Question 1: The risk-free rate is 7.6 percent. Potpourri Inc. stock has a beta of 1.7 and an expected return of 16.7 percent. Assume the capital-asset-pricing model holds.
1. What is the expected market risk premium?
2. Magnolia Industries stock has a beta of 0.8. What is the expected return on the Magnolia stock?
3. Suppose you have invested $10,000 in a combination of Potpourri and Magnolia stock. The beta of the portfolio is 1.07. How much did you invest in each stock? What is the expected return of the portfolio?
Question 2: The Tuft Company is generating cash flow of $333,000 per year. If they invest in a new press, they expect to increase their cash flow to $400,000 per year. The cash outflow for the new press is $250,000; to accept or reject the investment they have to consider the
A) press cost of $250,000 and total cash flow of $400,000 per year.
B) press cost of $250,000 and incremental cash flow of $67,000 per year.
C) current cash flow of $333,000 and the cost of $250,000
Question 3: What is the nominal rate of interest given a real rate of interest of 5.0% and an inflation rate of 7.0%? (express your answer with one significant figure)
Question 4: You have been asked to evaluate two pollution control devices. The wet scrub costs $100 to set up and $50 per year to operate. It must be completely replaced every 3 years, and it has no salvage value. The dry scrub device costs $200 to set up and $30 per year to operate. It lasts for 5 years and has no salvage value. Assuming pollution control equipment is replaced as it wears out, which method do you recommend if the cost of capital is 10%? Determine the equivalent annuity cost (EAC) and show your decision by marking your choice. All revenues are assumed to be the same.
Question 5: ABC Inc. is considering the purchase of a $500,000 computer with an economic life of five years. The computer will be depreciated fully over five years using the straight line method.
The market value of the computer is $100K in five years. The computer will replace five office employees whose combined annual salaries are $120K. The machine will also lower the firms required net working capital (NWC) by $100K. This amount of NWC will need to be replaced once the machine is sold. Tc = 34%, discount rate is 12%. Determine the NPV to see if it is worth it?
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Yr-0
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Yr-1
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Yr-2
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Yr-3
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Yr-4
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Yr-5
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Annual salary savings
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120,000
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Depreciation
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100,000
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Pre-tax income
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Taxes
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6,800
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Operating C/F
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113,200
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ΔNWC
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-100,000
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Investment
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-500,000
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66,000
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Total C/F
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113,200
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