9. Profitability index Estimating the cash flow generated by $1 invested in a project The profitability index (PI) is a capital budgeting tool that is defined as the present value of a project’s cash inflows divided by the absolute value of its initial cash outflow. Consider this case: Happy Dog Soap Company is considering investing $2,750,000 in a project that is expected to generate the following net cash flows: Year Cash Flow Year 1 $275,000 Year 2 $500,000 Year 3 $475,000 Year 4 $475,000 Happy Dog Soap Company uses a WACC of 8% when evaluating proposed capital budgeting projects. Based on these cash flows, determine this project’s PI (rounded to four decimal places): 0.4869 0.5125 0.5638 0.4613 Happy Dog Soap Company’s decision to accept or reject this project is independent of its decisions on other projects. Based on the project’s PI, the firm should (ACCEPT or REJECT) the project? By comparison, the NPV of this project is (-$1,340,491, -$1,608,589, or -$1,072,343)?. On the basis of this evaluation criterion, Happy Dog Soap Company should INVEST or NOT INVEST in the project because the project WILL or WILL NOT increase the firm’s value.

Can someone please give details on how you solved them please!

Your firm just received an order from a customer for $50,000 of widgets. You have been tasked with evaluating the effect of time value of money on your firm’s cash flows (on a transaction-by-transaction basis). To fulfill this order your firm will need to produce and transport the widgets. This will take 50 days. Assume that the widgets will cost $30,000 in COGS; your firm is given 20 days to pay for the raw materials. Once the widgets are delivered to your customer, 40 days of trade credit will be provided to the customer. Assume a discount rate of 7%.

a. With the aforementioned assumptions, what is the NPV of this transaction?

b. Recalculate the NPV, assuming that your firm reduced the time needed to produce and transport the widgets to 35 days.

c. Next, treat the difference in NPV (NPV from part b minus NPV from part a) as a daily perpetuity and determine the total increase in firm value attributable to the improvement in inventory management.

Suppose that you decided to set up a short strip position using the Jan. 105 options. Find your profit/loss if the stock trades for $110 when the options expire. Round intermediate steps to four decimals and your final answer to two decimals. Do not use the dollar sign when entering your answer.

Suppose that you decided to set up a long strap position using the Feb. 110 options. Find your profit/loss if the stock trades for $127 when the options expire. Round intermediate steps to four decimals and your final answer to two decimals. Do not use the dollar sign when entering your answer.

A hedge fund manager believed that DEF stock would be relatively stable over her investment horizon and decided to use the Feb 120 options to create a straddle position based on her belief. If the stock trades for $127 when the options expire, what is her profit/loss?

• -90
• 90
• 280
• -280
• None of the above

Suppose that you decided to create a long strangle position using the 115 Feb call and the 110 Feb put when the stock price traded at $112. Find your profit/loss if the stock trades at $118 when the options expire.

• 105
• -105
• 605
• -605
• None of the above

Tucker Inc. common stock currently trades for $90/share. 6-month European put options on the stock have an exercise price and premium of $93 and $4, respectively. The annual risk free rate is 2%. What should be the value of a 6-month European call option on the stock with an exercise price of $93 according to put-call parity? Round intermediate steps to four decimals and your final answer to two decimals.

• 7.90
• .065
• 1.93
• 2.84
• 2.15

Suppose 6-month European call options with an exercise price of $93 actually have a market price of $2.15. Which of the following strategies could you employ to earn an arbitrage return?

• Short the market call, buy the stock, buy the put and short the present value of the exercise price at the risk-free rate.
• Buy the market call, short the stock, short the put and invest the present value of the exercise price at the risk-free rate.
• Short the market call, buy the stock, buy the put and invest the present value of the exercise price at the risk-free rate.
• Arbitrage is not possible.
• None of the above.

Find the arbitrage profit you could earn per call option.

• 575
• 209
• 69
• 22
• 0

Question 4

The stock of ABC Inc is trading at $50. You short sold 350 shares of ABC at this price. However, price increased to $55, at which point you decided to close the trade. What was your percentage return? The initial margin rate is 75%.

Question 5

Consider the short sale trade in the previous question. If your brokerage requires a maintenance margin of 40%, at what price will you get a margin call? The initial margin rate is 75%.

Question 6

You find that in a normal year, the S&P500 index gives a return of 12%. However, you think that there is a 40% probability of the economy going into recession next year. If that happens, you predict that the index return will be 2%. What is the expected return on the S&P500 next year?

Richards Inc. stock currently trades for $40, but you believe the company's earnings will decrease dramatically in the next six months which in turn will cause the company's stock to depreciate. Six-month European call options on the stock have an exercise price of $45 and a premium of .75. The annual risk free rate is 3%. You want to create a portfolio that mimics the payoff of owning a 6-month European put on on the stock. Which of the following steps must you do in order to achieve this payoff?

• Buy the call option, sell the stock, and borrow the present value of $4500 discounted at the risk-free rate.
• Sell the call option, buy the stock, and invest the present value $4500 discounted at the risk-free rate.
• Buy the call option, sell the stock, and invest the present value of $4500 discounted at the risk-free rate.
• Sell the call option, sell the stock, and invest the present value $4500 discounted at the risk-free rate

What should be the price of a six-month European put option with an exercise price of $45 according to put-call parity? Round intermediate steps to four decimals and your final answer to two decimals. Do not use currency symbols or words when entering your response.

Find your portfolio's profit/loss if Richards stock sells for $32 at the end of six-months. Round intermediate steps to four decimals.

• 508
• 792
• -792
• -508
• 658

compare and contrast capital asset model to the free cash flow model?

You analyzed the returns of a sample of stocks. You found that, on average, the firms with high E/P ratios have higher subsequent returns.

(i) Discuss an explanation for this pattern that is consistent with the EMH.

(ii) Discuss an explanation that is not consistent with the EMH.

(A couple sentences per part.)

Clever tests to discriminate between alternative explanations. LaPorta, Lakonishok, Shleifer, and Vishny (“Good News for Value Stocks,” Journal of Finance, June 1997) study the returns on stocks on the few days surrounding their quarterly earnings announcements (relative to various expected return benchmarks). They find that on average, high-B/M stocks earn 0.9% around an earnings announcement. In contrast, low-B/M stocks earn an average of -0.1% around an earnings announcement. The difference is statistically significant.

(i) High returns around earnings announcements are more likely to occur if the earnings surprise is _______. (Fill in the blank with “positive” or “negative”.)

(ii) Discuss whether the return pattern found by LaPorta et al. (1997) around earnings announcements is more consistent with the irrational expectations (behavioral) view, or the risk factor (efficient markets) view of the book-to-market effect, and explain your logic.

You have been given the following return​ data,

F, ​G, and H over the period 2018 2021. Using these​ assets, you have isolated three investment​ alternatives:

a. Calculate the portfolio return over the​ 4-year period for each of the three alternatives. b. Calculate the standard deviation of returns over the​ 4-year period for each of the three alternatives. c. On the basis of your findings in parts a and b​, which of the three investment alternatives would you​ recommend? Why?

What is a loan amortization schedule, and what are some ways these schedules are used?

The founder of Alchemy Products Inc. discovered a way to turn gold into lead and patented this new technology. He then formed a corporation and invested $1,500,000 in setting up a production plant. He believes that he could sell his patent for $72 million.

a. What is the book value of the firm? (Enter your answer in dollars not in millions.)

b. What is the market value of the firm? (Enter your answer in dollars not in millions.)

c. If there are two million shares of stock in the new corporation, what would be the book value per share? (Round your answer to 2 decimal places.)

d. If there are two million shares of stock in the new corporation, what would be the price per share? (Round your answer to 2 decimal places.)

Jim wants to buy a property and needs to borrow 195,000. He can get a loan at 7% for 25 years. Loan origination fees will be $4,700. Assume the lender also imposes a prepayment penalty of 3 percent of the outstanding loan balance if the loan is repaid within 8 years of closing. If Jim repays the loan after 6 years with the penalty, what is the effective interest rate?

8.1%

7.0%

7.9%

7.5%