Finance 10 Problems Exam 2015

| June 3, 2016

Question
1. During periods of high inflation, U.S. firms have strong incentives to purchase short-lived assets and frequently replace them, rather than investing in long-lived assets. (True, False, Uncertain and explain your response)

2. If a firm uses the Discounted Payback rule, it will never accept a negative NPV project. (True, False, Uncertain and explain your response)

3. Having risen from virtually nothing in the early 1980s, stocks and stock options comprised roughly half of the average CEO compensation in public US firms in 1995. [Source: The Economist, May 4, 1996, p. 80] While this increase in pay for performance helps to align the interests of managers and shareholders, it also makes managers more focused on the short-term and more risk averse. (True, False, Uncertain and explain your response)

4. Assume that all you have available are data for the following ratios and your firm and your industry.

Total Asset Turnover

= Revenues/Assets

Total Margin

= EBIT/Revenues

Net Profit Margin

= Earnings/Revenues

Times Interest Earned

= EBIT/Interest

Return on Equity

= Earnings/Equity

If you want to evaluate the financial risk of your company and you can only use one of the measures, which one would it be and why?

5. When risk averse investors choose portfolios and assets to include in them, volatility is not the way they should measure risk. (True, False, Uncertain and explain your response)

6. Rau Inc. has 6.0 percent coupon bonds on the market with 9 years to maturity. The bonds make semi-annual payments and currently sell for 110 percent of par. What is the YTM?

You will upload an Excel spreadsheet that shows all of your work and the solution.

7. JJ Enterprises is considering the purchase of a new machine that will produce thumb drives. The new machine will require an initial investment of $100,000 and has an economic life of five years and will be fully depreciated by the straight line method. The machine will produce 15,000 thumb drives per year with each costing $2.00 to make. Each will be sold at $4.50. Assume JJ Enterprises uses a discount rate of 14 percent and has a tax rate of 34 percent. What is the NPV of the project and should JJ Enterprises make the purchase.

You will upload an Excel spreadsheet that shows all of your work and the solution.

8. A company is building a fuel efficient power plant which will generate its first annual cash flow of $18m exactly 4 years from today. As it ages, the volume it produces will remain constant but competing new technologies will drive prices down further. Hence the cash flows it creates will decline by 1% per year. Exactly 45 years from today, this plant will be scrapped, and the Environmental Protection Agency will require $30m expenditures to dismantle and clean it up. The plant’s OCC is 8%. What is the highest price that a buyer should consider paying for it?

9. VBN is a microcap stock included in the Wilshire 5000 index. The following lists the actual returns on VBN and the Wilshire 5000 index for 6 recent years.

Year

VBN

Wilshire

20X1

-18.0%

13.0%

20X2

-10.0%

-8.0%

20X3

15.0%

1.0%

20X4

60.0%

32.0%

20X5

15.0%

27.0%

20X6

28.0%

13.0%

i) Calculate the covariance between the returns on VBN and the Wilshire 5000 index.
ii) Does VBN’s returns move with or against the returns on the Wilshire 5000?
iii) Is VBN highly, moderately, or barely sensitive to fluctuations in the Wilshire 5000?

You will upload a Word Document that shows all of your work and the solution.

10. What is the price of a T-Bond with exactly 24.5 years to maturity and coupons with rate 5.875% paid semi-annually? Its yield is 6.5% BEY (Bond Equivalent Yield is semi-annually compounded).

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