Practice Exam: Answer the following questions with the given information.
Project questions: 1. Fun Inc.'s corporate tax rate is 35%. It has 4,000 coupon paying bond outstanding with $1,000 per value, 20-year maturity, and a coupon rate of 7%. The bonds are currently selling for 103% of the par value. The bonds make semi-annual interest payments. Fun Inc. also has 90,000 common shares outstanding, selling for S57 per share. The firm has a market beta of 1.10 Market risk premium is currently 8% and risk-free rate is 6%. The firm is considering a project This project requires an initial investment of S11.5 million and promises to yield annual earnings of $1.4 million perpetually. Determine whether the firm should take the project using the IRR method. Please show all necessary computation including the WACC and make your conclusion [15 Marks] 2. Mathews Mining Company is looking at a project that has the following forecasted sales: first- year sales are 6,800 units and will grow at 15% over the next four years (a five-year project). The price of the product will start at $124 per unit and increase each year at 5%. The production costs are expected to be 62% of the current year's sales price. The manufacturing equipment to aid this project will have a total cost (including installation) of $1,400,000. It will be depreciated using MACRS and has a seven-year MACRS life classification. Fixed costs will be S50,000 per year Mathews Mining has a tax rate of 30%. The manufacturing equipment can be sold for $80,000 at the end of the five-year project. If the cost of capital for this project is 12%, should the project be taken? Do the necessary computation and make your conclusion using NPV method. [15 Marks] TABLE 10.4 MACRS Fixed Annual Expense Percentages by Recovery Class 3-Year 5-Year 7-Year0-Year 15-Year20-Year 3.750% 7219% 6.677% 6.177% 5.713% 6.23% 5.285% 4.888% 4.522% | 5.91% | 4.462% 4.461 % 4.462% 5.90% | 4.461 % 4.462% 5.90% | 4.461 % 5.91% | 4.462% 4.461 % 4.462% 4.461 % 33.33% | 20.00% | 14.29% | 10.00% | 5.00% 44.45% | 32.00% | 24.49% | 18.00% 9.50% 14.81% | 19.20% | 1749% | 14.40% 8.55% 7.70% 6.93% 241% | 11.52% | 12.49% | 11.52% 9.22% 737% 6.55% 6.55% 6.56% 6.55% 3.28% 11.52% 8.93% 8.93% 8.93% 4.45% 5.76% | | 5.90% 5.90% 10 5.90% 5.91% 13 5.91% 16 2.95% 17 19 20 21 4.461 % 2.231 % 3, Red Door Inc has the following information for 2016 and a corporate tax rte of 36% Sales Depreciation Cost of Goods Sold Other Expenses Interest Cash Accounts Receivable Short-term notes payable Long-term debt Net Fixed Assets Accounts Payable Inventory Dividends $7,233 $1,038 $2,487 $591 $485 $3,972 $%5,021 $732 $12,700 S31,805 $3,984 $8,927 $882 a. Prepare a Statement of Comprehensive Income for Red Door Inc. Please provide also information on the dividend amount and retained earnings. [5 Marks] b. Prepare a statement of financial position for Red Door Inc. [5 Marks] 4. You are currently seeking new opportunities given your potential. Your current salary is $35,000. One employer is offering to double your salary and is willing to allow you to have 2% increment every year. Additionally, this employer is willing to offer you a $50,000 bonus on the 25th year anniversary at the job. Another potential employer is offering you a guaranteed job for the next 40 years with a salary of $90,000 per year. If you plan on retiring after 40 years, which job will give the highest present value? Assume current market interest rate is 4%. [10 Marks 5. You are a financial analyst. A stock is expected to pay a dividend in one year of $2 per share It is expected that dividends after that will grow at a constant rate of 3% per year. Returns on the stock have a correlation with the market of 0.35. The standard deviation of the stock's returns is 0.3, and the standard deviation of the returns to the market is 0.15. The yield on Treasury Bills (i.e. the risk-free rate of interest) is 4% and the expected risk premium (ie. expected return above that of T-bills) on the market is 8%. If the current price of the stock in the market is $20, would you recommend buying or selling this stock? Is the stock has more systematic risk than the market? Do the necessary computations and make your conclusion. [10 Marks] 6. There are three possible scenarios for the economy over the next year, Below Average, Average, or Above Average. The possible returns on two stocks, on the stock market, and on Treasury Bills under the different scenarios are given below: [10 Marks] Economy Probability Stock1 Stock 2 return Return to Return to Stock market return T-Bills 0.3 4% 0% Above Average Average Below Average -2% 0.4 9% 12% 4% 10% 0.3 10% 22% 4% 20% As a portfolio manager you are expected to recommend to your clients how they should invest their money. If your clients want to have a portfolio of the two stocks what proportion of your money should be invested in each stock in order for their portfolio to have the same level of systematic risk as the stock market on average? 7. You are in charge of a capital budgeting project under which you are considering two mutually exclusive projects. Both projects have very different initial investments and they involve not only initial investment but also investment requirements throughout the duration of the projects. You are considering NPV, IRR, and PI as your assessment tools. Determine which method will be the most reliable and why? Please provide all necessary detail on each of the methods. [5 Marks] 8. Most academic research concludes that financial markets are semi-strong-form efficient. Discuss how this conclusion may be justified. [5 Marks] Project questions: 1. Fun Inc.'s corporate tax rate is 35%. It has 4,000 coupon paying bond outstanding with $1,000 per value, 20-year maturity, and a coupon rate of 7%. The bonds are currently selling for 103% of the par value. The bonds make semi-annual interest payments. Fun Inc. also has 90,000 common shares outstanding, selling for S57 per share. The firm has a market beta of 1.10 Market risk premium is currently 8% and risk-free rate is 6%. The firm is considering a project This project requires an initial investment of S11.5 million and promises to yield annual earnings of $1.4 million perpetually. Determine whether the firm should take the project using the IRR method. Please show all necessary computation including the WACC and make your conclusion [15 Marks] 2. Mathews Mining Company is looking at a project that has the following forecasted sales: first- year sales are 6,800 units and will grow at 15% over the next four years (a five-year project). The price of the product will start at $124 per unit and increase each year at 5%. The production costs are expected to be 62% of the current year's sales price. The manufacturing equipment to aid this project will have a total cost (including installation) of $1,400,000. It will be depreciated using MACRS and has a seven-year MACRS life classification. Fixed costs will be S50,000 per year Mathews Mining has a tax rate of 30%. The manufacturing equipment can be sold for $80,000 at the end of the five-year project. If the cost of capital for this project is 12%, should the project be taken? Do the necessary computation and make your conclusion using NPV method. [15 Marks] TABLE 10.4 MACRS Fixed Annual Expense Percentages by Recovery Class 3-Year 5-Year 7-Year0-Year 15-Year20-Year 3.750% 7219% 6.677% 6.177% 5.713% 6.23% 5.285% 4.888% 4.522% | 5.91% | 4.462% 4.461 % 4.462% 5.90% | 4.461 % 4.462% 5.90% | 4.461 % 5.91% | 4.462% 4.461 % 4.462% 4.461 % 33.33% | 20.00% | 14.29% | 10.00% | 5.00% 44.45% | 32.00% | 24.49% | 18.00% 9.50% 14.81% | 19.20% | 1749% | 14.40% 8.55% 7.70% 6.93% 241% | 11.52% | 12.49% | 11.52% 9.22% 737% 6.55% 6.55% 6.56% 6.55% 3.28% 11.52% 8.93% 8.93% 8.93% 4.45% 5.76% | | 5.90% 5.90% 10 5.90% 5.91% 13 5.91% 16 2.95% 17 19 20 21 4.461 % 2.231 % 3, Red Door Inc has the following information for 2016 and a corporate tax rte of 36% Sales Depreciation Cost of Goods Sold Other Expenses Interest Cash Accounts Receivable Short-term notes payable Long-term debt Net Fixed Assets Accounts Payable Inventory Dividends $7,233 $1,038 $2,487 $591 $485 $3,972 $%5,021 $732 $12,700 S31,805 $3,984 $8,927 $882 a. Prepare a Statement of Comprehensive Income for Red Door Inc. Please provide also information on the dividend amount and retained earnings. [5 Marks] b. Prepare a statement of financial position for Red Door Inc. [5 Marks] 4. You are currently seeking new opportunities given your potential. Your current salary is $35,000. One employer is offering to double your salary and is willing to allow you to have 2% increment every year. Additionally, this employer is willing to offer you a $50,000 bonus on the 25th year anniversary at the job. Another potential employer is offering you a guaranteed job for the next 40 years with a salary of $90,000 per year. If you plan on retiring after 40 years, which job will give the highest present value? Assume current market interest rate is 4%. [10 Marks 5. You are a financial analyst. A stock is expected to pay a dividend in one year of $2 per share It is expected that dividends after that will grow at a constant rate of 3% per year. Returns on the stock have a correlation with the market of 0.35. The standard deviation of the stock's returns is 0.3, and the standard deviation of the returns to the market is 0.15. The yield on Treasury Bills (i.e. the risk-free rate of interest) is 4% and the expected risk premium (ie. expected return above that of T-bills) on the market is 8%. If the current price of the stock in the market is $20, would you recommend buying or selling this stock? Is the stock has more systematic risk than the market? Do the necessary computations and make your conclusion. [10 Marks] 6. There are three possible scenarios for the economy over the next year, Below Average, Average, or Above Average. The possible returns on two stocks, on the stock market, and on Treasury Bills under the different scenarios are given below: [10 Marks] Economy Probability Stock1 Stock 2 return Return to Return to Stock market return T-Bills 0.3 4% 0% Above Average Average Below Average -2% 0.4 9% 12% 4% 10% 0.3 10% 22% 4% 20% As a portfolio manager you are expected to recommend to your clients how they should invest their money. If your clients want to have a portfolio of the two stocks what proportion of your money should be invested in each stock in order for their portfolio to have the same level of systematic risk as the stock market on average? 7. You are in charge of a capital budgeting project under which you are considering two mutually exclusive projects. Both projects have very different initial investments and they involve not only initial investment but also investment requirements throughout the duration of the projects. You are considering NPV, IRR, and PI as your assessment tools. Determine which method will be the most reliable and why? Please provide all necessary detail on each of the methods. [5 Marks] 8. Most academic research concludes that financial markets are semi-strong-form efficient. Discuss how this conclusion may be justified. [5 Marks]
