Question 1. (Term Structure of Interest Rates) You want to invest your savings of $30,000 in government securities for the next two years. At the present, you can invest either in a security that pays interest of 8% per year for the next two years or in a security that matures in one year and pays 10 percent interest. If you make the latter choice, you would then reinvest your savings at the end of the first year for another year.
a. Why might you choose to make the investment in the one-year security that pays an interest rate of 10 percent, as opposed to investing in the two-year security paying 8 percent? Provide numerical support for your answer. Which theory of term structure have you supported in your answer?
b. Assume your required rate of return on the second-year investment is 7 percent; otherwise, you will choose to go with the two-year security. What rationale could you offer for your preference?
Question 2. (Measuring Cash Flows) Given the information that follows, compute the free cash flows and financing cash flows for the J.B. Chavez Corporation for the year ended December 31, 2008.
J.B. Chavez Corporation, Balance Sheet at 12/31/07 and 12/31/08 ($000)
Assets
|
|
12/31/07
|
12/31/08
|
|
Cash
|
$225
|
$175
|
|
Accounts receivable
|
450
|
430
|
|
Inventory
|
575
|
625
|
|
Current assets
|
$1250
|
$1230
|
|
Plant and equipment
|
$2200
|
$2500
|
|
Less: Accumulated depreciation
|
(1000)
|
(1200)
|
|
Net plant and equipment
|
$1200
|
$1300
|
|
Total assets
|
$2450
|
$2530
|
Liabilities and Owners' Equity
|
|
12/31/07
|
12/31/08
|
|
Accounts payable
|
$250
|
$115
|
|
Notes payable-current (9%)
|
0
|
115
|
|
Current liabilities
|
$250
|
$230
|
|
Bonds
|
$600
|
$600
|
|
Owners' equity
|
|
|
|
Common stock
|
$300
|
$300
|
|
Paid-in capital
|
600
|
600
|
|
Retained earnings
|
700
|
800
|
|
Total owners' equity
|
$1600
|
$1700
|
|
Total liabilities and owners' equity
|
$2450
|
$2530
|
J.B. Chavez Corporation, Income Statement for the year ending 12/31/07 and 12/31/08
|
|
2007
|
2008
|
|
Sales
|
$1250
|
$1450
|
|
Cost of goods sold
|
700
|
875
|
|
Gross profit
|
$550
|
$575
|
|
Operating expenses
|
30
|
45
|
|
Depreciation
|
220
|
200
|
|
Net operating income
|
$300
|
$330
|
|
Interest expense
|
50
|
60
|
|
Net income before taxes
|
$250
|
$270
|
|
Taxes (40%)
|
100
|
108
|
|
Net income
|
$150
|
$162
|
Question 3. (Ratio Analysis) The balance sheet and income statement for the Simsboro Paper Company are as follows:
|
Balance Sheet ($000)
|
|
|
Cash
|
$1,000
|
|
Accounts receivable
|
1,500
|
|
Inventories
|
1,000
|
|
Current assets
|
$3,500
|
|
Net fixed assets
|
$4,500
|
|
Total assets
|
$8 000
|
|
Accounts payable
|
$1,000
|
|
Accrued expenses
|
600
|
|
Short-term notes payable
|
200
|
|
Current liabilities
|
$1,800
|
|
Long-term debt
|
2,100
|
|
Owners' equity
|
$4,100
|
|
Total liabilities and owners' equity
|
$8 000
|
|
|
|
|
Income Statement ($000)
|
|
|
Net sales (all credit)
|
$7,500
|
|
Cost of goods sold
|
(3,000)
|
|
Gross profit
|
$4,500
|
|
Operating expenses'
|
(3,000)
|
|
Operating income (EBIT)
|
$1,500
|
|
Interest expense
|
(367)
|
|
Earnings before taxes
|
$1,133
|
|
Income taxes (40%)
|
(453)
|
|
Net income
|
$ 680
|
Including depreciation expense of $500 for the year.
Calculate the following ratios:
|
Current ratio
Times interest earned
Inventory turnover
Total asset turnover
Operating profit margin Operating return on assets
|
Debt ratio
Average collection period Fixed asset turnover
Gross profit margin
Return on equity
|
Question 4. (Present Value of an Annuity) What is the present value of the following annuities?
a. $3,000 a year for 10 years discounted back to the present at 8%
b. $50 a year for 3 years discounted back to the present at 3%
Question 5. (Solving for PMT in an Annuity) To pay for your child's education, you wish to have accumulated $25,000 at the end of 15 years. To do this, you plan on depositing an equal amount in the bank at the end of each year. If the bank is willing to pay 7% compounded annually, how much must you deposit each year to obtain your goal?
Question 6. (Expected Rate of Return and Risk) Clevenger Manufacturing, Inc., has prepared the following information regarding two investments under consideration. Which investment should be accepted?
| Security A |
Security B
|
|
Probability
|
Return Probability
|
Return
|
|
|
.20
|
-2%
|
.10
|
5%
|
|
.50
|
19%
|
.30
|
7%
|
|
.30
|
25%
|
.40
|
12%
|
|
|
|
.20
|
14%
|
Question 7. a. (Required Rate of Return Using CAPM) Compute a fair rate of return for Apple
common stock, which has a 1.5 beta. The risk-free rate is 8 percent and the market portfolio (New York Stock Exchange stocks) has an expected return of 16 percent.
b. Why is the rate you computed a fair rate?
Question 8. (Bond Valuation) You own a bond that pays $75 in annual interest, with a $1,000 par value. It matures in 15 years. Your required rate of return is 6 percent.
a. Calculate the value of the bond.
b. How does the value change if your required rate of return (i) increases to 10 percent or (ii) decreases to 4 percent?
c. Explain the implications of your answers in part (b) as they relate to interest rate risk, premium bonds, and discount bonds.
d. Assume that the bond matures in 5 years instead of 15 years. Recompute your answers in part (b).
e. Explain the implications of your answers in part (d) as they relate to interest rate risk, premium bonds, and discount bonds.
Question 9. (Common Stockholder Expected Return) The common stock of Bouncy-Bob Moore Co. is selling for $33.84. The stock recently paid dividends of $3 per share and has a projected constant growth rate of 8.5 percent. If you purchase the stock at the market price, what is your expected rate of return?