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solve the questions step by step please. all the questions from finance class.

Take-Home Final Exam

Course: Business 330 - Principle of Finance

Date due: as announced in class (05/03/16)

1) Answer all questions. Total points of the test: 280.

2) Provide clear statements and analyses. State your assumptions whenever you

need them. Do turn in on time. No late turn-in will be accepted. Do not

collaborate in all respects. If you violate this policy, you will fail this test.

3) Good Luck! God bless you all.

1. (10 points) Explain the ideas of Systematic, Un-systematic Risk and their relationship

with CAPM. What kind of portfolios will have their expected rates of returns (versus

their ?beta?s?) located on the Security Market Line?

2. (20 points) You?re given with a 5-year auto loan from your credit union. Suppose the

total loan you have is \$32,000 and the current market interest rate is 4.6% for the shortterm loans with the same creditability as yours. Answer the following questions:

a) Given that the APR (namely the Annual Percentage Rate. That is, the stated

interest agreed on the loan) of the loan is 4.6% per year, what is the monthly

payment if you?re intended to have the loan for 5 years?

b) What is the effective annual rate if the loan is compounded monthly?

c) Suppose the credit union says that if you?d like to retire the loan earlier, say at the

end of the 3rd year, you need to pay (say) \$18,000 for the rest of the loan, would

you take it given that you have no difficulty to generate the cash flow? Why or

why not?

d) Suppose the original agreement that you signed with credit union is to have a 3year loan and pay back the loan with \$21,200 at the end of year 3, how much will

be your monthly payment now?

e) Given that the present value of the loan which is \$25,000 now, what is the Internal

Rate of Return (IRR) for this loan? Is this rate different from the 4.6% market

interest rate? Why or why not?

3. (40 points) You are given with the following information of two projects planned by

your company. Each cash flow per year shown in Table 1 represents the cash flow at

the end of each year during the project. For instance, for project A, the cash flow as 735

in first year is expected at the end of the Year 1. The initial outlays for the projects are

paid out by installments with regular payments as 0.84 million at the beginning of each

year for project 1 and \$0.91 million per beginning of each year for project 2,

respectively.

Project

A

B

Year 1

523

638

Table 1: (in thousands)

Year 2

Year 3

Year 4

2390

1029

2327

3189

1842

Answer the following questions.

Year 5

2601

a) Suppose the cost of capital is 14%, what is the Net Present Value for each

project? Which project would you prefer? Why?

b) What are the pros and cons in using the NPV decision rule for the capital

budgeting?

c) Let the corporate income tax rate be 22%, the cost of debts (that is, the interest

rate) be 6.5%, the cost of equity be 26% and there is no preferred stock issued by

the firm. Assuming the weighted average cost of capital is given as 14% in a),

what is the debt-to-equity ratio for your company?

d) Find the IRR (Internal Rate of Return) for project A and project B. What is your

decision based on the IRR criterion?

e) Suppose there is a 40% chance that the market may be bad and the cash flows for

both projects when market condition is bad will change to

Project

A

B

Year 1

350

376

Year 2

720

-1872

Year 3

-919

-1008

Year 4

-1092

Year 5

-1321

That is to say, the original cash flows in Table 1 only have 60% chance to happen. What

is your decision for each project? What is the value contributed by the ?Real Option?(that

is, the possibility to discontinue the project) for each project if you can discontinue the

projects when you find out that they may not be successful when possible negative cash

flows are expected?

4. (40 points) You are given with the following information of two proposals of financing

programs for your home loan. Suppose the new house costs you \$672,400 (sales taxes

and others are included). One program is asking you to deposit a 20% down payment on

the \$672,400 and it provides you with 2.4% interest rate for 15-year monthly payments of

the remaining balance, the other program is a 100% financing program which gives a

1.2% for the first 5 year plus the PMI (property mortgage insurance) as \$150 per month

with a balloon payment as \$650,000, (that is, a lump-sum payment at the end of 5 th year).

The mortgage rate increases to 4.8% afterward for a 30-year mortgage if the balloon

payment is not paid and refinancing is applied (That is, the extended program for

refinancing is for 30 years and it?s not for the 25 years leftover only). Let there be no

prepayment penalty. That is, you may pay off the loan should you have some extra cash

later on. The brokerage fees and commissions are already taken into account in all the

numbers given. Answer the following questions:

a) What is the monthly payment for each program in the first 5 years? Which one more

favorable to you if your monthly income is \$6,000 before tax? (Notice that most

lenders will require the borrower to have the ratio between mortgage payment and

monthly gross income no greater than 33%).

b) Suppose 4 years later, the market price of your house is \$768,000. The tax rate on

gains/losses on house sales is 6%. Will you consider selling this house and buy a

bigger one if your income has gained to \$8500 per month? What is the annualized

rate of return net of your financing cost in your housing investment for each

financing program?

c) Suppose there is a 12% income tax on your gain in selling your house, how much is

the after-tax return now for each financing program?

5. (40 points) You have the following information for the company ?Spy?. The ?beta?

coefficient for ?Spy? is 1.05 based on the past information. The 5-year average of 30-day

T-bill rate is 2%, the average market return of (say, S&amp;P 500 index) in the same period is

14.5%. Answer the following questions:

a) What is the required rate of return for ?Spy?? Why do we call it ?required? rate of

return?

b) Suppose the current dividend for ?Spy? is \$3.12 per share with possible expected

growth rate as 7% per year from now on, what is your assessment for the value of

Spy?s stock?

c) Suppose without using the information of ?beta?, the current market price for the

?Spy?s stock is \$26.50 per share. Let the capital market be efficient as ideally

assumed. That is, the current stock price is equal to the stock?s present value.

What is the required rate of return for this stock now if the information in (b) still

applies? What is the ?beta? associated with this stock now?

d) ?Spy? has the following capital structure: the firm issued 6 million shares of

common stock with the stock price given in c) and dividend in b), the firm also

issued 2 million shares of preferred stock with \$1.09 preferred dividend per share,

and currently, ?Spy? has \$90 million in debts with interest rate as 6%. Suppose

the current preferred stock price is \$6.72 per share. The corporate tax rate is 30%

and the common stock price is as given in c), what is the (after-tax) weighted

average cost of capital (after tax) for ?Spy??

e) What is meaning of ?Weighted Average Cost of Capital (after tax)?? Why do we

usually apply it as the discount rate for expected future cash flows in capital

budgeting decisions?

6. (30 points) Let the information on your portfolio be given as follows. You have three

funds in the basket. The &quot;beta's&quot; among them that are estimated by using S&amp;P 500 index

are given as follows; 1 = 0.47, 2 = 1.83 3 = 0.92. Answer the following questions;

a) Why do we need these &quot;beta's&quot; to construct the portfolio?

b) If the risk-free rate is given as 2%, what are the required returns for fund 1 and

fund 2 if the market rate of return is expected to have 12%?

c) Is it possible to construct a risk-free (or zero-beta) portfolio by combining asset 1

and asset 2? If yes, what is the required return for this portfolio? If the transaction

cost for this portfolio requires 2.5% of commission, will you do it?

d) If you'd like to form a portfolio with fund 1 and fund 2 that replicates fund 3?s

beta, what are the weights of this portfolio? What are the assumptions needed for

the construction of such portfolio?

7. (40 points) Company Wii gives you the following information for its operation. The

expected income available for dividends is \$42 million next year before the firm has

any debts. Suppose there is a 25% corporate income tax imposed on the company.

Company Wii has no debt originally. There are 6 million shares of common stocks

outstanding. Let the market price for the stock be \$42.5 per share before debt.

Suppose that there is no expansion plan for the company to either spend on working

capital vs. long-term investment or to apply the accumulated retained earning.

Answer the following questions:

a) What is the possible dividend per share for the common stock before company

Wii has debt? What is the cost of equity for Company Wii?s stock before debt?

Suppose that Company Wii now has issued some bonds with 6% coupon rate recently.

Let Company Wii?s total debts (with the above coupon bond) be \$80 million and let

this coupon rate represent the cost of debt, how much will be the value of

stockholders? equities under Modigliani and Miller?s proposition 2?

b) What is the cost of equity for Company Wii, if there?s no preferred stock issued

for this company?

c) What is the weighted average cost of capital after Company Wii has debts?

d) Suppose the risk-free rate is 2%, S&amp;P 500 index return is 12%, what is the

?beta? of Company Wii?s common stock after issuing debts?

e) What are the limitations of M&amp;M proposition 2?

8. (20 points) You are given with the following information of a firm &quot;Hunger Game&quot; in

food industry. Assume that the firm did not issue preferred stocks while the firm may

have some foreign subsidiaries overseas. The firm is making hi-tech instruments for

medication. This industry tends to have gross profit margin such as 18% and other

set-up costs are also high due to the production and technology. The R&amp;D (Research

and Development) costs are entirely reported as operating expenses according to the

GAAP.

Balance Sheet (in millions)

Assets

Cash

Marketable securities

Accounts Receivable

Inventory

Plant, Building, and Equipment (net)

Investments in affiliates

Total Assets

Liabilities

Short-term debts

Accounts payable

2011

2012

2013

130

51

220

1062

1873

0

210

200

350

1078

2203

430

70

1000

200

450

1790

329

3336

4471

3839

107

121

585

130

326

1092

30

534

357

Interest payable

Tax payable

Other Accrued Expenses

Bonds payable

75

147

20

1028

298

120

15

1076

62

128

35

450

1001

74

1201

154

1975

144

178

3336

59

4471

124

3839

Net Sales

Cost of Goods Sold

Selling and General Expenses

Depreciation Expense

Interest Expense

2011

6529

2215

1771

213

397

2012

5418

3109

812

169

109

2013

6083

3310

1059

484

221

Income Tax Expense

Net Income

275

1658

237

982

254

755

Stockholders' Equity

Common stock

Retained earning

Total liabilities and equities

Income Statement(in millions)

a) Perform the Ratio Analysis for the firm. (Present all ratios you know.) Will the

accounting policy on revenue recognition influence the ratios? Why or why not?

b) Show the Common-Size Statements for Company Hunger Game.

c) Given your result in a), what is your opinion on the firm's performance so far?

What is the firm's strategy in raising capital? What are the firm's possible

business and financial strategies in your opinions?

d) Given the above information, what will be possible dividend per share for 2013

of Company Hunger Game? Suppose the firm has 6 million shares of stock

issued in the market, what is the possible required rate of return for their stock if

you based on the shareholders? equity of 2013?

9. (20 points) Consider the following claims. Answer them with ?True? or ?False?

and your explanation. No credit will be given if no explanation is shown.

a) All firms can issue debts if their asset values are sufficient enough. In particular,

the values of the firms will always increase as they raise more debts since

interests on corporate debts are tax-deductible.

b) If the capital market is so efficient that all essential information for the firms?

values is disclosed in the public, then there is no chance for any investor to make

a profit.

c) One of the drawback of Net Present Value principle is that one will easily tend to

accept the project(s) that have less years of cash flows - if other things being

equal.

d) The expected rate of return for a stock when determined by the Capital Asset

Pricing Model (CAPM) is the ?goal (or target)? of the rate of return for the firm?s

equity. Hence, if the stock returns actually reach this rate, it is good enough

e) Capital budgeting is to determine the best capital structure for the firm in raising

capital from the capital market.

f) To calculate the weighted average cost of capital is to assume that expected rates

of return from different sources are evaluated according to relative contributed

proportions on entire capitalization without references to where and who

contributed the fund.

g) The yield to maturity of the corporate bond is always the expected rate for return

for bondholders, regardless of their intended holding horizons of the bonds.

10. (20 points) Suppose that you?re given the following information of rates of return for

the stock market as assessed by your financial analyst in mutual fund. Answer the

following questions:

a) What are the means, standard deviations for each fund? Why does the ?mean? of

the rate of return represent the expectation on the risky asset?

b) What are the co-variances for these funds? Are these funds mutually

?diversifiable?? Why or why not?

c) Explain the assumption(s) and reason(s) why the expected rate of return of

investor can be represented by the expected value of the rate of return.

d) Suppose that Fund A represents the Market Portfolio. Let the risk-free rate be 3%,

what are the required rates of return for Fund B, and Fund C?

States of

world

Boom

Recovery

Recession

the Probability

1/2

1/4

1/4

Fund A

12%

18%

4%

Fund B

Fund C

36%

8%

-12%

18%

16%

-8%

e) Explain the M&amp;M proposition 1 in words and intuition. Do not copy the equations

given in the class.

Paper#9209170 | Written in 27-Jul-2016

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