / $797,756 / $625,102

Multiyear NPV = (-immediate cost) + (benefit/(1+r)) + (benefit/(1+r)^2) + (benefit/(1+r)^3) + ... -1000000 + (590000/1.069) + (590000/(1.069)^2) + (590000/(1.069)^3) = 551179.713059 NPV = $551,180 Multiyear NPV = (-immediate cost) + (benefit/(1+r)) + (benefit/(1+r)^2) + (benefit/(1+r)^3) + ... -1000000 + (570000/1.069) + (570000/(1.069)^2) + (570000/(1.069)^3) = 498597.349904 NPV = $498,597

The Gamma Company is planning on investing in a new project. This project requires an initial investment into a new machinery of $450,000. The Gamma Company expects cash inflows from this project to be as follows: $200,000 in year 1, $225,000 in year 2, $275,000 in year 3, and $200,000 in year 4 of the project. If the appropriate discount rate for this project is 17% then the NPV of the project is closest to _____________________. $219,837 / $248,632 / $139,947 / $163,738 / $208,267 / $195,630 What's the IRR? 30.9% / 39.2% / 27.4% / 34.1% / 24.3% / 21.5% The Gamma Company is planning on investing in a new project. This project requires an initial investment into a new machinery of $420,000. The Gamma Company expects cash inflows from this project to be as follows: $200,000 in year 1, $225,000 in year 2, $275,000 in year 3, and $200,000 in year 4 of the project. If the appropriate discount rate for this project is 16% then the NPV of the project is closest to _____________________. $189,737 / $144,385 / $236,552 / $197,850 / $216,578 / $206,265 What's the IRR? 24.8% / 35.7% / 38.4% / 31.2% / 28.6% / 26.7%

Multiyear NPV = (-immediate cost) + (benefit/(1+r)) + (benefit/(1+r)^2) + (benefit/(1+r)^3) + ... -450000 + (200000/1.17) + (225000/(1.17)^2) + (275000/(1.17)^3) + (200000/(1.17)^4) = 163737.632587 NPV = $163,738 IRR in calc = 34.1197% All in calculator: NPV = $206,265 IRR = 38.434%

You have an opportunity to invest $100,000 now in return for $80,000 in one year and $30,000 in two years. If your cost of capital is 9.0%​, what is the NPV of this​ investment?

Multiyear NPV = (-immediate cost) + (benefit/(1+r)) + (benefit/(1+r)^2) + (benefit/(1+r)^3) + ... = (-100000) + (80000 / 1.09) + (30000 / (1.09)^2) = -1355.104789

RiverRocks, Inc., is considering a project with the following projected free cash​ flows: (Year # & $ in millions) 0=-50.2 / 1=9.3 / 2=19.4 / 3=19.1 / 4=14.3 The firm believes​ given the risk of this​ project, the WACC method is the appropriate approach to valuing the project.​ RiverRocks' WACC is 11.1%. Should it take on this​ project? Why or why​ not?

Multiyear NPV = (-immediate cost) + (benefit/(1+r)) + (benefit/(1+r)^2) + (benefit/(1+r)^3) + ... = -50.2 + (9.3/(1+0.111)) + (19.4/(1+0.111)^2) + (19.1/(1+0.111)^3) + (14.3/(1+0.111)^4) = -2.798 million RiverRocks should not take on this project because the NPV is negative.

Ford has a weighted average cost of capital of​ 8%. Ford is considering investing in a new plant that will save the company 30 million over each of the first two​ years, and then 20 million each year thereafter. If the initial investment is​ $300 million, what is the net present value​ (NPV) of the​ project? A. ​$250.00 million B. ​-$32.16 million C. ​-$50.00 million D. ​$267.84 million

Multiyear NPV = (-immediate cost) + (benefit/(1+r)) + (benefit/(1+r)^2) + (benefit/(1+r)^3) + ... Thereafter: 20mil/0.08 = 250000000 -300000000 + (30000000/1.08) + ((30000000 + 250000000)/(1.08)^2) = -32,167,352.537723 Answer: B. -$32.16 million

All of the following is a source of cash except: -increase in short-term debt -decrease in inventory -increase in common stock -increase in accounts payable -increase in accounts receivable

increase in accounts receivable

A firm is considering investing in a new project with an upfront cost of $650 million. The project will generate an incremental free cash flow of $51 million in the first year and this cash flow is expected to grow at an annual rate of 2.5% forever. If the firm's WACC is 9.5%, what is the net present value of this project? a. $96.8 million b. $78.6 million c. $1.397 billion d. $746.8 million e. $728.6 million f. $1.379 billion A firm is considering investing in a new project with an upfront cost of $400 million. The project will generate an incremental free cash flow of $50 million in the first year and this cash flow is expected to grow at an annual rate of 3% forever. If the firm's WACC is 12%, what is the net present value of this project? a. $555.6 million b. $523.3 million c. $155.6 million d. $123.3 million e. $183.3 million f. $583.3 million

NPV = -(initial costs) + (FCF1 / (r - g)) r = WACC NPV = -650000000 + (51000000 / (0.095 - 0.025)) = 78,571,428.571428 Answer: b. $78.6 million NPV = -(initial costs) + (FCF1 / (r - g)) r = WACC NPV = -400000000 + (50000000 / (0.12 - 0.03)) = 155555555.555556 Answer: c. $155.6 million

RiverRocks​ (whose WACC is 12.1​%) is considering an acquisition of Raft Adventures​ (whose WACC is 14.2​%). The purchase will cost $103.3 million and will generate cash flows that start at $15.9 million in one year and then grow at 4.3% per year forever. What is the NPV of the​ acquisition?

NPV = -(initial costs) + (FCF1 / (r - g)) r = WACC of Raft Adventures = 14.2% NPV = -103.3 + (15.9 / (0.142 - 0.043)) NPV = $57.31 million

You are preparing to produce some goods for sale. You will sell them in one year and you will incur costs of $81,000 immediately. If your cost of capital is 7.5%​, what is the minimum dollar amount you need to sell the goods for in order for this to be a​ non-negative NPV?

NPV = PV(Benefits) - PV(Costs) NPV = (FV / (1 + r)) - PV(Costs) >= 0 FV = PV(Costs) * (1 + r) FV = 81000 * 1.075 Answer: $87,075

An elderly relative offers to sell you their used 1958 Cadillac Eldorado for $52,000. You note that very similar cars are selling on the open market for $87,000. You don't care for classic cars and would rather buy a new Ford Explorer for $35,000. What is the net value of buying the Cadillac? -$35,000, since this is the value of the car that you really want to buy. -$52,000, since the Cadillac could be bought for this price. -$0, since you do not care for classic cars and have no use for the Cadillac -$87,000, since the Cadillac could be sold for this price. -$35,000, since this is the difference between purchase and resale price of the Cadillac.

Net value = difference between cost/benefit 1 year Cadillac = 52,000 Similar = 87,000 Ford = 35,000 benefit of similar (87,000) - cost of Cadillac (52,000) = net value ($35,000) Answer: $35,000, since this is the difference between purchase and resale price of the Cadillac.

The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. If her discount rate is 5.5%, should she accept the project? (Graph description: a downward sloping line from left to right that crosses over 0 into negative #s around 3.5% discount rate)

No, because the NPV is negative at that rate.

An unlevered firm is financed ____________________ . -only by zero-coupon bonds -only by debt -only by equity -only by amortizing loans -only by revolving debt facilities -by a blend of debt and equity

Only by equity

A: i=$135,000, npv=$14,000 / B: i=200,000, npv=30,000 / C: i=125,000, npv=20,000 / D: i=150,000, npv=27,000 / E: i=175,000, npv=25,000 / F: i=75,000, npv=13,000 Assuming that your capital is constrained, which project should you invest in first? Project D / Project C / Project F / Project B / Project A / Project E

PI = NPV / resource consumed A: 14000/135000 = 0.103704 B: 30000/200000 = 0.15 C: 20000/125000 = 0.16 D: 27000/150000 = 0.18 (highest) E: 25000/175000 = 0.142857 F: 13000/75000 = 0.173333 Answer: Project D

A retail coffee company is planning to open 105 new coffee outlets that are expected to generate $14.9 million in free cash flows per​ year, with a growth rate of 2.8% in perpetuity. If the coffee​ company's WACC is 9.6%​, what is the NPV of this​ expansion?

PV = FCF1 / (rWACC - g) PV = 14900000 / (0.096 - 0.028) = 219117647.058824 = $219.12 million

A firm issues 5-year bonds with a coupon rate of 4.7%, paid semiannually. The credit spread for this firm's 5-year debt is 1.2%. New 5-year Treasury notes are being issued at par with a coupon rate of 5.1%. What should the price of the firm's outstanding 5-year bonds be if their face value is $1,000? $931.65 / $1035.71 / $1247.67 / $933.15 / $932.28

PV in calc (with semiannual conversions) FV = 1,000 YTM = (treasury rate + credit spread) / 2 payments = (5.1 + 1.2) / 2 = 3.15% PMT = face value (coupon rate / 2) = 1,000 (0.047 / 2) = $23.5 N = 5 years * 2 payments per year = 10 total periods PV = ? = $932.28

How is preferred stock similar to​ bonds? -Dividend payments to preferred shareholders​ (much like bond interest payments to​ bondholders) are tax deductible. -Preferred stock is not like bonds in any way. -Preferred stockholders expect to receive a stated value at maturity (much like bondholders do). -Investors can sue the firm if preferred dividend payments are not paid​ (much like bondholders can sue for nonpayment of interest​ payments). -Preferred stockholders receive a dividend payment​ (much like interest payments to​ bondholders) that is usually fixed.

Preferred stockholders receive a dividend payment​ (much like interest payments to​ bondholders) that is usually fixed.

Most corporations measure the value of a project in terms of which of the following? -present value (PV) -discount factor -interest rate factor -future value (FV) -discount value

Present value (PV)

The outstanding bonds of Dane Corp. have ten years to maturity, 6.50% coupon rate, annual coupon, price of $93 per $100 face value. What is the estimate of the pretax cost of debt if the tax rate is 30%? 5.16% / 7.52% / 6.60% / 5.26% / 7.37% / 4.62% The outstanding bonds of Robox Corp. have ten years to maturity, 6.65% coupon rate, annual coupon, and a price of $95 per $100 face value. What is the estimate of the pretax cost of debt if the tax rate is 30%? 7.52% / 5.16% / 4.62% / 6.60% / 7.37% / 5.26%

Pretax cost of debt is = to YTM In calc: n=10, pv=-93, pmt=6.5, fv=100 YTM = 7.521% So, pretax cost of debt = 7.52% Pretax cost of debt is = to YTM In calc: n=10, pv=-95, pmt=6.65, fv=100 YTM = 7.521% So, pretax cost of debt = 7.374%

In​ 2007, interest rates were about​ 4.5% and inflation was about​ 2.8%. What was the real interest rate in ​2007, approximately? 2.0% / 1.7% / 6.1% / 1.5% / 7.3%

Real interest rate = (nominal rate - inflation rate) / (1 + inflation rate) (4.5 - 2.8) / (1 + 0.028) = 1.653696% Answer = 1.7%

A Xerox DocuColor photocopier costing $44,000 is paid off in 60 monthly installments at 6.90% APR. After three years the company wishes to sell the photocopier. What is the minimum price for which they can sell the copier so that they can cover the cost of the balance remaining on the loan? $28,191 / $15,546 / $19,433 / $21,676 / $23,319 / $25,804 A homeowner has five years of monthly payments of $1,100 before she has paid off her house. If the interest rate is 7​% ​APR, what is the remaining balance on her​ loan? A. $44,442 B. $55,552 C. $66,663 D. $77,773

Remaining balance = PV of remaining months (3 years * 12 months = 36 periods) & (6.9/12=0.575%) Step 1: find PMT in calc (n=60,i/y=0.575,pv=44,000,fv=0) PMT = $869.18 Step 2: 60 months - 36 = 24 remaining months Step 3: new PV in calc (n=24,i/y=0.575,pmt=869.18, fv=0) PV= $19,432.89 Answer: $19,433 5year * 12 months = 60 per / 7 apr / 12=0.583333% pmt: remian months = 60 PV n=60, i/y=0.583333, pmt=1100, fv=0 = $55,552

FEX, a grocery store, is considering offering one-hour photo developing in their store. The firm expects that sales from the new one-hour machine will be $175,000 per year. FEX currently offers overnight film processing with annual sales of $90,000. While FEX expects that many of the one-hour photo sales will be to new customers, it also expects that some of the old customers will switch to the new one-hour machine. Specifically, FEX estimates that 40% of their current overnight photo customers will switch and use the one-hour service. Given these expectations, the level of incremental sales associated with introducing the new one hour photo service is closest to ________. $121,000 / $54,000 / $70,000 / $175,000 / $139,000 / $36,000

Revenue for new one-hour machine = 175000 Revenue for current overnight film processing = 90000 Revenue of current customers switching services = current revenue * % of switches = 90000 * 0.4 = 36000 Incremental sales for new one-hour machine = revenue for new machine - revenue of switches = 175000 - 36000 = 139000 Answer: $139,000

A graphic designer needs a new laptop and notices that he can pay $2600 for a Dell XPS laptop upfront, or lease it from the manufacturer for monthly payments of $75 each for four years. The designer can borrow at an interest rate of 14% APR compounded monthly. What is the cost of leasing the laptop over buying it outright it terms of dollars today? -Leasing costs $22 more than buying -Leasing costs $145 less than buying. -Leasing costs $116 less than buying. -Leasing costs $116 more than buying. -Leasing costs $145 more than buying. -Leasing costs $22 less than buying

Step 1: Find monthly rate with compounding APR / 12 months per year = 14% / 12 = 1.166667% month Step 2: Find PV of monthly payments with annuity discount rate → 4 years * 12 months = 48 periods (N=48, I/Y=1.166667, PMT=75, FV=0) → PV = $2,744.59 Step 3: Find the value → 2,744.59 - 2,600 = $144.59 Answer: Leasing costs $145 more than buying.

Assume CornerStore has debt with a book (par) value of $41 million, trading at 120% of par value. The firm has book equity of $45 million, and 850 thousand common shares outstanding trading at $96.50 per share. What weights should CornerStore use in calculating its WACC? a. 40.9% for debt, 59.1% for equity b. 33.3% for debt, 66.7% for equity c. 49.3% for debt, 50.7% for equity d. 57.2% for debt, 42.8% for equity e. 43.8% for debt, 56.2% for equity f. 37.5% for debt, 62.5% for equity Assume JUP has debt with a book value of $22 ​million, trading at​ 120% of par value. The firm has book equity of $22 ​million, and 2 million shares trading at $20 per share. What weights should JUP use in calculating its​ WACC? mv of debt = 22000000*1.2 = 26400000 mv of equity = 2000000*20 = 40000000 total = 40000000 + 26400000 = 66400000 debt weight = 26400000/66400000 = 0.39759 equity weight = 40000000/66400000 = 0.60241

Step 1: calculate MV of debt & equity MV of debt = BV of debt * % of par value traded at MV of debt: 41,000,000 * 1.2 = 49,200,000 MV of equity = # of shares outstanding * price per share MV of equity: 850,000 * 96.50 = 82,025,000 Step 2: calculate total MV of the firm MV of assets = MV of equity + MV of debt = 82,025,000 + 49,200,000 = 131,225,000 Step 3: calculate weights Weight = MV of debt or equity / total MV of firm For equity: weight = 82,025,000 / 131,225,000 = 0.625071 = 62.5% For debt: weight = 49,200,000 / 131,225,000 = 0.374929 = 37.5% Answer: f. 37.5% for debt, 62.5% for equity

Investment A: 0=-$1 mil / 1=$300,000 / 2=$400,000 / 3=$500,000 Investment B: 0=-$1 mil / 1=$500,000 / 2=$400,000 / 3=$300,000 An investor is considering the two mutually exclusive investments shown above. Her cost of capital is 8%. Which of the following statements about the investor's choice is the most accurate? -The investor should take investment A since it has a greater net present value (NPV). -The investor should take investment B since it has a greater net present value (NPV). -The investor should take investment A since it has a greater internal rate of return (IRR). -The investor should take both investments since both have positive net present value (NPV). -The investor should take both investments since both have positive internal rate of return (IRR).

Step 1: calculate NPV since & choose the highest since it's a better predictor of value than IRR. Multiyear NPV = (-immediate cost) + (benefit/(1+r)) + (benefit/(1+r)^2) + (benefit/(1+r)^3) + ... A: -1000000 + (300000/1.08) + (400000/(1.08)^2) + (500000/(1.08)^3) = $17,629.43 B: -1000000 + (500000/1.08) + (400000/(1.08)^2) + (300000/(1.08)^3) = $44,048.16 Answer: The investor should take investment B since it has a greater net present value (NPV).

A stationery company plans to launch a new type of indelible ink pen. Advertising for the new product will be heavy and will cost the company $8 million next year, although the company expects general revenues of $280 million next year from sources other than sales of the new pen. If the company has a corporate tax rate of 35% on its pretax income, what effect will the advertising for the new pen have on its taxes? a. It will increase taxes by $2.8 million. b. It will reduce taxes by $2.8 million. c. It will have no effect on taxes. d. It will increase taxes by $8 million. e. It will reduce taxes by $5.2 million. f. It will increase taxes by $5.2 million. Ford Motor Company is considering launching a new line of hybrid​ diesel-electric SUVs. The heavy advertising expenses associated with the new SUV launch would generate operating losses of $40 million next year. Without the new​ SUV, Ford expects to earn pretax income of $70 million from operations next year. Ford pays a 20​% ​tax-rate on its pretax income. The amount that Ford Motor Company owes in taxes next year with the launch of the new SUV is closest​ to:

Step 1: calculate taxes owed next year without the new product line Taxes owed next year = pretax income * tax rate on pretax income = 280000000*0.35 = 98000000 Step 2: calculate pretax income next year with new product line Pretax income with new product line = pretax income - operating losses = 280000000-8000000 = 272000000 Step 3: calculate taxes owed next year with the new product line Taxes owed next year = pretax income * tax rate on pretax income = 272000000*0.35 = 95200000 Step 4: calculate the incremental tax associated with the new product line Incremental tax = taxes owed without new product line - taxes owed with new product line = 98000000 - 95200000 = 2800000 Answer: b. It will reduce taxes by $2.8 million. taxes owed without: 70000000*0.2 = 14000000 pretax income with: 70000000-40000000 = 30000000 taxes owed with: 30000000*0.2 = 6,000,000

Shore Services has 1.2 million shares outstanding. It expects earnings at the end of the year of $6.0 million. Shore pays out 60% of its earnings in total: 40% paid out as dividends and 20% used to repurchase shares. If Shore's earnings are expected to grow by 5% per year, these payout rates do not change, and Shore's equity cost of capital is 10%, what is Shore's share price? $48 / $12 / $72 / $60 / $36 / $24

Step 1: calculate total payouts = payout plan % * expected earnings = 0.6 * $6 mil = $3,600,000 Step 2: calculate the PV (future total dividends & repurchases) with constant growth rate perpetuity PV = total payouts / (rE - g) PV = 3600000 / (0.1 - 0.05) = $72,000,000 Step 3: calculate share price with total payout model P0 = PV(future total dividends & repurchases) / # of shares outstanding P0 = 72000000 / 1.2 mil P0 = $60

What is the yield to maturity of a(n) eight-year, $5000 bond with a 4.4% coupon rate and semiannual coupons if this bond is currently trading for a price of $4723.70? 5.264% / 6.317% / 5.255% / 2.632% / 2.627% What is the yield to maturity of a five​-year, $10,000 bond with a 4.6​% coupon rate and semiannual coupons if this bond is currently trading for a price of $9,682​?

Step 1: convert to semiannual 8 years * 2 payments = 16 total periods 4.4% coupon rate / 2 payments = 2.2% semiannually PMT = coupon rate * face value = 0.022 * 5,000 = $110 Step 2: I/Y in calc (n=16,pv=-4723.70,pmt=110,fv=5000) I/Y = 2.627% Step 3: convert to APR. 2.627 * 2 = 5.254% Answer: 5.255% Step 1: convert to semiannual 5 years * 2 payments = 10 total periods 4.6% coupon rate / 2 payments = 2.3% semiannually PMT = coupon rate * face value = 0.023 * 10,000 = $230 Step 2: I/Y in calc (n=10,pv=-9682,pmt=230,fv=10000) I/Y = 2.666% Step 3: convert to APR. 2.666* 2 = 5.332% Answer: 5.332%

A project requires an initial investment of $1.265 million. It expects to generate a perpetual cash flow. The first year cash flow is expected at $95,000. The cash flows are then expected to grow at 2.5% forever. If the cost of capital for this project is 12%, what is the project's NPV? -$0.265 million / $1.000 million / $0.265 million / -$0.480 million / -$0.174 million / $0.174 million What's the IRR? -IRR is 11.0%; project should not be accepted -IRR is 10.0%; project should be accepted -IRR is 10.5%; project should not be accepted -IRR is 10.5%; project should be accepted -IRR is 10.0%; project should not be accepted -IRR is 11.0%; project should be accepted A project requires an initial investment of $1.2 million. It expects to generate a perpetual cash flow. The first year cash flow is expected at $100,000. The cash flows are then expected to grow at 1.25% forever. The appropriate cost of capital for this project is 11%. What is the project's IRR and should it be accepted based on the IRR rule? -IRR is 9.6%; project should not be accepted -IRR is 9.6%; project should be accepted -IRR is 10.6%; project should be accepted -IRR is 10.6%; project should not be accepted -IRR is 11.6%; project should not be accepted -IRR is 11.6%; project should be accepted

Step 1: find PV of cash flows PV(cf) = cash flow / (r - g) PV(cf) = 95,000 / (0.12 - 0.025) PV(cf) = 1,000,000 Step 2: calculate NPV NPV = PV(Benefits - PV(Costs) NPV = $1 mil - $1.265 mil = -265,000 NPV = -$0.265 million IRR: r = (CF1 / CF0) + g r = (95000 / 1265000) + 0.025 = 0.100099 r = 10.0% (which is less that cost of capital at 12%) Answer: IRR is 10.0%; project should not be accepted IRR = (CF1 / CF0) + g = (100000 / 1200000) + 0.0125 = 0.095833 = 9.58% (IRR is less than cost of capital at 11%) Answer: IRR is 9.6%; project should not be accepted

A car dealership offers a car for $28,000, with up to one year to pay for the car. If the interest rate is 5%, what is the net present value (NPV) of this offer to buyers who elect not to pay for the car for one year? $1,400 / $28,000 / $26,667 / -$1,400 / -$1,333 / $1,333

Step 1: find the PV of Costs PV / (1 + r) 28,000 / 1.05 $26,666.67 Step 2: calculate the NPV NPV = PV(Benefits) - PV(Costs) NPV = 28000 - 26,666.67 = $1,333.33

A ten-year, zero-coupon bond with a yield to maturity of 4% has a face value of $1000. An investor purchases the bond when it is initially traded, and then sells it four years later. What is the annual rate of return of this investment, assuming the yield to maturity does not change? 2.40% / 3.20% / 3.80% / 4.00% / 2.00%

Step 1: find years left until maturity 10 - 4 = 6 years Step 2: find PV of the 6 years left P = face value / (1 + r)^n = 1000 / 1.04^6 = $790.314526 Step 3: find PV of full 10 years = 1000 / 1.04^10 = $675.564169 Step 4: find rate of return with 4 years Rate of return = (face value / price) ^1/n - 1 Rate of return = (pv remaining / pv maturity) ^1/n - 1 = (790.314526 / 675.564169) ^1/4 - 1 = 0.04 Answer: 4%

Spacefood Products has just paid a dividend of $2.40 per share. It is expected that this dividend will grow by 5% per year each year in the future. What will be the current value of a single share of Spacefood's stock if the firm's equity cost of capital is 12%? $24.00 / $34.29 / $28.50 / $30.86 / $36.00 / $22.29

Stock value with constant dividend growth: If P0 = Div1 / (rE - g), then P0 = (Div0 * (1 + g)) / (rE - g) P0 = (2.4 * 1.05) / (0.12 - 0.05) P0 = $36

The internal rate of return​ (IRR) is the interest rate that sets the net present value​ (NPV) of the cash flows equal to zero. -True -False

True

Your estimate of the market risk premium is 8%. The risk-free rate of return is 1.5% and the stock of Southwest Airlines (LUV) has a beta of 1.26. What is Southwest Airlines' cost of equity capital under these assumptions? 10.08% / 10.76% / 10.98% / 9.89% / 11.58% / 9.69% Your estimate of the market risk premium is 6%. The risk-free rate of return is 1% and General Motors has a beta of 1.6. What is General Motors' cost of equity capital under these assumptions? 9.0% / 13.7% / 10.6% / 15.2% / 9.6% / 14.4%

Use CAPM where cost of equity capital = risk-free rate + equity beta * market risk premium = 0.015 + 1.26 * 0.08 = 0.1158 = 11.58% Use CAPM where cost of equity capital = risk-free rate + equity beta * market risk premium = 0.01 + 1.6 * 0.06 = 0.106 = 10.6%

Wild​ Swings, Inc.'s stock has a beta of 2.5. If the​ risk-free rate is 6.0% and the market risk premium is 7.0%​, what is an estimate of Wild​ Swings' cost of​ equity?

Use CAPM where cost of equity capital = risk-free rate + equity beta * market risk premium = 0.06 + 2.5 * 0.07 = 0.235 = 23.5%

HighGrowth Company has a stock price of $21. The firm will pay a dividend next year of $1.18​, and its dividend is expected to grow at a rate of 4.5% per year thereafter. What is your estimate of​ HighGrowth's cost of equity​ capital?

Use CDGM with Div1 where cost of equity capital = (Div1 / current price) + g = (1.18 / 21) + 0.045 = 0.10119 = 10.12%

Year 1 = $97.25 / Year 2 = $94.53 / Year 3 = $91.83 / Year 4 = $89.23 / Year 5 = $87.53 The above table shows the price per $100-face value bond of several risk-free, zero-coupon bonds. What is the yield to maturity of the two-year, zero-coupon, risk-free bond shown? 2.85% / 2.83% / 1.43% / 2.89% / 5.79%

Use the YTM equation to solve year 2. YTM = (face value / price) ^1/n - 1 = (100 / 94.53) ^1/2 - 1 = 0.028526 = 2.85%

Assume General Energy just paid a dividend of $2 per share. Analysts expect the dividends to grow at 10% for next two years. After that, the dividend growth rate is expected to decline to a long-term perpetual growth rate of 2%. If the cost of equity capital for General Energy is 6%, what is the value estimate of its stock price today? $52.14 / $60.50 / $50.18 / $55.00 / $48.33 / $59.15

Valuing a firm with changing growth rates (no payout) (N = last year used in equation) Step 1: create timeline Year 0 = ? / Year 1 = 2*(1+0.1) / Year 2 = 2*(1+0.1)^2 / Year 3 = PN ... Step 2: calculate PN PN = (DivN + (1+g)) / (rE - g) PN = ((2*(1+0.1)^2)*(1+0.02)/(0.06-0.02) PN = $61.71 Step 3: calculate current price P0=(P1/(1+rE))+(P2/(1+rE)^2)+(P3/(1+rE)^3)+(PN/(1+rE)^N) P0 = ((2*1.1)/1.06) + ((2*(1.1)^2)/1.06^2) + (61.71/1.06^2) P0 = $59.150943 P0 = $59.15

Molson Coors Beverage Co, a manufacturer of beverages, is planning to purchase Cedar Fair theme parks. Molson Coors should use the ________ to evaluate the purchase of the business of Cedar Fair. -WACC of Cedar Fair -WACC of Molson Coors -average WACC of beverage industry -divisional cost of capital -average market return -blended WACC of Cedar and Molson

WACC of Cedar Fair

Mackenzie Company has a price of $36 and will issue a dividend of $2.00 next year. It has a beta of 1.5​, the​ risk-free rate is 5.5%​, and the market risk premium is estimated to be 4.8%. a. Estimate the equity cost of capital for Mackenzie. b. Under the​ CDGM, at what rate do you need to expect​ Mackenzie's dividends to grow to get the same equity cost of capital as in part(a​)?

a. Use CAPM where equity cost of capital = risk-free rate + equity beta * market risk premium = 0.055 + 1.5 * 0.048 = 0.127 = 12.7% b. g = equity cost of capital - (Div1 / P) g = 0.127 - (2 / 36) = 0.071444 = 7.14%

Walmart expects to pay a dividend of $2.28 next year and you expect these dividends to grow at 3.8% a year into indefinite future. The stock price of Walmart is $139 per share. What is your estimate of the Walmart's cost of equity capital? 5.44% / 1.64% / 5.50% / 4.88% / 2.16% / 4.93% IBM expects to pay a dividend of $6.52 next year and you expect these dividends to grow at 4% a year into indefinite future. The price of IBM is $117 per share. What is your estimate of the IBM's cost of equity capital? 7.98% / 8.82% / 9.57% / 10.35% / 10.93% / 11.50%

Ways to find cost of equity: -CAPM: uses risk-free rate + equity beta * market risk premium -CDGM: uses (Div1 / current price) + g = ((Div0 * (1 + g)) / current price) + g Use CDGM & Div1 for Walmart. = (2.28 / 139) + 0.038 = 0.054403 = 5.44% CDGM: cost of equity capital = (Div1 / current price) + g = (6.52 / 117) + 0.04 = 0.095726 = 9.57%

A firm's overall cost of capital that is a blend of the costs of the different sources of capital is known as the firm's ________. -weighted average cost of capital -cost of equity infusion -cost of preferred stock -cost of common stock -cost of debt

Weighted average cost of capital

MACRS Year 0 Year 1 Year 2 Year 3 Dep rate 33.33% 44.45% 14.81% 7.41% A machine is purchased for $575,000 and is used through the end of Year 2. The machine will be depreciated using the 3-Year MACRS schedule in the table above. At the end of Year 2, the machine is sold for $75,000. What is the after-tax cash flow from the sale of the machine at the end of Year 2 if the firm's marginal tax rate is 35%? $32,392 / $63,663 / $42,608 / $15,916 / $75,000 / $86,337

Year 0 annual depreciation = 575000 * 0.3333 = 191647.5 Year 1 annual depreciation = 575000 * 0.4445 = 255587.5 Year 2 annual depreciation = 575000 * 0.1481 = 85157.5 Acc dep = 191647.5 + 255587.5 + 85157.5 = 532392.5 Book value = purchase price - acc dep = 575000 - 532392.5 = 42607.5 Capital gain = sale price - book value = 75000 - 42607.5 = 32392.5 After-tax cash flow = sale price - tax rate * capital gain = 75000 - 0.35 * 32392.5 = 63662.625 Answer: $63,663

An oil company is buying a​ semi-submersible oil rig for $30 million.​ Additionally, it will cost $1.5 million to move the oil rig to the​ oil-field and to prepare it for operations. If it is depreciated over six years using​ straight-line depreciation, what are the yearly depreciation expenses in this​ case? A. $6.0 million B. $5.0 million C. $4.8 million D. $5.3 million An oil company is buying a​ semi-submersible oil rig for $15 million.​ Additionally, it will cost $1.5 million to move the oil rig to the​ oil-field and to prepare it for operations. If it is depreciated over six years using​ straight-line depreciation, what are the yearly depreciation expenses in this​ case? A. $2.3 million B. $2.8 million C. $3.0 million D. $2.5 million

Yearly depreciation=depreciable basis / depreciable life (30000000+1500000)/6 = 5,250,000 Answer: D. $5.3 million Yearly depreciation=depreciable basis / depreciable life (15000000+1500000)/6 = 2,750,000 Answer: B. $2.8 million

Which of the statements below is TRUE? a. Accounting Identity is: Assets = Liabilities + Stockholders' Equity. b. Accounting Identity is: Assets = Stockholders' Equity − Liabilities. c. Accounting Identity is: Stockholders' Equity = Assets + Liabilities. d. Accounting Identity is: Assets = Liabilities − Stockholders' Equity. e. Accounting Identity is: Liabilities = Assets + Stockholders' Equity.

a. Accounting Identity is: Assets = Liabilities + Stockholders' Equity.

FastTrack​ Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $205,900 per year. Once in​ production, the bike is expected to make $288,224 per year for 10 years. The cash inflows begin at the end of year 7. (For parts​ a-b, assume the cost of capital is 10.2%). a. Calculate the NPV of this investment opportunity. Should the company make the​ investment? b. Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged. c. Calculate the NPV of this investment opportunity. Should the company make the​ investment? (assume the cost of capital is 14.8%)

a. In new NPV calc: https://www.calculatestuff.com/financial/npv-calculator $88,897.45 Accept because NPV is >= 0. b. In new IRR calc: https://www.calculatestuff.com/financial/irr-calculator 11.613% Max dev: 11.613 - 10.2 = 1.413 c. In new NPV calc: -$146,653.23 Reject because NPV is < 0.

Book Co. has 1.4 million shares of common equity with a par​ (book) value of $1.50​, retained earnings of $30.9 ​million, and its shares have a market value of $50.57 per share. It also has debt with a par value of $20.3 million that is trading at 105% of par. a. What is the market value of its​ equity? b. What is the market value of its​ debt? c. What weights should it use in computing its​ WACC?

a. MV of equity = # shares outstanding * price per share = 1400000 * 50.57 = 70,798,000 = $70.8 million b. MV of debt = debt value * % traded at par = 20300000 * 1.05 = 21,315,000 = $21.32 million c. Total MV of assets = MV of debt + MV of equity = 70.8 mil + 21.32 mil = 92,113,000 Debt weight = MV of debt / total assets = 21315000 / 92113000 = 0.231401 = 23.14% Equity weight = MV of equity / total assets = 70798000 / 92113000 = 0.768599 = 76.86%

You have been offered a unique investment opportunity. If you invest $8,200 ​today, you will receive $410 one year from​ now, $1,230 two years from​ now, and $8,200 ten years from now. a. What is the NPV of the opportunity if the cost of capital is 5.3% per​ year? Should you take the​ opportunity? b. What is the NPV of the opportunity if the cost of capital is 1.3% per​ year? Should you take it​ now?

a. Multiyear NPV = (-immediate cost) + (benefit/(1+r)) + (benefit/(1+r)^2) + (benefit/(1+r)^3) + ... NPV = -8200 + (410/1.053) + (1230/(1.053)^2) + (8200/(1.053)^10) = -1808.845738 NPV at 5.3% = -$1,808.85 You should not take this opportunity. b. NPV = -8200 + (410/1.013) + (1230/(1.013)^2) + (8200/(1.013)^10) = 609.788537 NPV = $609.79 You should take this opportunity.

Your factory has been offered a contract to produce a part for a new printer. The contract would last for 3 years and your cash flows from the contract would be $5.24 million per year. Your upfront setup costs to be ready to produce the part would be $7.83 million. Your discount rate for this contract is 8.5%. a. What does the NPV rule say you should​ do? b. If you take the​ contract, what will be the change in the value of your​ firm?

a. Multiyear NPV = (-immediate cost) + (benefit/(1+r)) + (benefit/(1+r)^2) + (benefit/(1+r)^3) + ... NPV= -7830000 + (5240000/1.085) + (5240000/(1.085)^2) + (5240000/(1.085)^3) NPV = 5,553,077.226153 = $5.55 million The NPV rule says that you should accept the contract because the NPV>0. b. Change in value = NPV Change in value = $5.55 million

You are choosing between two projects. The cash flows for the projects are given in the following table​ ($ million): (Project A: 0=-49 / 1=26 / 2=20 / 3=20 / 4=14) (Project B: 0=-100 / 1=18 / 2=42 / 3=49 / 4=60) a. What are the IRRs of the two​ projects? b. If your discount rate is 5.3%​, what are the NPVs of the two​ projects? c. Why do IRR and NPV rank the two projects​ differently?

a. Plug into calc IRR project A = 25.725% = 25.7% IRR project B = 20.645% = 20.6% b. Plug into calc NPV project A = $22.25 NPV project B = $45.74 c. NPV and IRR rank the two projects differently because they are measuring different things. 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 run a construction firm. You have just won a contract to build a government office complex. Building it will require an investment of $9.6 million today and $4.5 million in one year. The government will pay you $21.3 million in one year upon the​ building's completion. Suppose the interest rate is 10.8%. a. What is the NPV of this​ opportunity? b. How can your firm turn this NPV into cash​ today?

a. Step 1: find PV(Benefits) = FV / (1 + r) PV(Benefits) = 21300000 / 1.108 = 19223826.714801 PV(Benefits) = $19.22 million Step 2: find PV(Costs) = FV / (1 + r) PV(Costs) = 4500000 / 1.108 = 4061371.841155 PV(Costs) = $4.06 million Step 3: calculate NPV = PV(Benefits) - PV(Costs) NPV = $19.22 mil - $4.06 mil = $15.16 mil Step 4: subtract the initial investment as well NPV = 15.16 - 9.6 = $5.56 million b. The firm can borrow $19.22 million today and pay it back with 10.8% interest using the $21.3 million it will receive from the government.

Orchid Biotech Company is evaluating several different development projects for experimental drugs. Although the cash flows are difficult to​ forecast, the company has come up with the following estimates of the initial capital requirements and NPVs for the​ projects: (project #, initial capital $, # of research scientists, NPV $) (1, 10, 2, 10.1) / (2, 15, 3, 19) / (3, 15, 4, 22) / (4, 20, 3, 25) / (5, 30, 12, 60.2) Given a wide variety of staffing​ needs, the company has also estimated the number of research scientists required for each development project​ (all cost values are given in millions of​ dollars). a. Suppose that Orchid has a total capital budget of $60 million. How should it prioritize these​ projects? b. Suppose that Orchid currently has 12 research scientists and does not anticipate being able to hire more in the near future. How should Orchid prioritize these​ projects?

a. Step 1: find profitability index for each project PI = NPV / resource consumed p1 = 10.1 / 10 = 1.01 p2 = 19 / 15 = 1.27 p3 = 22 / 15 = 1.47 p4 = 25 / 20 = 1.25 p5 = 60.2 / 30 = 2.01 Step 2: prioritize starting with the highest PI to max cost 1. p5 (30) / 2. p3 (30+15=45) / 3. p2 (45+15=60) = budget b. Step 1: find NPV / headcount ratio PI = NPV / # of research scientists needed p1 = 10.1 / 2 = 5.1 p2 = 19 / 3 = 6.3 p3 = 22 / 4 = 5.5 p4 = 25 / 3 = 8.3 p5 = 60.2 / 12 = 5.0 Step 2: prioritize starting with highest PI to max head# 1. p4 (3) / 2. p2 (3+3=6) / 3. p3 (6+4=10) / 4. p1 (10+2=12) =budget

Which of the following is usually NOT a factor that must be considered when estimating the revenues and costs arising from a new product? a. the fluctuations in the cost of capital over the period in question b. the prices of technology products generally fall over time c. the sales of a new product will typically accelerate, plateau, and ultimately decline over time d. competition tends to reduce profit margins over time in most industries

a. the fluctuations in the cost of capital over the period in question

Whose interests should a financial manager consider paramount when making a financial decision? a. the creditors who extend loans to the company b. the stockholders who have risked their money to become owners of the company c. the public who consume the company's goods and services d. the senior management and associated colleagues at the executive level within the company e. the employees and associated stakeholders who are employed by the company

b. The stockholders who have risked their money to become owners of the company.

Which of the following costs would you consider when making a capital budgeting decision? a. past research and development cost b. opportunity cost c. interest cost d. fixed overhead cost e. sunk cost

b. opportunity cost

Which of the following bonds is trading at a premium? a. a ten-year bond with a $4,000 face value whose yield to maturity is 6.0% and coupon rate is 5.9% APR paid semiannually b. a seven-year zero coupon bond whose yield to maturity is 9.0% c. a five-year bond with a $2,000 face value whose yield to maturity is 7.0% and coupon rate is 7.2% APR paid semiannually d. a 15-year bond with a $10,000 face value whose yield to maturity is 8.0% and coupon rate is 7.8% APR paid semiannually e. a two-year bond with a $50,000 face value whose yield to maturity is 5.2% and coupon rate is 5.2% APR paid monthly

coupon rate above YTM = premium coupon rate same as YTM = par coupon rate below YTM = discount Answer: c. a five-year bond with a $2,000 face value whose yield to maturity is 7.0% and coupon rate is 7.2% APR paid semiannually

In general, it is possible to eliminate ________ risk by holding a large portfolio of assets. a. market specific b. systematic c. market-wide d. unsystematic e. unsystematic and systematic f. non-diversifiable

d. unsystematic

While ________ seems to be a reasonable measure of risk when evaluating a large portfolio, the ________ of an individual security does not explain the size of its average return. a. the mean return, variance b. mode, mean return c. the mean return, standard deviation d. mode, volatility e. volatility, volatility

e. volatility, volatility

A linear regression was done to estimate the relation between Sprint's stock returns and the market's return. The intercept of the line was found to be 0.23 and the slope was 1.47. Which of the following statements is true regarding Sprint's stock? a. The volatility of Sprint's stock returns is 1.47% b. The standard deviation of Sprint's returns is 23%. c. The risk-free rate is 1.47%. d. Sprint's beta is 0.23. e. Sprint's alpha is 1.47. f. Sprint's beta is 1.47.

f. Sprint's beta is 1.47. (because slope = beta)

AllCity, Inc., is financed 38% with​ debt, 6% with preferred​ stock, and 56% with common stock. Its pretax cost of debt is 6.4%​, its preferred stock pays an annual dividend of $2.46 and is priced at $33. It has an equity beta of 1.13. Assume the​ risk-free rate is 2%​, the market risk premium is 6.9% and​ AllCity's tax rate is 25%. What is its​ after-tax WACC? ​Note: Assume that the firm will always be able to utilize its full interest tax shield.

rwacc with preferred stock = (rE * E%) + (rpfd * P%) + (rD * (1 - TC) * D%) which = (cost of equity * equity weight) + (preferred capital * preferred stock weight) + (debt capital * (1 - corporate tax rate) * debt weight) rE = risk-free rate + equity beta * market risk premium = 0.02 + 1.13 * 0.069 = 0.09797 = 9.797% rpfd = dividends / price of preferred stock = 2.46 / 33 = 0.074545 = 7.4545% = (0.09797*0.56)+(0.074545*0.06)+(0.064*(1-0.25)*0.38) = 0.077576 = 7.76%