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business
principles of finance

Questions and Answers of Principles Of Finance

a. Compute the annual returns on the funds for the period.
e. If you had to choose between the two stocks, which would you choose? Explain briefly.
d. The covariance and correlation of the returns for each firm. Use two formulas to compute the correlation: The Excel function Correl and the definition Correlation r r Cov r r A B A B A B,, ( )= (
c. The variance and the standard deviation of returns, for the period of 10 years for each firm. Which stock is riskier?
b. The mean (average) 10- year return for the period for each firm.Which stock has the higher average return?
a. The annual returns for each stock.
18. (Compute average return and sigma) Go to the Principles of Finance with Excel companion website for Chapter 7, where you’ll find a template with data on annual stock prices for Kellogg and Ford
17. (Compute average return and sigma) Go to the Principles of Finance with Excel companion website for Chapter 7, where you’ll find data on annual stock prices for Kellogg for 1995– 2014.
16. (Compute average return and sigma) Go to the Principles of Finance with Excel student website for Chapter 7, where you’ll find a template for data on annual stock prices for Ford Motor Company
b. Use the Excel function Frequency to build a frequency distribution of the stock returns and graph this distribution.
a. Compute the daily stock returns and graph them.
15. (Compute average return and sigma) Go to the Principles of Finance with Excel companion website for Chapter 7, where you’ll find a template for daily adjusted closing prices for AMD
b. What should be the exchange rate on 1 January 2011 in order for the investment in SFr to be better than the investment in the U.S. dollars?
a. One year after the start of the savings in Switzerland, the exchange rate was 1.45 Sfr per U.S. dollar. If the investor turned his savings back into dollars, what rate of return did he earn?
14. (Return calculation) On 1 January 2010, an American investor bought$1,000,000 worth of Swiss francs (SFr) and put it in a savings account for 1 year. The annual interest rate in Swiss francs was
13. (Annual return calculation) At the end of 2009, an investor bought 10,000 shares of Yakuna Corporation for ¥456 each in the Japanese stock market(¥ is the symbol for Japanese yen). At that
12. (Trading volume and return) A well- known finance professor published a paper in which he argued that due to the high volume of stock trade in the Internet, he expects stock returns to decline in
11. (Risk and return) Can you think of a risk- based explanation for the following finding? Over the last 40 years, “small stocks”— defined as shares of firms with a low market value— had
b. What will be the influence of the new estimation on the DEF stock price, assuming the cost of capital for the stock holders is 15%?
a. What will be the influence of the new probability distribution on the expected return on DEF bonds?
10. (Expected return calculation) “DEF” is a firm that is traded on NASDAQ. On 1/ 1/ 2014, the company issued 10,000 zero coupon bonds. Each bond has a face value of $100 and matures on 1/ 1/
9. (Risk and volume of trade) On 15 January 2016, the U.S. government issued two series of bonds. The two series are completely identical except for the fact that the volume of trade in the first
8. (Ex- ante and ex- post risk and return) During a finance lecture, Professor Johnson explained to his students the relation between higher risk and higher expected returns. At the end of the
7. (Risk- return trade- off) One of the ways in which the U.S. helps foreign countries is to guarantee their bank loans. Explain (in short) what are the benefits for foreign countries in getting
6. (Risk- neutral investor) On Planet “Apathy,” all investors are indifferent to risk. The annual expected returns of government bonds are 5%. Does that mean that the average stock returns should
5. (Risk- neutral investor) A risk- neutral investor is willing to make bets with an expected return of zero. Suppose a risk- neutral investor is offered the chance to participate in a die- toss game
4. (Risk-averse investor) A basic assumption of economics is that investors are risk averse, meaning that when they view asset A as riskier than asset B they will demand a higher expected return.A
3. (Factors affecting return) During a stamp collector convention, the chairman spoke about the profitability of investing in rare stamps. “Last year I invested$150,000 in rare stamps. These stamps
2. (Factors affecting return) Can a corporate bond have a lower expected return than a government bond? Can it have lower ex- post return?
1. (Should we only consider returns?) Professor Smith was bragging at the local watering hole about her abilities as an investor in the stock market: “In the last month, I earned 8% on my
b. Fill in the data table at the bottom of the template to show the relation between annual vaccine sales and the NPV.
a. If the annual sales are 200,000, what will be the NPV and IRR of the product over its 10- year life?
19. (Cash- flow analysis) The Long- Life Company has a new vaccine. The company estimates that it has a 10- year monopoly for the production of the vaccine, and it is trying to estimate how many
Variable costs: $50 per pair of shoes.Kane’s discount rate is 12%, the corporate rate is 35%, and R&D expenses are tax deductible against other profits of the company. Assume that at the end of the
Fixed costs: $300,000 annually.
Expected annual sales: 5,000 pairs of shoes at $150 per pair.
Investment in machinery: $250,000 (at t = 3); expected life span of the machine, 10 years. The machine will produce in years 4, 5, …, 13.
Expected life span of project: 10 years from purchase of the machine in year 4.
Production and sales: Can only begin in year 4, after an appropriate machine is purchased at the end of year 3.
R&D: $200,000 annually today and in each of the next 3 years(years 0, …, 3).
17. (Cash- flow analysis) Kane Running Shoes is considering the manufacturing of a special shoe for race walking that will indicate if an athlete is running(this happens if neither of the walker’s
b. Due to Poseidon’s good connections on Olympus, he can get a tax reduction. What is the maximum tax rate at which the project will be profitable?
a. Will the shipping line be profitable?
16. (Cash- flow analysis) Poseidon is considering opening a shipping line from Athens to Rhodes. In order to open the shipping line, Poseidon will have to purchase two ships that cost 1,000 gold
b. Plot a graph showing the profitability of investment in each machine type depending on the annual production.
a. If the company manufactures 1,000,000 units per year, which machine should it buy?
The cost of capital of Coka is 11% and the corporate tax rate is 40%. The machine will be straight- line depreciated over 12 years to its terminal value.a. What is the minimum number of cans that the
13. (Cash- flow analysis, break- even points) The Coka company is a soft drink company. Until today, the company bought empty cans from an outside supplier that charges $0.20 per can. In addition,
b. Plot a graph in which the NPV is the dependent variable of the annual production.
a. What is the break- even point of the bathrobe department (what is the minimal number of units it needs to sell so the expansion is profitable)?
Price per bathrobe: Each of the bathrobes will be sold at a price of$45 at the first year. The company estimates that it can raise the price of the bathrobes by 10% in each of the following years.The
Variable costs: First- year variable costs are estimated at $30 per bathrobe, but due to the expected increase in labor costs, they are expected to rise at 5% per year.
Fixed costs: Incremental fixed costs of the new department will be$40,000 annually.
Advertising campaign: The head of the marketing department estimates that the campaign will cost $80,000 annually.
Purchase of a new machine: The cost of the machine is $150,000, and its expected life span is 5 years. The machine will be depreciated to zero salvage value, but the chief economist of the company
10. (Cash- flow analysis) The “Less Is More” company manufactures swimsuits.The company is considering expanding to the bathrobe market. The proposed investment plan includes:
e. The Marketing Vice President would like some sensitivity analysis done. He asks, “What would be the NPV of the project if annual unit sales vary from 400,000, 450,000, …, 900,000 and if the
d. The C&S Marketing Vice President suggested canceling the advertising campaign. In his opinion, the company sales will not be reduced significantly due to the cancellation. What is the minimum
c. What is the minimum price that the company should charge for each bar if the project is to be profitable? Assume that the price of the bar does not affect sales.
b. What is the NPV of the project if the marketing director’s projections are correct?
a. What are the capital gains/ losses from selling the machine after 5 years?
The machine can produce up to 1 million ice cream bars annually. The marketing director of C&S believes that if the company will spend $30,000 on advertising in the first year and another $10,000 in
9. (Cash- flow analysis) The “Cold and Sweet” (C&S) company manufactures ice cream bars. The company is considering the purchase of a new machine that will top the bar with high- quality
b. What is the NPV of purchasing the air- conditioning system if the discount rate is 12% and corporate tax rate is 35%?
a. What is the December equivalent pre- tax and pre- depreciation annual profits?
You are the owner of a factory located in a hot tropical climate. The monthly production of the factory is $100,000 except during June– September, when it falls to $80,000 due to the heat in the
b. Calculate the project’s IRR.
7. (NPV and cash flows) The ABD Company is considering buying a new machine for one of its factories. The machine cost is $100,000, and its expected life span is 8 years. The machine will be
2. (Sunk costs) Your uncle is a proud owner of an up- market clothing store.Because business is down, he is considering replacing the languishing tie department with a new sportswear department. In
c. What is the discount rate that makes you indifferent between the two alternatives?
b. If the relevant discount rate is 9%, which alternative should you prefer?
1. (Sunk costs) We return to the sunk cost example of Section 6.2. You have invested $100,000 in a badly built house. For $20,000 invested today, you can fix up the house and sell it 1 year from
Miscellaneous expenses of $1,000 also occur at mid- year.
The annual rent of $24,000 occurs at mid- year. This is an approximation to the fact that the renters pay their rent monthly.
b. Compute the balloon payment that gives a 7% EAIR.
a. Assuming 30 days per month, compute the effective annual interest rate (EAIR) in the lease.
Smart car cash cost: $18,800
Daily payment: $9.95 per day, payable monthly
No initial deposit, $8,995 balloon payment at end of lease
Lease term: 48 months
17. (EAIR on a lease) Capital Star Motors of Canberra, Australia, has the following lease offer for a Smart car:
c. What is the effective annual interest rate on the Uranus mortgage?
b. After repaying his credit card debts, how much money will Michael have left?
a. What will Michael’s monthly payments be on the new mortgage?
There are no penalties involved in repaying the $67,000 existing mortgage.
The new mortgage would be for 25 years and would have an annual interest rate of 9.23% (this is APR, i.e., stated rate). The mortgage would be repayable in equal monthly payments over this term, at a
16. (Refinancing mortgage, EAIR) Michael Smith was in trouble: He was unemployed and living on his monthly disability pay of $1,200. His credit card debts of $19,000 were threatening to overwhelm
d. Receive 10% stated annual interest rate in the first year and 15%stated annual interest rate in the second year, compounded annually.
c. Receive 11.5% stated annual interest rate, compounded daily.
b. Receive 12.5% stated annual interest rate, compounded annually.
a. Receive 12% stated annual interest rate, compounded monthly.
5. (FV with stated rate) You plan to put $10,000 in a savings plan for 2 years. How much will you have at the end of 2 years with each of the following options?
d. $400 at the end of each year (in perpetuity) commencing in 1 year
c. $9,000 at the end of 4 years
b. $10,000 at the end of 5 years
a. $5,000 today
14. (PV with stated rate) Assuming that the interest rate is 5%, compounded semi- annually, which of the following is more valuable?
d. Byfus Bank is offering 11.5% stated annual interest rate, compounded continuously.
c. Plebian Bank is offering 10% stated annual interest rate, compounded monthly.
b. WNC Bank is offering 11% stated annual interest rate, compounded twice a year.

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