Question 1
You have won a $1 million cash prize. Those awarding the prize have given you four payout choices:
• $1 million today
• $1.2 million lump sum in two years
• $1.5 million lump sum in five years
• $2 million lump sum in eight years
Your stockbroker tells you that must be capable to earn 10% on an investment portfolio. For each alternative noted above where you know the prospect value, compute the present value and elucidate why your choice of a payoff alternative is the best course of action.
Question 2
You are faced with a decision on whether to purchase a machine for your business. The cost of the machine is $25,000. Cash saving, including labour, raw materials, and tax saving because of depreciation, are $3,500 per year for ten years. The present value of cash saving is $21,506 at a 10% discount rate. Must you buy the machine? Why or why not?
Question 3
You own shares in a company whose stock price today is $36.34. Management expects dividends to grow at a steady rate of six percent for the foreseeable future. The last dividend was $3.25. Your needed rate of return for stocks is 16%. Should you sell the shares you have or add to your holdings? Support your answer.
Question 4
Mr. Hugh Warner is an extremely cautious businessman. His supplier offers trade credit terms of 3/10, net 80. Mr. Warner never takes the discount offered, but he pays his suppliers in 70 days rather than the 80 days allowed so he is certain the payments are never late. What is Mr. Warner's cost of not taking the cash discount? (Make sure to show your work.)
Question 5
The ABC Corporation has a $1,000 par value bond outstanding with 20 years to maturity. The bond carries a yearly interest payment of $95 and is currently selling for $920 per bond. The ABC Corporation is in the 25% tax bracket. What would the after-tax cost of a new bond issue be? The yield to maturity on new issue will be the same as yield to maturity on the old issue since the risk and maturity date will be similar.
Question 6
a). In the management of cash and marketable securities, why must the primary concern be for maximization of profit?
b). Why would a financial manager want to raise disbursements?
c). Why may investors demand a higher rate of return for an investment in Microsoft than in United Airlines?
d). Elucidate: ‘If inflationary expectations reduce, the yield to maturity will decline, which means a higher bond price’.
Question 7
a). Adjust the annual formula for a future value of a single amount at 12 percent for 10 years to a half yearly compounding formula. What are the interest factors (FVIF) before and after? Why are they different?
b). Why is the remaining time to maturity a significant factor in evaluating the impact of a change in yield to maturity on the bond prices?
c). Why is a change in needed yield for preferred stock likely to have a greater impact on price than a change in required yield for bonds?
Question 8
What factors may affect a firm's price-earnings ratio, and why?
Question 9
Global Services is considering a promotional campaign that will raise annual credit sales by $400,000. The company will require investments in accounts receivable, inventory, and plant and equipment. The turnover for each is as follows:
Accounts receivable 4x
Inventory 8x
Plant and equipment 2x
All $400,000 of the sales will be collectible. But, collection costs will be 4 percent of sales, and production and selling costs will be 76 percent of sales. The cost to carry inventory will be 8 percent of inventory. Depreciation expense on the plant and equipment will be 5 percent of plant and equipment. The tax rate is 30 percent.
a). Calculate investments in accounts receivable, inventory, and plant and equipment based on turnover ratios. Add the three together.
b). Calculate accounts receivable collection costs and production and selling costs and add the two figures together.
c). Calculate costs of carrying inventory.
d). Calculate depreciation expense on the new plant and equipment.
e). Add together all the costs in parts b, c, and d.
f). Subtract the answer from part e from the sales figure of $400,000 to arrive at income before taxes. Subtract taxes at a rate of 30 percent to arrive at income after taxes.
Question 10
a). Discuss the relative volatility of short and long-term interest rates
b). What is the importance to working capital management of matching sales and production?
c). A firm that uses short-term financing techniques for a portion of permanent current assets is assuming more risk but expects higher returns than a firm with a normal financing plan. Elucidate.