Question

2. What is the assumed objective in a corporation? Briefly explain in no more than 150 words why this objective is necessary and why it is appropriate. (5 points)

3. You took out a 20 year mortgage of $350,000, 3 years ago where you pay $2,450.00 per month. You want to decide on whether you should pay the mortgage off early. What are the factors you should consider in making this decision if your household income is $6,000, and your monthly expenses of $2, 500. Your family includes 3 children who are 12, 10 and 8 years old. Discuss how you would proceed in making such a decision.State all assumptions. (5 points)

4. Your 60 year old mother is in reasonable good health and has just received her retirement funds of $140,000 from her employer of 40 years. As a financial management student, she trusts you to create an investment portfolio which will be suitable for her. Her tolerance for risk is low. Provide justification for your options. (5 points)

5. The following are financial statements which are commonly heard.

Comment on the veracity of those statements.

(a) If someone makes money, someone else loses it.

(b) Investing is nothing more than gambling

(d) The stock market will always go up.

QUESTION 2 (25 points)

Day Shades Inc. (DSI) has 20,000 bonds issued and outstanding with a 10 percent coupon rate compounded semi-annually. These bonds have 13 years left to maturity and they currently sell for 104 percent of par value.

The company has 5 million shares issued and outstanding with a market value of $3.85 per share. The company’s stock has a beta of 1.20. The expected return on the market is 11 percent and the yield on the risk-free asset is currently 6 percent.

DSI is currently considering a new five-year expansion project that requires an initial investment of $3.8 million in fixed assets. At the end of the project, the fixed assets would be depreciated to zero over the project’s five year life. The fixed assets can be sold for $550,000. Additionally, DSI will need to make an initial investment of $300,000 in working capital for the project and an additional investment of $50,000 in every year thereafter. The project is expected to generate annual sales revenue of $2,945,000 with associated costs of $1,255,000. The annual tax rate for DSI is 36 percent. A. Calculate the weighted average cost of capital (WACC) for DSI. B. Using the projected after-tax cash flows for DSI, calculate and comment on the Net Present Value (NPV) of the project. C. Under which circumstance can the WACC be used in investment appraisals D. Why do we use an after tax figure for the cost of debt but not for the cost of equity?

Answer 1

Question 2:

The assumed objective of a corporation is to generate profits on a long term basis. The corporation is said to be a "going concern" meaning it has infinite life. An objective of the firm is to come up with a clear picture on how to achieve the target of profits along with helping the society and the environment. This is called corporate social responsibility. Hence the objective is necessary to give a clear picture of what the organization wants to achieve and how this would affect all stakeholders from top management, investors, employees, society and even the government.

The objective also helps in the formation of the mission and vision statement for the organization and also reflects the culture of the founding members over the long term. Hence its appropriate for an organization to build an objective and follow it throughout the life of a corporation.

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