FIN 3403 Quiz #1 - Version 1 12 points [Show all work for credit] Time Value

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1 FIN 3403 Quiz #1 - Version 1 [Show all work for credit] Time Value Frohlich Fall 1998 Do either problem one or two: (12 pts.) [show all work] 1. A)The Tried and True Company had earnings of $.30 per share in By 1998, a period of 20 years, its earnings had grown to $.96 per share. What has been the compound annual rate of growth in the company s earnings? B)Using this growth rate as an investor s required rate of return, what should an investor have paid for a share of stock in 1978 if the market value of the company s stock is $30 now? Ans: A: 5.98% B: $ A)Thirty years ago, Jesse Jones bought 10 acres of land for $1000 per acre in what is now downtown Houston. What has been the compound annual rate of growth in the land s value if the land is worth $4, per acre today? B) If the investor had required a compound annual rate of return equal to the land s value growth rate computed in A, what should they have paid per acre for additional land purchased 10 years ago (assume land value per acre is $ today)? Ans: A: 5% B: $

2 FIN 3403 Quiz #2 - Version 1 [Show all work for credit] Time Value Frohlich Fall 1998 Do either problem one or two: (12 pts.) [show all work] 1. Bill will go to college 15 years from now (end of year 15) and requires $30,000, $31,000, $32,000, $33,000 each year at UNF. In addition, he plans to retire in 30 years. He expects to have $100,000 available for each of the 20 years of retirement in Hawaii. These funds will need to be available at the beginning of each year (starting in year 31 or end of year 30). If he has $30,000 that can be used to meet these obligations, how much must he save at the end of each of the next 30 years? The funds earn a 13% rate of return. ANS: PV of cash flows net need pymt Dr. Jones has two children. One will go to University for his Master=s at the beginning of the second year (beginning of year 2 or end of year 1), for two years and require $40,000 and $45,000 consecutively. The second child will go to college 10 years from now (end of year 10) and will require $15,000 every year for the next four years. Dr. Jones is planning to retire 15 years from now(end of year 15). On his retirement, Dr. Jones expects to live for 5 years. He plans to withdraw $50,000, $60,000, $70,000, $80,000, $90,000 at the beginning of each year. His first withdrawal will occur at the beginning of year 16 (end of year 15). If he has $30,000 available today, and the interest rate is 10%, how much does he need to save each year during the next 15 years? PV of cash flows 161, net 131, Pymt for 15 years $

3 FIN 3403 Quiz # 3- Version A Chapter 1 and 2 Time Value Frohlich Fall The shareholder wealth maximization goal states that management should seek to maximize the of the expected future returns to the owners of the firm. a. Future value b. Compound value c. Percentage value d. Present value 2. Shareholder wealth is measured by the of the shareholder s common stock holdings. a. Book value b. Market value c. Historic value d. Compound value Do either problem one or two: (8 pts.) [show all work] 1. Richard deposits $100,000 into his savings account today, May 1, 1992 (end of year 0). He deposits $70,000 into the same account each May 1 beginning in 1994 and ending on May 1, (A total of 7 payments.) $150,000 is withdrawn on May 1, 1999 (end of year 7). Considering a pretax interest rate of 8%, a marginal tax rate of 25%, and an average tax rate of 22% what will be the after-tax balance of his account on May 1,2001 (end of year 9)? Ans: Discount rate: 8%*(1-.25)= 6% FV of cash flows $623, Mr. Marx placed $25,000 into his savings account today. The account pays interest semiannually at the annual rate of 12%. How much could he withdraw every month starting one month from now so that the savings account balance will be zero at the end of two years?.12 2 Ans: First find effective rate: (1 + ) 1 =.1236 = 12.36% (This is the equivalent annual rate) 2 Discount Rate: 12.36%/12 =1.03% PV of Payments: $25,000; pymts $1,181 3

4 Frohlich Fall 1998 FIN 3403 Quiz # 4- Version A Chapter 1 and 2 Time Value 1. Α savings institutions use most of their funds for. Commercial banks use most of their funds for. a. commercial mortgages; consumer mortgages b. mortgages for consumers; business loans and commercial real estate loans c. business loans, commercial real estate loans and mortgages for consumers d. commercial real estate loans and mortgages for consumers; business loans 2. Finance companies differ from commercial banks, savings institutions, and credit unions because: a. finance companies normally do not obtain funds from deposits. b. finance companies main purpose is to finance acquisitions by companies. c. finance companies main purpose is to provide residential mortgages. d. finance companies use most of their funds to purchase stocks. Do either problem one or two: (8 pts.) [show all work] Work must be neatly done to be graded 1. Ms. Underwood had financed a piece of equipment for his factory at Tampa. For this machine he borrowed $75,000 (end of year 0) at 24%. He would have to pay the loan off over 2 years. His institution allows him to skip June & July payments. What must the value for the end of the month payments be for this loan given that June & July payments are zero. First payments occurs Jan 1 st 1998 (end of month 1). Ans: Discount Rate: 24%/12=2% 75,000 = Pymt(PVIFA 2%,5) +Pymt(PVIFA2%,10)(PVIF2%,7) +Pymt (PVIFA 2%,5)(PVIF 2%,19) 75,000 = Pymt [ (PVIFA 2%,5) + (PVIFA 2%,10) (PVIF2%,7) + (PVIFA 2%,5) (PVIF 2%, 19)] Must use Tables: 75,000= Pymt [(4.713) +(8.983)(.871) +(4.713) (.686)] 75,000= Pymt[ ] 75,000= Pymt{ } Pymt =4,756 4

5 2. Frank Delly has just turned 20 years old (end of year 0). He currently has $20,000 toward his planned retirement at age 60 (end of year 40). He wants to accumulate enough money over the 40 years to provide a 10 year retirement annuity of $250,000 payable at the end of the year starting with his 61 st birthday (end of year 41). Frank also plans to save $10,000 at the end of year for the next 30 years. Interest rate for the first 30 years will have a pretax rate of % and % thereafter. Frank has an average tax rate of 25% and a marginal tax rate of 30%. What equal annual payments must he save at the beginning of year 31 through 40 to meet his objective? Ans: Discount Rates: Years 1-30: % (1-.30)= 5% Years 31- : % (1-.30) = 8% Bring Cash Flows to end of Year 30: Have at Year 30: $750,827 Need at Year 30: $777,017 Pymts: 31-40: $3,903 5

6 FIN 3403 Quiz # 5- Version A Bonds Frohlich Fall 1998 Do either problem one or two: (12 pts.) [show all work] Work must be neatly done to be graded 1. ABC Corporation issued July 1, 1985 with a 10% coupon bonds that will mature on July 1, The interest on these bonds is paid and compounded annually. A. Determine the value (price) of a $1000 ABC bond as of July 1, 1985 to an investor who holds the bond until maturity (20 years from now) and whose rate of return is 12 percent. ANS: 851 B. What would the rate of return on the ABC Corporation bonds be if you paid $900 for the bonds on July 1, 2000 and interest is paid annually? ANS: 12.83% 6

7 2.Tay, Inc. has outstanding bonds with a par value of $1,000 at the time of issuance (5 years ago) that pay an annual coupon rate of 12%. The maturity date was 20 years from the date of issuance. Investors are now requiring an 18% rate of return on this type of bonds due to TAY s increased risk. A. What price would these bonds sell for now? ANS: 695 B. If you sell these bonds for $1100 five years from now, what will be your return? Use the price calculated in A as your purchase price. ANS: 24.47% 7

8 FIN 3403 Quiz # 6- Version A Bonds Frohlich Fall If a firm could sell a mortgage bond at an 8% interest rate, it could sell an otherwise identical debenture at a. a rate less than 8% b. 8% c. a rate greater than 8% d. none of the above/cannot be determined 2. When the required rate of return is the coupon rate, the bond will sell at a discount. a. less than b. greater than c. the same as d. equal to Do either problem one or two: (8 pts.) [show all work] Work must be neatly done to be graded 1.ABC Corp. Inc. has planned to offer a $1,000 par value bond which matures in 17 years (August 1, 2015). The coupon rate on the bond for the first 4 years is 12.5%, for the next 5 years is 13.75%, for the next 3 years is 11.5% and the last 5 years is 10.25%. The bonds are callable at $1,100 beginning on August 1, You require a 12% rate of return on a bond of this quality and maturity and assuming interest is paid annually at the end of each year, at what price should the investor pay for the bond today (August 1, 1998) if a. The bond is not called? ANS: $ b. The bond is called August 1, 2010? ANS: $1077 8

9 2.ABC Corp. Inc. has planned to offer a $1,000 par value bond which matures in 17 years (August 1, 2015). The coupon rate on the bond for the first 4 years is 12.5%, for the next 5 years is 13.75%, for the next 3 years is 11.5% and the last 5 years is 10.25%. The bonds are callable at $1,100 beginning on August 1, You paid $850 today (August 1, 1998) for this bond. Assuming interest is paid annually at the end of each year, what will your return be if a. The bond is not called? ANS: 15.04% b. The bond is called August 1, 2010? ANS: 16.04% 9

10 FIN 3403 Quiz #7 - Version A [Show all work for credit] Common Stock Frohlich Spring The market value of common stock is primarily based on a. the firm s future earnings b. book value c. total assets d. retained earnings 2. In the constant-growth dividend valuation model, the required rate of return on a common stock can be shown to be equal to the sum of the dividend yield plus: a. Yield-to-maturity b. Cost of capital c. Present value yield d. Price appreciation yield Do either problem one or two: (8 pts.) SHOW ALL WORK 1.Over the past 10 years UTX Company common stock dividends have grown from $2.00 to $4.74 per share (currently). Determine the value of UTX common stock to an investor who requires a 16% rate of return, assuming that dividends continue growing for the foreseeable future at the same rate as over the past 10 years ANS: The stock of GTX currently pays a dividend (D 0 ) of $3. The firm expects its earnings and dividends to grow at 6% over the next 3 years, 5% per year from the beginning of year 4 to the end of year 7 and 4% thereafter (beginning in year 8) Determine the value of a share of GTX company to an investor with a 12% required rate of return. ANS:

11 FIN 3403 Quiz #8 - Version A [Show all work for credit] Financial Performance Frohlich Fall 1998 Do either of the problems one or two: (12 pts.) SHOW ALL WORK 1. Tarheel Furniture Company is planning to establish a wholly owned subsidiary to manufacture upholstery fabrics. Tarheel expects to earn $1 million after tax on the venture during the first year. The president of Tarheel wants to know what the subsidiary s balance sheet would look like. The president believes that it would be advisable to begin the new venture with ratios that are similar to the industry average. Tarheel plans to make all sales on credit. All calculations assume a 365-day year. In your computations, you should round all numbers to the nearest $,000. Based upon the industry average financial ratios presented here, complete the projected balance sheet for Tarheel s upholstery subsidiary. Industry Averages Current ratio 2:1 Quick ratio 1:1 Net profit margin ratio 5 percent Average collection period 20 days Debt ratio 40 percent Total asset turnover ratio 2 times Current liabilities/stockholders equity 20 percent Forecasted Upholstery Subsidiary Balance Sheet Cash Total current liabilities Accounts receivable Long-term debt Inventory Total debt Total current assets Stockholders equity Net fixed assets Total liabilities and stockholders equity Total assets 11

12 ANS: Forecasted Upholstery Subsidiary Balance Sheet Cash 3.70 Million Total current liabilities 4.8Million Accounts receivable Million Long-term debt 11.2 Million Inventory 4.8 Million Total debt 16Million Total current assets 9.6 Million Stockholders equity 24Million Net fixed assets 30.4 Million Total Assets 40Million Total liabilities and stockholders equity 40Million 2. Sun Minerals, Inc. is considering issuing additional long-term debt to finance an expansion. At the present time, the company has $50 million in 10 percent debt outstanding. Its after-tax net income is $12 million, and the company is in the 40 percent tax bracket. The company is required by the debt holders to maintain its times interest earned ratio at 3.5 or greater. a. What is the present coverage (times interest earned) ratio? ANS: 5 b. How much additional 10 percent debt can the company issue now and maintain its times interest earned ratio at 3.5? (Assume for this calculation that earnings before interest and taxes remain at their present level.) ANS: Additional Debt 21.4 Million c. If the interest rate on additional debt is 12 percent, how much unused a debt capacity s does the company have? ANS: Additional Debt Million 12

13 FIN 3403 Quiz #9 - Version A [Show all work for credit] Capital Budgeting Frohlich Fall Which of the following is not a major step in the capital budgeting process? a. generating investment project proposals b. estimating cash flows c. analyzing the effect of a project on the firms financial ratios d. performing a project post-audit and review 2. The dollar amount of interest charges is: a. always considered in the net cash flow calculation b. normally not considered in the net cash flow calculation c. always considered as part of the net investment d. none of the above Do either problem One or two: (8 pts.) SHOW ALL WORK 1. Ralph s Bow Works (RBW) is planning to add a new line of bow ties that will require the acquisition of a new knitting and typing machine. The machine will cost $150,000. It is classified as a 7-year MACRS asset and will be depreciated as such. Interest costs associated with financing the equipment purchase are estimated to be $50,000 per year. The expected salvage value of the machine at the end of 10 years is $75,000. The decision to add the new line of bow ties will require additional net working capital of $50,000 immediately, $25,000 at the end of year 1, and $10,000 at the end of year 2. RBW expects to sell $275,000 worth of the bow ties during each of the 10 years of product life. RBW expects the sales of its other ties to decline by $25,000 (in year one) as a result of adding this new line of ties. The lost sales level will remain constant at $25,000 over the 10-year life of the proposed project. The cost of producing and selling the ties is estimated to be $50,000 per year. RBW will realize savings of $5,000 each year because of lost sales on its other tie lines. The marginal tax rate is 40 percent. Compute the net investment (year 0) and the net cash flows for years 1 and 10 for this project. ANS: NINV=200,000 CF Year 1 = 106,574 CF Year 10 = 253,000 13

14 2. Clyne Industries want to market its new Slammin Jammin Basketball Goal Set. To bring this product to the market will require the purchase of equipment costing $750,000. Shipping and installation expenses associated with the equipment are estimated to be $75,000. In addition, Clyne will incur incremental employee training and recruiting expenses of $100,000, all of which will be incurred at time 0. Additional net working capital investments of $50,000 will be required at time 0. $25,000 in year 1, and $10,000 in year 2. Revenues are expected to be $275,000 in year 1 and grow at a rate of $25,000 per year through year 5, and then decline by $25,000 per year until the project is terminated at the end of year 10. Annual operating expenses are expected to be $100,000 in year 1 and to grow at a rate of $10,000 per year until the end of the project life. Depreciation will be under MACRS for a 7-year class asset. The salvage value of the equipment at the end of 10 years is expected to be $50,000. The marginal, ordinary tax rate is 40 percent and the capital gains tax rate is 30 percent. Compute the expected net cash flow for year 10, the last year in the life of the projects. ANS: CF Year 10:=151,000 14

15 FIN 3403 Quiz #10 [Show all work for credit] Capital Budgeting Frohlich Fall 1998 ANSWER BOTH PROBLEMS (12 pts.) SHOW ALL WORK 1. Two mutually exclusive investment projects have the following forecasted cash flows: Year A B 0 -$20,000 -$20, , , , , ,000 a. Compute the internal rate of return for each project. ANS: A: 32.17% B: 31.27% b. Compute the net present value for each project if the firm has a 12 percent cost of capital. ANS: A: $12,167 B: $14,064 c. Which project should be adopted? Why? ANS: Project B Has the highest Net Present Value 15

16 2. Commercial Hydronics is considering replacing one of it s larger control devices. A new unit sells for $35,000 (delivered). An additional $3,000 will be needed to install the device. The new device has an estimated 20-year service life. The estimated salvage value at the end of 20 years will be $3,000. The new control device will be depreciated over 20 years on a straight-line basis to $0. The existing control device (original cost - $15,000) has been in use for 12 years, and it has been fully depreciated (that is, its book value equals zero). Its scrap value is estimated to be $1,000. The existing device could be used indefinitely, assuming the firm is willing to pay for its very high maintenance costs. The firm s marginal tax rate of 40 percent. The new control device requires lower maintenance costs and frees up personnel who normally would have to monitor the system. Estimated annual cash savings from the new device will be $10,000. The firm s cost of capital is 10 percent. Using this information, evaluate the relative merits of replacing the old control device using the net present value approach. ANS: IRR = 17.38% IRR > Cost of Capital (10%) Accept NPV=20,419 NPV > 0 Accept 16

17 Frohlich Spring 1997 FIN 3483 Quiz #11 - Version 2 [Show all work for credit] Risk Adjustment 1. Total project risk is a. the contribution project makes to the risk of the firm b. measured by the correlation coefficient c. the chance that a project will perform different from expections d. measured by the project s beta 2. The risk-adjusted discount rate approach is preferable to the weighted cost of capital approach when a. all projects have the same risk characteristics b. the risk-free rate is known with certainty c. the projects under consideration have different risk characteristics d. the firm is unlevered Do either problem one or two: (8 pts.) SHOW ALL WORK 1. Essex Chemical Company is considering an expansion into a new product line that is more risky than its existing product mix. The new product line requires an investment, NINV, of $10 million and is expected to generate annual net cash inflows of $2.0 million over a 10-year estimated economic life. Essex Chemical s weighted cost of capital is 12 percent, and the new product line requires an estimated risk-adjusted discount rate of 17 percent, based upon the security market line and betas for comparable companies engaged in the contemplated new line of business. a. What is the project s NPV, using the company s weighted cost of capital? b. What is the project s NPV, using the risk-adjusted discount rate? c. Should Essex Chemical adopt the project? Answer: a. 1.3 million b million c. No 17

18 2. The Carthage Sceptre Corporation is evaluating a possible investment in a new regional distribution warehouse. A careful evaluation of the anticipated net cash flows and net investment expected from the project indicates that the expected net present value (NPV) of this project is $4.5 million. The anticipated standard deviation of this expected NPV is $3 million, and the distribution of the project s NPV is approximately normal. What is the chance that this project will have a positive NPV at least equal to $1,000,000? Answer: 87.9% 18

19 FIN 3483 Frohlich Spring 1997 Quiz #12- Version 1 [Show all work for credit] Cost of Capital and Break Points 1. The cost of capital is a. the rate of return required by investors in the firm s securities b. the minimum rate of return required on new investments of average risk undertaken by the firm c. approximately 10 percent for most firms d. a and b only 2. If a firm adopts a large proportion of above-average-risk investment projects that are not offset by below-average-risk investment projects a. its cost of capital will rise b. the average risk premium for the firm will decline c. the risk-free rate will increase as more risk is added d. none of the above Do either problem one or two: (8 pts) SHOW ALL WORK 1. Colbyco Industries has a target capital structure of 60 percent common equity, 30 percent debt, and 10 percent preferred stock. The cost of retained earnings is 15 percent, and the cost of new equity (external) is 16 percent. Colbyco anticipates having $20 million of new retained earnings available over the coming year. Colbyco can sell $15 million of first-mortgage bonds with an after-tax cost of 9 percent. Its investment bankers feel the company could sell $10 million of debentures with a 9.5 percent after-tax cost. Additional debt would cost 10 percent after tax and be in the form of subordinated debentures. The after-tax cost of preferred stock financing is estimated to be 14 percent. Compute the marginal cost of capital schedule for Colbyco, and determine the break points in the schedule. Answer: Break Point Weighted Marginal Cost of Capital 33,333, ,000, ,333, Additional Funds

20 20

21 2. Owens Enterprises is int he process of determining its capital budget for the next fiscal year. The firm s current capital structure, which it considers to be optimal, is contained in the following balance sheet: Balance Sheet Current assets $40,000,000 Accounts Payable $ 20,000,000 Fixed assets 400,000,000 Other current liabilities 10,000,000 Total assets $440,000,000 Long-term debt 123,000,000 Common stock at par 15,500,000 Paid in capital in excess of par 51,000,000 Retained earnings 220,500,000 Total liabilities and stockholders equity $440,000,000 Through discussions with the firm s investment bankers, lead bank, and financial officers, the following information has been obtained: The firm expects net income from this year to total $80 million. The firm intends to maintain its dividend policy of paying percent of earnings to stockholders. The firm can borrow $18 million from its bank at a 13 percent annual rate. Any additional debt can be obtained through the issuance of debentures (at par) that carry a 15 percent coupon rate. The firm currently pays 4.40 per share in dividends (D 0 ). Dividends have grown at a 5 percent rate in the past. This growth is expected to continue. The firm s common stock currently trades at $44 per share. If the firm were to raise any external equity, the newly issued shares would net the company $40 per share. The firm is in the 40 percent marginal tax bracket. Compute Owens marginal cost of capital schedule. Answer: Break Point Weighted Marginal Cost of Capital 60,000, ,000,

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