Finance FIN 320F
The div yield for a one-year period is = to the annual div amount / by the ___
Beginning stock price
_____ were a bright spot for U.S. investors during 2008
Bonds
Capital ___ is the decision-making process for accepting and rejecting projects
Budgeting
Which of the following are reasons why IRR continues to be used in practice?
Businesspeople prefer to talk about rates of return, the IRR of a proposal can be calculated without knowing the appropriate discount rate, and it is easier to communicate info about a proposal with an IRR
Sales $558,400 Costs 346,800 Depreciation 94,500 EBIT ? Taxes ? Net Income ? Fill in the missing numbers and then calculate the OCF. What is the depreciation tax shield?
EBIT = 117,100 Taxes = 40,985 NI = 76,115 OCF = 170,615 Dep tax shield = 33,075 OCF = EBIT + Dep - Taxes OR OCF = NI + Dep OR OCF = (Sales - costs)(1 - Tax) + (Dep)(Tax)
For the given cash flows, suppose the firm uses the NPV decision rule. Year Cash Flow 0 -$148,000 1 68,000 2 71,000 3 55,000 A. At a required return of 9%, what is the NPV of the project? B. At a required return of 20%, what is the NPV of the project?
A. NPV = $16614.69 B. NPV = -$10199.07
The PI rule for an independent project is to ___ the project if the PI is greater than 1
Accept
What is the profitability index decision rule?
Accept if greater than 1
What is the def of expected return?
It is the return an investor expects to earn on a risky asset in the future
Both Projects A and B are acceptable as independent projects. However, the selection of either one of these projects eliminates the option of selecting the other project. Which one of the following terms best describes the relationship between Project A and Project B?
Mutually exclusive
The year 2008 was
One of the worst years for stock market investors in U.S. history
What is the relationship between the profitability index and the NPV? Are there any situations in which you might prefer one method over the other? Explain.
PI ranks multiple positive NPV projects
Describe how the profitability index is calculated and describe the information this measure provides about a sequence of cash flows.
PV of future cash flows / initial or cost
A pro forma financial statement is a financial statement that
projects future years' operating results.
Thrill Rides is considering adding a new roller coaster to its amusement park. The addition is expected to increase its overall ticket sales. In particular, the company expects to sell more tickets for its current roller coaster and experience extremely high demand for its new coaster. Sales for its boat ride are expected to decline but food and beverage sales are expected to increase significantly. All of the following are side effects associated with the new roller coaster with the exception of the
ticket sales for the new coaster.
Soft and Cuddly is considering a new toy that will produce the following cash flows. Should the company produce this toy based on IRR if the firm requires a rate of return of 17.5%? Year Cash Flow 0 -$132000 1 $97000 2 $42000 3 $28000
IRR = 16.45 < 17.5, so no.
Consider the following cash flows Year Cash Flow 0 -$32,000 1 14,200 2 17,500 3 11,600 What is the IRR of the above set of cash flows?
IRR = 17.32%
What is the IRR of the following set of cash flows? Year Cash Flow 0 -$61300 1 $18900 2 $64500 3 $7600
IRR = 23.86%
What is a real rate of return?
It is a percentage change in buying power It is a rate of return that has been adjusted for inflation
As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?
It is likely to decrease, it may eventually be almost totally eliminated
What is the nominal rate of return on an investment?
It is the percentage change in the dollar value of an investment
The second lesson from studying capital market history states that the _____ the potential reward, the _____ the risk
Lower, lower AND greater, greater
Normal dist is completely described by the ___ and ___
Mean, var or SD
Valley Forge and Metal purchased a truck five years ago for local deliveries. Which one of the following costs related to this truck is the best example of a sunk cost? Assume the truck has a usable life of five years.
Money spent last month repairing a damaged front fender
Higher cash flows earlier in a project's life are ___ valuable than higher cash flows later on
More
If a firm is evaluating two possible projects, both of which require the use of the same production facilities, and taking one project means that we cannot take the other, these projects would be considered ___
Mutually exclusive
Which one of the following is generally considered to be the best form of analysis if you have to select a single method to analyze a variety of investment opportunities?
NPV
Ed owns a store that caters primarily to men. Each of the answer options represents an item related to a planned store expansion. Each of these items should be included in the expansion analysis with the exception of the cost
of the blueprints that have been drawn of the expansion area.
If a stock's returns for years 1 to 4 were 3%, 5%, 8%, and -2%, what is the standard dev of these returns?
Avg = 3+5+8-2 = 3.5 SD = √(Var) = √((Ʃ(actual - avg)^2) / (n - 1) ) => √((Ʃ(actual - 3.5)^2) / (3) ) = 4.203
Which of the following are true based on the year-to-year returns from 1926 - 2014?
Common stocks frequently exp -returns, and T-bills sometimes outperform common stocks
Year______Large co return_______T-bill return______Risk prem 1973______-14.69%__________________7.29%________________-21.98% 1974______-26.47%__________________7.99%________________-34.46% 1975______37.23%___________________5.87%________________31.36% 1976______23.93%___________________5.07%________________18.86% 1977______-7.16%____________________5.45%________________-12.61% 1978______6.57%____________________7.64%________________-1.07% Total_____19.41%____________________39.3%________________-19.90 Calculate the arithmetic average returns for large-company stocks and T-bills over this time period. Calculate the standard deviation of the returns for large-company stocks and T-bills over this time period. Calculate the observed risk premium in each year for the large-company stocks versus the T-bills. What was the arithmetic average risk premium over this period? What was the standard deviation of the risk premium over this period? Is it possible for the risk premium to be negative before an investment is undertaken? Can the risk premium be negative after the fact? Explain.
Avg1 = 19.41 / 6 = 3.24% Var1 = (Ʃ(actual - .0324)^2) / 5 = .058136 SD = √(.058136) = .2411 Avg2 = 39.31 / 6 = 6.55% Var2 = (Ʃ(actual - .0655)^2) / 5 = .000153 SD = √(.000153) = .0124 Avg3 = -19.90 / 6 = -3.32% Var3 = (Ʃ(actual + .0332)^2) / 5 = .062078 SD = √(.062078) = .2492 Before, no mostly bc investors demand compensation. After, yes if asset's nominal return is unexpectedly low, risk-free return rate is unexpectedly high, or both
Using the following returns, calculate the average returns, the variances, and the standard deviations for X and Y. Year X Y 1 16% 36% 2 -17 -8 3 13 21 4 15 -15 5 24 39
Avgx = 10.2% Varx = (Ʃ(actual - .102)^2) / 4 = .02487 SDx = √(.02487) = .1577 or 15.77% Avgy = 14.6% Vary = (Ʃ(actual - .146)^2) / 4 = .06203 Sdy = √(.06203) = .2491 or 24.91%
The computation of variance requires 4 steps. Place the steps in the correct order from the first step to the last step Calc the dev of each return from the expected return Calc the exp return Calc the avg sq dev Sq each dev
Calc the exp return Calc the dev of each return from the expected return Sq each dev Calc the avg sq dev
Which of the following is a disadvantage of the PI?
Cannot rank mutually exclusive projects
Suppose you bought 100 shares of Banks & Bower, Inc. for $50 a share. During the year, B&B paid a $0.50 per share div. At year end, B&B was selling for $60 a share. What is your total percentage return?
Cap gains yield = (60 - 50) / 50 = .2 Div yield = div / P1 = .5 / 50 = .01 Total percentage return BE = Cap yield + Div yield = .2 + .01 = .21 or 21%
The%age change in the price of a stock over a period of time is called its ___
Capital gains yield
You buy a stock for $100. In one year its price rises to $114, and it pays a $1 dividend. Your capital gains yield is
Capital gains yield = (Price2 - P1) / P1, (114 - 100) / 100 = .14 or 14%
CrossTown Builders is considering remodeling an old building it currently owns. The building was purchased ten years ago for $1.2 million. Over the past ten years, the firm rented out the building and used the rent to pay off the mortgage. The building is now owned free and clear and has a current market value of $1.9 million. The company is considering remodeling the building into industrial-type apartments at an estimated cost of $1.6 million. The estimated present value of the future income from these apartments is $4.1 million. Which one of the following defines the opportunity cost of the remodeling project?
Current market value of the building
Kolby's Korndogs is looking at a new sausage system with an installed cost of $896,000. This cost will be depreciated straight-line to zero over the project's seven-year life, at the end of which the sausage system can be scrapped for $101,000. The sausage system will save the firm $189,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $47,000. If the tax rate is 30% and the discount rate is 6%, what is the NPV of this project?
Dep = 896,000 / 7 Salvage = 101,000(1 - .3) I = -896,000 - 47,000 End = 47,000 + Salvage NPV = I + OCF(PVIFA) + End/(1.06)^7 NPV = 88189.73
"When evaluating projects, we're only concerned with the relevant incremental aftertax cash flows. Therefore, because depreciation is a noncash expense, we should ignore its effects when evaluating projects." Evaluate this statement
Depreciation is tax-deductable and decreases taxes paid (cash outflow) by a certain amount (dep tax shield). So, bc saving money on taxes is technically a cash inflow, you would take its effects into account.
Historically, there is a ______ relationship between risk and expected return in the financial markets.
Direct
When calculating NPV, the pv of the nth cash flow is found by dividing the nth cash flow by 1 plus ___ rate raised to the nth power
Discount
The net present value profile illustrates how the net present value of an investment is affected by which one of the following?
Discount rate
Suppose a stock had an initial price of $72 per share, paid a dividend of $1.65 per share during the year, and had an ending share price of $85. Compute the total percentage return. What was the dividend yield? The capital gains yield? What if the ending share price is $62.
Div yield = 1.65 / 72 = .0229 Cap gains yield = (85 - 72) / 72 = .1806 R = .1806 + .0229 = .2035 or 20.35% Div = .0229 Cap = (62 - 72) / 72 = -.1389 R = -.1389 + .0229 = -.1160 or -11.60%
The total dollar return on a stock is the sum of the ___ and the ___
Dividends capital gains
Which of the following are ways to make money by investing in stocks?
Dividends, capital gains
You purchased 250 shares of a particular stock at the beginning of the year at a price of $87.25. The stock paid a dividend of $1.15 per share, and the stock price at the end of the year was $94.86. What was your dollar return on this investment?
Dollar return = 250(94.86 - 87.25 + 1.15) = $2,190
Consider the following two mutually exclusive projects Year Cash Flow(A) Cash Flow(B) 0 -$416,000 -$35,500 1 48,500 19,500 2 57,500 14,200 3 74,500 14,100 4 531,000 10,900 The required return on these investments is 12%. a. What is the payback period for each project? b. What is the NPV for each project? c. What is the IRR for each project? d. What is the profitability index for each project? e. Based on your answers in (a) through (d), which project will you finally choose?
a. Project A = 3.44 years Project B = 2.13 years b. A = $63629.95 B = 10194.12 c. A = 16.78% B = 26.52% d. A = 1.15 B = 1.29 e. A
The Tattle Teller has a printing press sitting idly in its back room. The press has no market value to another printer because the machine utilizes old technology. The firm could get $480 for the press as scrap metal. The press is six years old and originally cost $174,000. The current book value is $3,570. The president of the firm is considering a new project and feels he can use this press for that project. What value, if any, should be assigned to the press as an initial cost of the new project?
$480
Kenny, Inc., wants to set up a new manufacturing plant. They bought land six years ago for $5.3 million to use as a warehouse and distribution site, but the company decided to rent facilities elsewhere. The land would net $7.4 million if it were sold today. The company wants to build its new plant on this land. The plant will cost $26.5 million to build, and requires $1.32 million worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the initial investment in fixed assets when evaluating this project? Why?
$5.3 should be ignored bc they are sunk costs and $7.4 is opportunity cost, $7.4 + $26.5 + $1.32 = $35.22 mil
The model that precisely specifies the relationship between the nominal and real rate is R = nominal r = real h = rate of inflation
(1 + R) = (1 + r) * (1 + h)
H. Cochran, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $1,950,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,145,000 in annual sales, with costs of $1,205,000. If the tax rate is 35%, what is the OCF for this project?
(2.145mil - 1.205mil - (1.95mil / 3))(1 - .35) = 188,500 + (1.95/3) = 838,500 = OCF
Winnebagel Corp. currently sells 28,000 motor homes per year at $77,000 each and 7,000 luxury motor coaches per year at $120,000 each. The company hopes to sell 29,000 new campers per year at $23,500 each. An independent consultant has determined that if the company introduces the new campers, it should boost the sales of its existing motor homes by 2,500 units per year and reduce the sales of its motor coaches by 750 units per year. What is the amount to use as the annual sales figure when evaluating this project? Why?
(Sales from new) 29,000*23,500 + (Synergy: ↑ sales) 2,500*77,000 + (Erosion: ↓ sales) -750*120,000 = 784mil
Which one of the following indicates that a project is expected to create value for its owners?
+ NPV
A new project is expected to generate an operating cash flow of $38,728 and will initially free up $11,610 in net working capital. Purchases of fixed assets costing $52,800 will be required to start up the project. What is the total cash flow for this project at Time zero?
-$41,190
You bought a bond with an annual coupon rate of 6.5% 1 yr ago for $1,032. The bond sells for $1,020 today Assuming a $1,000 face value, what was your total dollar return on this investment over the past year? What was your total nominal rate of return on this investment over the past year? If the inflation rate last year was 3%, what was your total real rate of return on this investment?
1. C payment = (c rate)(face) = (.065)(1000) = $65 Total dollar return = (1020 - 1032) + 65 = $53 2. Total nominal rate of return R = ((1020 - 1032) + 65) / 1032 = T $ return / 1032 = .0514 or 5.14% 3. Using Fisher (1 + R) = (1 + r)(1 + h), total real rate of return was r = (1.0514 / 1.03) - 1 = .0207 or 2.07%
Arrange the following investments from highest to lowest risk (standard deviation) based on what our study of capital market history from 1926 - 2014 has revealed as shown in table 10.3 Large-company stocks Small-company stocks Long-term gov bonds U.S. Treasury bills Long-term corporate bonds
1. Small-company stocks 2. Large-company stocks 3. Long-term corporate bonds 4. Long-term gov bonds 5. U.S. Treasury bills
Arrange the following investments starting from lowest historical risk premium to highest Large-company stocks Small-company stocks U.S. Treasury Bills Long-term corporate bonds
1. U.S. Treasury Bills 2. Long-term corporate bonds 3. Large-company stocks 4. Small-company stocks
In 2003, Porsche unveiled the Cayenne, priced more than $40,000. Porsche's decision to enter SUVs was in response to the success of other SUVs. Vehicles in this class had generated years of high profits. Porsche then introduced the Cayenne Turbo S at a price of $114,000 in 2015. Analysts were concerned that Porsche was a late entry into the market and the Cayenne would damage Porsche's reputation as a maker of high-performance automobiles. 1. In evaluating the Cayenne, would you consider the possible damage to Porsche's reputation? 2. Porsche was one of the last manufacturers to enter the SUV market. Why would one company decide to proceed with a product when other companies, at least initially, decide not to enter the market? 3. In evaluating the Cayenne, what do you think Porsche needs to assume regarding the substantial profit margins that exist in this market? Is it likely they will be maintained as the market becomes more competitive, or will Porsche be able to maintain the profit margin because of its image and the performance of the Cayenne?
1. Yes you should consider possible rep damage bc if rep went down, sales of existing cars would decrease. 2. Just a ? to think about, maybe they can make it at a lower cost or market better, or one made a mistake 3. They would recognize that more comp = less profits. This means companies must innovate and seek to reduce costs to keep up with comp.
What is IRR for a project with an initial investment of $500 and subsequent cash inflows of $145 per yr for 5 yrs?
13.82%
A piece of newly purchased industrial equipment costs $715,000 and is classified as seven-year property under MACRS. Calculate the annual depreciation allowances and end-of-the-year book values for this equipment. Year 3yr 5yr 7yr 1 33.33% 20.00% 14.29% 2 44.45 32.00 24.49 3 14.81 19.20 17.49 4 7.41 11.52 12.49 5 11.52 8.93 6 5.76 8.92 7 8.93 8 4.46 Year Beg Book Val Dep Annual Dep Allowance End-of-yr Book Val 1 $715,000.00 14.29% $102,173.50 $612,826.50 2 612,826.50 24.49% 175,103.50 437,723.00 3 437,723.00 17.49% 125,053.50 312,669.50 4 312,669.50 12.49% 89,303.50 223,366.00 5 223,366.00 8.93% 63,849.50 159,516.50 6 159,516.50 8.92% 63,778.00 95,738.50 7 95,738.50 8.93% 63,849.50 31,889.00 8 31,889.00 4.46% 31,889.00 0 Consider an asset that costs $545,000 and is depreciated straight-line to zero over its eight-year tax life. The asset is to be used in a five-year project. At the end of the project, the asset can be sold for $95,000(market). If the relevant tax rate is 35%, what is the aftertax cash flow from the sale of this asset?
545,000/8 = 68,125(annual dep)*5 = 340,625(accumulated dep) => 545,000 - acc dep = 204,375(book) Aftertax cash flow = market + (book - market)(.35) = 133,281.25
A proposed new investment has projected sales of $645,000. Variable costs are 40% of sales, and fixed costs are $168,000, depreciation is $83,000. Prepare a pro forma income statement assuming a tax rate of 35%. What is the projected net income?
645,000 - (645,000*.4) - 168,000 - 83,000 = 136,000*(1 - .35) = $88,400 = NI
The internal rate of return is a function of ___
A project's cash flows
Percentage returns are more convenient than dollar returns bc they
Allow comparison against other investments, and apply to any amount invested
A +capital gain on a stock results from ___
An increase in price
Your firm is contemplating the purchase of a new $410,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $30,000 at the end of that time. You will save $125,000 before taxes per year in order processing costs, and you will be able to reduce working capital by $35,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. If the tax rate is 35%, what is the IRR for this project? Suppose your required return on the project is 10% and your pretax cost savings are $145,000 per year. Will you accept the project? What if the pretax cost savings are only $105,000 per year?
Annual dep = 410,000 / 5 = 82,000 Aftertax salvage = 30,000(1 - .35) = 19,500 OCF = 125,000(.65) + 82,000(.35) = 109,950 NPV = 0 = -410,000 + 35,000 + 109,950/(1 + IRR) + ... + 109,950/(1 + IRR)^5 + (19,500 - 35,000)/(1 + IRR)^5 IRR = 13.37% OCF = 145,000(.65) + 28,700 = 122,950 NPV = -375,000 + 122,950(PVIFA) + (-15,500)/(1.1)^5 = 81,452.95 OCF = 105,000(.65) + 28,700 = 96,950 NPV = -375,000 + 96,950(PVIFA) + (-15,500)/(1.1)^5 = -17,107.50 Accept first, reject second
JL & Co. is contemplating the purchase of a new $428,000 computer-based order entry system. The system will be depreciated straight-line to zero over the project's six-year life. The pretax resale value is $215,000. The system will save $148,000 before taxes per year in order processing costs and will reduce working capital by $46,000 at the beginning of the project. Working capital will revert back to normal at the end of the project. If the tax rate is 34%, what is the IRR for this project?
Annual dep = 428,000 / 6 Aftertax salvage = 215,000(1 - .34) Initial = -428,000 + 46,000 OCF = $148,000(1 - .34) + (annual dep)(.34) = $121,933.33 NPV = 0 = initial + $121,933.33(PVIFA) + (-$46,000 + aftertax salvage)/(1 + IRR)^6 In calculator, irr(initial, {OCF, (OCF + aftertax salvage - 46000)}, {5, 1}) IRR = 25.32%
Kolby's Korndogs is looking at a new sausage system with an installed cost of $655,000. This cost will be depreciated straight-line to zero over the project's five-year life, at the end of which the sausage system can be scrapped for $85,000. The sausage system will save the firm $183,000 per year in pretax operating costs, and the system requires an initial investment in net working capital of $35,000. If the tax rate is 34% and the discount rate is 8%, what is the NPV of this project?
Annual dep = 655,000 / 5 = 131,000 Aftertax salvage = 85,000(0 - 85,000)(.34) = 56,100 OCF = 183,000(1 - .34) + 131,000(.34) = 165,320 NPV = -655,000 - 35,000 + 165,320(PVIFA) + (aftertax salvage + NWC)/(1.08^5) = $32,075.95
You've observed the following returns on Barnett Corporation's stock over the past five years −12%, 23%, 18%, 7%, and 13%. What was the arithmetic average return on the stock over this five-year period? What was the variance of the returns over this period? The standard deviation?
Avg = 9.8% Var = (Ʃ(actual - .098)^2) / 4 = .01837 SD = √(.01837) = .1355 or 13.55%
An asset used in a four-year project falls in the five-year MACRS class for tax purposes. The asset has an acquisition cost of $7,100,000 and will be sold for $1,460,000(market) at the end of the project. If the tax rate is 34%, what is the aftertax salvage value of the asset?
Book = 7.1mil - 7.1(.2 + .32 + .192 + .1152) = 1,226,880 => market + (book - market)(.34) = 1,380,739.2
The net present value of an investment represents the difference between the investment's
Cost and market value
The PI is also called the ___ ratio
Cost-benefit
Sprigg Lane Manufacturing, Inc., needs to purchase a new central air-conditioning system for a plant. There are two choices. The first system costs $50,000 and is expected to last 10 years, and the second system costs $72,000 and is expected to last 15 years. Assume that the opportunity cost of capital is 10%. Which air-conditioning system should Sprigg Lane purchase?
Equivalent Annual Cost EAC1 = 50,000 / (((1-(1+r)^(-n)))/r) = 8,137.27 EAC2 = 72,000 / (PVFA) = 9,466.11 Sprigg Lane should purchase the first one
A textbook publisher has an existing finance textbook. The publisher is debating to produce a shorter (and lower-priced) book. What are some of the considerations that should come into play?
Erosion, the effect on current products from a new product being sold, and Competition, whether or not other competitors would produce products which would decrease sales as well (also making erosion less relevant) should be considered
Flo is considering three mutually exclusive options for the additional space she plans to add to her specialty women's store. The cost of the expansion will be $148,000. She can use this additional space to add children's clothing, an exclusive gifts department, or a home décor section. She estimates the present value of the cash inflows from these projects are $121,000 for children's clothing, $178,000 for exclusive gifts, and $145,000 for decorator items. Which option(s), if any, should she accept?
Exclusive gifts only
The Oceanside Marina is considering the purchase of an excursion boat. Model SL would require an initial investment of $2.2 million and produce annual after-tax cash inflows of $1.2 million for each of three years. Model LL would require an initial investment of $5.5 million and produce annual after-tax cash inflows of $1.3 million for each of 7 years. Oceanside's discount rate is 8%. Which model should be chosen?
Find NPV of each NPVSL = -2,200,000 + 1,200,000(PVFA) = $892,516 NPVLL = -5,500,000 + 1,300,000(PVFA) = $1,268,281 Find EAS of each NPV = EAS(PVFA) $892,516 = EASSL(2.5771) gives EASSL = $892,516/2.5771 = $346,326 $1,268,281 = EASLL(5.2064) gives EASSL = $1,268,281/5.2064 = $243,600 Model SL has the highest EAS and should be selected
A project has the following cash flows. What is the internal rate of return? Year Cash Flow 0 -$33800 1 $12360 2 $14580 3 $16710
IRR = 13.23
When a company declares a div, shareholders generally receive ___
cash
A proposed project requires an initial cash outlay of $49,000 for equipment and an additional cash outlay of $18,700 in Year 1 to cover operating costs. During Years 2 through 4, the project will generate cash inflows of $42,500 a year. What is the net present value of this project at a discount rate of 11.6%?
NPV = $26343.72
Empire Industries is considering adding a new product to its lineup. This product is expected to generate sales for four years after which time the product will be discontinued. What is the project's net present value at a required rate of return of 14.8%? Year Cash Flow 0 -$62000 1 $16500 2 $23800 3 $27100 4 $23300
NPV = -$62,000 + $16,500 / (1 + .148) + $23,800 / 1.1482 + $27,100 / 1.1483 + $23,300 / 1.1484 NPV = $1758.71
In the previous problem, suppose the required return on the project is 14%. What is the project's NPV?
NPV = -1.95mil + 838,500/(1.14) + 838,500/(1.14)^2 + 838,500/(1.14)^3 NPV = -3311.55
Jim's Hardware is adding a new product to its sales lineup. Initially, the firm will stock $36,000 of the new inventory, which will be purchased on 30 days' credit from a supplier. The firm will also invest $13,000 in accounts receivable and $11,000 in equipment. What amount should be included in the initial project costs for net working capital?
Net working capital = -$36,000 + 36,000 -13,000 = -$13,000
We have seen that over long periods of time, stock investments have tended to substantially outperform bond investments. However, it is not at all uncommon to observe investors with long horizons holding entirely bonds. Are such investors irrational?
No, they just like to play it safe and gain steady but minimal rate increase. Stocks are riskier and some investors are risk-averse.
The Blue Lagoon is considering a project with a five-year life. The project requires $32,000 of fixed assets that are classified as five-year property for MACRS. Variable costs equal 67% of sales, fixed costs are $12,600, and the tax rate is 34%. What is the operating cash flow for Year 4 given the following sales estimates and MACRS depreciation allowance percentages? Year 1 2 3 4 5 Sales $32,000 34,500 35,600 38,900 42,000 MACRS rate 20% 32% 19.2% 11.52% 11.52%
OCF = (sales-cost)(1-tax)+(dep)(tax) = (38,900 - var - fixed)(1-.34) + (32,000*.1152)(.34) = $1,409.80
H. Cochran, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,310,000. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate $2,220,000 in annual sales, with costs of $1,210,000. If the tax rate is 30%, what is the OCF for this project?
OCF = 938,000
Given that Transocean Ltd. Was down by 63% for 2014, why did some investors hold the stock? Why didn't they sell out before the price declined so sharply?
Probably same reason as first, and maybe sunk costs. Easy to see after the fact, but not then. Being implicated in Deepwater Horizon oil spill in 2010 didn't help. Investors may have expected a turnaround.
Consider the following two mutually exclusive projects Year Cash Flow(X) Cash Flow(Y) 0 -$15,300 -$15,300 1 6,770 7,410 2 7,350 7,670 3 4,870 3,750 a. What is the IRR for each? b. What is the crossover rate for these two projects?
Project X = 12.28% Project Y = 12.42% IRR(initial - initial, {X1-Y1, X2-Y2, X3-Y3}) = 9.63%
What is the equation for the nominal rate of return? R = nominal r = real h = rate of inflation
R ≈ r + h
If the IRR is greater than the ___ ___, we should accept the project
Required return
What is the return on a portfolio that consists of $50,000 in an index fund, $30,000 in a bond fund, and $20,000 in a foreign stock fund? The exp returns are 7%, -3%, and 18%, respectively
Return on portfolio = Ʃ(Portfolio weight * Exp returns) = .5(.07) + .3(-.03) + .2(.18) = .062 or 6.2%
The excess return is the difference between the rate of return on a risky asset and the ___ rate
Risk-free
Rolston Music Company is considering the sale of a new sound board used in recording studios. The new board would sell for $27,300, and the company expects to sell 1,500 per year. The company currently sells 1,850 units of its existing model per year. If the new model is introduced, sales of the existing model will fall to 1,520 units per year. The old board retails for $24,900. Variable costs are 55% of sales, depreciation on the equipment to produce the new board will be $2,150,000 per year, and fixed costs are $3,200,000 per year. If the tax rate is 38%, what is the annual OCF for the project?
Sales = (1,500*27,300 + (-330)*24,900)(1 - .55) - 3.2mil - 2.15mil = 9,379,850(1 - .38) = 5,815,507 OCF = 5,815,507 + 2.15mil = 7,965,507
The Ibbotson SBBI data show that over the long-term,
Small-company stocks had highest risk level and generated highest avg return T-bills, which had lowest risk, also generated lowest return
Which of the following are true about variance?
Standard dev is the sq rt of var, and var is a measure of the squared dev of a security's return from its expected return
The true risk of any investment comes from ___
Surprises
Which of the following are needed to describe the distribution of stock returns?
The standard dev of returns, and the mean return
Given that RadNet, Inc., was up by 411% for 2014, why didn't all investors hold RadNet?
They all wish they had, the price performance must not have been foreseeable. There is no guarantee that RadNet. Inc could have gone down by 411%, unexpected events produce unexpected results
The square of the standard deviation(SD) is equal to the
Variance
If you wish to create a portfolio of stocks, what is the req min number of stocks?
You must invest in stocks of more than one corp
Reece Company is presented with the following mutually exclusive projects. The required return for both is 14% Year Project M Project N 0 -$137,000 -$358,000 1 63,800 151,000 2 81,800 183,000 3 72,800 136,000 4 58,800 113,000 a. What is the IRR for each project? b. What is the NPV for each project? c. Which, if either, of the projects should the company accept?
a. Project M = 36.12% Project N = 24.31% b. M = $65759.60 N = $73969.90 c. N
