FINANCIAL LEVERAGE EFFECTS

The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $12 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $5.7 million with a 0.2 probability, $2.5 million with a 0.5 probability, and $0.3 million with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. Do not round intermediate calculations. Round your answers to two decimal places at the end of the calculations.

Debt/Capital ratio is 0.

Debt/Capital ratio is 10%, interest rate is 9%.

Debt/Capital ratio is 50%, interest rate is 11%.

Debt/Capital ratio is 60%, interest rate is 14%.

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 5% per year, with a SD of 20%. The hedge fund risk premium is estimated at 10% with a SD of 35%. 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.

a-1. Assuming the correlation between the annual returns on the two portfolios is 0.3, what would be the optimal asset allocation?  

a-2. What is the expected return on the portfolio?

a-3 Calculate Greta’s capital allocation using an annual correlation of 0.3?

The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $14 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $4.4 million with a 0.2 probability, $2.8 million with a 0.5 probability, and $0.3 million with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. Do not round intermediate calculations. Round your answers to two decimal places at the end of the calculations.

Debt/Capital ratio is 0.

Debt/Capital ratio is 10%, interest rate is 9%.

Debt/Capital ratio is 50%, interest rate is 11%.

Debt/Capital ratio is 60%, interest rate is 14%.

STPL is considering acquiring Pie Smiles, a small chain bakery that specialise in making gourmet pies. A sales manager from Pie Smiles has provided the following actual sales:

The sales manager from Pie Smiles has suggested that sales would be $8,200 in year 1.  

Required:

1. Using exponential smoothing with a weight of α =0.3, develop forecasts for years 2 through to 6 .
2. Using smoothing constants of 0.6 and 0.9, develop forecasts for the sales of pies.
3. What effect did the smoothing constant have on the forecast for the sale of pies?
4. Use a 3-year moving average forecasting model to forecast the sales of pies.
5. Using the trend projection model, develop a forecasting model for the sales of pies.
6. Which is the preferred method to predict the sales of pies: exponential smoothing with a smoothing constant of 0.3, a 3-year moving average or a trend line? In your response justify why you made that choice.

The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $14 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $5.7 million with a 0.2 probability, $1.5 million with a 0.5 probability, and $0.3 million with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. Do not round intermediate calculations. Round your answers to two decimal places at the end of the calculations.

Debt/Capital ratio is 0.

RÔE = %

σ = %

CV =

Debt/Capital ratio is 10%,interest rate is 9%.

RÔE = %

σ = %

CV =

Debt/Capital ratio is 50%,

interest rate is 11%.

RÔE = %

σ = %

CV =

Debt/Capital ratio is 60%, interest rate is 14%.

RÔE = %

σ = %

CV =

Continue without saving

Tharaldson Corporation makes a product with the following standard costs:

The company reported the following results concerning this product in June.

The company applies variable overhead on the basis of direct labor-hours. The direct materials purchases variance is computed when the materials are purchased.

The variable overhead efficiency variance for June is:

Garrison 16e Rechecks 2017-10-31

Multiple Choice

$1,696 F

$1,600 U

$1,696 U

$1,600 F

Suppose x has a distribution with μ = 20 and σ = 5. (a) If random samples of size n = 16 are selected, can we say anything about the x distribution of sample means? Yes, the x distribution is normal with mean μ x = 20 and σ x = 1.25. No, the sample size is too small. Yes, the x distribution is normal with mean μ x = 20 and σ x = 5. Yes, the x distribution is normal with mean μ x = 20 and σ x = 0.3. (b) If the original x distribution is normal, can we say anything about the x distribution of random samples of size 16? Yes, the x distribution is normal with mean μ x = 20 and σ x = 0.3. No, the sample size is too small. Yes, the x distribution is normal with mean μ x = 20 and σ x = 5. Yes, the x distribution is normal with mean μ x = 20 and σ x = 1.25. Find P(16 ≤ x ≤ 21). (Round your answer to four decimal places.)

There are two traffic lights on a commuter's route to and from work. Let X₁ be the number of lights at which the commuter must stop on his way to work, and X₂ be the number of lights at which he must stop when returning from work. Suppose that these two variables are independent, each with the pmf given in the accompanying table (so X₁, X₂ is a random sample of size n = 2).

μ = 1, σ² = 0.6

Calculate σ_To².

σ_To² =

How does it relate to σ², the population variance?

σ_To² =  · σ²

(d)

Let X₃ and X₄ be the number of lights at which a stop is required when driving to and from work on a second day assumed independent of the first day. With T_o = the sum of all four X_i's, what now are the values of E(T_o) and V(T_o)?

E(T_o)=V(T_o)=

(e)

Referring back to (d), what are the values of

P(T_o = 8) and P(T_o ≥ 7)

[Hint: Don't even think of listing all possible outcomes!]

P(T_o = 8)

=

P(T_o ≥ 7)

=

The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $19 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $5.5 million with a 0.2 probability, $3 million with a 0.5 probability, and $0.3 million with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. Do not round intermediate calculations. Round your answers to two decimal places at the end of the calculations.

Debt/Capital ratio is 0.
RÔE =

σ =

CV =

Debt/Capital ratio is 10%, interest rate is 9%.

RÔE =

σ =

CV  =

Debt/Capital ratio is 50%, interest rate is 11%.

RÔE =

σ =

CV  =

Debt/Capital ratio is 60%, interest rate is 14%.

RÔE =

σ =

CV  =