Assignment
Part A: Answer each of the following questions. Show all calculations where necessary.
A firm is considering two mutually exclusive investments, each with an initial outlay of $100,000 and an expected life of 3 years. Assume that the firm has a cost of capital of 10 percent for each project. The two investments are of equal risk and have the following cash flows:
Investment A Investment B
Cash Flow Cash Flow
Year 0 -$100,000 -$100,000
Year 1 $40,000 $55,000
Year 2 $50,000 $55,000
Year 3 $110,000 $55,000
Calculate the payback period and the net present value for each investment. Show your calculations.
Based on the NPV and payback period calculations, which investment should the firm choose? Why?
2. What is the basic relationship between interest rates and bond prices, and why does this relationship exist?
3. Why is preferred stock considered to be a hybrid security? Explain.
Part B: Answer each of "the following questions. Show all calculations where necessary.
An investor expects the value of a $1,000 investment to double within 8 years. What is the expected annual rate of growth in the investment?
A firm has a total debt of $600,000 and equity of $400,000. What is the debt/net worth ratio and the debt-to-total assets ratio for the firm? Show your calculations.
3. In brief, what happens to the value of money if prices in general fall?
What is the future value of a $10,000 investment after 18 years, if the annual rate of interest is 8 percent? Show your calculations.
A bond has a principal amount of $1,000, an annual interest payment of $100, and a maturity of 10 years. What is the bond's value or price, if comparable debt yields 12 percent?
A firm has preferred stock outstanding that has a $40 annual dividend, a $1,000 par value, and no maturity. If comparable yields are 9 percent, what should be the price of the preferred stock?
Your broker recommends that you purchase Good Mills stock at $30. The stock pays a $2.20 annual dividend that's expected to grow annually at 8 percent. (The same rate of growth is expected for its per-share earnings.) If you want to earn 15 percent on your funds, should you purchase this stock? Show your calculations. Identify three advantages of establishing a corporation instead of a sole proprietorship.
9. What are the main functions of the break-even analysis? Jennifer wants to buy a new car four years from now that will cost $15,000. To meet this goal, now much money must she save annually, if the funds earn an interest rate of 6 percent?