Fundamentals of Finance
Problems
When solving these problems, please show your work in a neat and organized manner, and circle your answer. If submitting multiple pages, your papers must be stapled. Do your best or I'll tell your mother.
1. You are considering the following two equally-risky investments. If you are indifferent between these two investments, what is the NPV of Project B?
|
t0 |
t1 |
t2 |
t3 |
t4 |
| Project A: |
-40000 |
26000 |
20000 |
16000 |
10000 |
| Project B: |
-40000 |
14000 |
18000 |
22000 |
26000 |
2. Suppose you just finished analyzing a 5-year capital investment, but you get a call from the CFO saying the initial cost of the equipment will be $1 million more than expected. How much will NPV change? The equipment is 5-year MACRS property. Assume a 35% marginal tax rate, 10% required return, and no change in salvage value.
3. Stock Y has a beta of 1.40 and an expected return of 16%. Stock Z has a beta of 0.7 and an expected return of 9.0%. If these two stocks are correctly priced, what is the expected return on the market index, E(Rm)?
4. A capital investment will produce cash flows of $10,000 annually, in arrears, over its 10-year life. This looks like a great investment since the IRR of 14.97% far exceeds the 10.00% required return. To be sure, calculate the NPV.
5. Suppose you just finished a capital investment analysis on a $250 million project with the following results. What's the standard deviation of the project's IRR?
| Scenario |
Probability |
IRR |
| Worst case |
30% |
-2% |
Base case
|
50% |
14% |
Best case
|
20% |
23% |
6. You invested $100,000 of your client's money in a portfolio of stocks. At the end of the first year the portfolio was worth $115,000. At the end of the second year the portfolio was worth $138,000. Then the market crashed, and during the third year the portfolio lost 40% of its value. What was the annual geometric mean return over the entire three-year period?
7. One year ago you paid $1,093 for an 8% coupon bond which had a remaining maturity of 14 years. The coupons are paid semiannually. The current YTM on this bond is 6.2%. If you sold the bond today, what would be your holding-period return (%)?
8. An asset that originally cost $175,000 is sold for $75,000 after three years of use. The asset is classified as 5-year property for tax purposes. If the company has a 35% marginal tax rate, what is the after-tax salvage value?
9. Stock XYZ just paid its $5 annual dividend, which is expected to grow 20% annually for the next three years. After that, the dividend is expected to grow a mere 2% forever due to emerging competition. If you require a 14% return, what is the most you'd pay for this stock today?
10. EarthCom stock has been trading for $72 per share. It just paid a $4 annual dividend, and investors require a 14% return. According to the Dividend Growth Model, what would be the stock price if EarthCom reported revenue that disappointed the market causing growth expectations to be cut in half?