Assignment:
Practice Problems for Final Exam
Use these problems to determine how well your studying is going. Do not expect that the problems on the final exam will be identical to these.
1. Suppose you need $1,000 4 years from now.
a. If your bank compounds interest at an 8% annual rate, how much will you need to deposit into your account one year from now to reach your goal?
b. If you had $700 to deposit today, what interest rate would you need to earn in order to have the $1,000 in 4 years?
2. You are planning for your retirement in 30 years. At that time you want to have enough saved to be able to afford to spend $100,000 per year (starting at time 31) for 20 years (if you live longer than 20 years your kids will have to support you).
a. How much will you need to have saved by time 30 if the expected interest rate from time 30 to 50 is 10 percent per year?
b. Suppose that at time 30 you will receive a retirement bonus of $50,000 from your company. If the interest rate is expected to be 12 percent, compounded monthly, from now until time 30, how much would you need to save at the end of each month in order to be able to make the desired withdrawals at retirement?
3. A 10-year, $1000 face value bond makes annual payments and has a coupon rate of 6 percent.
a. If the current yield on the bond is 6.5 percent, what is the bond's price?
b. Suppose that a year from now the bond sells at a yield to maturity of 7 percent. What is the price of the bond?
c. What is your rate of return if you purchase the bond at the price in (a), hold it for a year, and then sell it for the price in (b)?
4. DFB, Inc. expects earnings this year of $5 per share, and it plans to pay a $3 dividend to shareholders. DFB will retain $2 per share of its earnings to reinvest in new projects that have an expected return of 15% per year. DFB plans to maintain the same dividend payout rate and return on new investments in the future and will not change its number of outstanding shares. Investors expect an 11% rate of return on the stock.
a. What growth rate of earnings would you forecast for DFB?
b. What price would you estimate for DFB stock?
c. What is the present value of growth opportunities?
d. If DFB were to reinvest all of its earnings this year and then begin the payout plan described above, what would be the price of the stock today?
5. Louisville Loopers expects to make baseball bats with labour and material costs of $7 per unit which they will sell for $14 each. Investment in depreciable plant and equipment will be $15,000, and will be depreciated straight-line over the useful life of 15 years to a final value of zero. The fixed costs are $600 each year. The company faces a tax rate of 40% and has a cost of capital of 10%.
a. If sales are 500 units each year, what is the annual cash flow in years 1-15?
b. What is the payback period for the project? Give the fractional year.
c. What is the net present value for the project?
d. Should Louisville Loopers accept the project?
e. How many units would Louisville Loopers need to sell in order to break even on a Net Present Value basis?
6. Consider the following information for Columbia Power Co. Assume the company's tax rate is 35%.
Debt: 4,000 8 percent coupon bonds outstanding, $1,000 par value, ten years to maturity, selling for 101 percent of par; the bonds make semiannual payments and have a yield to maturity of 7.85%.
Common Stock: 50,000 shares outstanding, selling for $62 per share; the beta is 1.10.
Preferred Stock: 9,000 shares of 5 percent preferred stock outstanding, issued at $100 per share, but currently selling for $60 per share.
Market: 7 percent market risk premium and 4 percent risk-free rate.
a. Find the costs of debt, common stock, and preferred stock.
b. Find the market values of debt, common stock, and preferred stock.
c. Calculate the firm's weighted average cost of capital.
7. Stockwell Inventory Systems, Inc., has announced a rights offer. The company has announced that it will take four rights to buy a new share in the offering at a subscription price of $25. At the close of business the day before the ex-rights day, the company's stock sells for $50 per share.
a. What is the ex-rights price?
b. What is the value of a right?
c. Suppose that on the morning that the stock goes ex-rights the stock sells for $45 per share and the rights sell for $4 each. Describe a transaction in which you could use these prices to create an immediate profit.
8. Consul, Inc., a prominent consumer products firm, is debating whether or not to convert its allequity capital structure to one that is 40 percent debt. Currently, there are 500 shares outstanding and the price per share is $65. EBIT is expected to remain at $3,000 per year forever. The interest rate on new debt is 7 percent, and there are no taxes.
a. Ms. Atkins, a shareholder of the firm, owns 100 shares of stock. What is her cash flow under the current capital structure, assuming the firm has a dividend payout rate of 100 percent?
b. What will Ms. Atkins' cash flow be under the proposed capital structure of the firm? Assume that she keeps all 100 of her shares. (Hint: How many shares will be repurchased if the firm uses the proceeds of the debt to buy back shares at $65?)
c. Suppose Consul does convert, but Ms. Atkins prefers the current all-equity capital structure. Show how she could delever her shares of stock to recreate the original capital structure.
d. Using your answer to part (c), explain why Consul's choice of capital structure is irrelevant.
9. Miles' Manor, an unassuming resort in western Ontario, currently has an all-equity capital structure. Miles' Manor has an expected EBIT of $20,000 per year forever and a required rate of return to equity of 16%. There are no personal taxes, but Miles' pays corporate taxes at the rate of 30%, and all transactions take place in an otherwise perfect capital market.
a. What is Miles' Manor worth?
b. How much will the value of the firm increase if Miles' Manor leverages the firm by borrowing half the value of the unleveraged firm at a rate of 10%.
c. What will be the required rate of return on equity and the WACC at the level of debt found in (b)?
d. What is the theoretical maximum value for Miles' Manor (if it were all debt)?
10. The balance sheet for Intranet Browser Corp. is shown here in market value terms. There are 10,000 shares of stock outstanding.
Market Value Balance Sheet
Cash $ 15,000 Equity $150,000
Fixed Assets 135,000
Total $150,000 Total $150,000
a. The company has declared a dividend of $0.30 per share. The stock goes ex-dividend tomorrow. Ignoring any tax effects, what is the stock selling for today? What will it sell for tomorrow? After the dividend, what will be the value of shares and of cash for an investor with 100 shares?
b. Now suppose that Intranet Browser has announced it is going to repurchase $3,000 worth of stock instead of paying out the dividend. What effect will the repurchase have on an investor who currently holds 100 shares and sells two of those shares back to the company in the repurchase (i.e., what is the value of the investor's share and cash?)
c. Now suppose that Intranet Browser again changes its mind and decides to issue a 2 percent stock dividend instead of either issuing the cash dividend or repurchasing 2 percent of the outstanding stock. How would this action affect a shareholder who owns 100 shares of the stock?
Attachement:- Theory of Finance.rar