FRANK G. ZARB SCHOOL OF BUSINESS
December 16, 2013
Answer any 4 out of 5 questions. If you answer all five questions, Question 5 will be dropped.
1. You have $100,000 invested in this portfolio. $55,000 is invested in IBM: Recession
Probability of State of Economy
What is the expected return and standard deviation of each stock? What is the portfolio expected return and standard deviation? You are considering adding another stock, DNKN, with a beta of 1.3 to the portfolio. The market risk premium is 8% and the risk-free rate is 2.5%. What is the expected return of this asset? You decide to open a separate account at another brokerage firm. Your goal is to have a portfolio beta of 1.12. The portfolio consists of 20% U.S. Treasury bills, 50% stock A, and 30% stock B. Stock A has a risklevel equivalent to that of the overall market. What is the beta of stock B? Please interpret what this beta measure represents relative to the beta of the market.
What is the difference between systematic and unsystematic risk? Be sure to mention which is diversifiable risk and non-diversifiable risk.
The discount rate is 10%. These are independent projects.
How long does each project take to payback on a nominal basis? What about on a discounted basis? Which project(s) would you select if you used the NPV method? Why? Which project(s) would you select if you used the IRR methods. Why? If these were mutually exclusive projects, what is the cross-over rate for these two projects? Explain the significance of this rate.
Explain to Grandma the problem of multiple rates of returns under the IRR method? Under what conditions will you have multiple IRRs?
SummerTyme Inc is considering a new three year expansion project that requires an initial fixed asset investment of $3.9 million. The fixed asset will be depreciated straight-line to zero over its three-year life, after which time it will be worthless. The project is estimated to generate $2,650,000 in annual sales, with costs of $840,000. The tax rate is 35%. The discount rate is 12%.
What is the OCF each year for this project?
Assuming the required return on this project is 12%, what is the project’s NPV? What is the project’s IRR? Should you accept or reject this project? Suppose the project requires an initial investment in net working capital of $300,000, and the fixed asset will have a market value of $210,000 at the end of the project. What is the project’s year 0 net cash flow? Year 1? Year 2? Year 3? What is the new NPV?
Discuss how sunk costs, opportunity costs, side effects, financing costs, and taxes should be treated in capital budgeting analysis and why. Limit your answer to two sentences for each.
Evenflow Corp has 9 million shares of common stock outstanding, 250,000 shares outstanding of preferred stocks, and 8,000 semiannual bonds outstanding.
There are 8,000 semiannual bonds paying a 6.5% coupon with 20 years to maturity and currently selling for $920 per $1000 face value.
The preferred stocks are selling for $93 paying $5constant dividends. The current market price of the stock is $57 and the beta is 1.05. The market risk premium is 8% and 4.5% risk-free rate.
What is the weighted average cost of capital (WACC) if the marginal tax rate is 35%? If the cash flow from assets are -$135,000 in year 0, $46,000 in year 1, $57,000 in year 2, and $62,000 in year 3, should the firm accept or reject the project?
The floatation costs for issuing debt, preferred stock and common...
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