Greta, an elderly investor, has a degree of risk aversion of A = 3 when applied to return on wealth over a one-year horizon. She is pondering two portfolios, the S&P 500 and a hedge fund, as well as a number of one-year strategies. (All rates are annual and continuously compounded.) The S&P 500 risk premium is estimated at 9% per year, with a SD of 24%. The hedge fund risk premium is estimated at 14% with a SD of 39%. The returns on both of these portfolios in any particular year are uncorrelated with its own returns in other years. They are also uncorrelated with the returns of the other portfolio in other years. The hedge fund claims the correlation coefficient between the annual returns on the S&P 500 and the hedge fund in the same year is zero, but Greta is not fully convinced by this claim.

What should be Greta’s capital allocation? (Do not round your intermediate calculations. Round your answers to 2 decimal places.)

An antique automobile is depreciating, i.e. losing value i.e. going down in price at a rate of 7% per annum compounded annually. Betty and Bob have an account, which earns interest at a rate of 12% per annum continuously compounded. They originally had $8,000 in the account and withdrew $2000 after the second year and $2,500 after the third year. They had enough money (exactly) to buy the automobile after 5 years. Algebraically find the original value of the automobile. Your final answer should be correct to 2 places after the decimal point.

An S&L pays 5% per annum compounded quarterly. Bert and Bertha are now 50 years old. They will deposit $200 per quarter at the end of each quarter until they are 65 years old.

1. How much is in their retirement account at the end of this period i.e. at 65?
2. 3 months after their last deposit they start withdrawing equal amounts each quarter until they are 80 i.e. for the next 15 years Find the size of the withdrawals.
3. How much cash did they deposit? How much cash did they withdraw? What was the total interest?

Sally Prescott plans on retiring in 15 years, that is, she will work for another 15 full years. When she retires she plans on spending 3 years in Bulgaria volunteering for the Peace Corps. After which she will spend her time in Boca Raton, Florida at a townhouse she purchased 5 years ago for $250,000. She currently has $100,000 in savings. She estimates that she will need $20,000 a year for living expenses in Bulgaria and then $35,000 a year for approximately 20 years when she retires to Florida. If she earns 4% compounded monthly in her savings account, how much must she deposit each year to meet her financial goals? She will withdraw her annual cash flows at the beginning of each year, that is, her first $20,000 withdrawal will occur at the beginning of year 16, before she travels to Bulgaria. Her annual deposits will begin at the end of this year and continue until she leaves for Bulgaria.

1. Good versus Bad Debt. Is there such a thing as good debt, what types of debt do you consider to be "good"? What types do you consider to be "bad"?

2. Are you considered a default risk? How would a lender evaluate you based on "the five C's" of character, capital, capacity, collateral, and conditions? How could you plan to make yourself more attractive to a lender in the future?

3. Some credit cards offer reward points or 1 percent higher cash back reward for all purchases made on the card. How would you feel about using such a card to get those rewards with the intention of paying off the balance each month? Do you have one of these cards now?

4. If you have ever missed a repayment deadline, what was the result? What could you have done differently/better?

5. Are you concerned that the major national credit bureaus may have files containing information about you? What do you think about the process required to correct errors in those files?

Chapter 7

2. If you wanted to borrow money to study abroad for a semester and could pay it back within two years after returning, would you prefer a single-payment loan, an installment loan, or a cash advance on a credit card? Why?

4. If you were the borrower, how would you feel about the fact that interest costs are higher in the early months of a declining- balance loan than they are in the later months?

A simplified income statement for ABC firm (in million dollars):

Key fact: Purchases are 80% of COGS

1) Besides reducing operating expenses, please identify two other means to improve the bottom line (i.e., to increase the operating income)?

Now, let’s perform a what-if analysis. In the first scenario, we analyze how an 8% reduction in the cost of purchased goods would impact operating profit?

2) How much is the current cost of purchased goods?

3) How much is the saving associated with an 8% reduction in cost of purchases?

4) Fill in the following income statement, reflecting 8% reduction in cost of purchases

5) Based on the income statement table you computed above, a dollar saved in COGS translates into ________dollar (s) increase in operating income.

6). Based on the income statement table you computed above, an 8% reduction in cost of purchases can lead to ____________% increase in operating income.

Please show work!!

Prepare a statement of cash flows for Valium’s Medical Supply Corporation. (Enter your answers in thousands. Amounts to be deducted should be indicated with a minus sign.)

FitcomCorp. is considering a three-year project that will require an initial investment of $41,000. If market demand is strong, FitcomCorp. thinks that the project will generate cash flows of $28,000 per year. However, if market demand is weak, the company believes that the project will generate cash flows of only $1,750 per year. The company thinks that there is a 50% chance that demand will be strong and a 50% chance that demand will be weak.

If the company uses a project cost of capital of 11%, what will be the expected net present value (NPV) of this project?

-$5,348

-$5,580

-$4,882

-$4,650

FitcomCorp. has the option to delay starting this project for one year so that analysts can gather more information about whether demand will be strong or weak. If the company chooses to delay the project, it will have to give up a year of cash flows, because the project will then be only a two-year project. However, the company will know for certain if the market demand will be strong or weak before deciding to invest in it.

What will be the expected NPV if FitcomCorp. delays starting the project?

$2,661

$3,131

$27,424

$7,781

What is the value of FitcomCorp.’s option to delay the start of the project?     

Shai Co. is considering a four-year project that will require an initial investment of $7,000. The base-case cash flows for this project are projected to be $14,000 per year. The best-case cash flows are projected to be $26,000 per year, and the worst-case cash flows are projected to be -$4,500 per year. The company’s analysts have estimated that there is a 50% probability that the project will generate the base-case cash flows. The analysts also think that there is a 25% probability of the project generating the best-case cash flows and a 25% probability of the project generating the worst-case cash flows.

What would be the expected net present value (NPV) of this project if the project’s cost of capital is 12%?

$30,587

$24,470

$29,058

$35,175

Shai now wants to take into account its ability to abandon the project at the end of year 2 if the project ends up generating the worst-case scenario cash flows. If it decides to abandon the project at the end of year 2, the company will receive a one-time net cash inflow of $4,750 (at the end of year 2). The $4,750 the company receives at the end of year 2 is the difference between the cash the company receives from selling off the project’s assets and the company’s -$4,500 cash outflow from operations. Additionally, if it abandons the project, the company will have no cash flows in years 3 and 4 of the project.

Using the information in the preceding problem, find the expected NPV of this project when taking the abandonment option into account.

$33,946

$30,551

$37,341

$42,433

What is the value of the option to abandon the project?