Question 1:
"Mr. Art Deco will be paid $100,000 one year hence. This is a nominal flow, which he discounts at an 8% nominal discount rate:
PV = 100,000/1.08 = $92,593
The inflation rate is 4%.
Calculate the PV of Mr. Deco's payment using the equivalent real cash flow and real discount rate. (You should get exactly the same answer as he did.)"
Question 2:
The following table shows the nominal returns on U.S. Stocks and the rate of inflation:
| Year |
Nominal Return (%) |
Inflation (%) |
| 2004 |
12.5 |
3.3 |
| 2005 |
6.4 |
3.4 |
| 2006 |
15.8 |
2.5 |
| 2007 |
5.6 |
4.1 |
| 2008 |
-37.2 |
0.1 |
a) What was the standard deviation of the market returns?
b) Calculate the average real return.
Question 3:
Suppose that the Treasury bill rate were 6% rather than 4%. Assume that the expected return on the market stays at 10%. Use the betas in Table 8.2 (p. 193) - also provided below.
"a. Calculate the expected return from Dell.
b. Find the highest expected return that is offered by one of these stocks.
c. Find the lowest expected return that is offered by one of these stocks.
d. Would Ford offer a higher or lower expected return if the interest rate were 6% rather than 4%? Assume that the expected market return stays at 10%.
e. Would Exxon Mobil offer a higher or lower expected return if the interest rate were 8%?
Question 4:
A company is 40% financed by risk-free debt. The interest rate is 10%, the expected market risk premium is 8%, and the beta of the company's common stock is .5.
| Risk Free Debt |
Interest Rate |
Market Risk Premium |
Beta |
Taxes |
| 40% |
10% |
8% |
0.5 |
35% |
a. What is the company cost of capital?
b. What is the after-tax WACC, assuming that the company pays tax at a 35% rate?
Question 5:
Suppose that the expected variable costs of Otobai's project are ¥33 billion a year and that fixed costs are zero.
a. How does this change the degree of operating leverage (DOL)?
b. Now recompute the operating leverage assuming that the entire ¥33 billion of costs are fixed.
Question 6:
Here are key financial data for House of Herring, Inc.:
| Earnings per share for 2015 |
$5.50 |
| Number of shares outstanding |
40 million |
| Target payout ratio |
50% |
| Planned dividend per share |
$2.75 |
| Stock price, y/e 2015 |
$130 |
"House of Herring plans to pay the entire dividend early in January 2016. All corporate and personal taxes were repealed in 2014.
a. Other things equal, what will be House of Herring's stock price after the planned dividend payout?
b. Suppose the company cancels the dividend and announces that it will use the money saved to repurchase shares. What happens to the stock price on the announcement date? Assume that investors learn nothing about the company's prospects from the announcement. How many shares will the company need to repurchase?
c. Suppose the company increases dividends to $5.50 per share and then issues new shares to recoup the extra cash paid out as dividends. What happens to the ex-dividend share prices? How many shares will need to be issued? Again, assume investors learn nothing from the announcement about House of Herring's prospects.
Question 7:
"Assume that MM's theory holds with taxes. There is no growth, and the $40 of debt is expected to be permanent. Assume a 40% corporate tax rate.
a. How much of the firm's value is accounted for by the debt-generated tax shield?
b. How much better off will UF's a shareholder be if the firm borrows $20 more and uses it to repurchase stock?"
Question 8:
A project costs $1 million and has a base-case NPV of exactly zero (NPV = 0). What is the project's APV in the following cases?
a. If the firm invests, it has to raise $500,000 by a stock issue. Issue costs are 15% of net proceeds.
b. If the firm invests, its debt capacity increases by $500,000. The present value of interest tax shields on this debt is $76,000.
Question 9:
If a firm pays its bills with a 30-day delay, what fraction of its purchases will be paid in the current quarter? In the following quarter? What if the delay is 60 days?