Question 1: Suppose that a thirty-year Treasury bond offers a 4% coupon rate, paid semiannually. The market price of the bond is $1,000, equal to its par value.
What is the discounted payback period for the bond, assuming its 4% coupon rate is the required return? What general principle does this example illustrate regarding a project's life, its discounted payback period, and its NPV?
Question 2: Calculate the NPV for the following twenty-year projects. Comment on the acceptability of each. Assume that the firm has an opportunity cost of 14%.
a. Initial cash outlay is $15,000; cash inflows are $13,000 per year.
b. Initial cash outlay is $32,000; cash inflows are $4,000 per year.
c. Initial cash outlay is $50,000; cash inflows are $8,500 per year.
Question 3: A certain investment requires an initial outlay of $12 million and subsequently produces annual cash inflows of $1.4 million in perpetuity. A firm evaluating this investment uses a discount rate of 10%. What is the investment's NPV? What is the EVA each period? What is the present value of the stream of EVAs?
Question 4: Puritan Motors has a capital structure consisting almost entirely of equity.
a. If the beta of Puritan stock equals 1.6, the risk-free rate equals 6%, and the expected return on the market portfolio equals 11%, then what is the cost of equity?
b. Suppose that a 1% increase in expected inflation causes a 1% increase in the risk-free rate. Holding all other factors constant, what will this do to the firm's cost of equity? Is it reasonable to hold all other factors constant? What other part of the calculation of the cost of equity is likely to change if the expected inflation rises?
Question 5: In its 2009 annual report, The Coca-Cola Company reported sales of $30.99 billion for fiscal year 2009 and $31.94 billion for fiscal year 2008. The company also reported operating income (roughly equivalent to EBIT) of $8.23 billion in 2009 and $8.45 billion in 2008. Meanwhile, arch rival PepsiCo, Inc., reported sales of $43.23 billion in 2009 and $43.25 billion is 2008. PepsiCo's operating income was $8.04 billion in 2009 and $6.96 billion in 2008. Based on these figures, which company had higher operating leverage?