(Each of the following parts is independent.)

1. According to the Capital Asset Pricing theory, what return would be required by an investor whose portfolio is made up of 40% of the market portfolio (m) and 60% of Treasury bills (i.e. risk-free asset)?  Assume the risk-free rate is 3% and the market risk premium is 7%?   

2. You are considering investing in the following two stocks. The risk-free rate is 7 percent and the market risk premium is 8 percent.

1. Compute the expected and required return (using CAPM) on each stock.   
2. Which asset is worth investing? Support your answer with calculations.   

3. Which pair of stocks used to form a 2-asset portfolio would have the greatest diversification effect for the portfolio? Briefly explain.

(d)       Explain the terms systematic risk and unsystematic risk and their importance in determining        investment return.   

Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital. = 10.0% = 11.20% = 15.0% tax rate = 34% = 3 = 24.9% = 2% Assume that the firm will partially finance the project with a $3,000,000 interest-only 30-year loan at 10.0 percent APR with annual payments. What is the levered after-tax incremental cash flow for year 1? What is the levered after-tax incremental cash flow for year 30?

Suppose your firm would like to earn 10% yearly return from the following two investment projects of equal risk.

(a)       If only one project can be accepted, based on the NPV method which one should it be?  Support your answer with calculations.

(b)       Suppose there is another four-year project (Project C) and its cash flows are as follows:

C₀ = –$8,000

             C₁ =   $2,000

               C₂ =   $2,500

               C₃ =   $2,000

               C₄ =   $4,000

(i)      Given the above cash flow patterns, at what required rate of return will Project C have the same NPV as Project B?  Briefly explain your answer.

(ii)     If Project C has the same risk as Project B, without calculations, explain which project will you pick?   

(iii)   If cash flow C₄ of Project C is unknown to you (while C₀ – C₃ are known and as above) and the project’s cost of capital is 10%, what amount of C₄ will make Project C worth accepting?

(iv)    If your firm’s investment policy (based on payback method) is such that it only accepts projects whose initial investment can be recouped within three years, will Project B and/or Project C be accepted?   

(c)       Based on the estimated cash flows of Project A, will you expect its internal rate of return (IRR) to be positive?  Briefly explain your answer WITHOUT calculations.

(d)       What kind of rate of return is the 10% interest stated in the question for Projects A and B?  How can it be used in making investment decisions (i.e. its role in investment decision making)?

Consider a firm that has a zero-coupon bond that matures in 4 years. The face value is $30 million, and the risk-free rate is 6%. The current market value of the firm’s assets is $40 million, and the firm’s equity is currently worth $18 million. Suppose the firm is considering a project with an NPV = $500,000. What is the implied standard deviation of returns? What is the delta? What is the approximate change in stockholder value from an NPV of $500,000?

- Spam Corp. is financed entirely by common stock and has a beta of 1.30. The firm is expected to generate a level, perpetual stream of earnings and dividends. The stock has a price-earnings ratio of 8 and a cost of equity of 12.5%. The company’s stock is selling for $50. Now the firm decides to repurchase half of its shares and substitute an equal value of debt. The debt is risk-free, with an interest rate of 3%. The company is exempt from corporate income taxes. a. Calculate the cost of equity after the refinancing. b. Calculate the price-earnings ratio after the refinancing. c. Calculate the stock’s beta after the refinancing.

Foods’ (BF) balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%. The yield to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million. The balance sheet also shows that the company has 10 million shares of stock, and the stock has a book value per share of $5.00. The current stock price is $20.00 per share, and stockholders' required rate of return, r_s, is 12.25%. The company recently decided that its target capital structure should have 35% debt, with the balance being common equity. The tax rate is 40%. Calculate WACCs based on book, market, and target capital structures, and then find the sum of these three WACCs.

KNF Company (KNFC) is considering a new project that involves the production of additional product for which cash out flows and inflows have already estimated. KNFC has 14 million shares of common stock outstanding, 900,000 shares of 9 percent preferred stock outstanding and 210,000 ten percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 per share and has a beta of 2.028125, the preferred stock currently sells for $80 per share, and the bonds have 17 years to maturity and sell for 91 percent of par. The return on market portfolio is 12.5 percent, T-bonds (risk free assets) are yielding 4.5 percent, and KNFC's tax rate is 32 percent. What WACC should KNFC apply to this new project's cash flows if the project has the same risk as KNFC 's typical project?

Course readings and any external readings.

Discussion forum posts or other course objectives.

The assets of Dallas & Associates consist entirely of current assets and net plant and equipment, and the firm has no excess cash. The firm has total assets of $2.8 million and net plant and equipment equals $2.4 million. It has notes payable of $140,000, long-term debt of $748,000, and total common equity of $1.5 million. The firm does have accounts payable and accruals on its balance sheet. The firm only finances with debt and common equity, so it has no preferred stock on its balance sheet.

Write out your answers completely. For example, 25 million should be entered as 25,000,000. Negative values, if any, should be indicated by a minus sign. Round your answers to the nearest dollar, if necessary.

1. What is the company's total debt?

   $ ___

2. What is the amount of total liabilities and equity that appears on the firm's balance sheet?

   $ _____

3. What is the balance of current assets on the firm's balance sheet?

   $ ______

4. What is the balance of current liabilities on the firm's balance sheet?

   $ ______

5. What is the amount of accounts payable and accruals on its balance sheet? (Hint: Consider this as a single line item on the firm's balance sheet.)

   $ _________

6. What is the firm's net working capital? If your answer is zero, enter "0".

   $ ________

7. What is the firm's net operating working capital?

   $ ________

8. What is the monetary difference between your answers to part f and g?

   $ ________

   What does this difference indicate?

   -Select-The difference indicates Notes payable balance.The difference indicates Accounts payable balance.The difference indicates Current liabilities balance.

chapter 3 question 6

Topperton Company has developed a new industrial product. An outlay of $8 million is required for equipment to produce the new product, and additional net working capital of $400,000 is required to support production and marketing. In addition, a one-time $400,000 (before-tax) expense will be incurred the year that the equipment is placed into service. The equipment will be depreciated on a straight-line basis to a zero book value over 6 years. Although the depreciation life is 6 years, the project is expected to have a productive life of 8 years, and it is estimated that the equipment can be sold for $1 million at that time. Revenues minus expenses are expected to be $3 million per year. The cost of capital for this project is 14%, and the relevant tax rate is 30%. What is the NPV of the new product?

BONDS – Problem

Huskies Corp. issued 9-year $750,000 bond on January 1, 2006 with coupon rate of 10%. The bond pays interest semiannually every June 30 and December 31, with the principal to be paid at the end of year 9. The effective market interest rate at the issuance date is 8%.

a. Calculate the proceeds and show clearly what you use for RATE, NPER, PMT, FV ?

b. What journal entry was recorded at issuance?

c. What annual coupon rate would Huskies have to offer in order to obtain total proceeds of $750,000 on the issuance of these bonds

d. UNRELATED to above. Labradors Inc. repurchased the bond which has been issued several years ago and which has a Face Value of $800,000 and unamortized premium of $42,000. The bond was repurchased at 106. Record the journal entry that the company made when it repurchased the bond.

Grunewald Industries sells on terms of 1/10, net 40. Gross sales last year were $4,416,500 and accounts receivable averaged $482,500. Half of Grunewald's customers paid on the 10th day and took discounts. What are the nominal and effective costs of trade credit to Grunewald's nondiscount customers? (Hint: Calculate daily sales based on a 365-day year, calculate the average receivables for discount customers, and then find the DSO for the nondiscount customers.) Do not round intermediate calculations. Round your answers to two decimal places!

ABC Plc is considering an investment between two mutually exclusive projects with the following annual cash flows:

ANNUAL CASH FLOWS

Year                          Project A                           Project B

0                                $-50,000                            $-80,000

1                                    30,000                               40,000

2                                    30,000                               40,000

3                                    30,000                               40,000

4                                    30,000                               40,000

5                                    30,000                              40,000

ABC Plc requires a 16 percent rate of return on projects of this nature.

Required:

1. Compute the NPV of both projects.
2. Compute the internal rate of return on both projects.
3. Compute the profitability index of both projects.
4. Compute the non-discounted payback period on both projects.
5. Compute the discounted payback period on both projects.
6. Which of the two projects, if either, should ABC Plc accept? Why?

FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the costs is $196,200 per year. Once in production, the bike is expected to make $293,055 per year for 10 years. The cash inflows begin at the end of year 7.

For parts A-C, assume the cost of capital is 10.7%

a. Calculate the NPV of this investment opportunity. Should the company make the investment?

b.Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.

c. How long must development last to change the decision? For parts d-f, assume the cost of capital is 13.9%

d. Calculate the NPV of this investment opportunity. Should the company make the investment

e. How much must this cost of capital estimate deviate to change the decision?

f. How long must development last to change the decision?