FIN 202 RECITATION QUESTIONS 1) Sunbeam Corporation is trying to choose between the following two mutually exclusive projects. Assume that the required return is 12% for both projects. Year Project A Project B 0 $7,500.00 -$20,000.00 1 $3,750.00 $3,000.00 2 $3,750.00 $8,000.00 3 $3,750.00 $13,000.00 4$3,750.00 $18,000.00 a. If you apply "Payback" cnitenion, which investment you choose? Why? b. If you apply "Discounted Payback" criterion, which investment you choose? Why? c. If you apply "Profitability Index" criterion, which investment you choose? Why? d. If you apply "NPV" criterion, which investment you choose? Why? e. If you apply "IRR" criterion, which investment you choose? Why? f. Based on your answer in (a) through (e), which project will you finally choose? Why? of a new project by purchasing a computer-based order entry system that costs $560,000. The machine wl be depreciated straight-line to zero over its five-year life time. The machine will be worth $56,000 at the end of the project (at the end of five-year life). The project is estimated to generate $450,000 in annual sales, with cost of $170,000. And you will be able to reduce working capital by $71,000. If the tax rate is 34 percent, what is the IRR for this project? 3. Stock in Daenerys Industries has a beta of 1.2. The market risk premium is 8 percent, and T-bills are currently vielding 5.1 percent. The company's most recent dividend was $1.50 per share, and dividends are expected to grow at an annual rate of 8 percent indefinitely. If the stock sells for $40 per share, what is your best estimate of the company's cost of equity? 4. Titan Mining Corporation has 8.2 million shares of common stock outstanding, 260,000 shares of 4 percent preferred stock outstanding, and 140,000 7 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $30 per share and has a beta of 1.10, the preferred stock currently sells for $80 per share, and the bonds have 10 years to maturity and sell for 110 percent of par. Annual yield to maturity of the bonds is 5.68%. The market risk premium is 7 percent, T-bills are yielding 3 percent, and the company's tax rate is 38 percent a. What is the firm's market value capital structure? b. If the company is evaluating a new investment project that has the same risk as the firm's typical project, what rate should the firm use to discount the project's cash flows? 5) Consider the following information Security MMNN Security PRST 1.56 1.67 Standard Deviatio 21% 19% a. Which security has more total risk? Why? b. Which security has more systematic risk? Why? c. Which security should have the higher expected return? Why? 6) You have $15,000 to invest in a portfolio containing Stock A and Stock B. Your goal is to create a portfolio that has an expected return of 14%. Assume that Stock A has an expected return of 13%, and Stock B has an expected return of 9%. a. How much money will you invest in stock B? b. How do you interpret your answer? 7) There are three states of economy and you are given the following probabilities and returns for each stock for each state of economy. You invest 65% in stock X and 35% in stock Y. The betas for each stock are also given belovw Probability of State of Economy 25% 50% 25% State of Returns if State Occurs Economy Stock X 20% 10% 5% StockY Boom Normal Recession 18% 3% 3% Stock Portfolio Weights Beta 1.05 0.70 65% 35% a. Calculate the expected return of the portfolio b. Calculate the standard deviation of the portfolio c. Calculate the beta of the portfolio d. Is the systemic risk of the portfolio is more or less than the market? 8) Eco Corporation is considering a five year project to improve its production efficiency Buying a new machine for $25,000, the company will generate $12,500 per year in annual sales, with costs of $5,500. The machine wil be depreciated straight-line to zero over its 10-year life and it will have a salvage value of $13,000 at the end of the project. The salvage of the machin at the end of its lifetime is expected to be 0. The project also requires investing $8,000 in inventory and other net working capital items. Ifthe relevant tax rate is 35% and your discount rate is 15%, compute NPV of the project
