Calculate the change in NPV if sales were to drop by 500 units. (Enter your answer as a positive number. Do not round intermediate calculations and round your answer to 2 decimal places (e.g., 32.16).)  

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1. Consider the following cash flows of two mutually exclusive projects for Spartan Rubber Company. Assume the discount rate for Spartan Rubber Company is 11 percent.

Year Dry Prepreg Solvent Prepreg
0 –$ 1,790,000   –$ 795,000
1   1,109,000     420,000
2   918,000     690,000
3   759,000     408,000
________________________________________

a. What is the payback period for each project? (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

Payback period
Dry Prepreg   years

Solvent Prepreg  years

________________________________________

b. What is the NPV for each project? (Do not round intermediate calculations. Round your answers to 2 decimal places (e.g., 32.16).)

NPV
Dry Prepreg $

Solvent Prepreg $

________________________________________

c. What is the IRR for each project? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places (e.g., 32.16).)

IRR
Dry Prepreg  %

Solvent Prepreg  %

________________________________________

d. Calculate the incremental IRR for the cash flows. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

Incremental IRR  %

 

2. Mario Brothers, a game manufacturer, has a new idea for an adventure game. It can market the game as a traditional board game or as an interactive CD-ROM, but not both. Consider the following cash flows of the two mutually exclusive projects for Mario Brothers. Assume the discount rate for Mario Brothers is 8 percent.

Year Board Game CD-ROM
0 –$ 1,750    –$ 3,800
1   800     2,300
2   1,500     1,680
3   320     1,350
________________________________________

a. What is the payback period for each project? (Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16).)

Payback period
Board game  years

CD-ROM  years

________________________________________

b. What is the NPV for each project? (Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16).)

NPV
Board game $

CD-ROM $

________________________________________

c. What is the IRR for each project? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places (e.g., 32.16).)

IRR
Board game  %

CD-ROM  %

________________________________________

d. What is the incremental IRR? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

Incremental IRR  %

3.
Suppose you are offered a project with the following payments:

Year Cash Flows
0 $ 8,700
1 −4,700
2 −3,400
3 −2,500
4 −1,000
________________________________________

a. What is the IRR of this offer? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

IRR  %

b. If the appropriate discount rate is 11 percent, should you accept this offer?

Reject

Accept

c. If the appropriate discount rate is 24 percent, should you accept this offer?

Accept

Reject

d-1. What is the NPV of the offer if the appropriate discount rate is 11 percent? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places (e.g., 32.16).)

NPV $

d-2. What is the NPV of the offer if the appropriate discount rate is 24 percent? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places (e.g., 32.16).)

NPV $

4.
Sanborn Corp. is comparing two different capital structures. Plan I would result in 9,000 shares of stock and $80,000 in debt. Plan II would result in 7,500 shares of stock and $120,000 in debt. The interest rate on the debt is 8 percent.

a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $50,000. The all-equity plan would result in 12,000 shares of stock outstanding. What is the EPS for each of these plans? (Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16).)

EPS
Plan I $

Plan II $

All equity $

________________________________________

b. In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? (Do not round intermediate calculations.)

EBIT
Plan I and all-equity $

Plan II and all-equity $

________________________________________

c. Ignoring taxes, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

EBIT $

d-1 Assuming that the corporate tax rate is 40 percent, what is the EPS of the firm? (Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16).)

EPS
Plan I $

Plan II $

All equity $

________________________________________

d-2 Assuming that the corporate tax rate is 40 percent, what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? (Do not round intermediate calculations.)

EBIT
Plan I and all-equity $

Plan II and all-equity $

________________________________________

d-3 Assuming that the corporate tax rate is 40 percent, at what level of EBIT will EPS be identical for Plans I and II? (Do not round intermediate calculations.)

EBIT $

5.
Acetate, Inc., has equity with a market value of $22.6 million and debt with a market value of $11.3 million. The cost of debt is 8 percent per year. Treasury bills that mature in one year yield 4 percent per year, and the expected return on the market portfolio is 10 percent. The beta of Acetate’s equity is 1.11. The firm pays no taxes.

a. What is Acetate’s debt-equity ratio? (Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)

Debt–equity ratio

b. What is the firm’s weighted average cost of capital? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

Weighted average cost of capital  %

c. What is the cost of capital for an otherwise identical all-equity firm? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

Cost of capital  %

6.
Cavo Corp. has 7 percent coupon bonds making annual payments with a YTM of 6.5 percent. The current yield on these bonds is 6.85 percent.

How many years do these bonds have left until they mature? (Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)

Maturity of bond  years

7.
We are evaluating a project that costs $832,000, has an eight-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 40,000 units per year. Price per unit is $40, variable cost per unit is $15, and fixed costs are $700,000 per year. The tax rate is 35 percent, and we require a return of 18 percent on this project.

a. Calculate the accounting break-even point. (Do not round intermediate calculations and round your final answer to nearest whole number (e.g., 32).)

Break-even point  units

b-1 Calculate the base-case cash flow and NPV. (Do not round intermediate calculations and round your NPV answer to 2 decimal places (e.g., 32.16).)

Cash flow   $

NPV $

________________________________________

b-2 What is the sensitivity of NPV to changes in the sales figure? (Do not round intermediate calculations and round your final answer to 3 decimal places (e.g., 32.161).)

ΔNPV/ΔQ $

b-3 Calculate the change in NPV if sales were to drop by 500 units. (Enter your answer as a positive number. Do not round intermediate calculations and round your answer to 2 decimal places (e.g., 32.16).)

NPV would by $

c. What is the sensitivity of OCF to changes in the variable cost figure? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to nearest whole number (e.g., 32).)

ΔOCF/ΔVC $

8.
Applied Nanotech is thinking about introducing a new surface cleaning machine. The marketing department has come up with the estimate that Applied Nanotech can sell 16 units per year at $304,000 net cash flow per unit for the next four years. The engineering department has come up with the estimate that developing the machine will take a $14.8 million initial investment. The finance department has estimated that a discount rate of 12 percent should be used.

a. What is the base-case NPV? (Enter your answer in dollars, not millions of dollars (e.g. 1,234,567). Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)

Base-case NPV $

b. If unsuccessful, after the first year the project can be dismantled and will have an aftertax salvage value of $10.9 million. Also, after the first year, expected cash flows will be revised up to 21 units per year or to 0 units, with equal probability. What is the revised NPV? (Enter your answer in dollars, not millions of dollars (e.g. 1,234,567). Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)

Revised NPV $

 

Which of the following are NOT ways risk management can be used to increase the value of a firm?

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Which of the following are NOT ways risk management can be used to increase the value of a firm?

 

a. Risk management can help a firm maintain its optimal capital budget.

 

b. Risk management can reduce the expected costs of financial distress.

 

c. Risk management can help firms minimize taxes.

 

d. Risk management can allow managers to defer receipt of their bonuses and thus postpone tax payments.

 

e. Risk management can increase debt capacity.

Option d is correct.

 

Risk management can allow managers to defer receipt of their bonuses and thus postpone tax payments. Hence, this can increase the value of the firm.

 

 

 

2. Which of the following statements about interest rate and reinvestment rate risk is CORRECT?

 

a. Interest rate price risk exists because fixed-rate debt securities lose value when interest rates rise, while reinvestment rate risk is the risk of earning less than expected when interest payments or debt principal are reinvested.

 

b. Interest rate price risk can be eliminated by holding zero coupon bonds.

 

c. Reinvestment rate risk can be eliminated by holding variable (or floating) rate bonds.

 

d. Interest rate risk can never be reduced.

 

e. Variable (or floating) rate securities have more interest rate (price) risk than fixed rate securities.

 

Option a. is correct.

 

Interest rate price risk exists because fixed-rate debt securities lose value when interest rates rise, while reinvestment rate risk is the risk of earning less than expected when interest payments or debt principal are reinvested.

 

3. A swap is a method used to reduce financial risk. Which of the following statements about swaps, if any, is NOT CORRECT?

 

a. The earliest swaps were currency swaps, in which companies traded debt denominated in different currencies, say dollars and pounds.

 

b. Swaps are very often arranged by a financial intermediary, who may or may not take the position of one of the counterparties.

 

c. A problem with swaps is that no standardized contracts exist, which has prevented the development of a secondary market.

 

d. A company can swap fixed interest payments for floating interest payments.

 

e. A swap involves the exchange of cash payment obligations.

Option c is correct.

 

A problem with swaps is that no standardized contracts exist, which has prevented the development of a secondary market.

 

 

 

4. Which of the following statements is most CORRECT?

 

a. Futures contracts generally trade on an organized exchange and are marked to market daily.

 

b. Goods are never delivered under forward contracts, but are almost always delivered under futures contracts.

 

c. There are futures contracts for currencies but no forward contracts for currencies.

 

d. Futures contracts don’t have any margin requirements but forward contracts do.

 

e. One advantage of forward contracts is that they are default free.

 

Option a. is correct.

 

Futures contracts generally trade on an organized exchange and are marked to market daily.

 

 

 

5. A commercial bank recognizes that its net income suffers whenever interest rates increase. Which of the following strategies would protect the bank against rising interest rates?

 

a. Entering into an interest rate swap where the bank receives a fixed payment stream, and in return agrees to make payments that float with market interest rates.

 

b. Purchase principal only (PO) strips that decline in value whenever interest rates rise.

 

c. Enter into a short hedge where the bank agrees to sell interest rate futures.

 

d. Sell some of the bank’s floating-rate loans and use the proceeds to make fixed-rate loans.

 

e. Buying inverse floaters.

 

Option c is correct.

 

Enter into a short hedge where the bank agrees to sell interest rate futures.

 

 

 

Klieman Company’s perpetual preferred stock sells for $90 per share and pays a $7.50 annual dividend per share. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the price paid by investors. What is the company’s cost of preferred stock?

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The Federal Reserve recently shifted its monetary policy, causing Lasik Vision’s WACC to change. Lasik had recently analyzed the project whose cash flows are shown below. However, the CFO wants to reconsider this and all other proposed projects in view of the Fed action. How much did the changed WACC cause the forecasted NPV to change? Assume that the Fed action will not affect the cash flows, and note that a project’s projected NPV can be negative, in which
case it should be rejected.
Old WACC = 10%
Year:
Cash flows:

New WACC = 8%
0
1
-$1,000
$500

2
$520

3
$540

Question 2
1.Johnson Industries finances its projects with 40% debt, 10% preferred stock, and 50% common stock.

The company can issue bonds at a YTM of 8.4%.
The cost of preferred stock is 9%.
The risk-free rate is 6.57%.
The market risk premium is 5%.
Johnson Industries’ beta is equal to 1.3.
Assume that the firm will be able to use retained earnings to fund the equity portion of its capital budget.
The company’s tax rate is 30%. What is the company’s WACC?

Question 3
The capital budgeting director of Sparrow Corporation is evaluating a project that costs $200,000, is expected to last for 10 years and produces after-tax cash flows, including depreciation, of $44,503 per year. If the firm’s WACC is 14% and its tax rate is 40%, what is the project’s IRR?

Question 4
An analyst has collected the following information regarding Christopher Co.:

The company’s capital structure is 70% equity and 30% debt.
The YTM on the company’s bonds is 9%.
The company’s year-end dividend is forecasted to be $0.80 a share.
The company expects a constant dividend growth rate of 9% a year.
The company’s stock price is $25.
The company’s tax rate is 40%.
The company anticipates that it will need to raise new common stock this year, and flotation costs will equal 10% of the amount issued.

Assume the company accounts for flotation costs by adjusting the cost of capital. Given this information, calculate the company’s WACC.

Question 5
Klieman Company’s perpetual preferred stock sells for $90 per share and pays a $7.50 annual dividend per share. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the price paid by investors. What is the company’s cost of preferred stock?

Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.

/in /by

FIN 3403
1). Whitewall Tire Co. just paid a $1.60 dividend on its common shares. If Whitewall is expected to increase its annual dividend by 2 percent per year into the foreseeable future and the current price of Whitewall’s common shares is $11.66, what is the cost of common stock for Whitewall?

2). WACC for a firm: Capital Co. has a capital structure, based on current market values, that consists of 50 percent debt, 10 percent preferred shares, and 40 percent common shares. If the returns required by investors are 8 percent, 10 percent, and 15 percent for debt, preferred equity, and common stock, respectively, what is Capital’s after-tax WACC? Assume that the firm’s marginal tax rate is 40 percent.

3)Morgan Insurance Ltd. issued a fixed-rate perpetual preferred stock three years ago and placed it privately with institutional investors. The stock was issued at $25 per share with a $1.75 dividend. If the company were to issue preferred stock today, the yield would be 6.5 percent. The stock’s current value is

a. $25.00

b. $26.92

c. $37.31

d. $40.18
(SHOW YOUR WORK)

4) What does the WACC for a firm tell us?

5) Your boss just completed computing your firm’s weighted average cost of capital. He is relieved because he says that he can now use that cost of capital to evaluate all projects that the firm is considering for the next four years. Evaluate that statement.

6). Maltese Falcone, Inc., has not checked its weighted average cost of capital for four years. Firm management claims that since Maltese has not had to raise capital for new projects since that time, they should not have to worry about their current weighted average cost of capital since they have essentially locked in their cost of capital. Critique that statement.

7). Mike’s T-Shirts, Inc., has debt claims of $400 (market value) and equity claims of $600 (market value). If the after-tax cost of debt financing is 11 percent and the cost of equity is 17 percent, what is Mike’s weighted average cost of capital?

8). The market value of a firm’s assets is $3 billion. If the market value of the firm’s liabilities is $2 billion, what is the market value of the stockholders’ investment and why?

9). Below is a partial aging of accounts receivable for Bitar Roofing Services. Fill in the rest of the information and determine Bitar’s days’ sales outstanding. How does it compare to the industry average of 40 days?
Age of Account (days) Value of Account % of Total Value
0–10 $211,000
11–30  120,360
31–45  103,220
46–60   72,800
Over 60   23,740
Total $531,120

10) What does 4/15, net 3 mean?

11). Suppose you are a financial manager at a big firm and you expect the interest rates to decline in the near future. What current asset investment strategy would you recommend the company pursue?

12). Wolfgang’s Masonry management estimates that it takes the company 27 days on average to pay off its suppliers. It also knows that it has days’ sales in inventory of 64 days and days sales’ outstanding of 32 days. How does Wolfgang’s cash conversion cycle compare to that of an industry average of 75 days?

13). You would like to own a common stock that has a record date of Friday, September 9, 2011. What is the last date that you can purchase the stock and still receive the dividend?

14). List and define four types of dividends

15). What are the key events and dates in the dividend payment process?

16). Discuss why the dividend payment process is so much simpler for private companies than for public companies.

17). Describe what the Capital Asset Pricing Model (CAPM) tells us and how to use it to evaluate whether the expected return of an asset is sufficient to compensate an investor for the risks associated with that asset.

18) Discuss which type of risk matters to investors and why.

19) Explain the concept of diversification.

20) You must choose between investing in stock A or stock B. You have already used CAPM to calculate the rate of return you should expect to receive for each stock given their systematic risk and decided that the expected return for both exceeds that predicted by CAPM by the same amount. In other words, both are equally attractive investments for a diversified investor. However, since you are still in school and do not have a lot of money, your investment portfolio is not diversified. You have decided to invest in the stock that has the highest expected return per unit of total risk. If the expected return and standard deviation of returns for stock A are 10 percent and 25 percent, respectively, and the expected return and standard deviation of returns for stock B are 15 percent and 40 percent, respectively, which should you choose? Assume that the risk-free rate is 5 percent.

21). CSB, Inc., has a beta of 1.35. If the expected market return is 14.5 percent and the risk-free rate is 5.5 percent, what is the appropriate required return of CSB (using the CAPM)?