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Short Answer Questions: You should be able to answer these in a sentence or two (Limit explanations to half page maximum). Questions are worth 5 points each.

 

1.       Why do lower transaction costs make a market more efficient?

 

2.       If a firm’s ROE is less than the required return, what will happen to net present value of the growth opportunities (NPVGO)? 

 

PROBLEMS:

For all problems, show you work and highlight your answer. Numbers in ( ) indicate how many points each item is worth. No credit will be given on problems without supporting work, even if the final answer is correct.  Unless stated otherwise, interest is compounded annually and payments occur at the end of the period.  Face value for bonds is $1000. 

 

1.       (10) You have the following financial needs: At the end of year 5, you need $6000; at the end of years 6 and 7, you need $4000 (each year); at the end of year 8, you need $3000. You plan to set aside equal annual payments (at the end of) each year for the next 4 years to provide for your needs.  If the interest rate is 6%, how much do you set aside each year?

 

2.       (5) Faraday issued preferred stock with a $4.80 dividend per year.    If you buy the stock for $60, what is your return?

 

3.       (10) Five years ago, Acme issued 15-year bonds at par.  The bonds have a coupon rate of 7.6% with coupons paid semiannually.  They currently trade at $1151.50 per bond. 

a)      Find the yield to maturity on the bonds. 

b)      Acme wants to issue more debt.  They are considering 10-year bonds.  What coupon rate will the new bonds have if the added debt does not change the chance that Acme will default? Explain.

 

4.        (10) Gif Energy expects to have earnings per share (EPS) of $1.14 next year.  They have a retention rate of 26% and their return on equity (ROE) is 15.2%.  If the investors’ required return (cost of capital) is 6.6%, find the current stock price.   

 

5.       (10) Hunt Inc. just paid a dividend of $2.60.  They expect dividends to grow at 25% for the next 2 years.  After year 2, the firm will have a retention rate of 20%.  The ROE will remain at 40%. If the required return is 17%, find the current price

 

6.       (10) Calculate the payback and profitability index. The maximum payback period is 2 years and the cost of capital is 12%.

 

Project

Time 0

1

2

3

Fun Time

-1000

950

400

-225

Clock Works

-500

550

0

0

Bug Hugs

-1100

500

500

500

 

a.       If the projects are independent, which one(s) do you select? Why?

b.      If they are mutually exclusive, which one would you prefer? Why?

 

7.       (14) Top Inc. is interested in developing a new toy.  The toys will sell for $25 each and they plan to sell 10 million toys at the end of each year for 4 years.  Variable costs are $20 per toy; fixed costs are $10,000,000 per year.  The interest expense is $3,000,000 per year.  The project requires an additional machine that costs $120,000,000 to be depreciated to a zero book value on a straight‑line basis over 4 years.  The machine has a salvage value of $20,000,000. The tax rate is 40%.  The initial investment in net working capital is $5,000,000.  No additional net working capital is needed for the project and no net working capital will be returned.  The variable and fixed costs do not include the depreciation and the interest expenses.  There is no horizon value.

a.       If the cost of capital is 8%, find the net present value.   

b.      Find the internal rate of return.

c.       Do you accept the project? Explain.  

 

8.        (15) You are forecasting the balance sheet and income statement for Sand Blaster for Y1.  You use the Y0 statements and the following assumptions:  Sales grow by 25%; cost of goods sold and SG&A keep the same relationship to sales.  Depreciation expense grows by $400,000.  Long-term debt has a 7% interest rate.  The firm wants to maintain the same cash balance; accruals will not change; accounts receivable turnover and inventory turnover will remain the same.  Accounts payable turnover will decrease by 2%.  The firm has excess capacity, will not issue stock and will pay a constant dividend (in dollars).  Assume there are 365 days in a year. Calculate the additional funds needed. 

 

SAND BLASTER: INCOME STATEMENT (M$)

Fiscal Year Ending

Y0

Y1

Sales

                  190.00

 

Cost of Goods Sold

                  122.00

 

SG&A

                     50.00

 

Depreciation

                       3.00

 

Earnings Before Interest & Tax (EBIT)

                     15.00

 

Interest Expense

7.00

 

Earnings Before Tax

                     8.00

 

Taxes (40%)

                       3.20

 

Net Income

                       4.80

 

Dividends

                       3.80

 

 

SAND BLASTER: BALANCE SHEET (M$)

Fiscal Year Ending

Y0

Y1

Cash

50

 

Accounts Receivable

80

 

Inventories

150

 

Net Fixed Assets

960

 

TOTAL ASSETS

1,240

 

Accruals

20

 

Accounts Payable

90

 

Long Term Debt

100

 

Common Stock

180

 

Retained Earnings

850

 

Total Liability & Equity

1,240