SECTION A:
1. James Fromholtz is considering whether to invest in a newly formed investment fund. The fund's investment objective is to acquire home mortgage securities at what it hopes will be bargain prices.
The fund sponsor has suggested to James that the fund's performance will hinge on how the national economy performs in the coming year. Specifically, he suggested the following possible outcomes: State of the Economy Prob Return Expansion and recovery 15% 25% Modest growth 35% 15% Continued recession 20% 5% Falls into depression 30% 13%
a. What is your estimate of the expected rate of return from this investment opportunity?
b. What is the Standard Deviation of the Returns?
2. Barry Swifter is considering retirement. Barry's retirement portfolio currently is valued at $750,000 and is allocated 50% to Treasury Bills, 20% to S&P 500 Index Fund, and 30% to Emerging-Market Fund as follows: Expected Return $ Value Treasury bills 4.5% S&P 500 Index Fund 8.0% Emerging Market Fund 12.0%
Based on the current portfolio composition and the expected rates of return, what is the expected rate of return for Barry's portfolio? Use a Spreadsheet to prepare your answer.
3. The Chetar Company Inc. has proposed the following project: Cost of the project is expected to be $4,000,000. Gross revenues will be $750,000 for the first 10 years. Average Variable Cost is 60% of Gross Revenues. The company's cost of preferred stock is 9%.
The cost of equity capital is 13.5%, and the after tax cost of debt is 7.5%. The company's tax rate of 30% The asset was to be depreciated MACRS 7 years (15%, 25%, 17%, 12%, 9%, 9%, 9%, 4%).
i. What is the book value of the asset after 5 years? Show (SPREADSHEET) Depreciation for each year to Year 5!!!
ii. If the asset is to be sold for $1,800,000 after five years, what is the capital gain or loss on the asset?
iii. If the company's Cost of Capital is 10.68%, should this project be accepted or rejected?