Download Final Exam, Fall 09 - Department of Finance, Insurance and

Finance 3104
Fall 2009
Final Exam
Professor G. R. Thompson
points
20
1.
Your Student Number____________________
Answer in the space provided
Do not place your name on this exam!
SHOW ALL WORK!!!
You have recently become employed by Harry’s Kitty Toys and have been
assigned to their capital budgeting department. You have determined the
following information to be accurate. The firm's shares are currently selling for
$40.00, the estimated growth rate of earnings is 7%, and the expected dividend is
$2.40. Talks with the investment banking company with which the firm does
business indicate that selling new shares of common will cost $8.00 per share.
The firm can borrow up to $35,000 from the bank for 8%. Above that $35,000,
any additional debt will be in the form of bonds that have a coupon rate of 11%
and a flotation cost of $16 per bond. These would be 30 year bonds that pay
semiannual interest. The firm expects this year's before tax income to be
$325,000 and plans to continue to pay out 50% of its net income in common
dividends.
The firm's tax rate is 36%.
The firm currently has the capital structure displayed by the following balance
sheet entries:
Harry INC.
Balance Sheet
12 – 31- 09
ASSETS
Total:
(in Millions)
CLAIMS
Debt:
Common Equity:
Total:
880
308
572
880
The capital outlay information, as well as the projected after tax cash flows for
each of the investment opportunities, is displayed below. Each of these projects
is assumed to be independent of all of the others.
These are as follows:
Project
A
B
C
D
E
Cost
$50,000
40,000
60,000
80,000
35,000
Annual Inflow
$15,410
9,219
16,335
14,996
12,259
Years
6
10
9
8
4
Clearly develop and draw in a graph the firm's complete MCC and IOS curves.
Which projects should the firm undertake? (Use this page and page 2 for your
work. (Be sure to show all your work for partial credit!)
1
2
Your Student number__________________
(Use this space for question number 1 only)
3
10
2.
What is the number of bonds that Harry must issue in question number 1?
Show your work.
10
3.
What is the number of common shares that Harry must issue?
Show your work.
4
20
4.
Walter’s Rawhide Chewies, WRC as it is known locally back in the New River
Valley, is considering expanding production of their very popular “Rug Rat
Chewy”. This rawhide product is very popular in the developing markets of
Eastern Europe and the sales team is arguing strongly for replacing the currently
owned production equipment to meet increased demand. WRC’s production
and sales teams have gathered the following data with regard to the proposed
replacement.
1)
The purchase price of the new machine is $240,000, installed.
2)
The new machine will be straight line depreciated to zero over its six year
operating life. It will have a $30,000 salvage value at the end of its life.
3)
The old machine was originally purchased 4 years ago for $180,000 and
is being straight line depreciated to zero over a 10 year life. It will be sold
for $75,000 if we purchase the new machine. This old machine is
expected to have a salvage value of $15,000 at the end of its 10 year life.
4)
The new machine will be much more efficient and will allow the firm to
carry $12,000 less in inventory for the six years of production of this
product.
5)
Sales from this operation will be $86,000 per year over its life.
6)
Costs, other that depreciation, will be $39,500 per year.
7)
The firm's tax rate is 37%.
8)
The firm's cost of capital is 15%.
What is the machine's NPV? What is the machine's IRR? Should the firm
invest?
Plot the project’s net present value profile.
Show all your work! You may use page 5 for this question if you need it.
5
Your Student number__________________
(Use this space for question number 4 only)
6
20
5.
A friend of mine is concerned about his retirement portfolio. He wishes to
keep his money invested in the stock market but at the same time he is
concerned that the market will take a "double dip" and go down once more.
My friend has almost ten percent of his wealth invested in the stock of the
company where he works and a change in the market is going to hurt him
significantly.
Here is his concern: He thinks if the market falls again it will be because
investors will be experiencing increased risk aversion.
Indeed, he and his
broker agree there is a chance the market risk premium will change by a full
three percent. What will such a change do to the value of the stock in the
company where he works if the following details are true before this possible
shock to the market?
Specifically, the stock has a beta of .75, a constant
growth rate of 8%, a recently paid dividend of $1.25, and a current price of
$27.00. The current risk free rate is 4% and will not change.
Show all your work and draw the appropriate graph for full credit.
7
5 ea)
6.
Please answer each of the following. Show your work (the entries in your
calculator) as well as a final answer.
a)
What is the equilibrium price for a perpetual preferred stock that pays
$6.16 per year if the required rate of return is 14.5%?
b)
What is the expected rate of return on a perpetual bond that pays a 10%
coupon and has a current market price of $689.66?
c)
What is the holding period on a bond I purchased 5 years ago (on 13
October, 2004) at $920 if I sell the bond today for $1145? The following
describes the bond: It was originally sold on 13 October 1999, matures on
13 October 2039, and has a coupon rate of 13%.
d)
What is the market equilibrium price of a common share if the most
recently paid dividend was $1.40, the growth rate is negative 5%, and the
required rate of return is 16%?
8