Question 5

(a)











(b)



TLT company has $720 million in common stock outstanding. Its cost of equity is 12%. Moreover, TLT has $360 million in 6% coupon rate bonds outstanding. The bond is currently sold at par. There are no taxes in the country in which TLT company operates.

i. Calculate the weighted average cost of capital (WACC) of TLT.

ii. TLT has decided to issue $180 million in common stock and use the proceeds to buy back its bonds. According to the Modigliani & Miller (M&M) propositions, what are the TLT’s new WACC and new cost of equity?

Critically discuss the importance of dividend clientele effect to the firm value. (word limit: 150 words)

ROST Corporation is a manufacturer of a variety of kitchen utensils. In order to improve the
quality of existing products, the production manager of the company proposes to replace a
machine used in the molding process. As a financial manager of the company, you are
responsible for assessing the feasibility of this project. After a preliminary study, it is
estimated that the new project will generate additional sales revenue of $310,200 in each of
the next four years. It is known that the company faces a marginal tax of 26% and wants a
17% required rate of return. In addition, the company employs the straight-line method to
compute its depreciation. To finance the project, the company would have to borrow
$1,200,000 at 10% interest from its bank. Other findings of the study are presented as
follows:
Old Machine New Machine
Initial purchase price $1,120,000 $960,000
Tax life 20 years 4 years
Age 16 years 0 years
Expected salvage value $0 $0
Current market value $224,000 N.A.
Annual cash expense $360,000 $380,000
(a)
(b)
(c)
Determine the annual after-tax cash flows associated with this project.
Determine whether you would accept or reject the project if the net present
value rule is used.
Without doing any calculation, how would you reply to your boss if he told you
to evaluate this project by the internal rate of return rule rather than the net
present value rule? (word limit: 150 words)

(a)
(b)
TLT company has $720 million in common stock outstanding. Its cost of
equity is 12%. Moreover, TLT has $360 million in 6% coupon rate bonds
outstanding. The bond is currently sold at par. There are no taxes in the
country in which TLT company operates.
i. Calculate the weighted average cost of capital (WACC) of TLT.
ii. TLT has decided to issue $180 million in common stock and use the
proceeds to buy back its bonds. According to the Modigliani & Miller
(M&M) propositions, what are the TLT’s new WACC and new cost of
equity?
Critically discuss the importance of dividend clientele effect to the firm
value. (word limit: 150 words)

Question 4

ROST Corporation is a manufacturer of a variety of kitchen utensils. In order to improve the quality of existing products, the production manager of the company proposes to replace a machine used in the molding process. As a financial manager of the company, you are responsible for assessing the feasibility of this project. After a preliminary study, it is estimated that the new project will generate additional sales revenue of $310,200 in each of the next four years. It is known that the company faces a marginal tax of 26% and wants a 17% required rate of return. In addition, the company employs the straight-line method to compute its depreciation. To finance the project, the company would have to borrow $1,200,000 at 10% interest from its bank. Other findings of the study are presented as follows:

Old Machine New Machine Initial purchase price $1,120,000 $960,000 Tax life 20 years 4 years Age 16 years 0 years Expected salvage value $0 $0 Current market value $224,000 N.A. Annual cash expense $360,000 $380,000 (a)

(b)


(c)








Determine the annual after-tax cash flows associated with this project.

Determine whether you would accept or reject the project if the net present value rule is used.

Without doing any calculation, how would you reply to your boss if he told you to evaluate this project by the internal rate of return rule rather than the net present value rule? (word limit: 150 words)

"Ann wants to buy an office building which costs $1,000,000. She obtains a 30 year fully amortizing fixed rate mortgage with 80% LTV, an annual interest rate of 4%, with monthly compounding and monthly payments. The mortgage has a 2% prepayment penalty if the borrower prepays in the first 5 years. Suppose Ann makes the required monthly payment for 3 years and prepays after her final monthly payment at the end of 3 years. What is the annualized IRR on Ann s mortgage? "  

Kenny is planning for retirement in 20 years. Currently, he has $300,000 in a savings account
and $600,000 in a mutual fund. Moreover, he plans to add to his savings by depositing $3,000
per month in his savings account at the beginning of each month for the next twenty years
until retirement. The savings account will return 5% APR compounded monthly and the
investment in the mutual fund will return 8% compounded annually.
(a) How much money will Kenny have at retirement 20 years later?
(b)Kenny expects to live for 20 years after he retires and at retirement he will
deposit all of his savings in a bank account paying 2% APR compounded
monthly. If he wants to withdraw an equal sum of money at the end of
each month from the bank account for financing his daily expenses after
retirement, how much can he withdraw each time?
(c)If the yield to maturity of a bond is higher than its coupon rate, the par
value of the bond should be higher than its price, resulting in a discount
bond. Conversely, if the yield to maturity of a bond is lower than its
coupon rate, the par value of the bond should be lower than its price,
resulting in a premium bond. Critically discuss this phenomenon. (word
limit: 150 words)

After attending a seminar about corporate social responsibility (CSR), John advised Mary to
focus her investment on those companies with CSR plans. However, Mary argued with John
that maximizing shareholders’ wealth is the only goal of financial management, not CSR. Do
you agree with Mary’s viewpoint? Think of some specific scenarios to illustrate your
arguments and justify your stance. (word limit: 300 words)

Consider the following two investors’ portfolios consisting of investments in four stocks:
Stock Beta Jack's Portfolio Nelson's Portfolio
A 1.3 $2,500 $10,000
B 1.0 $2,500 $5,000
C 0.8 $2,500 $5,000
D -0.5 $2,500 $2,500
Portfolio Expected Return 10% 9%
(a)
Calculate the beta on portfolios of Jack and Nelson respectively.

(b) Assuming that the risk-free rate is 4% and the expected return on the
market is 12%, determine the required return on portfolios of Jack and
Nelson respectively.

(c) From your answers in part (b), explain whether portfolios of Jack and
Nelson are over-priced, under-priced or correctly priced.

(d) State and explain whether the following statement is true or false:
“If a security lies above the security market line (SML), then it must be
over-priced.” (word limit: 150 words)

BUSI 320 Comprehensive Problem 3

Use what you have learned about the time value of money to analyze each of the following decisions:

Decision #1:   Which set of Cash Flows is worth more now?

Assume that your grandmother wants to give you generous gift. She wants you to choose which one of the following sets of cash flows you would like to receive:

Option A: Receive a one-time gift of $10,000 today.

Option B: Receive a $1400 gift each year for the next 10 years. The first $1400 would received 1 year from today.   

Option C: Wait exactly 10 years from today and then receive a one-time gift of $17,000.

Compute the Present Value of each of these options if you expect the interest rate to be 2% annually for the next 10 years.    Which of these options does financial theory suggest you should choose?

       Option A would be worth $__________ today.

Option B would be worth $__________ today.

       Option C would be worth $___________today.

       Financial theory supports choosing Option _______

Compute the Present Value of each of these options if you expect the interest rate to be 5% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

       Option A would be worth $__________ today.

       Option B would be worth $__________today.

       Option C would be worth $__________today.

      Financial theory supports choosing Option ______

Compute the Present Value of each of these options if you expect to be able to earn 8% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

      Option A would be worth $__________today.

       Option B would be worth $__________today

       Option C would be worth $_________ today.

       Financial theory supports choosing Option _______

Decision #2: Planning for Retirement

Erich and Mallory are 22, newly married, and ready to embark on the journey of life.   They both plan to retire 45 years from today. Because their budget seems tight right now, they had been thinking that they would wait at least 10 years and then start investing $2400 per year to prepare for retirement. Mallory just told Erich, though, that she had heard that they would actually have more money the day they retire if they put $2400 per year away for the next 10 years - and then simply let that money sit for the next 35 years without any additional payments – then they would have MORE when they retired than if they waited 10 years to start investing for retirement and then made yearly payments for 35 years (as they originally planned to do).   Please help Erich and Mallory make an informed decision:   

Assume that all payments are made at the END a year (or month), and that the rate of return on all yearly investments will be 7.5% annually.

(Please do NOT ROUND when entering “Rates” for any of the questions below)

a) How much money will Erich and Mallory have in 45 years if they do nothing for the next 10 years, then put $2400 per year away for the remaining 35 years?

b1) How much money will Erich and Mallory have in 10 years if they put $2400 per year away for the next 10 years?

b2) How much will the amount you just computed grow to if it remains invested for the remaining 35 years, but without any additional yearly deposits being made?

c) How much money will Erich and Mallory have in 45 years if they put $2400 per year away for each of the next 45 years?

d) How much money will Erich and Mallory have in 45 years if they put away $200 per MONTH at the end of each month for the next 45 years? (Remember to adjust 7.5% annual rate to a Rate per month! (do NOT round!)

e) If Erich and Mallory wait 25 years (after the kids are raised!) before they put anything away for retirement, how much will they have to put away at the end of each year for 20 years in order to have $800,000 saved up on the first day of their retirement 45 years from today?

Question 2

Kenny is planning for retirement in 20 years. Currently, he has $300,000 in a savings account and $600,000 in a mutual fund. Moreover, he plans to add to his savings by depositing $3,000 per month in his savings account at the beginning of each month for the next twenty years until retirement. The savings account will return 5% APR compounded monthly and the investment in the mutual fund will return 8% compounded annually.

(a) How much money will Kenny have at retirement 20 years later? (b)





(c)
Kenny expects to live for 20 years after he retires and at retirement he will deposit all of his savings in a bank account paying 2% APR compounded monthly. If he wants to withdraw an equal sum of money at the end of each month from the bank account for financing his daily expenses after retirement, how much can he withdraw each time?

If the yield to maturity of a bond is higher than its coupon rate, the par value of the bond should be higher than its price, resulting in a discount bond. Conversely, if the yield to maturity of a bond is lower than its coupon rate, the par value of the bond should be lower than its price, resulting in a premium bond. Critically discuss this phenomenon. (word limit: 150 words)

Geary Machine Shop is considering a 4-year project to improve its production efficiency. Buying a new machine press for $510,621 is estimated to result in $161,346 in annual pretax cost savings. The press falls in the MACRS five-year class (Refer to the MACRS table on page 277), and it will have a salvage value at the end of the project of $119,530. The press also requires an initial investment in spare parts inventory of $57,367, along with an additional $8,489 in inventory for each succeeding year of the project. If the shop's tax rate is 0.35 and its discount rate is 0.1, what is the total cash flow in year 4? (Do not round your intermediate calculations.)

(Make sure you enter the number with the appropriate +/- sign)

Dog Up! Franks is looking at a new sausage system with an installed cost of $662,692. This cost will be depreciated straight-line to 23,962 over the project's 7-year life, at the end of which the sausage system can be scrapped for $95,309. The sausage system will save the firm $222,899 per year in pretax operating costs, and the system requires an initial investment in net working capital of $51,567. If the tax rate is 0.37 and the discount rate is 0.09, what is the total cash flow in year 7? (Make sure you enter the number with the appropriate +/- sign)

A firm is must choose to buy the GSU-3300 or the UGA-3000. Both machines make the firm’s production process more efficient which in turn increases incremental cash flows. The GSU-3300 produces incremental cash flows of $24,453.00 per year for 8 years and costs $100,693.00. The UGA-3000 produces incremental cash flows of $28,659.00 per year for 9 years and cost $125,955.00. The firm’s WACC is 9.72%. What is the equivalent annual annuity of the GSU-3300? Assume that there are no taxes.

Please round to 2 decimal places

With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital, they decided to focus on surf print table and floor lamps to accent people’s homes. They projected unit sales of these lamps to be 8,700 in the first year, with growth of 5 percent each year for the next five years. Production of these lamps will require $52,000 in net working capital to start. The net working capital will be recovered at the end of the project. Total fixed costs are $112,000 per year, variable production costs are $25 per unit, and the units are priced at $55 each. The equipment needed to begin production will cost $192,000. The equipment will be depreciated using the straight-line method over a five-year life and is not expected to have a salvage value. The effective tax rate is 34 percent and the required rate of return is 30 percent.

What is the NPV of this project?

1. You own a portfolio of two stocks, O and Q. Stock O is valued at $4,000 and has an expected return of 10.5 percent. Stock Q has an expected return of 18.7 percent. What is the expected return on the portfolio if the portfolio total value is $5,000?

   		11.73 percent
   		10.92 percent
   		12.14 percent
   		13.03 percent

1. Cornel Co. has a beat of 1.4. If the risk-free rate is 3% and the market return is 12%, what is its cost of equity assume CAPM?

   		18.0%
   		16.5%
   		15.6%
   		17.6%