AGEC $424$ EXAM 2 (132 points)

Spring 2015

Name______

Show your work for all questions. Logically correct work, including calculator inputs and outputs (distinguish the output) when appropriate, must be shown to receive credit for your answers. I did not write “show your work here” on the questions, but you still must show your work!

1.  (8 points) Carol Pasca just had her fifth birthday. As a birthday present, her uncle promised to contribute $300 per month to her education fund until she turns 18 and starts college. Carol’s parents estimate college will cost $2,500 per month for four years, but don’t think they’ll be able to save anything toward it for five years. How much will Carol’s parents need to contribute to the fund each month starting on her tenth birthday to pay for her college education? Assume the fund earns 6% compounded monthly.

2.  What are the monthly mortgage payments on a 30-year loan for $250,000 at 5.75% compounded monthly?

a. (4 points) Show work and calculate the monthly payment to the penny

b. (10 points) Construct an amortization table for the first two months of the loan. Show the work for your interest calculation.

Month Beg Bal Payment Interest Prin. Reduction End Balance

3.  (4 points) First Bank offers you a car loan at an annual interest rate of 10% compounded monthly. What effective annual interest rate is the bank charging you?

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a. / 10.38%
b. / 10.42%
c. / 10.45%
d. / 10.47%

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4.  (4 points) The Lexington Property Development Company has a $10,000 note receivable from a customer due in three years. How much is the note worth today if the interest rate is

a. 12% compounded monthly?

b. 8% compounded quarterly?

5.  (4 points) You want to purchase a boat that costs $40,000. You want to finance as much of the purchase as possible with a 5-year bank loan at 12% compounded monthly, but can only afford loan payments of $750 per month. How much will you need as a down payment to buy the boat?

6.  (5 points) Jackrabbit Inc. has an outstanding semiannual, 8% coupon, $1000 face value bond with 12 years to maturity. What is this bond worth assuming the market is currently requiring a 6% rate of return on bonds of this risk?

7.  (5 points) Wildman Products Inc. has an outstanding semiannual, 9% coupon, $1000 face value bond priced at $1075. The bond has 5 years to maturity. What is this bond’s YTM?

8.  (5 points) What is the current yield of the above Wildman Products bond? What are the expected capital gains the first year?

  1. (5 points) Berry Corp. issued a $1,000 bond with a 14% coupon paid semiannually. It has a yield to maturity of 11%. The bond matures in 15 years. However, it is callable in 10 years with a call premium of one year’s interest. What is the bond’s yield to call if it is purchased today at a price determined by its yield to maturity?

10.  (5 points) Undue Perversity Inc. has a 10 year, callable, semiannual, $1000 face value, 12% coupon bond for sale. It is callable in 3 years with a $100 call premium. If comparable bonds of this risk yield 6% and you expect this bond to be called, what is its value?

11.  (5 points) Sharbaugh Inc.’s most recent dividend was $2.00 per share. The dividend is expected to grow at a rate of 4% per year for the foreseeable future. If the market return is 13% on investments with comparable risk, what should the stock sell for today?

12.  (14 points) Cantaloupe Growers Corp. is expanding into a new geographic area. Management expects the new market to fuel growth of 22% for three years. After that normal growth of 6% will resume. Cantaloupe’s most recent annual dividend was $1.25. Other fruit companies have been returning about 12% lately. How much should a share of Cantaloupe be worth?

13.  (8 points) Charlie Dobbs is considering investing in Astrotech. His research has revealed the following:

The market is returning 11%.; Three month treasury bills are yielding 5%.

Astrotech’s beta is 1.2.; Astrotech recently paid a dividend of $1.50.

Analysts expect Astrotech to grow at 4% indefinitely.

How much should Charlie be willing to pay for a share of Astrotech?

a. / $19.02
b. / $12.00
c. / $10.26
d. / $18.29

14.  (2 points) The return on an investment in stock:

a. / is subject to risk but is generally non-negative like a savings account.
b. / has a standard deviation that has historically been small relative to its average value.
c. / consists of dividend and capital gains yields.
d. / is always very risky.

15.  (2 points) The risks associated with owning a single stock are called:

a. / systematic risk because all stocks in the system are affected.
b. / market risk because the stocks are purchased in the stock market.
c. / stand-alone risk because the stock stands alone outside of any portfolio.
d. / business risk because the stocks represent businesses.

16.  (2 points) Risk in finance:

a. / is variability in return.
b. / can be decomposed into business-specific and market components.
c. / will be accepted by some investors if higher expected returns are offered in compensation.
d. / all of the above

17.  (2 points) The underlying principles of portfolio theory include:

a. / diversifying business-specific risk away.
b. / basing decisions on stocks’ risk/return characteristics in a portfolio context rather than on a stand-alone basis.
c. / getting the highest available return for the amount of risk the investor is comfortable with.
d. / all of the above

18.  (2 points) Which of the following statements is false?

a. / Beta is meaningful only if an investor holds a well-diversified portfolio.
b. / You can completely eliminate risk if you hold a well diversified portfolio.
c. / A portfolio composed of only one stock will not be well diversified.
d. / A wise investor diversifies to capture the high average return of stocks while avoiding as much risk as possible.
e. / All of the above statements are correct.
  1. (2 points) A firm that employs a relatively large proportion of debt in its capital structure will have a relatively ______degree of financial leverage.

a. low

b. high

c. insignificant

d. constant

  1. (2 points) The degree of operating leverage is measured by relating the percentage change in EBIT to the percentage change in

a. sales.

b. earnings per share.

c. debt ratio.

d. share price.

  1. (2 points) When a firm's cost structure consists principally of fixed costs:

a. it is said to have a great deal of operating leverage

b. those costs consist of rent, depreciation, direct labor, management salaries, direct materials, and utilities.

c. the firm might be a factory with many people and few machines

d. all of the above

  1. (2 points) The total variability of EPS associated with a change in sales is an indication of combined leverage best measured by

a. DOL

b. DFL

c. DOL + DFL

d. DOL x DFL

  1. (3 points) Assume that Herron, Inc. has a degree of financial leverage of 1.50. If EBIT increases from $150,000 this year to $165,000 next year, how much will earnings per share (EPS) increase, assuming no change in capital structure?

a. 6.7%

b. 10.0%

c. 15.0%

d. 22.5%

e. Cannot be determined from the information given.

  1. (2 points) A firm markets a product for $30 per unit that has a direct manufacturing cost of $15 per unit. Its contribution margin is:

a. 50%

b. 33.33%

c. $15

d. none of the above

  1. (3 points) Assume the following facts about a single product firm:

Selling price per unit = $25.00

Variable costs per unit = $21.25

Total monthly fixed costs = $3,000

What is the firm's annual breakeven volume in sales revenues?

a. $540,000

b. $240,000

c. $20,000

d. $9,600

  1. (3 points) Porter Productions sells video tapes for $15.00 each. Their variable cost per unit is $9.00. In addition, they incur $180,000 in fixed costs each year. What is the Porter's annual breakeven point in sales revenue?
  1. (2 points) If you invest 30% of your funds in AT&T stock with an expected rate of return of 10% and the remainder in GM stock with an expected rate of return of 15%, the expected return on your portfolio is:

a. 12.5%.

b. 13.0%.

c. 13.5%.

d. 14.5%.

e. none of the above

  1. (3 points) Elephant Company common stock has a beta of 1.2. The risk-free rate is 6 percent and the expected market rate of return is 12 percent. Determine the required rate of return on the security.
  1. (4 points) Ken Howard has a two stock portfolio consisting of Acton Inc. and Boron Corp. Assume the following conditions exist.

Return on the market = 13%

3 month Treasury bill rate = 6%

Acton’s beta = 1.15

Boron’s beta = 1.40

Market value of Ken’s investment in Acton = $125,000

Market value of Ken’s investment in Boron = $250,000

$375,000

Use the portfolio beta to see what the SML predicts as Ken’s required rate of return for the overall portfolio?

30.  (4 points) The Orion Corp. is evaluating a proposal for a new project. It will cost $50,000 to get the undertaking started. The project will then generate cash inflows of $20,000 in its first year and $16,000 per year in the next five years after which it will end. Orion uses an interest rate of 15% compounded annually for such evaluations. Calculate the Net Present Value of the project by treating the initial cost as a cash outflow (a negative) in the present, and adding the present value of the subsequent cash inflows as positives.

31.  (4 points) Assume the following facts about a company: Show work.

Capital / 0% debt / 40% debt / 0% debt / 40% debt
Debt / — / EBIT / $1,000
Equity / $3,000 / Less Interest Expense / —
Total Assets / $3,000 / EBT / $1,000
Shares @ $10 = / 300 / Taxes @ 40% / 400
Earnings after Tax / $ 600

What will be the company’s new EPS if it borrows money at 10% interest and uses it to retire stock until capital is 40% debt? The stock can be purchased at its book value of $10 per share. Fill in the above table and show the EPS calculation below.

a. / $3.33
b. / $4.89
c. / $2.93
d. / none of the above

32.  (4 points extra credit) Conestoga Ltd. has the following estimated probability distribution of returns. Calculate Conestoga’s expected return, the variance, standard deviation, and coefficient of variation.

Return Probability

4% .20

12% .50

14% .30

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