Ch. 13 FRL301 Common Final Test Bank, FRL301 Ch.21 Test Bank, FRL 301 Ch. 16 Test Bank, FRL301 Ch.14 Test Bank, Ch. 13 FRL301 Common Final Test Bank, FRL301 Ch. 10 Test Bank

Assume the current spot rate is C$1.2103 and the one-year forward rate is C$1.1952. The nominal risk-free rate in Canada is 3 percent while it is 4 percent in the U.S. Using covered interest arbitrage you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S.

$0.003 Arbitrage profit = [$1 (C$1.2103/$1) 1.03 ($1/C$1.1952)] - ($1 1.04) = $0.003

Assume the current spot rate is C$1.1875 and the one-year forward rate is C$1.1724. The nominal risk-free rate in Canada is 4 percent while it is 3 percent in the U.S. Using covered interest arbitrage you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S.

$0.023 Arbitrage profit = [$1 (C$1.1875/$1) 1.04 ($1/C$1.1724)] - ($1 1.03) = $0.023

Consider a project to supply 60,800,000 postage stamps to the U.S. Postal Service for the next 5 years. You have an idle parcel of land available that cost $760,000 five years ago; if the land were sold today, it would net you $912,000, aftertax. The land can be sold for $1,500,000 after taxes in 5 years. You will need to install $2,356,000 in new manufacturing plant and equipment to actually produce the stamps; this plant and equipment will be depreciated straight-line to zero over the project's 5-year life. The equipment can be sold for $456,000 at the end of the project. You will also need $469,000 in initial net working capital for the project, and an additional investment of $38,000 in every year thereafter. All net working capital will be recovered when the project ends. Your production costs are 0.38 cents per stamp, and you have fixed costs of $608,000 per year. Your tax rate is 31 percent and your required return on this project is 11 percent. What bid price per stamp should you submit?

$0.026

Suppose the Japanese yen exchange rate is ¥114 = $1, and the United Kingdom pound exchange rate is £1 = $1.83. Also suppose the cross-rate is ¥191 = £1. What is the arbitrage profit per one U.S. dollar?

$0.0923 $1 = ¥114 ¥114 (£1/¥191) = £0.596859 £0.596859 ($1.83/£1) = $1.0923 Profit = $1.0923 - $1 = $0.0923

Jefferson & Sons is evaluating a project that will increase annual sales by $138,000 and annual costs by $94,000. The project will initially require $110,000 in fixed assets that will be depreciated straight-line to a zero book value over the 4-year life of the project. The applicable tax rate is 32 percent. What is the operating cash flow for this project?

$38,720 OCF = ($138,000 - $94,000)(1 - 0.32) + ($110,000/4)(0.32) = $38,720

Fama's Llamas has a weighted average cost of capital of 10.5 percent. The company's cost of equity is 15.5 percent, and its pretax cost of debt is 8.5 percent. The tax rate is 34 percent. What is the company's target debt-equity ratio?

1.02 WACC = 0.105 = 0.155(E/V) + (0.085) (D/V) (1 - 0.34) 0.105(V/E) = 0.155 + 0.085(0.66) (D/E) 0.105(1 + D/E) = 0.155 + 0.0561(D/E) D/E = 1.02

Tidewater Fishing has a current beta of 1.48. The market risk premium is 8.9 percent and the risk-free rate of return is 3.2 percent. By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.60?

1.07 percent Increase in cost of equity = (1.60 - 1.48) 0.089 = 1.07 percent

What is the beta of the following portfolio? Stock/Amnt Invested/Beta A/$6700/1.58 B/$4900/1.23 C/$8500/0.79

1.16 ValuePortfolio = $6,700 + $4,900 + $8,500 = $20,100 BetaPortfolio = ($6,700/$20,100 1.58) + ($4,900/$20,100 1.23) + ($8,500/$20,100 0.79) = 1.16

The expected inflation rate in Finland is 2.8 percent while it is 3.7 percent in the U.S. A risk-free asset in the U.S. is yielding 4.9 percent. What approximate real rate of return should you expect on a risk-free Finnish security?

1.2 percent Approximate real rateF = Approximate real rateU.S = 0.049 - 0.037 = 1.2 percent

What is the expected return on this portfolio? A: E(r) 12%/#shares 300/$28 B: 12%/500/$10 C: 15%/600/$13

11.92 percent Portfolio value = (300 $28) + (500 $10) + (600 $13) = $8,400 + $5,000 + $7,800 = $21,200; E(r) = ($8,400/$21,200) (0.12) + ($5,000/$21,200) (0.07) + ($7,800/$21,200) (0.15) = 11.92 percent

You own a portfolio that has $2,000 invested in Stock A and $1,400 invested in Stock B. The expected returns on these stocks are 14 percent and 9 percent, respectively. What is the expected return on the portfolio?

11.94 percent E(Rp) = [$2,000/($2,000 + $1,400)] [0.14] + [$1,400/($2,000 + $1,400)] [0.09] = 11.94 percent

An unlevered firm has a cost of capital of 17.5 percent and earnings before interest and taxes of $327,500. A levered firm with the same operations and assets has both a book value and a face value of debt of $650,000 with a 7.5 percent annual coupon. The applicable tax rate is 38 percent. What is the value of the levered firm?

$1,407,286 VU = [$327,500 (1 - 0.38)]/0.175 = $1,160,285.71 VL = $1,160,285.71 + 0.38($650k) = $1,407,286

Cool Comfort currently sells 300 Class A spas, 450 Class C spas, and 200 deluxe model spas each year. The firm is considering adding a mid-class spa and expects that if it does it can sell 375 of them. However, if the new spa is added, Class A sales are expected to decline to 225 units while the Class C sales are expected to decline to 200. The sales of the deluxe model will not be affected. Class A spas sell for an average of $12,000 each. Class C spas are priced at $6,000 and the deluxe model sells for $17,000 each. The new mid-range spa will sell for $8,000. What is the value of the erosion?

$2,400,000 Erosion = [(300 - 225) x $12,000] + [(450 - 200) x $6,000] = $2,400,000

Consider the following income statement: SALES: 510944 COSTS: 332416 DEPRECIATION: 75600 EBIT: ? TAXES (32%): ? NI: ? What is the amount of the depreciation tax shield?

$24,192 Depreciation tax shield = $75,600 .32 = $24,192

What is the expected return and standard deviation for the following stock? State of Economy/Probability/RoR Recession/0.10/-0.19 Normal/0.60/0.14 Boom/0.30/0.35

17.00 percent; 15.24 percent E(R) = 0.10(-0.19) + 0.60(0.14) + 0.30(0.35) = 17.00 percent 2 = 0.10(-0.19 - 0.17)2 + 0.60(0.14 - 0.17)2 + 0.30(0.35 - 0.17)2 = 0.02322 = 0.02322 = 15.24 percent

Bruce & Co. expects its EBIT to be $100,000 every year forever. The firm can borrow at 11 percent. Bruce currently has no debt, and its cost of equity is 18 percent. The tax rate is 31 percent. Bruce will borrow $61,000 and use the proceeds to repurchase shares. What will the WACC be after recapitalization?

17.15 percent VU = $100,000(1 - 0.31)/0.18 = $383,333.33 VL = $383,333.33 + 0.31($61,000) = $402,243.33 RE = 0.18 + (0.18 - 0.11)($61,000/$402,243.33 - $61,000)(1 - 0.31) = 0.1886 WACC = 0.1886($402,243.33 - $61,000)/$402,243.33 + 0.11($61,000/$402,243.33) (1 - 0.31) = 17.15 percent

Winter's Toyland has a debt-equity ratio of 0.72. The pre-tax cost of debt is 8.7 percent and the required return on assets is 16.1 percent. What is the cost of equity if you ignore taxes?

21.43 percent RE = 0.161 + (0.161 - 0.087) 0.72 = 21.43 percent

Your firm is contemplating the purchase of a new $1,628,000 computer-based order entry system. The system will be depreciated straight-line to zero over its 5-year life. It will be worth $158,400 at the end of that time. You will save $633,600 before taxes per year in order processing costs and you will be able to reduce working capital by $115,764 (this is a one-time reduction). The net working capital will return to its original level when the project ends. The tax rate is 35 percent. What is the internal rate of return for this project?

21.65 percent OCF = $663,600(1 - 0.35) + ($1,628,000/5)(0.35) = $525,800

The expected return on JK stock is 15.78 percent while the expected return on the market is 11.34 percent. The stock's beta is 1.62. What is the risk-free rate of return?

4.18 percent E(r) = 0.1578 = rf + 1.62 (0.1134 - rf); rf = 4.18 percent

You observe that the inflation rate in the United States is 3.5 percent per year and that T-bills currently yield 3.8 percent annually. What do you estimate the inflation rate to be in Australia, if short-term Australian government securities yield 4.5 percent per year?

4.20 percent RUS - hUs = RFC - hFC 0.038 - 0.035 = 0.045 - hFC; hFC = 4.20 percent

Consider the following information on Stocks I and II: Recession/P0.06/A0.15/B-0.35 Normal/P0.25/A0.35/B0.35 Irrational Exuberance/P0.69/A0.43/B0.45 The market risk premium is 8 percent, and the risk-free rate is 3.6 percent. The beta of stock I is _____ and the beta of stock II is _____.

4.47; 4.26 E(RI) = 0.06(0.15) + 0.25(0.35) + 0.69(0.43) = 0.3932 BI: 0.3932 = 0.036 + BI (0.08); BI = 4.47 E(RII) = 0.06(-0.35) + 0.25(0.35) + 0.69(0.45) = 0.0377 BII: 0.0377 = 0.036 + BII (0.08); BII = 4.26

Jiminy's Cricket Farm issued a 30-year, 8 percent, semiannual bond 6 years ago. The bond currently sells for 114 percent of its face value. What is the aftertax cost of debt if the company's tax rate is 31 percent?

4.70 percent ENTER N: 24x2 IY /2 PV -1140 PMT 80/2 FV 1000 Solve for IY 6.81 0.0681(1-0.31)= 4.7%

Young's Home Supply has a debt-equity ratio of 0.80. The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent. What will the firm's cost of equity be if the debt-equity ratio is revised to 0.75?

14.23 percent WACC = [(1.0/1.8) 0.145] + [(0.8/1.8) 0.049] = 0.102333; WACC = 0.102333 = [(1.0/1.75) RE] + [(0.75/1.75) 0.049; RE = 14.23 percent

Samuelson Plastics has 7.5 percent preferred stock outstanding. Currently, this stock has a market value per share of $52 and a book value per share of $38. What is the cost of preferred stock?

14.42 percent Rp = (0.075 $100)/$52 = 14.42 percent

Suppose you observe the following situation: Security/Beta/E(r) Pete Corp//0.8/0.12 Repete Corp/1.1/0.16 Assume these securities are correctly priced. Based on the CAPM, what is the return on the market?

14.67 percent Rf : (0.12 - Rf)/0.8 = (0.16 - Rf)/1.1; Rf = 1.33 percent RM: 0.12 = 0.0133 + 0.8(RM - 0.0133); RM = 14.67 percent

Douglass & Frank has a debt-equity ratio of 0.45. The pre-tax cost of debt is 7.6 percent while the unlevered cost of capital is 13.3 percent. What is the cost of equity if the tax rate is 39 percent?

14.86 percent RE = 0.133 + (0.133 - 0.076) 0.45 (1 - 0.39) = 14.86 percent

The City Street Corporation's common stock has a beta of 1.2. The risk-free rate is 3.5 percent and the expected return on the market is 13 percent. What is the firm's cost of equity?

14.9 percent RE = 0.035 + 1.2(0.13 - 0.035) = 14.9 percent

Suppose your company needs $14 million to build a new assembly line. Your target debt-equity ratio is 0.84. The flotation cost for new equity is 9.5 percent, but the floatation cost for debt is only 2.5 percent. What is the true cost of building the new assembly line after taking flotation costs into account?

14.94 million fA = (1/1.84)(0.095) + (0.84/1.84) (0.025) = 0.063043 Amount raised = $14m/(1 - 0.063043) = $14.94 million

Miller Sisters has an overall beta of 0.64 and a cost of equity of 11.2 percent for the firm overall. The firm is 100 percent financed with common stock. Division A within the firm has an estimated beta of 1.08 and is the riskiest of all of the firm's operations. What is an appropriate cost of capital for division A if the market risk premium is 9.5 percent?

15.38 percent 0.112 = rf + 0.64(0.095); rf = 0.0512 ReDivision = 0.0512 + 1.08(0.095) = 15.38 percent

What is the expected return on a portfolio comprised of $6,200 of stock M and $4,500 of stock N if the economy enjoys a boom period? Boom: 14%/M: 23%/N: 5% Normal: 80%/M: 13%/N: 9% Recession: 6%/M: -31%/N: 18%

15.43 percent E(r)Boom = [$6,200/($6,200 + $4,500)][0.23] + [$4,500/($6,200 + $4,500)] [0.05] = 15.43 percent

Jungle, Inc. has a target debt-equity ratio of 0.72. Its WACC is 11.5 percent and the tax rate is 34 percent. What is the cost of equity if the aftertax cost of debt is 5.5 percent?

15.82 percent WACC = 0.115 = (1/1.72) RE + (0.72/1.72)(0.055); RE = 15.82 percent

Electronics Galore has 950,000 shares of common stock outstanding at a market price of $38 a share. The company also has 40,000 bonds outstanding that are quoted at 106 percent of face value. What weight should be given to the debt when the firm computes its weighted average cost of capital?

54 percent Debt: 40000 x 1000 x 1.06 = 42.4M Common: 950000 x 38 = 36.1M Total: 42.4M + 36.1M = 78.5M Weight(Debt): 42.4M/78.5M

The Corner Bakery has a bond issue outstanding that matures in 7 years. The bonds pay interest semi-annually. Currently, the bonds are quoted at 101.4 percent of face value and carry a 9 percent coupon. What is the firm's aftertax cost of debt if the tax rate is 30 percent?

6.11 percent N 7x2 IY /2 PV -1014 PMT 90/2 FV 1000 Solve for IY: 8.7285 Aftertax R(d)= 0.087285x(1-0.30)=6.11%

Simple Foods has a zero coupon bond issue outstanding that matures in 9 years. The bonds are selling at 42 percent of par value. What is the company's aftertax cost of debt if the tax rate is 38 percent?

6.12 percent N 9x2 IY /2 PV -420 FV 1000 Solve for IY: 9.8749 Aftertax R(d): 0.0998749x(1-0.38)=6.12

R.S. Green has 250,000 shares of common stock outstanding at a market price of $28 a share. Next year's annual dividend is expected to be $1.55 a share. The dividend growth rate is 2 percent. The firm also has 7,500 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 7 percent coupon, pay interest semiannually, and mature in 7.5 years. The bonds are selling at 98 percent of face value. The company's tax rate is 34 percent. What is the firm's weighted average cost of capital?

6.2 percent Debt: 7500 x .98= 7.35m Common: 250000 x 28= 7m Total: 14.35m R(e)= (1.55/28) + 0.02= 0.075357 Enter: N 7.5x2 IY /2 PV -980 PMT 70/2 FV 1000 Solve for IY: 7.35166 WACC: (7m/14.35m)(0.075457) + (7.35m/14.35m)(0.0735166)(1-0.34)= 6.2%

Suppose the current spot rate for the Norwegian kroner is $1 = NKr6.6869. The expected inflation rate in Norway is 6 percent and in the U.S. it is 3.5 percent. A risk-free asset in the U.S. is yielding 4 percent. What risk-free rate of return should you expect on a Norwegian security?

6.5 percent 0.04 - 0.035 = RFC - 0.06; RFC = 6.5 percent

Decline, Inc. is trying to determine its cost of debt. The firm has a debt issue outstanding with 15 years to maturity that is quoted at 107 percent of face value. The issue makes semiannual payments and has an embedded cost of 11 percent annually. What is the aftertax cost of debt if the tax rate is 33 percent?

6.76 percent Enter: N 15x2 IY /2 PV -1070 PMT 110/2 FV 1000 Solve for IY 10.085 R(D Aftertax) 0.10085(1-0.33)= 6.76%

The market has an expected rate of return of 10.7 percent. The long-term government bond is expected to yield 5.8 percent and the U.S. Treasury bill is expected to yield 3.9 percent. The inflation rate is 3.6 percent. What is the market risk premium?

6.8 percent Market risk premium = 10.7 percent - 3.9 percent = 6.8 percent

The Pizza Palace has a cost of equity of 15.3 percent and an unlevered cost of capital of 11.8 percent. The company has $22,000 in debt that is selling at par value. The levered value of the firm is $41,000 and the tax rate is 34 percent. What is the pre-tax cost of debt?

7.22 percent RE = 0.153 = 0.118 + (0.118 - RD) [$22,000/($41,000 - $22,000)] (1 - 0.34); RD = 7.22 percent

Bleakly Enterprises has a capital structure of 55 percent common stock, 10 percent preferred stock, and 35 percent debt. The flotation costs are 4.5 percent for debt, 7 percent for preferred stock, and 9.5 percent for common stock. The corporate tax rate is 34 percent. What is the weighted average flotation cost?

7.5 percent Average flotation cost = (0.55 0.095) + (0.10 0.07) + (0.35 0.045) = 7.5 percent

Which one of the following securities is used as a means of investing in a foreign stock that otherwise could not be traded in the United States?

American Depository Receipt

The reward-to-risk ratio for stock A is less than the reward-to-risk ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of 1.29. This information implies that:

either stock A is overpriced or stock B is underpriced or both.

The primary purpose of portfolio diversification is to:

eliminate asset-specific risk.

Interest rate parity:

eliminates covered interest arbitrage opportunities.

The home currency approach (p1):

employs uncovered interest parity to project future exchange rates.

Which one of the following is a suggested method of reducing a U.S. importer's short-run exposure to exchange rate risk?

entering a forward exchange agreement timed to match the invoice date

The static theory of capital structure advocates that the optimal capital structure for a firm:

equates the tax savings from an additional dollar of debt to the increased bankruptcy costs related to that additional dollar of debt.

Dan is comparing three machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs, differing machine lives, and will be replaced when worn out. Which one of the following computational methods should Dan use as the basis for his decision?

equivalent annual cost

Decreasing which one of the following will increase the acceptability of a project?

equivalent annual cost

The annual annuity stream of payments that has the same present value as a project's costs is referred to as which one of the following?

equivalent annual cost

International bonds issued in a single country and denominated in that country's currency are called:

foreign bonds.

A large U.S. company has £500,000 in excess cash from its foreign operations. The company would like to exchange these funds for U.S. dollars. In one of the following markets can this exchange be arranged?

foreign exchange market

Mr. Black has agreed to a currency exchange with Mr. White. The parties have agreed to exchange C$12,500 for $10,000 with the exchange occurring 4 months from now. This agreed-upon exchange rate is called the:

forward rate.

The forward rate market is dependent upon:

forward rates equaling the actual future spot rates on average over time.

A trader has just agreed to exchange $2 million U.S. dollars for $1.55 million Euros six months from today. This exchange is an example of a:

forward trade.

You would like to purchase a security that is issued by the British government. Which one of the following should you purchase?

gilt

The aftertax cost of debt:

has a greater effect on a firm's cost of capital when the debt-equity ratio increases.

The business risk of a firm:

has a positive relationship with the firm's cost of equity.

M&M Proposition II with taxes:

has the same general implications as M&M Proposition II without taxes.

Kelley's Baskets makes handmade baskets for distribution to upscale retail outlets. The firm is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project?

hiring additional employees to handle the increased workload should the firm accept the wreath project

The cost of equity for a firm:

ignores the firm's risks when that cost is based on the dividend growth model.

Incorporating flotation costs into the analysis of a project will:

increase the initial cash outflow of the project.

When a firm has flotation costs equal to 7 percent of the funding need, project analysts should:

increase the initial project cost by dividing that cost by (1 - 0.07).

The stand-alone principle advocates that project analysis should be based solely on which one of the following costs?

incremental

The difference between a firm's future cash flows if it accepts a project and the firm's future cash flows if it does not accept the project is referred to as the project's:

incremental cash flows

The costs incurred by a business in an effort to avoid bankruptcy are classified as _____ costs.

indirect bankruptcy

The operating cash flow for a project should exclude which one of the following?

interest expense

The condition stating that the interest rate differential between two countries is equal to the percentage difference between the forward exchange rate and the spot exchange rate is called:

interest rate parity.

Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by $1,000. Which of the following terms is used to describe this tax savings?

interest tax shield

Which form of financing do firms prefer to use first according to the pecking-order theory?

internal funds

Which one of the following supports the idea that real interest rates are equal across countries?

international Fisher effect

Which one of the following is an example of systematic risk?

investors panic causing security prices around the globe to fall precipitously

The pre-tax cost of debt:

is based on the current yield to maturity of the firm's outstanding bonds.

The cost of preferred stock:

is equal to the dividend yield.

The dividend growth model:

is only as reliable as the estimated rate of growth.

The weighted average cost of capital for a wholesaler:

is the return investors require on the total assets of the firm.

The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual return of 12 percent. This stock:

is underpriced.

A firm is technically insolvent when:

it is unable to meet its financial obligations.

A business firm ceases to exist as a going concern as a result of which one of the following?

liquidation

Which one of the following has the greatest tendency to increase the percentage of debt included in the optimal capital structure of a firm?

low probabilities of financial distress

You are considering the purchase of a new machine. Your analysis includes the evaluation of two machines which have differing initial and ongoing costs and differing lives. Whichever machine is purchased will be replaced at the end of its useful life. You should select the machine which has the:

lowest equivalent annual cost.

Which one of the following is represented by the slope of the security market line?

market risk premium

According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the:

market risk premium and the amount of systematic risk inherent in the security.

The expected rate of return on a stock portfolio is a weighted average where the weights are based on the:

market value of the investment in each stock.

A firm should select the capital structure that:

maximizes the value of the firm.

If a stock portfolio is well diversified, then the portfolio variance:

may be less than the variance of the least risky stock in the portfolio.

Assigning discount rates to individual projects based on the risk level of each project:

may cause the firm's overall weighted average cost of capital to either increase or decrease over time.

Which one of the following types of operations would be subject to the most political risk if the operation were conducted outside of a firm's home country?

military weapons manufacturing

The capital structure that maximizes the value of a firm also:

minimizes the cost of capital.

Which one of the following statements is correct concerning a portfolio of 20 securities with multiple states of the economy when both the securities and the economic states have unequal weights?

Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero.

Which of the following statements are correct in relation to M&M Proposition II with no taxes? I. The required return on assets is equal to the weighted average cost of capital. II. Financial risk is determined by the debt-equity ratio. III. Financial risk determines the return on assets. IV. The cost of equity declines when the amount of leverage used by a firm rises.

I and II only

When using the equivalent annual cost as a basis for deciding which equipment should be purchased, the equipment under consideration must fit which two of the following criteria? I. differing productive lives II. differing manufacturers III. required replacement at end of economic life IV. differing initial cost

I and III

Which of the following statements concerning risk are correct? I. Nondiversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for nondiversifiable risk. IV. Diversifiable risks are market risks you cannot avoid.

I and III only

All of the following are related to a proposed project. Which of these should be included in the cash flow at time zero? I. purchase of $1,400 of parts inventory needed to support the project II. loan of $125,000 used to finance the project III. depreciation tax shield of $1,100 IV. $6,500 of equipment needed to commence the project

I and IV only

Which of the following are examples of diversifiable risk? I. earthquake damages an entire town II. federal government imposes a $100 fee on all business entities III. employment taxes increase nationally IV. toymakers are required to improve their safety standards

I and IV only

Which of the following statements are correct concerning diversifiable risks? I. Diversifiable risks can be essentially eliminated by investing in thirty unrelated securities. II. There is no reward for accepting diversifiable risks. III. Diversifiable risks are generally associated with an individual firm or industry. IV. Beta measures diversifiable risk.

I, II and III only

By definition, which of the following costs are included in the term "financial distress costs"? I. direct bankruptcy costs II. indirect bankruptcy costs III. direct costs related to being financially distressed, but not bankrupt IV. indirect costs related to being financially distressed, but not bankrupt

I, II, III, and IV

If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to: I. reject some positive net present value projects. II. accept some negative net present value projects. III. favor high risk projects over low risk projects. IV. increase its overall level of risk over time.

I, II, III, and IV

Pro forma statements for a proposed project should: I. be compiled on a stand-alone basis. II. include all the incremental cash flows related to the project. III. generally exclude interest expense. IV. include all project-related fixed asset acquisitions and disposals.

I, II, III, and IV

The equivalent annual cost considers which of the following? I. required rate of return II. operating costs III. need for replacement IV. aftertax salvage value

I, II, III, and IV

The expected return on a portfolio considers which of the following factors? I. percentage of the portfolio invested in each individual security II. projected states of the economy III. the performance of each security given various economic states IV. probability of occurrence for each state of the economy

I, II, III, and IV

The weighted average cost of capital for a firm may be dependent upon the firm's: I. rate of growth. II. debt-equity ratio. III. preferred dividend payment. IV. retention ratio.

I, II, III, and IV

Which of the following conditions are required for absolute purchasing power parity to exist? I. goods must be identical II. goods must have equal economic value III. transaction costs must be zero IV. there can be no barriers to trade

I, II, III, and IV

A firm may file for Chapter 11 bankruptcy: I. in an attempt to gain a competitive advantage. II. using a prepack. III. while allowing the current management to continue running the firm. IV. only after the firm becomes insolvent.

I, II, and III only

The expected return on a portfolio: I. can never exceed the expected return of the best performing security in the portfolio. II. must be equal to or greater than the expected return of the worst performing security in the portfolio. III. is independent of the unsystematic risks of the individual securities held in the portfolio. IV. is independent of the allocation of the portfolio amongst individual securities.

I, II, and III only

Triangle arbitrage: I. is a profitable situation involving three separate currency exchange transactions. II. helps keep the currency market in equilibrium. III. opportunities can exist in either the spot or the forward market. IV. is based solely on differences in exchange ratios between spot and futures markets.

I, II, and III only

Which of the following statements related to financial risk are correct? I. Financial risk is the risk associated with the use of debt financing. II. As financial risk increases so too does the cost of equity. III. Financial risk is wholly dependent upon the financial policy of a firm. IV. Financial risk is the risk that is inherent in a firm's operations.

I, II, and III only

Suppose the spot and six-month forward rates on the Norwegian krone are Kr6.36 and Kr6.56, respectively. The annual risk-free rate in the United States is 5 percent, and the annual risk-free rate in Norway is 7 percent. What would the six-month forward rate have to be on the Norwegian krone to prevent arbitrage?

Kr6.4233 F180 = (Kr6.36)[1 + (0.07 - 0.05)]1/2 = Kr6.4233

Where does most of the trading in Eurobonds occur?

London

On Friday evening, Bank A loans Bank B Eurodollars that must be repaid the following Monday morning. Which one of the following is most likely the interest rate that will be charged on this loan?

London Interbank Offer Rate

Which one of the following states that the value of a firm is unrelated to the firm's capital structure?

M&M Proposition I

The concept of homemade leverage is most associated with:

M&M Proposition I with no tax.

Which one of the following states that a firm's cost of equity capital is directly and proportionally related to the firm's capital structure?

M&M Proposition II

Which one of the following is a correct method for computing the operating cash flow of a project assuming that the interest expense is equal to zero?

NI + D

Which one of the following formulas expresses the absolute purchasing power parity relationship between the U.S. dollar and the British pound?

PUK = S0 PUS

The present value of the interest tax shield is expressed as:

Tc x D

Which one of the following statements is correct given the following exchange rates? Country/US$ per 1 foreign unit Fri/Thurs South Africa/0.1028/0.1023 Thailand/0.0284/0.0286

The South African rand appreciated from Thursday to Friday against the U.S. dollar.

Which one of the following statements is correct for a firm that uses debt in its capital structure?

The WACC should decrease as the firm's debt-equity ratio increases.

Which one of the following statements related to Chapter 7 bankruptcy is correct?

Under a Chapter 7 bankruptcy, a trustee will assume control of the firm's assets until those assets can be liquidated.

Which one of the following statements related to unexpected returns is correct?

Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term.

The systematic risk of the market is measured by:

a beta of 1.0.

Which one of the following indicates a portfolio is being effectively diversified?

a decrease in the portfolio standard deviation

M&M Proposition II is the proposition that:

a firm's cost of equity is a linear function with a slope equal to (RA - RD).

Which one of the following is the best example of a diversifiable risk?

a firm's sales decrease

M&M Proposition I with tax supports the theory that:

a firm's weighted average cost of capital decreases as the firm's debt-equity ratio increases.

A stock with an actual return that lies above the security market line has:

a higher return than expected for the level of risk assumed.

The expected return on a stock computed using economic probabilities is:

a mathematical expectation based on a weighted average and not an actual anticipated outcome.

All else constant, which one of the following will increase a firm's cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2.

a reduction in the risk-free rate

The capital structure weights used in computing the weighted average cost of capital:

are based on the market value of the firm's debt and equity securities.

Preston Industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 70 percent of the firm's overall sales. Division A is also the riskier of the two divisions. Division B is the smaller and least risky of the two. When management is deciding which of the various divisional projects should be accepted, the managers should:

assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.

The subjective approach to project analysis:

assigns discount rates to projects based on the discretion of the senior managers of a firm.

Which one of the following is the legal proceeding under which an insolvent firm can be reorganized?

bankruptcy

Flotation costs for a levered firm should:

be weighted and included in the initial cash flow.

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset?

beta

Systematic risk is measured by:

beta.

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk?

capital asset pricing model

Which one of the following is an example of unsystematic risk?

consumer spending on entertainment decreased nationally

Treynor Industries is investing in a new project. The minimum rate of return the firm requires on this project is referred to as the:

cost of capital.

Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the:

cost of debt.

A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called?

cost of equity

Assume that $1 is equal to ¥98 and also equal to C$1.21. Based on this, you could say that C$1 is equal to: C$1(¥98/C$1.21) = ¥80.99. The exchange rate of C$1 = ¥80.99 is referred to as the:

cross-rate.

Based on M&M Proposition II with taxes, the weighted average cost of capital:

decreases as the debt-equity ratio increases.

A firm's cost of capital:

depends upon how the funds raised are going to be spent.

Based on the following information, the value of the U.S. dollar will _____ with respect to the yen and will _____ with respect to the Canadian dollar. Cur./Cur. per USD Japan yen/115.77 6-months forward/112.80 Canada dollar/1.1379 3-months forward/1.1339

depreciate; depreciate The U.S. dollar will depreciate against both the yen and the Canadian dollar because it will take less of either currency to buy one U.S. dollar in the future as compared to today.

Increasing which one of the following will increase the operating cash flow assuming that the bottom-up approach is used to compute the operating cash flow?

depreciation expense

The explicit costs, such as legal and administrative expenses, associated with corporate default are classified as _____ costs.

direct bankruptcy

In the spot market, $1 is currently equal to £0.6211. Assume the expected inflation rate in the U.K. is 2.6 percent while it is 4.3 percent in the U.S. What is the expected exchange rate four years from now if relative purchasing power parity exists?

£0.5799 E(S4) = £0.6211 [1 + (0.026 - 0.043)]4 = £0.5799

In the spot market, $1 is currently equal to £0.6211. Assume the expected inflation rate in the U.K. is 4.2 percent while it is 3.4 percent in the U.S. What is the expected exchange rate one year from now if relative purchasing power parity exists?

£0.6261 E(S1) = £0.6211 [1 + (0.042 - 0.034]1 = £0.6261

Which one of the following is a direct bankruptcy cost?

paying an outside accountant fees to prepare bankruptcy reports

Which one of the following will generally have the highest priority when assets are distributed in a bankruptcy proceeding?

payment of employee wages

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:

permits key employee retention plans only if an employee has another job offer.

The market value of the Blackwell Corporation just declined by 5 percent. Analysts believe this decrease in value was caused by recent legislation passed by Congress. Which type of risk does this illustrate?

political risk

Suzie owns five different bonds valued at $36,000 and twelve different stocks valued at $82,500 total. Which one of the following terms most applies to Suzie's investments?

portfolio

Steve has invested in twelve different stocks that have a combined value today of $121,300. Fifteen percent of that total is invested in Wise Man Foods. The 15 percent is a measure of which one of the following?

portfolio weight

The unbiased forward rate is a:

predictor of the future spot rate at the equivalent point in time.

Markley and Stearns is a multi-divisional firm that uses its WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to:

prefer higher risk projects over lower risk projects.

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

rate of return a firm must earn on its existing assets to maintain the current value of its stock.

The international Fisher effect states that _____ rates are equal across countries.

real

Which one of the following is least apt to reduce the unsystematic risk of a portfolio?

reducing the number of stocks held in the portfolio

Relative purchasing power parity:

relates differences in inflation rates to differences in exchange rates.

Edwards Farm Products was unable to meet its financial obligations and was forced into using legal proceedings to restructure itself so that it could continue as a viable business. The process this firm underwent is known as a:

reorganization.

The home currency approach (p2):

requires an applicable exchange rate for every time period for which there is a cash flow.

The cost of preferred stock is computed the same as the:

return on a perpetuity.

Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly?

reward-to-risk ratio

The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-free asset is referred to as the:

risk premium.

The expected risk premium on a stock is equal to the expected return on the stock minus the:

risk-free rate.

Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas?

security market line

AA Tours is comparing two capital structures to determine how to best finance its operations. The first option consists of all equity financing. The second option is based on a debt-equity ratio of 0.45. What should AA Tours do if its expected earnings before interest and taxes (EBIT) are less than the break-even level? Assume there are no taxes.

select the unlevered option since the expected EBIT is less than the break-even level

Jessica invested in Quantro stock when the firm was unlevered. Since then, Quantro has changed its capital structure and now has a debt-equity ratio of 0.30. To unlever her position, Jessica needs to:

sell some shares of Quantro stock and loan out the sale proceeds.

Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach?

selling fewer hot dogs because hamburgers were added to the menu

Absolute purchasing power parity is most apt to exist for which one of the following items?

silver

George and Pat just made an agreement to exchange currencies based on today's exchange rate. Settlement will occur tomorrow. Which one of the following is the exchange rate that applies to this agreement?

spot exchange rate

Trader A has agreed to give 100,000 U.S. dollars to Trader B in exchange for British pounds based on today's exchange rate of $1 = £0.62. The traders agree to settle this trade within two business day. What is this exchange called?

spot trade

The principle of diversification tells us that:

spreading an investment across many diverse assets will eliminate some of the total risk.

The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles?

stand-alone principle

Total risk is measured by _____ and systematic risk is measured by _____.

standard deviation; beta

Which one of the following should earn the most risk premium based on CAPM?

stock with a beta of 1.38

The market risk premium is computed by:

subtracting the risk-free rate of return from the market rate of return.

G & L Plastic Molders spent $1,200 last week repairing a machine. This week the company is trying to decide if the machine could be better utilized if they assigned it a proposed project. When analyzing the proposed project, the $1,200 should be treated as which type of cost?

sunk

Which one of the following costs was incurred in the past and cannot be recouped?

sunk

Party A has agreed to exchange $1 million U.S. dollars for $1.21 million Canadian dollars. What is this agreement called?

swap

Which one of the following is a risk that applies to most securities?

systematic

The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk.

systematic risk principle

The current book value of a fixed asset that was purchased two years ago is used in the computation of which one of the following?

tax due on the salvage value of that asset

Homemade leverage is:

the borrowing or lending of money by individual shareholders as a means of adjusting their level of financial leverage.

Which one of the following best describes the concept of erosion?

the cash flows of a new project that come at the expense of a firm's existing cash flows

M&M Proposition I with no tax supports the argument that:

the debt-equity ratio of a firm is completely irrelevant.

The bottom-up approach to computing the operating cash flow applies only when:

the interest expense is equal to zero.

The bid price is:

the minimum price you should charge if you want to financially breakeven.

The interest tax shield is a key reason why:

the net cost of debt to a firm is generally less than the cost of equity.

The type of exchange rate risk known as translation exposure is best described as:

the problem encountered by an accountant of an international firm who is trying to record balance sheet account values.

The intercept point of the security market line is the rate of return which corresponds to:

the risk-free rate.

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

the risks associated with the use of the funds required by the project.

The proposition that a firm borrows up to the point where the marginal benefit of the interest tax shield derived from increased debt is just equal to the marginal expense of the resulting increase in financial distress costs is called:

the static theory of capital structure.

The basic lesson of M&M Theory is that the value of a firm is dependent upon:

the total cash flow of the firm.

M&M Proposition I with taxes is based on the concept that:

the value of a firm increases as the firm's debt increases because of the interest tax shield.

The flotation cost for a firm is computed as:

the weighted average of the flotation costs associated with each form of financing.

Bankruptcy:

transfers value from shareholders to bondholders.

Which one of the following states that the current forward rate is an unbiased predictor of the future spot exchange rate?

unbiased forward rates

Which one of the following states that the expected percentage change in the exchange rate between two countries is equal to the difference in the countries' interest rates?

uncovered interest parity

Corporations in the U.S. tend to:

underutilize debt.

You have 100 British pounds. A friend of yours is willing to exchange 180 Canadian dollars for your 100 British pounds. What will be your profit or loss if you accept your friend's offer, given the following exchange rates? Country/Equiv./Currency per US$ Canada/?/1.2103 UK/1.16100/?

£7.63 loss [£100 (C$180/£100) ($1/C$1.2103) (£1/$1.6100)] - £100 = -£7.63 = £7.63 loss

Assume that $1 can buy you either ¥98.48 or £0.6211. If a TV in London costs £990, what will that identical TV cost in Tokyo if absolute purchasing power parity exists?

¥156,972 £990 ($1/£0.6211) (¥98.48/$1) = ¥156,972

Assume that ¥98.48 equal $1. Also assume that SKr7.7274 equal $1. How many Japanese yen can you acquire in exchange for 3,000 Swedish krone?

¥38,233 SKr3,000 ($1/SKr7.7274) (¥98.48/$1) = ¥38,233

How many Euros can you get for $2,100 if one euro is worth $1.2762?

€1,645.51 $2,100 (€1/$1.2762) = €1,645.51

A new coat costs 3,900 Russian rubles. How much will the identical coat cost in Euros if absolute purchasing power parity exists and the following exchange rates apply? Country/Equiv/C per USD Russia/?/27.0520 Euro/1.2762/?

€112.97 Ru3,900 ($1/Ru27.0520) (€1/$1.2762) = €112.97

Which one of the following is an example of a sunk cost?

$1,200 paid to repair a machine last year

Automated Manufacturers uses high-tech equipment to produce specialized aluminum products for its customers. Each one of these machines costs $1,480,000 to purchase plus an additional $49,000 a year to operate. The machines have a 6-year life after which they are worthless. What is the equivalent annual cost of one these machines if the required return is 16 percent?

-$450,657

Down Bedding has an unlevered cost of capital of 13 percent, a cost of debt of 7.8 percent, and a tax rate of 32 percent. What is the target debt-equity ratio if the targeted cost of equity is 15.51 percent?

.71 RE = 0.1551 = 0.13 + (0.13 - 0.078) D/E (1 - 0.32); D/E = 0.71

Mason Farms purchased a building for $729,000 eight years ago. Six years ago, repairs were made to the building which cost $136,000. The annual taxes on the property are $11,000. The building has a current market value of $825,000 and a current book value of $494,000. The building is totally paid for and solely owned by the firm. If the company decides to use this building for a new project, what value, if any, should be included in the initial cash flow of the project for this building?

$825,000 Opportunity cost = $825,000

Bob's Warehouse has a pre-tax cost of debt of 8.4 percent and an unlevered cost of capital of 14.6 percent. The firm's tax rate is 37 percent and the cost of equity is 18 percent. What is the firm's debt-equity ratio?

0.87 RE = 0.18 = 0.146 + (0.146 - 0.084) D/E (1 - 0.37); D/E = 0.87

Based on the information below, what is the cross-rate for Australian dollars in terms of Swiss francs? Currency/USD Equiv Australia dollar/0.7002 Switzerland franc/0.8008

0.8744 Cross-rate = 0.7002/0.8008 = 0.8744

You own a portfolio equally invested in a risk-free asset and two stocks. One of the stocks has a beta of 1.9 and the total portfolio is equally as risky as the market. What is the beta of the second stock?

1.10 ?p = 1.0 = (1/3)(0) + (1/3)(?x) + (1/3)(1.9); ?x = 1.1

You would like to combine a risky stock with a beta of 1.68 with U.S. Treasury bills in such a way that the risk level of the portfolio is equivalent to the risk level of the overall market. What percentage of the portfolio should be invested in the risky stock?

60 percent BetaPortfolio = 1.0 = [(x) 1.68] + [(1 - x) 0]; x = 60 percent

Jerilu Markets has a beta of 1.09. The risk-free rate of return is 2.75 percent and the market rate of return is 9.80 percent. What is the risk premium on this stock?

7.68 percent Risk premium = 1.09 (0.098 - 0.0275) = 7.68 percent

Precision Tool is analyzing two machines to determine which one it should purchase. The company requires a 15 percent rate of return and uses straight-line depreciation to a zero book value over the life of its equipment. Machine A has a cost of $892,000, annual operating costs of $26,300, and a 4-year life. Machine B costs $1,127,000, has annual operating costs of $19,500, and has a 5-year life. Whichever machine is purchased will be replaced at the end of its useful life. Precision Tool should purchase Machine _____ because it lowers the firm's annual cost by approximately _______ as compared to the other machine.

A; $16,965.

Morris Motors just purchased some MACRS 5-year property at a cost of $216,000. Which one of the following will correctly give you the book value of this equipment at the end of year 2? MACRS 5-year property Year Rate 1 20% 2 32 3 19.2 4 11.52 5 11.52 6 5.76

B. $216,000 x (1 - 0.20 - 0.32)

Which one of the following stocks is correctly priced if the risk-free rate of return is 3.7 percent and the market risk premium is 8.8 percent? Stock/Beta/Expected Return A/.64/9.47% B/.97/12.03% C/1.22/14.44% D/1.37/15.80% E/1.68/18.37%

C E(r)A = 0.037 + (0.64 x 0.088) = 0.0933 E(r)B = 0.037 + (0.97 x 0.088) = 0.1224 E(r)C = 0.037 + (1.22 x 0.088) = 0.1444 Stock C is correctly priced. E(r)D = 0.037 + (1.37 x 0.088) = 0.1576 E(r)E = 0.037 + (1.68 x 0.088) = 0.1848

Assume the spot rate on the Canadian dollar is C$0.9872. The risk-free nominal rate in the U.S. is 5.4 percent while it is only 3.8 percent in Canada. Which one of the following four-year forward rates best establishes the approximate interest rate parity condition?

C$0.9255 F4 = C$0.9872 [1 + (0.038 - 0.054)]4 = C$0.9255

Assume the spot rate on the Canadian dollar is C$1.1847. The risk-free nominal rate in the U.S. is 5 percent while it is only 4 percent in Canada. What one-year forward rate will create interest rate parity?

C$1.1734 F1/C$1.1847 = 1.04/1.05; F1 = C$1.1734

A risk-free asset in the U.S. is currently yielding 3 percent while a Canadian risk-free asset is yielding 2 percent. Assume the current spot rate is C$1.2103. What is the approximate three-year forward rate if interest rate parity holds?

C$1.1744 F3 = C$1.2103 [1 + (0.02 - 0.03)]3 = C$1.1744

Currently, $1 will buy C$1.2103 while $1.2762 will buy €1. What is the exchange rate between the Canadian dollar and the euro?

C$1.5446 = €1 (C$1.2103/$1) ($1.2762/€1) = C$1.5446/€1

Which one of the following stocks is correctly priced if the risk-free rate of return is 3.2 percent and the market rate of return is 11.76 percent? Stock/Beta/E(r) A/.87/11.03% B/1.09/12.97% C/1.18/13.21% D/1.34/15.02% E/1.62/17.07

E E(r)A = 0.032 + [0.87 (0.1176 - 0.032)] = 0.1065 E(r)B = 0.032 + [1.09 (0.1176 - 0.032)] = 0.1253 E(r)C = 0.032 + [1.18 (0.1176 - 0.032)] = 0.1330 E(r)D = 0.032 + [1.34 (0.1176 - 0.032)] = 0.1467 E(r)E = 0.032 + [1.62 (0.1176 - 0.032)] = 0.1707 Stock E is correctly priced.

Uncovered interest parity is defined as:

E(St) = S0 [1 + (RFC - RUS)]t.

Which one of the following formulas correctly describes the relative purchasing power parity relationship?

E(St) = S0 [1 + (hFC - hUS)]t

Keyser Petroleum just purchased some equipment at a cost of $67,000. What is the proper methodology for computing the depreciation expense for year 2 if the equipment is classified as 5-year property for MACRS? Year Rate 1 20% 2 32 3 19.2 4 11.52 5 11.52 6 5.76

E. $67,000 x 0.32

Which one of the following statements is correct concerning unsystematic risk?

Eliminating unsystematic risk is the responsibility of the individual investor.

International bonds issued in multiple countries but denominated solely in the issuer's currency are called:

Eurobonds.

U.S. dollars deposited in a bank in Switzerland are called:

Eurocurrency.

The capital asset pricing model (CAPM) assumes which of the following? I. a risk-free asset has no systematic risk. II. beta is a reliable estimate of total risk. III. the reward-to-risk ratio is constant. IV. the market rate of return can be approximated.

I, III, and IV only

The interest tax shield has no value when a firm has a: I. tax rate of zero. II. debt-equity ratio of 1. III. zero debt. IV. zero leverage.

I, III, and IV only

Which of the following variables used in the covered interest arbitrage formula are correctly defined? I. RFC: Foreign country nominal risk-free interest rate II. RUS: U.S. real risk-free interest rate III. F1: 360-day forward rate IV. S0: Current spot rate expressed in units of foreign currency per one U.S. dollar

I, III, and IV only

The aftertax cost of debt generally increases when: I. a firm's bond rating increases. II. the market rate of interest increases. III. tax rates decrease. IV. bond prices rise.

II and III only

Which of the following statements are correct? I. The usage of forward rates increases the short-run exposure to exchange rate risk. II. Accounting translation gains and losses are recorded in the equity section of the balance sheet. III. The long-run exchange rate risk faced by an international firm can be reduced if a firm borrows money in the foreign country where the firm has operations. IV. Unexpected changes in economic conditions are classified as short-run exposure to exchange rate risk.

II and III only

The price of one Euro expressed in U.S. dollars is referred to as a(n):

exchange rate.

A firm's overall cost of equity is:

highly dependent upon the growth rate and risk level of the firm.

Which one of the following makes the capital structure of a firm irrelevant?

homemade leverage

The top-down approach to computing the operating cash flow:

ignores noncash expenses

The _____ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly.

risk premium

Standard deviation measures which type of risk?

total

The average of a firm's cost of equity and aftertax cost of debt that is weighted based on the firm's capital structure is called the:

weighted average cost of capital

The value of a firm is maximized when the:

weighted average cost of capital is minimized.

The absolute priority rule determines:

which parties receive payment first in a bankruptcy proceeding.

Phone Home, Inc. is considering a new 5-year expansion project that requires an initial fixed asset investment of $2.484 million. The fixed asset will be depreciated straight-line to zero over its 5-year tax life, after which time it will be worthless. The project is estimated to generate $2,208,000 in annual sales, with costs of $883,200. The tax rate is 32 percent and the required return on the project is 11 percent. What is the net present value for this project?

$1,433,059 OCF = ($2,208,000 - $883,200)(1 - 0.32) + ($2,484,000/5)(0.32) = $1,059,840

Suppose your company imports computer motherboards from Singapore. The exchange rate is currently 1.5803S$/US$. You have just placed an order for 30,000 motherboards at a cost to you of 170.90 Singapore dollars each. You will pay for the shipment when it arrives in 120 days. You can sell the motherboards for $148 each. What will your profit be if the exchange rate goes up by 8 percent over the next 120 days?

$1,435,999 Profit = 30,000 {$148 - [(S$170.90) ($1/(S$1.5803 1.08))]} = $1,435,999

Peterborough Trucking just purchased some fixed assets that are classified as 3-year property for MACRS. The assets cost $9,800. What is the amount of the depreciation expense in year 3? MACRS 5-year property Year Rate 1 20 2 32 3 19.2 4 11.52 5 11.52 6 5.76

$1,451.38 Depreciation3 = $9,800 x 0.1481 = $1,451.38

Nelson Mfg. owns a manufacturing facility that is currently sitting idle. The facility is located on a piece of land that originally cost $159,000. The facility itself cost $1,460,000 to build. As of now, the book value of the land and the facility are $159,000 and $458,000, respectively. The firm owes no debt on either the land or the facility at the present time. The firm received a bid of $1,500,000 for the land and facility last week. The firm's management rejected this bid even though they were told that it is a reasonable offer in today's market. If the firm was to consider using this land and facility in a new project, what cost, if any, should it include in the project analysis?

$1,500,000 Relevant cost = $1,500,000

Stacy owns 38 percent of The Town Centre. She has decided to retire and wants to sell all of her shares in this closely held, all equity firm. The other shareholders have agreed to have the firm borrow $650,000 to purchase her shares of stock. What is the total market value of The Town Centre? Ignore taxes.

$1,710,526 Firm value = $650,000/0.38 = $1,710,526

You are working on a bid to build two apartment buildings a year for the next 5 years for a local college. This project requires the purchase of $750,000 of equipment that will be depreciated using straight-line depreciation to a zero book value over the project's life. The equipment can be sold at the end of the project for $325,000. You will also need $140,000 in net working capital over the life of the project. The fixed costs will be $628,000 a year and the variable costs will be $1,298,000 per building. Your required rate of return is 14.5 percent for this project and your tax rate is 35 percent. What is the minimal amount, rounded to the nearest $100, you should bid per building?

$1,733,000

Assume you can buy 52 British pounds with 100 Canadian dollars. How much profit can you earn on a triangle arbitrage given the following rates if you start out with 100 U.S. dollars? Country/Equiv/Curr. per USD Canada/?/1,2103 UK/?/0.6211

$1.33 [$100 (C$1.2103/$1) (£52/C$100) ($1/£0.6211)] - $100 = $1.33 profit

Sewer's Paradise is an all equity firm that has 5,000 shares of stock outstanding at a market price of $15 a share. The firm's management has decided to issue $30,000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 10 percent. What are the earnings per share at the break-even level of earnings before interest and taxes? Ignore taxes.

$1.50 Number of shares repurchased = $30,000/$15 = 2,000 EBIT/5,000 = [EBIT - ($30,000 .0.10)]/(5,000 - 2,000); EBIT = $7,500 EPS = [$7,500 - ($30,000 0.10)]/(5,000 - 2,000); EPS = $1.50

Today, you can get either 121 Canadian dollars or 1,288 Mexican pesos for 100 U.S. dollars. Last year, 100 U.S. dollars was worth 115 Canadian dollars or 1,291 Mexican pesos. Which one of the following statements is correct given this information?

$100 converted into Canadian dollars last year would now be worth $95.05. $100 (C$115/$100) ($100/C$121) = $95.05 $100 (Ps1,291/$100) ($100/Ps1,288) = $100.23

The Beach House has sales of $784,000 and a profit margin of 11 percent. The annual depreciation expense is $14,000. What is the amount of the operating cash flow if the company has no long-term debt?

$100,240 OCF = ($784,000 0.11) + $14,000 = $100,240

Northern Railway is considering a project which will produce annual sales of $975,000 and increase cash expenses by $859,000. If the project is implemented, taxes will increase from $141,000 to $154,000 and depreciation will increase from $194,000 to $272,000. The company is debt-free. What is the amount of the operating cash flow using the top-down approach?

$103,000 OCF = $975,000 - $859,000 - ($154,000 - $141,000) = $103,000

A proposed expansion project is expected to increase sales of JL Ticker's Store by $35,000 and increase cash expenses by $21,000. The project will cost $24,000 and be depreciated using straight-line depreciation to a zero book value over the 4-year life of the project. The store has a marginal tax rate of 30 percent. What is the operating cash flow of the project using the tax shield approach?

$11,600 OCF = ($35,000 - $21,000) (1 - 0.30) + ($24,000/4) (0.30) = $11,600

Dog Up! Franks is looking at a new sausage system with an installed cost of $397,800. This cost will be depreciated straight-line to zero over the project's 7-year life, at the end of which the sausage system can be scrapped for $61,200. The sausage system will save the firm $122,400 per year in pretax operating costs, and the system requires an initial investment in net working capital of $28,560. All of the net working capital will be recovered at the end of the project. The tax rate is 33 percent and the discount rate is 9 percent. What is the net present value of this project?

$118,821 OCF = $122,400(1 - 0.33) + ($397,800/7)(0.33) = $100,761.43

Colors and More is considering replacing the equipment it uses to produce crayons. The equipment would cost $1.37 million, have a 12-year life, and lower manufacturing costs by an estimated $304,000 a year. The equipment will be depreciated using straight-line depreciation to a book value of zero. The required rate of return is 15 percent and the tax rate is 35 percent. What is the net income from this proposed project?

$123,391.67 Net income = [$304,000 - ($1,370,000/12)] [1 - 0.35] = $123,391.67

The Pancake House has sales of $1,642,000, depreciation of $27,000, and net working capital of $218,000. The firm has a tax rate of 35 percent and a profit margin of 6 percent. The firm has no interest expense. What is the amount of the operating cash flow?

$125,520 OCF = ($1,642,000 x 0.06) + $27,000 = $125,520

Kwik 'n Hot Dogs is considering the installation of a new computerized pressure cooker that will cut annual operating costs by $23,000. The system will cost $39,900 to purchase and install. This system is expected to have a 4-year life and will be depreciated to zero using straight-line depreciation. What is the amount of the earnings before interest and taxes for this project?

$13,025 Earnings before interest and taxes = $23,000 - ($39,900/4) = $13,025

Georga's Restaurants has 4,500 bonds outstanding with a face value of $1,000 each and a coupon rate of 8.25 percent. The interest is paid semi-annually. What is the amount of the annual interest tax shield if the tax rate is 37 percent?

$137,362.50 Annual interest tax shield = 4,500 $1,000 0.0825 0.37 = $137,362.50

Edward's Manufactured Homes purchased some machinery 2 years ago for $319,000. These assets are classified as 5-year property for MACRS. The company is replacing this machinery today with newer machines that utilize the latest in technology. The old machines are being sold for $140,000 to a foreign firm for use in its production facility in South America. What is the aftertax salvage value from this sale if the tax rate is 35 percent? MACRS 5-year property Year Rate 1 20 2 32 3 19.2 4 11.52 5 11.52 6 5.76

$144,592 Book value2 = $319,000 x (1 - 0.20 - 0.32) = $153,120 Tax on sale = ($140,000 - $153,120) x 0.35 = -$4,592 (tax savings) After-tax cash flow = $140,000 + $4,592 = $144,592

The Fluffy Feather sells customized handbags. Currently, it sells 18,000 handbags annually at an average price of $89 each. It is considering adding a lower-priced line of handbags that sell for $59 each. The firm estimates it can sell 7,000 of the lower-priced handbags but will sell 3,000 less of the higher-priced handbags by doing so. What is the amount of the sales that should be used when evaluating the addition of the lower-priced handbags?

$146,000 Sales = (7,000 x $59) + (-3,000 x $89) = $146,000 -267

Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 and costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the amount of the earnings before interest and taxes for the first year of this project?

$148,000 EBIT = $875,000 - $640,000 - ($522,000/6) = $148,000

You are considering a project in Poland which has an initial cost of 275,000PLN. The project is expected to return a one-time payment of 390,000PLN four years from now. The risk-free rate of return is 4.5 percent in the U.S. and 3 percent in Poland. The inflation rate is 4 percent in the U.S. and 2 percent in Poland. Currently, you can buy 277PLN for 100USD. How much will the payment of 390,000PLN be worth in U.S. dollars four years from now?

$149,568 E(S4) = (277PLN/100USD) [1 + (0.03 - 0.045)]4 = 2.607502245PLN Payment = 390,000PLN ($1/2.607502245PLN) = $149,568

Heer Enterprises needs someone to supply it with 225,000 cartons of machine screws per year to support its manufacturing needs over the next 7 years, and you've decided to bid on the contract. It will cost you $1,170,000 to install the equipment necessary to start production; you'll depreciate this cost straight-line to zero over the project's life. You estimate that in 7 years, this equipment can be salvaged for $75,000. Your fixed production costs will be $360,000 per year, and your variable production costs should be $12.75 per carton. You also need an initial investment in net working capital of $112,500, all of which will be recovered when the project ends. Your tax rate is 32 percent and you require a 13 percent return on your investment. What bid price per carton should you submit?

$15.79

You are expecting a payment of 480,000PLN three years from now. The risk-free rate of return is 3 percent in the U.S. and 4 percent in Poland. The inflation rate is 2.5percent in the U.S. and 3 percent in Poland. Currently, you can buy 277PLN for 100USD. How much will the payment three years from now be worth in U.S. dollars?

$168,189 E(S3) = (277PLN/100USD) [1 + (0.04 - 0.03)]3 = 2.85393377PLN 480,000PLN ($1/2.85393377PLN) = $168,189

Marie's Fashions is considering a project that will require $28,000 in net working capital and $87,000 in fixed assets. The project is expected to produce annual sales of $75,000 with associated costs of $57,000. The project has a 5-year life. The company uses straight-line depreciation to a zero book value over the life of the project. The tax rate is 30 percent. What is the operating cash flow for this project?

$17,820 OCF = ($75,000 - $57,000)(1 - 0.30) + ($87,000/5)(0.30) = $17,820

Panelli's is analyzing a project with an initial cost of $102,000 and cash inflows of $65,000 in year one and $74,000 in year two. This project is an extension of the firm's current operations and thus is equally as risky as the current firm. The firm uses only debt and common stock to finance its operations and maintains a debt-equity ratio of 0.45. The aftertax cost of debt is 4.8 percent, the cost of equity is 12.7 percent, and the tax rate is 35 percent. What is the projected net present value of this project?

$17,840 WACC = (1/1.45) (0.127) + (0.45/1.45) (0.048) = 0.102483 NPV = -$102,000 + ($65,000/1.102483) + ($74,000/1.1024832) = $17,840

The Card Shoppe needs to maintain 23 percent of its sales in net working capital. Currently, the shoppe is considering a 6-year project that will increase sales from its current level of $387,000 to $421,000 the first year and to $465,000 a year for the following 5 years of the project. What amount should be included in the project analysis for net working capital in year 6 of the project?

$17,940 NWC recovery = ($465,000 - $387,000) 0.23 = $17,940

Phone Home, Inc. is considering a new 6-year expansion project that requires an initial fixed asset investment of $5.994 million. The fixed asset will be depreciated straight-line to zero over its 6-year tax life, after which time it will be worthless. The project is estimated to generate $5,328,000 in annual sales, with costs of $2,131,200. The tax rate is 31 percent. What is the operating cash flow for this project?

$2,515,482 OCF = (5,328,000 - $2,131,200)(1 - 0.31) + ($5,994,000/6)(0.31) = $2,515,482

You are planning a trip to Australia. Your hotel will cost you A$145 per night for seven nights. You expect to spend another A$2,800 for meals, tours, souvenirs, and so forth. How much will this trip cost you in U.S. dollars given the following exchange rates? Country: Australia US $ Equivalent: 0.6707 Currency per US$: 1.4910

$2,559 [(A$145 7) + A$2,800] ($1/A$1.4910) = $2,559

The common stock of Metal Molds has a negative growth rate of 1.5 percent and a required return of 18 percent. The current stock price is $11.40. What was the amount of the last dividend paid?

$2.26 D1 = [(0.18 - (-0.015)) $11.40] = $2.223; D0 = $2.223/(1 - 0.015) = $2.26

The Jean Outlet is an all equity firm that has 146,000 shares of stock outstanding. The company has decided to borrow the $1.1 million to repurchase 7,500 shares of its stock from the estate of a deceased shareholder. What is the total value of the firm if you ignore taxes?

$21,413,333 Firm value = 146,000 ($1.1m/7,500) = $21,413,333

You are working on a bid to build two city parks a year for the next three years. This project requires the purchase of $180,000 of equipment that will be depreciated using straight-line depreciation to a zero book value over the 3-year project life. The equipment can be sold at the end of the project for $34,000. You will also need $20,000 in net working capital for the duration of the project. The fixed costs will be $16,000 a year and the variable costs will be $168,000 per park. Your required rate of return is 15 percent and your tax rate is 34 percent. What is the minimal amount you should bid per park? (Round your answer to the nearest $100)

$217,600 OCF NPV = $180,000 + $20000 - ((34000(1-0.34) + 20000)/((1+0.15)^3)) = 172095.01 172095.01 = OCF x ((1-(1/(1+0.15)^3)/.15) OCF= 75373.65 NI = $75,373.65 - ($180,000/3) = $15,373.65 EBT = $15,373.65/(1 - 0.34) = $23,293.41 Sales = $23,293.41 + ($180,000/3) + $16,000 + ($168,000 2) = $435,293.41 Bid per park = $435,293.41/2 = $217,646.71 When rounded to the nearest $100, the bid price is $217,600.

You own a house that you rent for $1,100 a month. The maintenance expenses on the house average $200 a month. The house cost $219,000 when you purchased it 4 years ago. A recent appraisal on the house valued it at $239,000. If you sell the house you will incur $14,000 in real estate fees. The annual property taxes are $4,000. You are deciding whether to sell the house or convert it for your own use as a professional office. What value should you place on this house when analyzing the option of using it as a professional office?

$225,000 Opportunity cost = $239,000 - $14,000 = $225,000

L.A. Clothing has expected earnings before interest and taxes of $48,900, an unlevered cost of capital of 14.5 percent, and a tax rate of 34 percent. The company also has $8,000 of debt that carries a 7 percent coupon. The debt is selling at par value. What is the value of this firm?

$225,299.31 VU = [$48,900 (1 - 0.34)]/0.145 = $222,579.31 VL = $222,579.31 + 0.34 ($8,000) = $225,299.31

Crafter's Supply purchased some fixed assets 2 years ago at a cost of $38,700. It no longer needs these assets so it is going to sell them today for $25,000. The assets are classified as 5-year property for MACRS. What is the net cash flow from this sale if the firm's tax rate is 30 percent? MACRS 5-year property Year Rate 1 20 2 32 3 19.2 4 11.52 5 11.52 6 5.76

$23,072.80 Book value2 = $38,700 x (1 - 0.20 - 0.32) = $18,576 Aftertax salvage = $25,000 + [($18,576 - $25,000) x 0.30] = $23,072.80

You just purchased some equipment that is classified as 5-year property for MACRS. The equipment cost $147,000. What will the book value of this equipment be at the end of 4 years should you decide to resell the equipment at that point in time? MACRS 5-year property Year Rate 1 20 2 32 3 19.2 4 11.52 5 11.52 6 5.76

$25,401.60 Book Value4 = $147,000 x (0.1152 + 0.0576) = $25,401.60

You are analyzing a project with an initial cost of £48,000. The project is expected to return £11,000 the first year, £36,000 the second year and £38,000 the third and final year. There is no salvage value. The current spot rate is £0.6211. The nominal return relevant to the project is 12 percent in the U.S. The nominal risk-free rate in the U.S. is 4 percent while it is 5 percent in the U.K. Assume that uncovered interest rate parity exists. What is the net present value of this project in U.S. dollars?

$25,938 E(S1) = 0.6211 [1 + (0.05 - 0.04)]1 = 0.627311 E(S2) = 0.6211 [1 + (0.05 - 0.04)]2 = 0.63358411 E(S3) = 0.6211 [1 + (0.05 - 0.04)]3 = 0.639919951 CF0 = -£48,000 ($1/£0.6211) = -$77,282.24 CO1 = £11,000 ($1/£0.627311) = $17,535.16 CO2 = £36,000 ($1/£0.63358411) = $56,819.61 CO3 = £38,000 ($1/£0.639919951) = $59,382.43 NPV = -$77,282.24 + ($17,535.16/1.121) + ($56,819.61/1.122) + ($59,382.43/1.123) = -$77,282.24 + $15,656.39 + $45,296.25 + $42,267.24 = $25,938

Bright Morning Foods has expected earnings before interest and taxes of $48,600, an unlevered cost of capital of 13.2 percent, and debt with both a book and face value of $25,000. The debt has an 8.5 percent coupon. The tax rate is 34 percent. What is the value of the firm?

$251,500 VU = [$48,600 (1 - 0.34)] /0.132 = $243,000 VL = $243,000 + (0.34 $25,000) = $251,500

You are evaluating a project which requires $230,000 in external financing. The flotation cost of equity is 11.6 percent and the flotation cost of debt is 5.4 percent. What is the initial cost of the project including the flotation costs if you maintain a debt-equity ratio of 0.45?

$254,638 Average flotation cost = (1/1.45) (0.116) + (0.45/1.45) (0.054) = 0.0967586 Initial cost = $230,000/(1 - 0.0967586) = $254,638

Western Wear is considering a project that requires an initial investment of $274,000. The firm maintains a debt-equity ratio of 0.40 and has a flotation cost of debt of 7 percent and a flotation cost of equity of 10.5 percent. The firm has sufficient internally generated equity to cover the equity portion of this project. What is the initial cost of the project including the flotation costs?

$279,592 Average flotation cost = (1/1.40) (0) + (0.40/1.40) (0.07) = 0.02 Initial cost = $274,000/(1 - 0.02) = $279,592

A project will produce an operating cash flow of $14,600 a year for 8 years. The initial fixed asset investment in the project will be $48,900. The net aftertax salvage value is estimated at $11,000 and will be received during the last year of the project's life. What is the net present value of the project if the required rate of return is 12 percent?

$28,070.26

Galaxy Products is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Galaxy would have 178,500 shares of stock outstanding. Under Plan II, there would be 71,400 shares of stock outstanding and $1.79 million in debt outstanding. The interest rate on the debt is 10 percent and there are no taxes. What is the breakeven EBIT?

$298,333.33 EBIT/178,500 = [EBIT - 0.10($1,790,000)]/71,400; EBIT = $298,333.33

New Schools, Inc. expects an EBIT of $7,000 every year forever. The firm currently has no debt, and its cost of equity is 17 percent. The firm can borrow at 8 percent and the corporate tax rate is 34 percent. What will the value of the firm be if it converts to 50 percent debt?

$31,796.47 VU = $7,000 (1 - 0.34)/0.17 = $27,176.47 VL = $27,176.47 + 0.34 (0.50) ($27,176.47) = $31,796.47 Note: When levered, the value of debt is equal to one-half of the unlevered value of the firm.

Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. The equipment can be scraped at the end of the project for 5 percent of its original cost. Annual sales from this project are estimated at $420,000. Net working capital equal to 20 percent of sales will be required to support the project. All of the net working capital will be recouped. The required return is 16 percent and the tax rate is 35 percent. What is the amount of the aftertax salvage value of the equipment?

$31,850 Aftertax salvage value = $980,000 0.05 (1 - 0.35) = $31,850

Bruno's Lunch Counter is expanding and expects operating cash flows of $26,000 a year for 4 years as a result. This expansion requires $39,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $3,000 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 16 percent?

$32,409.57 NPV= -$39,000 - $3000 + $26000 x [(1-(1/(1+0.16)^4))/.16] + $3000/[(1+0.16)^4]] = $32409.57

Winnebagel Corp. currently sells 28,200 motor homes per year at $42,300 each, and 11,280 luxury motor coaches per year at $79,900 each. The company wants to introduce a new portable camper to fill out its product line. It hopes to sell 19,740 of these campers per year at $11,280 each. An independent consultant has determined that if Winnebagel introduces the new campers, it should boost the sales of its existing motor homes by 4,700 units per year, and reduce the sales of its motor coaches by 1,222 units per year. What is the amount that should be used as the annual sales figure when evaluating this project?

$323,839,400 Sales = (19,740 $11,280) + (4,700 $42,300) + (-1,222 $79,900) = $323,839,400

Exports Unlimited is an unlevered firm with an aftertax net income of $47,800. The unlevered cost of capital is 14.1 percent and the tax rate is 32 percent. What is the value of this firm?

$339,007 VU = $47,800/0.141 = $339,007

Consider an asset that costs $176,000 and is depreciated straight-line to zero over its 11-year tax life. The asset is to be used in a 7-year project; at the end of the project, the asset can be sold for $22,000. The relevant tax rate is 30 percent. What is the aftertax cash flow from the sale of this asset?

$34,600 Book value at end of year 7 = $176,000 4/11 = $64,000 Aftertax salvage value = $22,000 + [($64,000 - $22,000) .30] = $34,600

The camera you want to buy costs $289 in the U.S. How much will the identical camera cost in Canada if the exchange rate is C$1 = $0.8262? Assume absolute purchasing power parity exists.

$349.79 $289 (C$1/$0.8262) = C$349.79

Holly's is currently an all equity firm that has 9,000 shares of stock outstanding at a market price of $42 a share. The firm has decided to leverage its operations by issuing $120,000 of debt at an interest rate of 9.5 percent. This new debt will be used to repurchase shares of the outstanding stock. The restructuring is expected to increase the earnings per share. What is the minimum level of earnings before interest and taxes that the firm is expecting? Ignore taxes.

$35,910 EBIT/9,000 = [EBIT - ($120,000 0.095)]/[9,000 - ($120,000/$42)]; EBIT = $35,910

Bruce & Co. expects its EBIT to be $100,000 every year forever. The firm can borrow at 10 percent. Bruce currently has no debt, and its cost of equity is 20 percent. The tax rate is 31 percent. What will the value of Bruce & Co. be if the firm borrows $54,000 and uses the loan proceeds to repurchase shares?

$361,740 VU = $100,000 (1 - 0.31)/0.20; V = $345,000 VL = $345,000 + 0.31($54,000) = $361,740

Carson Electronics uses 70 percent common stock and 30 percent debt to finance its operations. The aftertax cost of debt is 5.4 percent and the cost of equity is 15.4 percent. Management is considering a project that will produce a cash inflow of $36,000 in the first year. The cash inflows will then grow at 3 percent per year forever. What is the maximum amount the firm can initially invest in this project to avoid a negative net present value for the project?

$382,979 WACC = 0.70(0.154) + 0.30(0.054) = 0.124 PV = $36,000/(0.124 - 0.03) = $382,979

Lamont Corp. uses no debt. The weighted average cost of capital is 11 percent. The current market value of the equity is $38 million and there are no taxes. What is EBIT?

$4,180,000 V = $38,000,000 = EBIT/0.11; EBIT = $4,180,000

You want your portfolio beta to be 0.95. Currently, your portfolio consists of $4,000 invested in stock A with a beta of 1.47 and $3,000 in stock B with a beta of 0.54. You have another $9,000 to invest and want to divide it between an asset with a beta of 1.74 and a risk-free asset. How much should you invest in the risk-free asset?

$4,574.71 BetaPortfolio = 0.95 = ($4,000/$16,000)(1.47) + ($3,000/$16,000)(0.54) + (x/$16,000)(1.74) + (($9,000 - x)/$16,000)(0); Investment in risk-free asset = $9,000 - $4,425.29 = $4,574.71

You have a $12,000 portfolio which is invested in stocks A and B, and a risk-free asset. $5,000 is invested in stock A. Stock A has a beta of 1.76 and stock B has a beta of 0.89. How much needs to be invested in stock B if you want a portfolio beta of 1.10?

$4,943.82 BetaPortfolio = 1.10 = ($5,000/$12,000)(1.76) + (x/$12,000)(0.89) + (($12,000 - $5,000 - x)/$12,000)(0); x = $4,943.82

Pewter & Glass is an all equity firm that has 80,000 shares of stock outstanding. The company is in the process of borrowing $600,000 at 9 percent interest to repurchase 12,000 shares of the outstanding stock. What is the value of this firm if you ignore taxes?

$4.0 million Firm value = 80,000 ($600,000/12,000) = $4 million

The Daily Brew has a debt-equity ratio of 0.72. The firm is analyzing a new project which requires an initial cash outlay of $420,000 for equipment. The flotation cost is 9.6 percent for equity and 5.4 percent for debt. What is the initial cost of the project including the flotation costs?

$455,738 Average flotation cost = (1/1.72) (0.096) + (0.72/1.72) (0.054) = 0.0784186 Initial cost = $420,000/(1 - 0.0784186) = $455,738

Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. The equipment can be scraped at the end of the project for 5 percent of its original cost. Annual sales from this project are estimated at $420,000. Net working capital equal to 20 percent of sales will be required to support the project. All of the net working capital will be recouped. The required return is 16 percent and the tax rate is 35 percent. What is the value of the depreciation tax shield in year 4 of the project?

$49,000 Depreciation tax shield = $980,000/7 0.35 = $49,000

The Lumber Yard is considering adding a new product line that is expected to increase annual sales by $238,000 and cash expenses by $184,000. The initial investment will require $96,000 in fixed assets that will be depreciated using the straight-line method to a zero book value over the 6-year life of the project. The company has a marginal tax rate of 32 percent. What is the annual value of the depreciation tax shield?

$5,120 Depreciation tax shield = ($96,000/6) x 0.32 = $5,120

The SLG Corp. uses no debt. The weighted average cost of capital is 12 percent. The current market value of the equity is $31 million and the corporate tax rate is 34 percent. What is EBIT?

$5,636,364 VU = $31,000,000 = EBIT (1 - 0.34)/0.12; EBIT = $5,636,364

Hanover Tech is currently an all equity firm that has 320,000 shares of stock outstanding with a market price of $19 a share. The current cost of equity is 15.4 percent and the tax rate is 36 percent. The firm is considering adding $1.2 million of debt with a coupon rate of 8 percent to its capital structure. The debt will be sold at par value. What is the levered value of the equity?

$5.312 million VL = (320,000 $19) + (0.36 $1.2m) = $6.512m VE = $6.512m - $1.2m = $5.312m

Kelso Electric is debating between a leveraged and an unleveraged capital structure. The all equity capital structure would consist of 40,000 shares of stock. The debt and equity option would consist of 25,000 shares of stock plus $280,000 of debt with an interest rate of 7 percent. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes.

$52,267 EBIT/40,000 = [EBIT - ($280,000 0.07)]/25,000; EBIT = $52,267

D. L. Tuckers has $21,000 of debt outstanding that is selling at par and has a coupon rate of 7.5 percent. The tax rate is 32 percent. What is the present value of the tax shield?

$6,720 Present value of the tax shield = 0.32 $21,000 = $6,720

Bernie's Beverages purchased some fixed assets classified as 5-year property for MACRS. The assets cost $87,000. What will the accumulated depreciation be at the end of year three? MACRS 5-year property Year Rate 1 20 2 32 3 19.2 4 11.52 5 11.52 6 5.76

$61,944 Depreciation = $87,000 x (0.20 + 0.32 + 0.192) = $61,944

Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 and costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the amount of the aftertax cash flow from the sale of the fixed assets at the end of this project?

$68,904 Aftertax salvage value = $522,000 0.20 (1 - 0.34) = $68,904

Bi-Lo Traders is considering a project that will produce sales of $28,000 and increase cash expenses by $17,500. If the project is implemented, taxes will increase by $3,000. The additional depreciation expense will be $1,600. An initial cash outlay of $1,400 is required for net working capital. What is the amount of the operating cash flow using the top-down approach?

$7,500 OCF = $28,000 - $17,500 - $3,000 = $7,500

The June Bug has a $270,000 bond issue outstanding. These bonds have a 7.5 percent coupon, pay interest semiannually, and have a current market price equal to 98.6 percent of face value. The tax rate is 39 percent. What is the amount of the annual interest tax shield?

$7,897.50 Annual interest tax shield = $270,000 0.075 0.39 = $7,897.50

Phone Home, Inc. is considering a new 4-year expansion project that requires an initial fixed asset investment of $3 million. The fixed asset will be depreciated straight-line to zero over its 4-year tax life, after which time it will have a market value of $231,000. The project requires an initial investment in net working capital of $330,000, all of which will be recovered at the end of the project. The project is estimated to generate $2,640,000 in annual sales, with costs of $1,056,000. The tax rate is 31 percent and the required return for the project is 15 percent. What is the net present value for this project?

$733,970 OCF = ($2,640,000 - $1,056,000)(1 - 0.31) + ($3,000,000/4)(0.31) = $1,325,460

Travis & Sons has a capital structure which is based on 40 percent debt, 5 percent preferred stock, and 55 percent common stock. The pre-tax cost of debt is 7.5 percent, the cost of preferred is 9 percent, and the cost of common stock is 13 percent. The company's tax rate is 39 percent. The company is considering a project that is equally as risky as the overall firm. This project has initial costs of $325,000 and annual cash inflows of $87,000, $279,000, and $116,000 over the next three years, respectively. What is the projected net present value of this project?

$76,011.23 WACC = (0.55 0.13) + (0.05 0.09) + [0.40 0.075 (1 - 0.39)] =0.0943 NPV -$325,000 + ($87,000/1.0943) + ($279,000/1.09432) + ($116,000/1.09433) = $76,011.23

You have $10,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 13 percent and Stock Y with an expected return of 8 percent. Your goal is to create a portfolio with an expected return of 12.4 percent. All money must be invested. How much will you invest in stock X?

$8,800 E(Rp) = 0.124 = .13x + .08(1 - x); x = 88 percent Investment in Stock X = 0.88($10,000) = $8,800

You are expecting a payment of C$100,000 four years from now. The risk-free rate of return is 3.8 percent in the U.S. and 4.1 percent in Canada. The inflation rate is 2 percent in the U.S. and 3 percent in Canada. Suppose the current exchange rate is C$1 = $0.8273. How much will the payment four years from now be worth in U.S. dollars?

$81,745 E(S4) = (C$1/$0.8273) [1 + (0.041 - 0.038)]4 = C$1.223321779 C$100,000 ($1/C$1.223321779) = $81,745

Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. The equipment can be scraped at the end of the project for 5 percent of its original cost. Annual sales from this project are estimated at $420,000. Net working capital equal to 20 percent of sales will be required to support the project. All of the net working capital will be recouped. The required return is 16 percent and the tax rate is 35 percent. What is the recovery amount attributable to net working capital at the end of the project?

$84,000 NWC recapture = $420,000 0.20 = $84,000

Jasper Metals is considering installing a new molding machine which is expected to produce operating cash flows of $73,000 a year for 7 years. At the beginning of the project, inventory will decrease by $16,000, accounts receivables will increase by $21,000, and accounts payable will increase by $15,000. All net working capital will be recovered at the end of the project. The initial cost of the molding machine is $249,000. The equipment will be depreciated straight-line to a zero book value over the life of the project. The equipment will be salvaged at the end of the project creating a $48,000 aftertax cash flow. At the end of the project, net working capital will return to its normal level. What is the net present value of this project given a required return of 14.5 percent?

$84,049.74 CF0 = -$249,000 + $16,000 - $21,000 + $15,000 = -$239,000 C07 = $73,000 + $48,000 - $16,000 + $21,000 - $15,000 = $111,000

Webster & Moore paid $139,000, in cash, for a piece of equipment 3 years ago. At the beginning of last year, the company spent $21,000 to update the equipment with the latest technology. The company no longer uses this equipment in its current operations and has received an offer of $89,000 from a firm that would like to purchase it. Webster & Moore is debating whether to sell the equipment or to expand its operations so that the equipment can be used. When evaluating the expansion option, what value, if any, should the firm assign to this equipment as an initial cost of the project?

$89,000 Relevant value = $89,000

Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 and costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the cash flow recovery from net working capital at the end of this project?

$92,000 Net working capital recovery = $218,000 + $39,000 - $165,000 = $92,000

Yesteryear Productions is considering a project with an initial start up cost of $960,000. The firm maintains a debt-equity ratio of 0.50 and has a flotation cost of debt of 6.8 percent and a flotation cost of equity of 11.4 percent. The firm has sufficient internally generated equity to cover the equity cost of this project. What is the initial cost of the project including the flotation costs?

$982,265 Average flotation cost = (1/1.5) (0.0) + (0.5/1.5) (0.068) = 0.0226667 Initial cost = $960,000/(1 - 0.0226667) = $982,265

Kelly's Corner Bakery purchased a lot in Oil City 6 years ago at a cost of $280,000. Today, that lot has a market value of $340,000. At the time of the purchase, the company spent $15,000 to level the lot and another $20,000 to install storm drains. The company now wants to build a new facility on that site. The building cost is estimated at $1.47 million. What amount should be used as the initial cash flow for this project?

-$1,810,000 CF0 = -$340,000 - $1,470,000 = -$1,810,000

A 4-year project has an initial asset investment of $306,600, and initial net working capital investment of $29,200, and an annual operating cash flow of -$46,720. The fixed asset is fully depreciated over the life of the project and has no salvage value. The net working capital will be recovered when the project ends. The required return is 15 percent. What is the project's equivalent annual cost, or EAC?

-$158,491

Lakonishok Equipment has an investment opportunity in Europe. The project costs €12 million and is expected to produce cash flows of €2.7 million in year 1, €3 million in year 2, and €2.8 million in year 3. The current spot exchange rate is $1.3/€. The current risk-free rate in the United States is 5 percent, compared to that in Europe of 3.5 percent. The appropriate discount rate for the project is estimated to be 18 percent, the U.S. cost of capital for the company. In addition, the subsidiary can be sold at the end of three years for an estimated €6.5 million. What is the NPV of the project?

-$2,016,686 E(S1) = (1.05/1.035)1 ($1.3/€) = $1.31884058/€ E(S2) = (1.05/1.035)2 ($1.3/€) = $1.337954211/€ E(S1) = (1.05/1.035)3 ($1.3/€) = $1.357344852/€ Year 0 cash flow = €-12,000,000 ($1.3/€) = -$15,600,000 Year 1 cash flow = €2,700,000 ($1.31884058/€) = $3,560,869.57 Year 2 cash flow = €3,000,000 ($1.337954211/€) = $4,013,862.63 Year 3 cash flow = €2,800,000 + €6,500,000) ($1.357344852/€) = $12,623,307.12 NPV = -$15,600,000 + ($3,560,869.57/1.18) + ($4,013,862.63/1.182) + ($12,623,307.12/1.183) = -$2,016,686

Home Furnishings Express is expanding its product offerings to reach a wider range of customers. The expansion project includes increasing the floor inventory by $430,000 and increasing its debt to suppliers by 70 percent of that amount. The company will also spend $450,000 for a building contractor to expand the size of its showroom. As part of the expansion plan, the company will be offering credit to its customers and thus expects accounts receivable to rise by $90,000. For the project analysis, what amount should be used as the initial cash flow for net working capital?

-$219,000 NWC requirement = -$430,000 + (0.70 $430,000) - $90,000 = -$219,000

Champion Bakers uses specialized ovens to bake its bread. One oven costs $689,000 and lasts about 4 years before it needs to be replaced. The annual operating cost per over is $41,000. What is the equivalent annual cost of an oven if the required rate of return is 13 percent?

-$272,638

The Bakery is considering a new project it considers to be a little riskier than its current operations. Thus, management has decided to add an additional 1.5 percent to the company's overall cost of capital when evaluating this project. The project has an initial cash outlay of $62,000 and projected cash inflows of $17,000 in year one, $28,000 in year two, and $30,000 in year three. The firm uses 25 percent debt and 75 percent common stock as its capital structure. The company's cost of equity is 15.5 percent while the aftertax cost of debt for the firm is 6.1 percent. What is the projected net present value of the new project?

-$5,964 WACCFirm = (0.75 0.155) + (0.25 0.061) = 0.1315 WACCProject = 0.1315 + 0.015 = 0.1465 NPV = -$62,000 + ($17,000/1.1465) + ($28,000/1.14652) + ($30,000/1.14653) = -$5,964

Hollister & Hollister is considering a new project. The project will require $522,000 for new fixed assets, $218,000 for additional inventory, and $39,000 for additional accounts receivable. Short-term debt is expected to increase by $165,000. The project has a 6-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. At the end of the project, the fixed assets can be sold for 20 percent of their original cost. The net working capital returns to its original level at the end of the project. The project is expected to generate annual sales of $875,000 with costs of $640,000. The tax rate is 34 percent and the required rate of return is 14 percent. What is the project's cash flow at time zero?

-$614,000 Initial cash flow = -$522,000 - $218,000 - $39,000 + $165,000 = -$614,000

You are analyzing a project with an initial cost of £130,000. The project is expected to return £20,000 the first year, £50,000 the second year and £100,000 the third and final year. There is no salvage value. The current spot rate is £0.6211. The nominal risk-free return is 5.5 percent in the U.K. and 6 percent in the U.S. The return relevant to the project is 14 percent in the U.S. Assume that uncovered interest rate parity exists. What is the net present value of this project in U.S. dollars?

-$8,030 E(S1) = 0.6211 [1 + (0.055 - 0.06)]1 = 0.6179945 E(S2) = 0.6211 [1 + (0.055 - 0.06)]2 = 0.614904528 E(S3) = 0.6211 [1 + (0.055 - 0.06)]3 = 0.611830005 CF0 = -£130,000 ($1/£0.6211) = -$209,306.07 CO1 = £20,000 ($1/£0.6179945) = $32,362.75 CO2 = £50,000 ($1/£0.614904528) = $81,313.44 CO3 = £100,000 ($1/£0.611830005) = $163,444.09 NPV = -$209,306.07 + ($32,362.75/1.141) + ($81,313.44/1.142) + ($163,444.09/1.143) = -$209,306.07 + $28,388.38 + $62,568.05 + $110,320.11 = -$8,030

The Buck Store is considering a project that will require additional inventory of $216,000 and will increase accounts payable by $181,000. Accounts receivable are currently $525,000 and are expected to increase by 9 percent if this project is accepted. What is the project's initial cash flow for net working capital?

-$82,250 NWC requirement = -$216,000 + $181,000 - ($525,000 0.09) = - $82,250

Sailcloth & More currently produces boat sails and is considering expanding its operations to include awnings for homes and travel trailers. The company owns land beside its current manufacturing facility that could be used for the expansion. The company bought this land 5 years ago at a cost of $319,000. At the time of purchase, the company paid $24,000 to level out the land so it would be suitable for future use. Today, the land is valued at $295,000. The company currently has some unused equipment that it currently owns valued at $38,000. This equipment could be used for producing awnings if $12,000 is spent for equipment modifications. Other equipment costing $490,000 will also be required. What is the amount of the initial cash flow for this expansion project?

-$835,000 CF0 = -$295,000 - $38,000 - $12,000 - $490,000 = -$835,000

Sister Pools sells outdoor swimming pools and currently has an aftertax cost of capital of 11.6 percent. Al's Construction builds and sells water features and fountains and has an aftertax cost of capital of 10.8 percent. Sister Pools is considering building and selling its own water features and fountains. The sales manager of Sister Pools estimates that the water features and fountains would produce 20 percent of the firm's future total sales. The initial cash outlay for this project would be $85,000. The expected net cash inflows are $16,000 a year for 7 years. What is the net present value of the Sister Pools project?

-$9,115

Highway Express has paid annual dividends of $1.16, $1.20, $1.25, $1.10, and $0.95 over the past five years respectively. What is the average dividend growth rate?

-4.51 percent ($1.20 - $1.16)/$1.16 = 0.034483 ($1.25 - $1.20)/$1.20 = 0.041667 ($1.10 - $1.25)/$1.25 = -0.12 ($0.95 - $1.10)/$1.10 = -0.136364 g = (0.034483 + 0.041667 - 0.12 - 0.136364)/4 = -4.51 percent

East Side, Inc. has no debt outstanding and a total market value of $136,000. Earnings before interest and taxes, EBIT, are projected to be $12,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 27 percent higher. If there is a recession, then EBIT will be 55 percent lower. East Side is considering a $54,000 debt issue with a 5 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 2,000 shares outstanding. Ignore taxes. If the economy enters a recession, EPS will change by ____ percent as compared to a normal economy, assuming that the firm recapitalizes.

-70.97 percent Share price = $136,000/2,000 = $68 Shares repurchased = $54,000/$68 = 794.117647 Annual interest = $54,000 0.05 = $2,700 EPSNormal = ($12,000 - $2,700)/(2,000 - 794.117647) = $7.712195 EPSRecession = {[$12,000 (1 - 0.55)] - $2,700}/(2,000 - 794.117647) = $2.239024 Percentage change = ($2.239024 - $7.712195)/$7.712195 = -70.97 percent

You want to invest in a project in Canada. The project has an initial cost of C$2.2 million and is expected to produce cash inflows of C$900,000 a year for 3 years. The project will be worthless after the first 3 years. The expected inflation rate in Canada is 4 percent while it is only 3 percent in the U.S. The applicable interest rate for the project in Canada is 13 percent. The current spot rate is C$1 = $0.8158. What is the net present value of this project in Canadian dollars?

-C$74,963 NPV= C$2.2m + C$900000 x (1-[(1/[1.13^3])/0.13]= C$74963

What is the variance of the returns on a portfolio that is invested 60 percent in stock S and 40 percent in stock T? Boom: 20%/S: 17%/T: 7% Normal: 80%/S: 13%/T: 10%

.000023 E(r)Boom = (0.60 0.17) + (0.40 0.07) = 0.13 E(r)Normal = (0.60 0.13) + (0.40 0.10) = 0.118 E(r)Portfolio = (0.20 0.13) + (0.80 0.118) = 0.1204 VarPortfolio = 0.20 (0.13 - 0.1204)2] + 0.80 (0.118 - 0.1204)2 = .000023

What is the variance of the returns on a portfolio comprised of $5,400 of stock G and $6,600 of stock H? Boom: 36%/G: 21%/H: 13% Normal: 64%/G: 13%/H: 7%

.001097 E(r)Boom = [$5,400/($5,400 + $6,600)][0.21] + [($6,600/($5,400 + $6,600)][0 .13] = 0.166 E(r)Normal = [$5,400/($5,400 + $6,600)][0.13] + [$6,600/($5,400 + $6,600)][0.07] = 0.097 E(r)Portfolio = (0.36 0.166) + (0.64 0.097) = 0.12184 VarPortfolio = [0.36 (0.166 - 0.12184)2] + [0.64 (0.097 - 0.12184)2] = 0.001097

The rate of return on the common stock of Lancaster Woolens is expected to be 21 percent in a boom economy, 11 percent in a normal economy, and only 3 percent in a recessionary economy. The probabilities of these economic states are 10 percent for a boom, 70 percent for a normal economy, and 20 percent for a recession. What is the variance of the returns on this common stock?

0.002244 E(r) = (0.10 0.21) + (0.70 0.11) + (0.20 0.03) = 0.104 Var = 0.10 (0.21 - 0.104)2 + 0.70 (0.11 - 0.104)2 + 0.20 (0.03 - 0.104)2 = 0.002244

If the economy is normal, Charleston Freight stock is expected to return 15.7 percent. If the economy falls into a recession, the stock's return is projected at a negative 11.6 percent. The probability of a normal economy is 80 percent while the probability of a recession is 20 percent. What is the variance of the returns on this stock?

0.011925 E(r) = (0.80 0.157) + (0.20 -0.116) = 0.1024 Var = 0.80 (0.157 - 0.1024)2 + 0.20 (-0.116 - 0.1024)2 = 0.011925

Jefferson & Daughter has a cost of equity of 14.6 percent and a pre-tax cost of debt of 7.8 percent. The required return on the assets is 13.2 percent. What is the firm's debt-equity ratio based on M&M II with no taxes?

0.26 RE = 0.146 = 0.132 + (0.132 - 0.078) D/E; D/E = 0.26

Your portfolio is comprised of 40 percent of stock X, 15 percent of stock Y, and 45 percent of stock Z. Stock X has a beta of 1.16, stock Y has a beta of 1.47, and stock Z has a beta of 0.42. What is the beta of your portfolio?

0.87 BetaPortfolio = (0.40 1.16) + (0.15 1.47) + (0.45 0.42) = 0.87

What is the standard deviation of the returns on a $30,000 portfolio which consists of stocks S and T? Stock S is valued at $12,000. B 5%/S 11%/T 5% N 85%/S 8%/T 6% R 10%/S -5%/T 8%

1.22 percent E(r)Boom = [$12,000/$30,000] [0.11] + [($30,000 - $12,000)/$30,000] [0.05] = 0.074 E(r)Normal = [$12,000/$30,000] [0.08] + [($30,000 - $12,000)/$30,000] [0.06] = 0.068 E(r)Bust = [$12,000/$30,000] [-0.05] + [($30,000 - $12,000)/$30,000] [0.08] = 0.028 E(r)Portfolio = (0.05 0.074) + (0.85 0.068) + (0.10 0.028) = 0.0643 VarPortfolio = [0.05 (0.074 - 0.0643)2] + [0.85 (0.068 - 0.0643)2] + [0.10 (0.028 - 0.0643)2] = .000148111 Std dev = 0.000148111 = 1.22 percent

A stock has an expected return of 11 percent, the risk-free rate is 6.1 percent, and the market risk premium is 4 percent. What is the stock's beta?

1.23 E(Ri) = 0.11 = 0.61 + ?i(0.04); ?i = 1.23

You recently purchased a stock that is expected to earn 22 percent in a booming economy, 9 percent in a normal economy, and lose 33 percent in a recessionary economy. There is a 5 percent probability of a boom and a 75 percent chance of a normal economy. What is your expected rate of return on this stock?

1.25 percent E(r) = (0.05 x 0.22) + (0.75 x 0.09) + (0.20 x -0.33) = 1.25 percent

Suppose the current spot rate for the Norwegian kroner is $1 = NKr6.7119. The expected inflation rate in Norway is 4 percent and in the U.S. 3 percent. A risk-free asset in the U.S. is yielding 4.5 percent. What approximate real rate of return should you expect on a risk-free Norwegian security?

1.5 percent Approximate real rateN = Approximate real rateU.S. = 0.045 - 0.03 = 1.5 percent

What is the standard deviation of the returns on a portfolio that is invested 52 percent in stock Q and 48 percent in stock R? Boom: 10%/Q: 14%/R: 16% Normal: 90%/Q: 8%/R: 11%

1.66 percent E(r)Boom = (0.52 0.14) + (.0.48 0.16) = 0.1496 E(r)Normal = (0.52 0.08) + (0.48 0.11) = 0.0944 E(r)Portfolio = (0.10 .0.1496) + (0.90 0.0944) = 0.09992 VarPortfolio = [0.10 (0.1496 - 0.09992)2] + [0.90 (0.0944 - 0.09992)2] = 0.000274 Std dev = 0.000274 = 1.66 percent

The common stock of Jensen Shipping has an expected return of 16.3 percent. The return on the market is 10.8 percent and the risk-free rate of return is 3.8 percent. What is the beta of this stock?

1.79 E(r) = 0.163 = 0.038 + ? (0.108 - 0.038); ? = 1.79

You are comparing stock A to stock B. Given the following information, what is the difference in the expected returns of these two securities? State of Economy: Normal Probability of State of Economy: 45% RoR if State Occurs: Stock A 14% Stock B 17% State: Recession Probability: 55% Ror: Stock A -22% Stock B -28%

1.95 percent E(r)A = (0.45 x 0.14) + (0.55 x -0.22) = -5.80 percent E(r)B = (0.45 x 0.17) + (0.55 x -0.28) = -7.75 percent Difference = -5.80 percent - (-7.75 percent) = 1.95 percent

Southern Home Cookin' just paid its annual dividend of $0.65 a share. The stock has a market price of $13 and a beta of 1.12. The return on the U.S. Treasury bill is 2.5 percent and the market risk premium is 6.8 percent. What is the cost of equity?

10.12 percent Re = 0.025 + (1.12 0.068) = 10.12 percent

National Home Rentals has a beta of 1.38, a stock price of $19, and recently paid an annual dividend of $0.94 a share. The dividend growth rate is 4.5 percent. The market has a 10.6 percent rate of return and a risk premium of 7.5 percent. What is the firm's cost of equity?

11.56 percent Re = (0.106 - 0.075) + (1.38 0.075) = 0.1345 Re = [($0.94 1.045)/$19] + 0.045 = 0.0967 Re Average = (0.1345 + 0.0967)/2 = 11.56 percent

Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 6.75 percent. The company also has 750,000 shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $53 a share. The common stock has a beta of 1.34 and sells for $42 a share. The U.S. Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent. What is the firm's weighted average cost of capital?

10.39 percent Re = 0.028 + 1.34 (0.112 - 0.028) = 0.14056 Rp = (0.07 $100)/$53 = 0.13208 Debt: .028 + 1.34(.112-.028) = 0.14056 Preferred: 75000 x 53= 39.75m Common 2.5m x 42= 105m Total: 224.75m WACC= (105m/224.75m)(0.14056) = (39.75m/224.75m)(-.13208) + (80m/224.75m)(0.0675)(1-0.38)= 10.39%

Henessey Markets has a growth rate of 4.8 percent and is equally as risky as the market. The stock is currently selling for $17 a share. The overall stock market has a 10.6 percent rate of return and a risk premium of 8.7 percent. What is the expected rate of return on this stock?

10.6 percent Re = (0.106 - 0.087) + (1.00 0.087) = 10.6 percent

Dog Gone Good Engines has a bond issue outstanding with 17 years to maturity. These bonds have a $1,000 face value, a 9 percent coupon, and pay interest semi-annually. The bonds are currently quoted at 87 percent of face value. What is the company's pre-tax cost of debt if the tax rate is 38 percent?

10.67 percent N 17x2 IY /2 PV -870 PMT 90/2 FV 1000 Solve for IY: 10.67

The Corner Bakery has a debt-equity ratio of 0.54. The firm's required return on assets is 14.2 percent and its cost of equity is 16.1 percent. What is the pre-tax cost of debt based on M&M Proposition II with no taxes?

10.68 percent RE = 0.161 = 0.142 + (0.142 - Rd) 0.54; Rd = 10.68 percent

Mullineaux Corporation has a target capital structure of 41 percent common stock, 4 percent preferred stock, and 55 percent debt. Its cost of equity is 19 percent, the cost of preferred stock is 6.5 percent, and the pre-tax cost of debt is 7.5 percent. What is the firm's WACC given a tax rate of 34 percent?

10.77 percent WACC = 0.41(0.19) + (0.04)(.065) + (0.55)(.075)(1 - 0.34) = 10.77 percent

Kelso's has a debt-equity ratio of 0.55 and a tax rate of 35 percent. The firm does not issue preferred stock. The cost of equity is 14.5 percent and the aftertax cost of debt is 4.8 percent. What is the weighted average cost of capital?

11.06 percent WACC = (1/1.55) (0.145) + (0.55/1.55) (0.048) = 11.06 percent

What is the expected return on a portfolio that is equally weighted between stocks K and L given the following information? Boom: 25%/K: 16%/L: 13% Normal: 75%/K: 12%/L: 8%

11.13 percent E(r) = 0.25[(0.16 + 0.13)/2] + 0.75[(0.12 + 0.08)/2] = 11.13 percent

The risk-free rate of return is 3.9 percent and the market risk premium is 6.2 percent. What is the expected rate of return on a stock with a beta of 1.21?

11.40 percent E(r) = 0.039 + (1.21 0.062) = 11.40 percent

The Green Paddle has a cost of equity of 13.73 percent and a pre-tax cost of debt of 7.6 percent. The debt-equity ratio is 0.65 and the tax rate is 32 percent. What is Green Paddle's unlevered cost of capital?

11.85 percent RE = 0.1373 = RU + (RU - 0.076) 0.65 (1 - 0.32); RU = 11.85 percent

ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $480,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $240,000 and the interest rate on its debt is 11 percent. Both firms expect EBIT to be $58,400. Ignore taxes. The cost of equity for ABC is _____ percent, and for XYZ it is ______ percent.

12.17; 13.33 ABC: RE = RA = $58,400/$480,000 = 12.17 percent XYZ: RE = 0.1217 + (0.1217 - 0.11)(1)(1) = 13.33 percent Note: ABC: Equity = $480,000 XYZ: Equity = $240,000; Debt = $480,000 - $240,000 = $240,000

A firm has debt of $12,000, a leveraged value of $26,400, a pre-tax cost of debt of 9.20 percent, a cost of equity of 17.6 percent, and a tax rate of 37 percent. What is the firm's weighted average cost of capital?

12.23 percent WACC = {[($26,400 - $12,000)/$26,400] 0.176} + [($12,000/$26,400) 0.092 (1 - 0.37)] = 12.23 percent

W.V. Trees, Inc. has a debt-equity ratio of 1.4. Its WACC is 10 percent, and its cost of debt is 9 percent. The corporate tax rate is 33 percent. What is the firm's unlevered cost of equity capital?

12.38 percent WACC = 0.10 = (1/2.4) RE + (1.4/2.4) (0.09) (1 - 0.33); RE = 0.15558 RE = 0.15558 = RU + (RU - 0.09)(1.4)(1 - 0.33); RU = 12.38 percent

Decker's is a chain of furniture retail stores. Furniture Fashions is a furniture maker and a supplier to Decker's. Decker's has a beta of 1.38 as compared to Furniture Fashion's beta of 1.12. The risk-free rate of return is 3.5 percent and the market risk premium is 8 percent. What discount rate should Decker's use if it considers a project that involves the manufacturing of furniture?

12.46 percent Re = 0.035 + 1.12(0.08) = 12.46 percent

Cookie Dough Manufacturing has a target debt-equity ratio of 0.5. Its cost of equity is 15 percent, and its cost of debt is 11 percent. What is the firm's WACC given a tax rate of 31 percent?

12.53 percent WACC = (1/1.5)(0.15) + (0.5/1.5)(0.11)(1 - 0.31) = 12.53 percent

Country Markets has an unlevered cost of capital of 12 percent, a tax rate of 38 percent, and expected earnings before interest and taxes of $15,700. The company has $11,000 in bonds outstanding that have a 6 percent coupon and pay interest annually. The bonds are selling at par value. What is the cost of equity?

12.55 percent VU = [$15,700 (1- 0.38)]/0.12 = $81,116.67 VL = $81,116.67 + (0.38 $11,000) = $85,296.67 VE = $85,296.67 - $11,000 = $74,296.67 RE = 0.12 + [(0.12 - 0.06) ($11,000/$74,296.67) (1 - 0.38)] = 12.55 percent

Jemisen's has expected earnings before interest and taxes of $6,200. Its unlevered cost of capital is 13 percent and its tax rate is 34 percent. The firm has debt with both a book and a face value of $2,500. This debt has a 9 percent coupon and pays interest annually. What is the firm's weighted average cost of capital?

12.66 percent VU = [$6,200 (1 - 0.34)]/0.13 = $31,476.92 VL = $31,476.92 + (0.34 $2,500) = $32,326.92 VE = $32,326.92 - $2,500 = $29,826.92 RE = 0.13 + (0.13 - 0.09) ($2,500/$29,826.92) (1 - 0.34) = 0.132213 WACC = [($29,826.92/$32,326.92) 0.132213] + [($2,500/$32,326.92) 0.09 (1 - 0.34)] = 12.66 percent

The Oil Derrick has an overall cost of equity of 13.6 percent and a beta of 1.28. The firm is financed solely with common stock. The risk-free rate of return is 3.4 percent. What is an appropriate cost of capital for a division within the firm that has an estimated beta of 1.18?

12.80 percent 0.136 = 0.034 + 1.28mrp; mrp = 0.0796875 ReDivision = 0.034 + 1.18(0.0796875) = 12.80 percent

Wayco Industrial Supply has a pre-tax cost of debt of 7.6 percent, a cost of equity of 14.3 percent, and a cost of preferred stock of 8.5 percent. The firm has 220,000 shares of common stock outstanding at a market price of $27 a share. There are 25,000 shares of preferred stock outstanding at a market price of $41 a share. The bond issue has a face value of $550,000 and a market quote of 101.2. The company's tax rate is 37 percent. What is the firm's weighted average cost of capital?

12.81 percent

Delta Lighting has 30,000 shares of common stock outstanding at a market price of $17.50 a share. This stock was originally issued at $31 per share. The firm also has a bond issue outstanding with a total face value of $280,000 which is selling for 86 percent of par. The cost of equity is 16 percent while the aftertax cost of debt is 6.9 percent. The firm has a beta of 1.48 and a tax rate of 30 percent. What is the weighted average cost of capital?

13.14 percent Common: 30000 x 17.5= 525000 Debt: 280000 x 0.86= 240000 Total= 756800

Thayer Farms stock has a beta of 1.12. The risk-free rate of return is 4.34 percent and the market risk premium is 7.92 percent. What is the expected rate of return on this stock?

13.21 percent E(r) = 0.0434 + (1.12 x 0.0792) = 13.21 percent

Percy's Wholesale Supply has earnings before interest and taxes of $106,000. Both the book and the market value of debt is $170,000. The unlevered cost of equity is 15.5 percent while the pre-tax cost of debt is 8.6 p

13.45 percent VU = [$106,000 (1 - 0.38)]/0.155 = $424,000 VL = $424,000 + (0.38 $170,000) = $488,600 VE = $488,600 - $170,000 = $318,600 RE = 0.155 + (0.155 - 0.086) ($170,000/$318,600) (1 - 0.38) = 0.177827 WACC = [($318,600/$488,600) 0.177827] + [($170,000/$488,600) 0.086 (1 - 0.38)] = 13.45 percent

Silo Mills has a beta of 0.87 and a cost of equity of 11.9 percent. The risk-free rate of return is 2.8 percent. The firm is currently considering a project that has a beta of 1.03 and a project life of 6 years. What discount rate should be assigned to this project?

13.57 percent. RE = 0.119 = 0.028 + (0.87 mrp); mrp = 0.1046 RProject = 0.028 + (1.03 0.1046) = 13.57 percent

Your portfolio is invested 26 percent each in Stocks A and C, and 48 percent in Stock B. What is the standard deviation of your portfolio given the following information? State/Prob/RorA/RorB/RorC Boom/0.25/0.25/0.25/0.45 Good/0.25/0.10/0.13/0.11 Poor/0.25.0.03/0.05/0.05 Bust/0.25/-0.04/-0.09/-0.09

13.73 percent E(Rp)Boom = 0.26(0.25) + 0.48(0.25) + 0.26(0.45) = 0.302 E(Rp)Good = 0.26(0.10) + 0.48(0.13) + 0.26(0.11) = 0.117 E(Rp)Poor = 0.26(0.03) + 0.48(0.05) + 0.26(0.05) = 0.0448 E(Rp)Bust = 0.26(-0.04) + 0.48(-0.09) + 0.26(-0.09) = -0.077 E(Rp) = 0.25(0.302) + 0.25(0.117) + 0.25(0.0448) + 0.25(-0.077) = 0.0967 p2 = 0.25(0.302 - 0.0967)2 + 0.25(0.117 - 0.0967)2 + 0.25(0.0448 - 0.0967)2 + 0.25(-0.077 - 0.0967)2 = 0.018856 p = 0.018856 = 13.73 percent

Stock in Country Road Industries has a beta of 0.97. The market risk premium is 10 percent while T-bills are currently yielding 5.5 percent. Country Road's most recent dividend was $1.70 per share, and dividends are expected to grow at a 7 percent annual rate indefinitely. The stock sells for $32 a share. What is the estimated cost of equity using the average of the CAPM approach and the dividend discount approach?

13.94 percent RE = 0.055 + 0.97(0.10) = 0.152 RE = [($1.70 1.07)/$32] + 0.07 = 0.12684375 RE Average = (0.152 + 0.12684375)/2 = 13.94 percent

The Market Outlet has a beta of 1.38 and a cost of equity of 14.945 percent. The risk-free rate of return is 4.25 percent. What discount rate should the firm assign to a new project that has a beta of 1.25?

13.94 percent. RE = 0.14945 = 0.0425 + (1.38 mrp); mrp = 0.0775 RProject = 0.0425 + (1.25 0.0775) = 13.94 percent

Grill Works and More has 8 percent preferred stock outstanding that is currently selling for $49 a share. The market rate of return is 14 percent and the firm's tax rate is 37 percent. What is the firm's cost of preferred stock?

16.33 percent Rp = (0.08 $100)/$49 = 16.33 percent

Titan Mining Corporation has 14 million shares of common stock outstanding, 900,000 shares of 9 percent preferred stock outstanding and 210,000 ten percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.15, the preferred stock currently sells for $80 per share, and the bonds have 17 years to maturity and sell for 91 percent of par. The market risk premium is 11.5 percent, T-bills are yielding 7.5 percent, and the firm's tax rate is 32 percent. What discount rate should the firm apply to a new project's cash flows if the project has the same risk as the firm's typical project?

16.41 percent MVD = 210,000 ($1,000) (0.91) = $191,100,000 MVE = 14,000,000 ($34) = $476,000,000 MVP = 900,000 ($80) = $72,000,000 V = $191,100,000 + $476,000,000 + $72,000,000 = $739,100,000 D/V = $191,100,000/$739,100,000 = 0.258558 E/V = $476,000,000/$739,100,000 = 0.644027 P/V = $72,000,000/$739,100,000 = 0.097416 RE = 0.075 + 1.15(0.115) = 0.20725 RP = $9/$80 = 0.1125 Enter N 17x2 IY /2 PV -910 PMT 100/2 FV 1000 Solve for IY: 11.19514 R(Aftertax): 0.1119514(1-0.32)= 0.076127 WACC= 0.644027(0.20725) + 0.097416(0.1125) + 0.258558(0.076127)= 16.14%

Suppose the spot and three-month forward rates for the yen are ¥128.79 and ¥133.85, respectively. What is the approximate annual percent difference between the inflation rate in the U.S. and in Japan?

16.67 percent hUS - hJAP (¥133.85 - ¥128.79)/¥128.79 = 0.39289 Approximate inflation difference = (1 + 0.039289)4 - 1 = 16.67 percent

What is the expected return of an equally weighted portfolio comprised of the following three stocks? State/Prob./RorA/RorB/RorC Boom/0.64/0.19/0.13/0.31 Bust/0.36/0.15/0.11/0.17

18.60 percent E(Rp)Boom = (0.19 + 0.13 + 0.31)/3 = 0.21 E(Rp)Bust = (0.15 + 0.11 + 0.17)/3 = 0.1433 E(Rp) = 0.64(0.21) + 0.36(0.1433) = 18.60 percent

New York Deli's has 7 percent preferred stock outstanding that sells for $36 a share. This stock was originally issued at $50 per share. What is the cost of preferred stock?

19.44 percent Rp = (0.07 $100)/$36 = 19.44 percent

The returns on the common stock of New Image Products are quite cyclical. In a boom economy, the stock is expected to return 32 percent in comparison to 14 percent in a normal economy and a negative 28 percent in a recessionary period. The probability of a recession is 25 percent while the probability of a boom is 10 percent. What is the standard deviation of the returns on this stock?

19.94 percent E(r) = (0.10 0.32) + (0.65 0.14) + (0.25 -0.28) = 0.053 Var = 0.10 (0.32 - 0.053)2 + 0.65 (0.14 - 0.053)2 + 0.25 (-0.28 - 0.053)2 = 0.039771 Std dev = 0.039771 = 19.94 percent

What is the standard deviation of the returns on a stock given the following information? State: Normal Probability: 30% Ror: 15% State: Normal P: 65% RoR: 12% State: Recession P: 5% RoR: 6%

2.03 percent E(r) = (0.30 0.15) + (0.65 0.12) + (0.05 0.06) = 0.126 Var = 0.30 (0.15 - 0.126)2 + 0.65 (0.12 - 0.126)2 + 0.05 (0.06 - 0.126)2 = 0.000414 Std dev = 0.000414 = 2.03 percent

Your portfolio has a beta of 1.12. The portfolio consists of 20 percent U.S. Treasury bills, 50 percent stock A, and 30 percent stock B. Stock A has a risk-level equivalent to that of the overall market. What is the beta of stock B?

2.07 BetaPortfolio = 1.12 = (0.2 x 0) + (0.5 x 1) + (0.3 x ?B); ?B = 2.07 The beta of a risk-free asset is zero. The beta of the market is 1.0.

Central Systems, Inc. desires a weighted average cost of capital of 8 percent. The firm has an aftertax cost of debt of 4.8 percent and a cost of equity of 15.2 percent. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital?

2.25 WACC = 0.08 = [We 0.152] + [(1 - We) 0.048)] We = 0.3077; Wd = 1 - We = 0.6923 Debt-equity ratio = 0.6923/0.3077 = 2.25

Suppose the exchange rates are as follows: Cur./Cur. per USD UK pound/0.5383 6-months forward/0.5363 Assume interest rate parity holds and the current six-month risk-free rate in the United States is 3.1 percent. What must the six-month risk-free rate be in Great Britain?

2.73 percent RFC = (£0.5363 - £0.5383)/£0.5383 + 0.31 = 2.73 percent

Suppose you observe the following situation: Bust/P.22/A-0.12/B-0.27 Normal/P.48/A.10/B/.05 Boom/P.30/A.23/B.28 Assume the capital asset pricing model holds and stock A's beta is greater than stock B's beta by 0.21. What is the expected market risk premium?

20.0 percent E(RA) = 0.22(-0.12) + 0.48(0.10) + 0.30(0.23) = .0906 E(RB) = 0.22(-0.27) + 0.48(0.05) + 0.30(0.28) = .0486 SlopeSML = (.0906 - 0.486)/0.21 = 20 percent

You currently own 600 shares of JKL, Inc. JKL is an all equity firm that has 75,000 shares of stock outstanding at a market price of $40 a share. The company's earnings before interest and taxes are $140,000. JKL has decided to issue $1 million of debt at 8 percent interest. This debt will be used to repurchase shares of stock. How many shares of JKL stock must you sell to unlever your position if you can loan out funds at 8 percent interest?

200 shares JKL interest = $1m 0.08 = $80,000 JKL shares repurchased = $1m/$40 = 25,000 JKL shares outstanding with debt = 75,000 - 25,000 = 50,000 JKL EPS, no debt = $140,000/75,000 = $1.866667 JKL EPS, with debt = ($140,000 - $80,000)/50,000 = $1.20 JKL value of stock = 50,000 $40 = $2m JKL value of debt = $1m JKL total value = $2m + $1m = $3m JKL weight stock = $2m/$3m = 2/3 JKL weight debt = $1m/$3m = 1/3 Your initial investment = 600 $40 = $24,000 Your new stock position = 2/3($24,000) = $16,000 Your new number of shares = $16,000/$40 = 400 Number of shares sold = 600 - 400 = 200 shares Check: Your new loans = 1/3($24,000) = $8,000 Your unlevered income = 600 $1.866667 = $1,120 Your levered income = (400 $1.20) + ($8,000 0.08) = $1,120

Johnson Tire Distributors has debt with both a face and a market value of $12,000. This debt has a coupon rate of 6 percent and pays interest annually. The expected earnings before interest and taxes are $2,100, the tax rate is 30 percent, and the unlevered cost of capital is 11.7 percent. What is the firm's cost of equity?

23.20 percent VU = [$2,100 (1 - 0.30)]/0.117 = $12,564.10 VL = $12,564.10 + (0.30 $12,000) = $16,164.10 VE = $16,164.10 - $12,000 = $4,164.10 RE = 0.117 + [(0.117 - 0.06) ($12,000/$4,164.10) (1 - 0.30)] = 23.20 percent

How many diverse securities are required to eliminate the majority of the diversifiable risk from a portfolio?

25

Assume the spot exchange rate for the Hungarian forint is HUF 215. Also assume the inflation rate in the United States is 4 percent per year while it is 9.5 percent in Hungary. What is the expected exchange rate 5 years from now?

281 F5 = 215[1 + (0.095 - 0.04)]5 = 281

Consider the following information on three stocks: Boom/0.45/0.55/0.35/0.65 Normal/0.5/0.44/0.18/0.04 Bust/0.05/0.37/-0.17/-0.64 A portfolio is invested 35 percent each in Stock A and Stock B and 30 percent in Stock C. What is the expected risk premium on the portfolio if the expected T-bill rate is 3.8 percent?

29.99 percent E(Rp)Boom = 0.35(0.55) + 0.35(0.35) + 0.30(0.65) = 0.51 E(Rp)Normal = 0.35(0.44) + 0.35(0.18) + 0.30(0.04) = 0.229 E(Rp)Bust = 0.35(0.37) + 0.35(-0.17) + 0.30(-0.64) = -0.122 E(Rp) = 0.45(0.51) + 0.50(0.229) + 0.05(-0.122) = 0.3379 RPi = 0.3379 - 0.038 = 29.99 percent

You just returned from some extensive traveling throughout the Americas. You started your trip with $20,000 in your pocket. You spent 3.4 million pesos while in Chile and 16,500 bolivares in Venezuela. Then on the way home, you spent 47,500 pesos in Mexico. How many dollars did you have left by the time you returned to the U.S. given the following exchange rates? (Note: Multiple symbols are used to designate various currencies. For example, the U.S. dollar is notated as "$" or as "USD".) Country/US$ Equiv./Currency per US$ Chile/?/668.0001 Mexico/0.0777/? Venezuela/?/2.1473

3,535 USD 20,000USD - [3.4mCLP (1USD/668.0001CLP)] - [16,500 VEF (1USD/2.1473VEF)] - [47,500MXN (0.0777USD/1MXN) = 3,535USD

Assume the spot rate for the Japanese yen currently is ¥98.48 per $1 and the one-year forward rate is ¥97.62 per $1. A risk-free asset in Japan is currently earning 2.5 percent. If interest rate parity holds, approximately what rate can you earn on a one-year risk-free U.S. security?

3.37 percent (¥97.62 - ¥98.48)/¥98.48 = 0.025 - RUS; RUS = 3.37 percent

The outstanding bonds of Tech Express are priced at $989 and mature in 8 years. These bonds have a 6 percent coupon and pay interest annually. The firm's tax rate is 39 percent. What is the firm's aftertax cost of

3.77 percent N 8 PV -989 PMT 60 FV 1000 Solve for IY: 6.1784 Aftertax R(d)= 0.061784x(1-0.39)=3.77

Boulder Furniture has bonds outstanding that mature in 13 years, have a 6 percent coupon, and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,040. What is the company's aftertax cost of debt if its tax rate is 32 percent?

3.78 percent N 13 PV -1040 PMT 60 FV 1000 Solve for IY: 5.5597 Aftertax R(d)= 0.055597 x (1-0.32) = 3.78

Wind Power Systems has 20-year, semi-annual bonds outstanding with a 5 percent coupon. The face amount of each bond is $1,000. These bonds are currently selling for 114 percent of face value. What is the company's pre-tax cost of debt?

3.98 percent Enter N 20x2 IY /2 PV -1,140 PMT 50/2 FV 1000 Solve for IY: 3.98

Naylor's is an all equity firm with 60,000 shares of stock outstanding at a market price of $50 a share. The company has earnings before interest and taxes of $87,000. Naylor's has decided to issue $750,000 of debt at 7.5 percent. The debt will be used to repurchase shares of the outstanding stock. Currently, you own 500 shares of Naylor's stock. How many shares of Naylor's stock will you continue to own if you unlever this position? Assume you can loan out funds at 7.5 percent interest. Ignore taxes.

375 shares Naylor's interest = $750,000 0.075 = $56,250 Naylor's shares repurchased = $750,000/$50 = 15,000 Naylor's shares outstanding with debt = 60,000 - 15,000 = 45,000 Naylor's EPS, no debt = $87,000/60,000 = $1.45 Naylor's EPS, with debt = ($87,000 - $56,250)/45,000 = $0.683333 Naylor's value of stock = 45,000 $50 = $2,250,000 Naylor's value of debt = $750k Naylor's total value = $2,250,000 + $750,000 = $3,000,000 Naylor's weight stock = $2,250,000/$3,000,000 = 0.75 Naylor's weight debt = $750,000/$3,000,000 = 0.25 Your initial investment = 500 $50 = $25,000 Your new stock position = 0.75 $25,000 = $18,750 Your new number of shares = $18,750/$50 = 375 shares Check: Your new loans = 0.25 $25,000 = $6,250 Your unlevered income = 500 $1.45 = $725 Your levered income = (375 $0.683333) + ($6,250 0.075) = $725

You own the following portfolio of stocks. What is the portfolio weight of stock C? Stock: #of Shares: $/share: A 500 $14 B 200 23 C 600 18 D 100 47

39.85 percent Portfolio weightC = (600 $18)/[(500 $14) + (200 $23) + (600 $18) + (100 $47)] = $10,800/$27,100 = 39.85 percent

Miller's Dry Goods is an all equity firm with 45,000 shares of stock outstanding at a market price of $50 a share. The company's earnings before interest and taxes are $128,000. Miller's has decided to add leverage to its financial operations by issuing $250,000 of debt at 8 percent interest. The debt will be used to repurchase shares of stock. You own 400 shares of Miller's stock. You also loan out funds at 8 percent interest. How many shares of Miller's stock must you sell to offset the leverage that Miller's is assuming? Assume you loan out all of the funds you receive from the sale of stock. Ignore taxes.

44.4 shares Miller's interest = $250,000 0.08 = $20,000 Miller's shares repurchased = $250,000/$50 = 5,000 Miller's shares outstanding with debt = 45,000 - 5,000 = 40,000 Miller's EPS, no debt = $128,000/45,000 = $2.844444 Miller's EPS, with debt = ($128,000 - $20,000)/40,000 = $2.70 Miller's value of stock = 40,000 $50 = $2,000,000 Miller's value of debt = $250,000 Miller's total value = $2,000,000 + $250,000 = $2,250,000 Miller's weight stock = $2,000,000/$2,250,000 = 0.888889 Miller's weight debt = $250,000/$2,250,000 = 0.111111 Your initial investment = 400 $50 = $20,000 Your new stock position = 0.888889 $20,000 = $17,777.78 Your new number of shares = $17,777.78/$50 = 355.5556 Number of shares sold = 400 - 355.5556 = 44.4 shares Check: Your new loans = 0.111111 $20,000 = $2,222.22 Your total unlevered income = 400 $2.844444 = $1,137.78 Your total levered income = (355.5556 $2.70) + ($2,222.22 0.08) = $1,137.78

Nelson's Landscaping has 1,200 bonds outstanding that are selling for $990 each. The company also has 2,500 shares of preferred stock at a market price of $28 a share. The common stock is priced at $37 a share and there are 28,000 shares outstanding. What is the weight of the common stock as it relates to the firm's weighted average cost of capital?

45.16 percent

You have a portfolio consisting solely of stock A and stock B. The portfolio has an expected return of 8.7 percent. Stock A has an expected return of 11.4 percent while stock B is expected to return 6.4 percent. What is the portfolio weight of stock A?

46 percent 0.087 = [0.114 x] + [0.064 (1 - x)]; x = 46 percent

Holdup Bank has an issue of preferred stock with a $5 stated dividend that just sold for $92 per share. What is the bank's cost of preferred?

5.43 percent RP = $5/$92 = 5.43 percent

Assume the spot rate for the British pound currently is £0.6211 per $1. Also assume the one-year forward rate is £0.6347 per $1. A risk-free asset in the U.S. is currently earning 3.4 percent. If interest rate parity holds, what rate can you earn on a one-year risk-free British security?

5.66 percent (£0.6347/£0.6211) = [(1 + RFC)/1.034]; RFC = 5.66 percent

Handy Man, Inc. has zero coupon bonds outstanding that mature in 8 years. The bonds have a face value of $1,000 and a current market price of $640. What is the company's pre-tax cost of debt?

5.66 percent N 8x2 IY /2 PV -640 FV 1000 Solve for IY: 5.66

What is the expected return on a portfolio which is invested 25 percent in stock A, 55 percent in stock B, and the remainder in stock C? Boom/5%/A: 19%/B: 9/C: 6% Normal/45%/A: 11%/B: 8%/ C: 13% Recession/50%/A; -23%/B: 5%/C: 25%

5.93 percent E(r)Boom = (0.25 0.19) + (0.55 0.09) + (0.20 0.06) = 0.109 E(r)Normal = (0.25 0.11) + (0.55 0.08) + (0.20 0.13) = .0975 E(r)Bust = (0.25 - 0.23) + (0.55 0.05) + (0.20 0.25) = 0.02 E(r)Portfolio = (0.05 0.109) + (0.45 0.0975) + (0.50 0.02) = 5.93 percent

North Side, Inc. has no debt outstanding and a total market value of $175,000. Earnings before interest and taxes, EBIT, are projected to be $16,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 35 percent higher. If there is a recession, then EBIT will be 70 percent lower. North Side is considering a $70,000 debt issue with a 7 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 2,500 shares outstanding. North Side has a tax rate of 34 percent. If the economy expands strongly, EPS will change by ____ percent as compared to a normal economy, assuming that the firm recapitalizes.

50.45 percent Share price = $175,000/2,500 = $70 Shares repurchased = $70,000/$70 = 1,000 Annual interest = $70,000 0.07 = $4,900 EPS Normal = [($16,000 - $4,900)(1 - 0.34)]/(2,500 - 1,000) = $4.884 EPS Expansion = (expression error)/(2,500 - 1,000) = $7.348 Percentage change = ($7.348 - $4.884)/$4.884 = 50.45 percent

What is the standard deviation of the returns on a portfolio that is invested in stocks A, B, and C? Twenty five percent of the portfolio is invested in stock A and 40 percent is invested in stock C. B 5/ A 17/B 6/C 22 N 55/A 8/B 10/C 15 R 40/A -3/B 19/C -25

7.83 percent E(r)Boom = (0.25 0.17) + (0.35 0.06) + (0.40 0.22) = 0.1515 E(r)Normal = (0.25 0.08) + (0.35 0.10) + (0.40 0.15) = 0.115 E(r)Bust = (0.25 -0.03) + (0.35 0.19) + (0.40 -0.25) = -0.041 E(r)Portfolio = (0.05 0.1515) + (0.55 0.115) + (0.40 -0.041) = 0.054425 VarPortfolio = [0.05 (0.1515 - 0.054425)2] + [0.55 (0.115 - 0.054425)2] + [0.40 (-0.041 - 0.054425)2] = 0.006132 Std dev = .006132 = 7.83 percent

The common stock of United Industries has a beta of 1.34 and an expected return of 14.29 percent. The risk-free rate of return is 3.7 percent. What is the expected market risk premium?

7.90 percent E(r) = 0.1429 = 0.037 + 1.34 Mrp; Mrp = 7.90 percent

The Shoe Outlet has paid annual dividends of $0.65, $0.70, $0.72, and $0.75 per share over the last four years, respectively. The stock is currently selling for $26 a share. What is this firm's cost of equity?

7.93 percent ($0.70 - $0.65)/$0.65 = 0.076923 ($0.72 - $0.70)/$0.70 = 0.028571 ($0.75 - $0.72)/$0.72 = 0.041667 g = (0.076923 + 0.028571 + 0.041667)/3 = .049054 Re = [($0.75 1.049054)/$26] + .049054 = 7.93 percent

A stock has a beta of 1.2 and an expected return of 17 percent. A risk-free asset currently earns 5.1 percent. The beta of a portfolio comprised of these two assets is 0.85. What percentage of the portfolio is invested in the stock?

71 percent ?p = 0.85 = 1.2x + (1 -x)(0); Bp = 71 percent

Chelsea Fashions is expected to pay an annual dividend of $0.80 a share next year. The market price of the stock is $22.40 and the growth rate is 5 percent. What is the firm's cost of equity?

8.57 percent R(e)= ($0.8/$22.4) + 0.5 = 8.57%

The common stock of Manchester & Moore is expected to earn 13 percent in a recession, 6 percent in a normal economy, and lose 4 percent in a booming economy. The probability of a boom is 5 percent while the probability of a recession is 45 percent. What is the expected rate of return on this stock?

8.65 percent E(r) = (0.45 x 0.13) + (0.50 x 0.06) + (0.05 x -0.04) = 8.65 percent

Sweet Treats common stock is currently priced at $19.06 a share. The company just paid $1.15 per share as its annual dividend. The dividends have been increasing by 2.5 percent annually and are expected to continue doing the same. What is this firm's cost of equity?

8.68 percent e = [($1.15 1.025)/$19.06] + 0.025 = 8.68 percent

Mangrove Fruit Farms has a $200,000 bond issue outstanding that is selling at 92 percent of face value. The firm also has 1,500 shares of preferred stock and 15,000 shares of common stock outstanding. The preferred stock has a market price of $35 a share compared to a price of $24 a share for the common stock. What is the weight of the preferred stock as it relates to the firm's weighted average cost of capital?

8.80 percent

You own a portfolio with the following expected returns given the various states of the economy. What is the overall portfolio expected return? Boom/27%/14% Normal/70%/8% Recession/3%/-11%

9.05 percent E(r) = (0.27 0.14) + (0.70 0.08) + (0.03 -0.11) = 9.05 percent

Granite Works maintains a debt-equity ratio of 0.65 and has a tax rate of 32 percent. The firm does not issue preferred stock. The pre-tax cost of debt is 9.8 percent. There are 25,000 shares of stock outstanding with a beta of 1.2 and a market price of $19 a share. The current market risk premium is 8.5 percent and the current risk-free rate is 3.6 percent. This year, the firm paid an annual dividend of $1.10 a share and expects to increase that amount by 2 percent each year. Using an average expected cost of equity, what is the weighted average cost of capital?

9.20 percent Re = 0.036 + 1.2(0.085) = 0.138 Re = [($1.10 1.02)/$19] + 0.02 = 0.0790526 Re Average = (0.138 + 0.0790526)/2 = 0.108526 WACC = (1/1.65) (0.108526) + (0.65/1.65) (0.098) (1 - 0.32) = 9.20 percent

Justice, Inc. has a capital structure which is based on 30 percent debt, 5 percent preferred stock, and 65 percent common stock. The flotation costs are 11 percent for common stock, 10 percent for preferred stock, and 7 percent for debt. The corporate tax rate is 37 percent. What is the weighted average flotation cost?

9.75 percent Average flotation cost = (0.65 0.11) + (0.05 0.10) + (0.30 0.07) = 9.75 percent

Which one of the following statements is correct concerning bid prices?

A firm can submit a bid that is higher than the computed bid price and still break even

Which one of the following statements is correct concerning a portfolio beta?

A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio.

Which one of the following statements is correct?

A project can create a positive operating cash flow without affecting sales.

Which one of the following statements is correct? A. Firms should accept low risk projects prior to funding high risk projects. B. Making subjective adjustments to a firm's WACC when determining project discount rates unfairly punishes low-risk divisions within a firm. C. A project that is unacceptable today might be acceptable tomorrow given a change in market returns. D. The pure play method is most frequently used for projects involving the expansion of a firm's current operations. E. Firms that elect to use the pure play method for determining a discount rate for a project cannot subjectively adjust the pure play rate.

A project that is unacceptable today might be acceptable tomorrow given a change in market returns.

In the spot market, $1 is currently equal to A$1.4910. Assume the expected inflation rate in Australia is 3.5 percent and in the U.S. 4.0 percent. What is the expected exchange rate one year from now if relative purchasing power parity exists?

A$1.4835 E(S1) = A$1.4910 [1 + (0.035 - 0.04)]1 = A$1.4835

Eads Industrial Systems Company (EISC) is trying to decide between two different conveyor belt systems. System A costs $427,000, has a 6-year life, and requires $112,000 in pretax annual operating costs. System B costs $517,000, has an 8-year life, and requires $79,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have a zero salvage value. Whichever system is chosen, it will not be replaced when it wears out. The tax rate is 33 percent and the discount rate is 24 percent. Which system should the firm choose and why?

A; The net present value is -$582,720.

Which one of the following is the depreciation method which allows accelerated write-offs of property under various lifetime classifications?

ACRS

Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Assume there are no taxes.

At the break-even point, there is no advantage to debt.

The LIBOR is primarily used as the basis for the rate charged on:

Eurodollar loans in the London market.

The interest rate parity approximation formula is:

Ft = S0 [1 + (RFC - RUS)]t.

Danielle's is a furniture store that is considering adding appliances to its offerings. Which of the following should be considered incremental cash flows of this project? I. utilizing the credit offered by a supplier to purchase the appliance inventory II. benefiting from increased furniture sales to appliance customers III. borrowing money from a bank to fund the appliance project IV. purchasing parts for inventory to handle any appliance repairs that might be necessary

I, II, and IV only

The foreign currency approach to capital budgeting analysis: I. is computationally easier to use than the home currency approach. II. produces the same results as the home currency approach. III. requires an exchange rate for each time period for which there is a cash flow. IV. computes the NPV of a project in both the foreign and the domestic currency.

I, II, and IV only

Which of the following are correct according to pecking-order theory? I. Firms stockpile internally-generated cash. I. Firms stockpile internally-generated cash. II. There is an inverse relationship between a firm's profit level and its debt level. III. Firms avoid external debt at all costs. IV. A firm's capital structure is dictated by its need for external financing.

I, II, and IV only

At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset? I. asset's standard deviation II. asset's beta III. risk-free rate of return IV. market risk premium

II and IV only

The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations? I. firms that have a 100 percent retention ratio II. firms that pay a constant dividend III. firms that pay an increasing dividend IV. firms that pay a decreasing dividend

II, III, and IV only

Which of the following should be included in the analysis of a new product? I. money already spent for research and development of the new product II. reduction in sales for a current product once the new product is introduced III. increase in accounts receivable needed to finance sales of the new product IV. market value of a machine owned by the firm which will be used to produce the new product

II, III, and IV only

Which of the following statements are correct? I. The SML approach is dependent upon a reliable measure of a firm's unsystematic risk. II. The SML approach can be applied to firms that retain all of their earnings. III. The SML approach assumes a firm's future risks are similar to its past risks. IV. The SML approach assumes the reward-to-risk ratio is constant.

II, III, and IV only

Which one of the following statements is correct concerning the foreign exchange market?

Importers, exporters, and speculators are key players in the foreign exchange market.

Which one of the following statements is correct?

Over time, the average unexpected return will be zero.

Which one of the following statements is correct? A. The subjective approach assesses the risks of each project and assigns an adjustment factor that is unique just for that project. B. Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects. C. Firms will correctly accept or reject every project if they adopt the subjective approach. D. Mandatory projects should only be accepted if they produce a positive NPV when the firm's WACC is used as the discount rate. E. The pure play approach should only be used with low-risk projects.

Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.

Which one of the following names matches the country where the bond is issued?

Rembrandt: Netherlands

You want to import $147,000 worth of rugs from India. How many rupees will you need to pay for this purchase if one rupee is worth $0.0202?

Rs 7,277,228 $147,000 (Rs 1/$0.0202) = Rs 7,277,228

You want to invest in a riskless project in Sweden. The project has an initial cost of SKr4.1million and is expected to produce cash inflows of SKr1.75 million a year for three years. The project will be worthless after three years. The expected inflation rate in Sweden is 3.2 percent while it is 4.3 percent in the U.S. A risk-free security is paying 5.5 percent in the U.S. The current spot rate is $1 = SKr7.7274. What is the net present value of this project in Swedish kroner? Assume the international Fisher effect applies.

SKr719,774 0.055 - 0.043 = RFC - 0.032; RFC = 0.044 Compute NPV

Three years ago, Knox Glass purchased a machine for a 3-year project. The machine is being depreciated straight-line to zero over a 5-year period. Today, the project ended and the machine was sold. Which one of the following correctly defines the aftertax salvage value of that machine? (T represents the relevant tax rate)

Sale price + (Book value - Sale price) x T

The common stock of Alpha Manufacturers has a beta of 1.47 and an actual expected return of 15.26 percent. The risk-free rate of return is 4.3 percent and the market rate of return is 12.01 percent. Which one of the following statements is true given this information?

The actual expected stock return indicates the stock is currently overpriced. E(r) = 0.043 + 1.47 (0.1201 - 0.043) = 15.63 percent The stock is overpriced because its actual expected return is less than the CAPM return.

You own some equipment that you purchased 4 years ago at a cost of $216,000. The equipment is 5-year property for MACRS. You are considering selling the equipment today for $75,500. Which one of the following statements is correct if your tax rate is 35 percent? MACRS 5-year property Year Rate 1 20 2 32 3 19.2 4 11.52 5 11.52 6 5.76

The aftertax salvage value is $62,138.68 Accumulated depreciation4 = $216,000 (0.20 + 0.32 + 0.192 + 0.1152) = $178,675.20 Book Value4 = $216,000 - $178,675.20 = $37,324.80 Taxable gain on sale = $75,500 - $37,324.80 = $38,175.20 Tax due = $38,175.20 0.35 = $13,361.32 Aftertax salvage value = $75,500 - $13,361.32 = $62,138.68

Assume the euro is selling in the spot market for $1.33. Simultaneously, in the 3-month forward market the euro is selling for $1.35. Which one of the following statements correctly describes this situation?

The euro is selling at a premium relative to the dollar.

Morris Industries has a capital structure of 55 percent common stock, 10 percent preferred stock, and 45 percent debt. The firm has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38 percent. Given this, which one of the following statements is correct?

The firm's cost of equity is unaffected by a change in the firm's tax rate.

Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure.

The model is dependent upon a reliable estimate of the market risk premium.

The bid price always assumes which one of the following?

The net present value of the project is zero.

Dexter Smith & Co. is replacing a machine simply because it has worn out. The new machine will not affect either sales or operating costs and will not have any salvage value at the end of its 5-year life. The firm has a 34 percent tax rate, uses straight-line depreciation over an asset's life, and has a positive net income. Given this, which one of the following statements is correct?

The new machine will generate positive operating cash flows, at least in the first few years of its life

Which one of the following statements related to risk is correct?

The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.

Which one of the following events would be included in the expected return on Sussex stock?

This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated.

Gateway Communications is considering a project with an initial fixed asset cost of $2.46 million which will be depreciated straight-line to a zero book value over the 10-year life of the project. At the end of the project the equipment will be sold for an estimated $300,000. The project will not directly produce any sales but will reduce operating costs by $725,000 a year. The tax rate is 35 percent. The project will require $45,000 of inventory which will be recouped when the project ends. Should this project be implemented if the firm requires a 14 percent rate of return? Why or why not?

Yes; The NPV is $466,940.57 Initial cash flow = -$2,460,000 - $45,000 = -$2,505,000 OCF = $725,000(1 - 0.35) + ($2,460,000/10)(0.35) = $557,350 Final cash flow = $45,000 + $300,000 (1 - 0.35) = $240,000 NPV= -$2505000 + $557350 x [(1-(1/(1+0.14)^10))/0.14] + (240000/((1+0.14)^10)) = $466940.57

The unlevered cost of capital refers to the cost of capital for a(n):

all-equity firm

The depreciation tax shield is best defined as the:

amount of tax that is saved because of the depreciation expense.

Which one of the following would make a project unacceptable?

an equivalent annual cost that exceeds that of an alternative project

Which one of the following will increase a bid price?

an increase in the required rate of return

Phil's is a sit-down restaurant that specializes in home-cooked meals. Theresa's is a walk-in deli that specializes in specialty soups and sandwiches. Both firms are currently considering expanding their operations during the summer months by offering pre-wrapped donuts, sandwiches, and wraps at a local beach. Phil's currently has a WACC of 14 percent while Theresa's WACC is 10 percent. The expansion project has a projected net present value of $12,600 at a 10 percent discount rate and a net present value of -$2,080 at a 14 percent discount rate. Which firm or firms should expand and offer food at the local beach during the summer months?

both Phil's and Theresa's

Which one of the following is the equity risk that is most related to the daily operations of a firm?

business risk

Scholastic Toys is considering developing and distributing a new board game for children. The project is similar in risk to the firm's current operations. The firm maintains a debt-equity ratio of 0.40 and retains all profits to fund the firm's rapid growth. How should the firm determine its cost of equity?

by using the capital asset pricing model

Changes in the net working capital requirements:

can affect the cash flows of a project every year of the project's life.

Unsystematic risk:

can be effectively eliminated by portfolio diversification.

The standard deviation of a portfolio:

can be less than the standard deviation of the least risky security in the portfolio.v

The standard deviation of a portfolio:

can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.

The operating cash flow of a cost cutting project:

can be positive even though there are no sales.

Net working capital:

can create either a cash inflow or a cash outflow at time zero of a project.

The optimal capital structure has been achieved when the:

debt-equity ratio results in the lowest possible weighted average cost of capital.

Which one of the following is a project cash inflow? Ignore any tax effects.

decrease in accounts receivable

The net book value of equipment will:

decrease slower under straight-line depreciation than under MACRS.

Which one of the following is the risk that a firm faces when it opens a facility in a foreign country, given that the exchange rate between the firm's home country and this foreign country fluctuates over time?

exchange rate risk

Which one of the following is most directly affected by the level of systematic risk in a security?

expected rate of return

You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent?

expected return

Which one of the following is the equity risk related to a firm's capital structure policy?

financial

Which one of the following best describes pro forma financial statements?

financial statements showing projected values for future time periods

You have computed the break-even point between a levered and an unlevered capital structure. Assume there are no taxes. At the break-even level, the:

firm is just earning enough to pay for the cost of the debt.

A basic interest rate swap generally involves trading a:

fixed rate for a variable rate.

Deep Mining and Precious Metals are separate firms that are both considering a silver exploration project. Deep Mining is in the actual mining business and has an aftertax cost of capital of 12.8 percent. Precious Metals is in the precious gem retail business and has an aftertax cost of capital of 10.6 percent. The project under consideration has initial costs of $575,000 and anticipated annual cash inflows of $102,000 a year for ten years. Which firm(s), if either, should accept this project?

neither Company A or Company B NPV= -575000 + 1022000 x (1-[1/(1+0.128)^10]/0.128)= 17071 Neither company should accept this project as the applicable discount rate for both firms is 12.8 percent and the NPV is negative at this discount rate.

Wilderness Adventures specializes in back-country tours and resort management. Travel Excitement specializes in making travel reservations and promoting vacation travel. Wilderness Adventures has an aftertax cost of capital of 13 percent and Travel Excitement has an aftertax cost of capital of 11 percent. Both firms are considering building wilderness campgrounds complete with man-made lakes and hiking trails. The estimated net present value of such a project is estimated at $87,000 at a discount rate of 11 percent and -$12,500 at a 13 percent discount rate. Which firm or firms, if either, should accept this project?

neither Wilderness Adventures nor Travel Excitement

Chapman Machine Shop is considering a 4-year project to improve its production efficiency. Buying a new machine press for $576,000 is estimated to result in $192,000 in annual pretax cost savings. The press falls in the MACRS 5-year class, and it will have a salvage value at the end of the project of $84,000. The press also requires an initial investment in spare parts inventory of $24,000, along with an additional $3,600 in inventory for each succeeding year of the project. The inventory will return to its original level when the project ends. The shop's tax rate is 35 percent and its discount rate is 11 percent. Should the firm buy and install the machine press? Why or why not?

no; The net present value is -$7,489.

The option that is foregone so that an asset can be utilized by a specific project is referred to as which one of the following?

opportunity cost

Suppose the spot exchange rate for the Canadian dollar is C$1.28 and the six-month forward rate is C$1.33. The U.S. dollar is selling at a _____ relative to the Canadian dollar and the U.S. dollar is expected to _____ relative to the Canadian dollar.

premium; appreciate The U.S. dollar is selling at a premium because it is more expensive in the forward market than in the spot market. The U.S. dollar is expected to appreciate in value relative to the Canadian dollar because the U.S. dollar is worth more Canadian dollars in the future than it is today.

Today, you can exchange $1 for £0.6211. Last week, £1 was worth $1.6104. How much profit or loss would you now have if you had converted £100 into dollars last week?

profit of ₤0.02 [£100 ($1.6104/£1) (£0.6211/$1)] - £100 = £0.02

Assume that an item costs $100 in the U.S. and the exchange rate between the U.S. and Canada is: $1 = C$1.27. Which one of the following concepts supports the idea that the item that sells for $100 in the U.S. is currently selling in Canada for $127?

purchasing power parity

When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project, the manager is utilizing the _____ approach.

pure play

Long-run exposure to exchange rate risk relates to:

unexpected changes in relative economic conditions.

A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20 percent. What type of risk does this news flash represent?

unsystematic

Which one of the following risks is irrelevant to a well-diversified investor?

unsystematic risk

Which one of the following is the primary determinant of a firm's cost of capital?

use of the funds

If a firm has the optimal amount of debt, then the:

value of the levered firm will exceed the value of the firm if it were unlevered.

In general, the capital structures used by U.S. firms:

vary significantly across industries.

The expected return on a stock given various states of the economy is equal to the:

weighted average of the returns for each economic state.

The equivalent annual cost method is useful in determining:

which one of two machines should be purchased when the machines are mutually exclusive, have different machine lives, and will be replaced once they are worn out.

A company that utilizes the MACRS system of depreciation:

will have a greater tax shield in year two of a project than it would have if the firm had opted for straight-line depreciation, given the same depreciation life.

The optimal capital structure:

will vary over time as taxes and market conditions change.

Spot trades must be settled:

within two business days.