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(20 points) Answer True or False

Finance

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1. (20 points) Answer True or False.  If a statement is not strictly true, then it is False.

_T__        The yield to maturity on a bond is different than the IRR for zero coupon bonds.

 

 

 

_F_           Payback is generally a better capital budgeting tool than IRR.

 

 

 

_T___       The depreciation tax shield is a cash flow.

 

 

 

________  If people feel more patient, bonds are more attractive and should give better returns.

 

 

 

_______    Firms that are expected to have high dividend growth in the future are likely to have a high price-to-earnings ratio.

 

 

_______    Cash flows and earning are usually interchangeable for capital budgeting purposes.

 

 

_______    Capital gains are not real cash flows because they create a tax shield/loss.

 

                

_______    Firms should always exercise an option to delay investment unless the NPV<0.

 

 

_______    Standard IRR is just a special case of the modified IRR.

                       

 

 

_______    DCF analysis is the only way to value private firms.

                

 

 

NOTE:           Is NOT a letter

 

2.  (10 points) Suppose that you are planning for retirement.  You want to have exactly $4 million dollars when you retire.  You just turned 26 and plan to retire on your 65^th birthday.  For the next 15 years, you can save $10,000 per year (with the first deposit being made one year from now), and at the end of that time (t=15) you plan to buy a car for your child as a gift that will cost $50,000.   How much will you have to save each year in years 16 until retirement so that you meet your retirement goal?  Assume the discount rate is 10 percent per year.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3. (10 points) The Dholakia Ditch Digging Company needs to raise capital.  They offer a bond with coupon payments of $5,000 payable once every three years.  The annuity lasts for exactly 30 years with the last payment occurring at the end of year 30.  The first payment is made at the end of year three.  Assume an annual interest rate of 7%. How much money can they raise today by issuing this bond?

 

 

 

 

 

 

4. (5 points) An investment pays you an annual 9% nominal interest rate compounded semiannually (4.5 percent twice a year).  A second investment of equal risk has a different annual nominal interest rate but interest is compounded monthly (12 times a year). What nominal annual interest rate on the second investment would you have to receive to make you indifferent (same effective rate) between the two investments?

        

 

 

5.  (15 points) Brian is getting nervous about his stock holding in KalraCo.  He bought the stock three years ago at $20 per share and the price is now $65 per share.  KalraCo. has a policy of paying out 60 percent of its earnings in dividends and Brian expects the company to continue earning about 12 percent return on equity. Over the past 12 months, KalraCo. paid $2.50 in dividends.  Assume a discount rate of 15%.

 

 

1. (10 points) Based on Brians’s projections, is the stock overpriced at $45 per share?

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2. (5 points) Should the firm increase or decrease their payout ratio?  Explain your answer.

 

 

 

 

 

 

6. (20 points) A firm is considering a project that requires an initial investment of $55,000.  The project is expected to generate revenues of $80,000 per year for three years.  Operating expenses will be 65% of revenues. The equipment will be depreciated on a straight-line basis to a zero net salvage value.   The equipment will have a life of 3 years.  The project feasibility study, which was just completed, cost $35,000.  The project requires an initial investment in working capital of $5,000.  Further investments in working capital will be needed as follows: an additional $3,000 at t=1 and $2,500 at t=2.  It is assumed that all of the investments in working capital made over t=0,1,2 will be completely recovered at the end of the project.  The corporate tax rate is 30%.  At t=3, the market value of the equipment is expected to be $20,000, but the company does not plan to sell it.  If the cost of capital is 10%, should the investment be undertaken?  

 

Answer on the following page.

 

 

 

 

 

 

 

 

7. (10 points)  You are an analyst for a pipe manufacturing corporation that is considering a new project which involves fabricating some custom pipe for a single customer. The project will take advantage of excess capacity in an existing plant. The plant has the capacity to produce 50,000 units of 18-inch pipe, but only 25,000 are being produced currently. Sales of 18-inch pipe are expected to increase by 10% a year. You want to use some of the remaining capacity to manufacture 20,000 units of custom 19.5-inch pipe for the next ten years (which will use up 40% of the total capacity), your customer will purchase this amount for the next ten years (no growth). An average unit of 18-inch pipe sells for $100 and costs $40 to make.  The tax rate for the corporation is 40% and the discount rate is 10%. Is there an opportunity cost involved for producing the custom pipe? If so, how much is it?