When projecting growing cash flows into perpetuity,

| June 3, 2016

Question
When projecting growing cash flows into perpetuity, the estimate should take into account the extra amount required for investment consistent with any projected growth in operating profit. (True, False, Uncertain and explain your response)

Payback is not an effective way to cope with risk. (True, False, Uncertain and explain your response)

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)

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?

CAPM implies that the only two assets that matter to every investor in corporate stocks and bonds are the risk-free Treasury Bill and the market portfolio of world-wide wealth. (True, False, Uncertain and explain your response)

Rau Inc. has 7.0 percent coupon bonds on the market with 9 years to maturity. The bonds make semi-annual payments and currently sell for 80 percent of par. What is the YTM?

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

JJ Enterprises is considering the purchase of a new machine that will produce thumb drives. The new machine will require an initial investment of $800,000 and has an economic life of five years and will be fully depreciated by the straight line method. The machine will produce 150,000 thumb drives per year with each costing $0.10 to make. Each will be sold at $2.00. 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.

You are building a pipeline which will generate its first annual cash flow of $2m exactly 5 years from today. As it ages, the volume it transports, and hence the cash flows it creates, will decline by 3% per year. Exactly 27 years from today, this pipeline will be scrapped, and the Environmental Protection Agency will require you to spend $50m then to dismantle it. The pipeline’s OCC is 9%. What’s the lowest price that you would consider selling it for?

The returns on QRC stock and an investor’s portfolio over three years are given in the table below.

Based on this data, compute the volatility of the portfolio and briefly describe how to interpret it.
Based on this data, calculate the correlation between QRC and the portfolio, and briefly describe what it means. Show your work.
Suppose the portfolio represents the portfolio of all wealth. What is QRC’s market beta?
Year QRC Portfolio
1 5.0% 19.0%
2 -3.0% 14.0%
3 13.0% 9.0%

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

You are considering buying a bond issued by General Motors with exactly 5.5 years remaining to maturity that just paid a coupon yesterday. It rained on your paper this morning so you do not know what the coupon rate is. However you are able to see that the quoted price is listed as $105-20 and the annualized yield is 7%, with semi-annual compounding. If the coupon is paid semi-annually, what is the quoted annualized coupon rate? Show your work.

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

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