Question

1. Which is a more meaningful measure of profitability for a firm, return on assets or return on equity? Why?

2. Tobi owns a perpetuity that will pay $2,000 a year, starting one year from now. He offers to sell you all of the remaining payments after the next 25 payments have been paid. What price should you offer him for payments 26 onward if you desire a rate of return of 10 percent? What does your offer price illustrate about the value of perpetuities?

3. Wilson’s Market is considering two mutually exclusive projects that will not be repeated. The required rate of return is 13.9 percent for Project A and 12.5 percent for Project B. Project A has an initial cost of $54,500, and should produce cash inflows of $16,400, $28,900, and $31,700 for Years 1 to 3, respectively. Project B has an initial cost of $69,400, and should produce cash inflows of $0, $48,300, and $42,100, for Years 1 to 3, respectively. Based on IRR, which project, if either, should be accepted and why? Based on the Payback Period, which project should be accepted if the cutoff point is 2.5 years.  

4. SJU Corp. issued a 10 year bond at a price of $1,000 two years ago in the US. The bond pays an annual coupon rate of 8% and the coupon interest is paid every six month. If the current market interest rate for this class of bond is 10%,

      a. what is the value of the bond right now?

      b. what was the market interest rate for the bond two year ago? Hint: no calculation

        needed

5. Massey Machine Shop is considering a four-year project to improve its production efficiency. Six months ago, it contracted with Dr. Wright to provide a thorough study of whether there was a need for this four-year efficiency project. The report was delivered one month ago and it’s cost was $30,000. The report suggests that the company should go ahead with the project subject to Massey’s financial analysis. Buying a new machine press for $450,000 is estimated to result in $120,000 in annual pretax cost savings. The press falls in the MACRS five-year class and it will have a salvage value at the end of the project of $85,000. At time 0, the press will also require an additional investment in inventory of $9,000. Meanwhile, the accounts payable will increase by $3000. Every other current accounts remain the same. If the company’s tax rate is 20% and the discount rate is 12%, should the company accept the project?   The MACRS schedule is as follows:

           

Year	5-year Class
1	20%
2	32%
3	19.2%
4	11.52%
5	11.52%
6	5.76%

Answer 1

Question-1.Which is a more meaningful measure of profitability for a firm, return on assets or return on equity? Why?

Answer-

Return on Assets = [Net Income / Total Asset]

Return on Equity = [Net Income / Share Holder's Equity].

The profitability of a firm Can be meaningfully measured by ROE or return on equity.

Reason-

• Share holder's equity represents the amount invested by the shareholders. ROE shows the net income earned on the money invested by the share holders. As we know that the primary objective of a firm is the wealth maximization of the share holders.Hence the ROE can be a meaningful measure of the profitability which shows how much return is earned on the wealth invested by the Owners of the Firm.
• On the Other hand ROA or return on assets can be a better measure for the efficiency of the Firm , as it shows the income earned on the assets of the firm, which refelcts its efficiency.

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