Youre given with a 5-year auto loan from your credit union. Suppose the car costs $46,000 and your down payment is $8,000. The current market interest rate is 4.4% for the short-term loans with the same creditability as yours. Answer the following questions:

1. Given that the APR (namely the Annual Percentage Rate. That is, the stated interest agreed on the loan) of the loan is 4.4% per year, what is the monthly payment if youre intended to have the loan for 5 years?

2. What is the effective annual rate if the loan is compounded monthly?

3. Suppose the credit union says that if youd like to retire the loan earlier, say at the end of the 3rd year, you need to pay (say) $24,000 for the rest of the loan, would you take it given that you have no difficulty to generate the cash flow? Why or why not?

4. Suppose the original agreement that you signed with credit union is to have a 3-year loan and pay back the loan with $24,000 at the end of year 3, how much will be your monthly payment now?

5. Given that the present value of the loan which is $35,000 now, what is the Internal Rate of Return (IRR) for this loan? Is this rate different from the 4.4% market interest rate? Why or why not?

You are given with the following information of two projects planned by your company. Each cash flow per year shown in Table 1 represents the cash flow at the end of each year during the project. For instance, for project A, the cash flow as 613 in first year is expected at the end of the Year 1. The initial outlays for the projects are paid out by installments with regular payments as 0.89 million at the beginning of each year for project 1 and $0.91 million per beginning of each year for project 2, respectively.

Table 1: (in thousands)

Project	Year 1	Year 2	Year 3	Year 4	Year 5
A	613	2192	1220	2427	2601
B	638	3189	2942

Answer the following questions.

a) Suppose the cost of capital is 12%, what is the Net Present Value for each project? Which project would you prefer? Why?

b) What are the pros and cons in using the NPV decision rule for the capital budgeting?

c) Let the corporate income tax rate be 25%, the cost of debts (that is, the interest rate) be 6.5%, the cost of equity be 26% and there is no preferred stock issued by the firm. Assuming the weighted average cost of capital is given as 12% in a), what is the debt-to-equity ratio for your company?

d) Find the IRR (Internal Rate of Return) for project A and project B. What is your decision based on the IRR criterion?

e) Suppose there is a 45% chance that the market may be bad and the cash flows for both projects when market condition is bad will change to

Project	Year 1	Year 2	Year 3	Year 4	Year 5
A	350	920	-919	-1092	-1321
B	376	-2872	-2008

That is to say, the original cash flows in Table 1 only have 55% chance to happen. What is your decision for each project? What is the value contributed by the Real Option(that is, the possibility to discontinue the project) for each project if you can discontinue the projects when you find out that they may not be successful when possible negative cash flows are expected?

You are given with the following information of two proposals of financing programs for your home loan. Suppose the new house costs you $680,400 (sales taxes and others are included). One program is asking you to deposit a 20% down payment on the $680,400 and it provides you with 3.2% interest rate for 15-year monthly payments of the remaining balance, the other program is a 100% financing program which gives a 1.2% for the first 5 year plus the PMI (property mortgage insurance) as $150 per month with a balloon payment as $650,000, (that is, a lump-sum payment at the end of 5th year). The mortgage rate increases to 5.4% afterward for a 30-year mortgage if the balloon payment is not paid and refinancing is applied (That is, the extended program for refinancing is for 30 years and its not for the 25 years leftover only). Let there be no prepayment penalty. That is, you may pay off the loan should you have some extra cash later on. The brokerage fees and commissions are already taken into account in all the numbers given. Answer the following questions:

a) What is the monthly payment for each program in the first 5 years? Which one more favorable to you if your monthly income is $6,000 before tax? (Notice that most lenders will require the borrower to have the ratio between mortgage payment and monthly gross income no greater than 33%).

b) Suppose 4 years later, the market price of your house is $868,000. The tax rate on gains/losses on house sales is 12%. Will you consider selling this house and buy a bigger one if your income has gained to $8500 per month? What is the annualized rate of return net of your financing cost in your housing investment for each financing program?

c) Suppose there is a 15% income tax on your gain in selling your house, how much is the after-tax return now for each financing program?

5. (40 points)You have the following information for the company Spear. The beta coefficient for Sear is 1.21 based on the past information. The 5-year average of 30-day T-bill rate is 2%, the average market return of (say, S&P 500 index) in the same period is 16.5%. Answer the following questions:

1. What is the required rate of return for Spear? Why do we call it required rate of return?

2. Suppose the current dividend for Spear is $3.12 per share with possible expected growth rate as 7% per year from now on, what is your assessment for the value of Spears stock?

3. Suppose without using the information of beta, the current market price for the Spears stock is $27.72 per share. Let the capital market be efficient as ideally assumed. That is, the current stock price is equal to the stocks present value. What is the required rate of return for this stock now if the information in (b) still applies? What is the beta associated with this stock now?

4. Spear has the following capital structure: the firm issued 6 million shares of common stock with the stock price given in c) and dividend in b), the firm also issued 2 million shares of preferred stock with $1.09 preferred dividend per share, and currently, Spear has $90 million in debts with interest rate as 6%. Suppose the current preferred stock price is $6.72 per share. The corporate tax rate is 30% and the common stock price is as given in c), what is the (after-tax) weighted average cost of capital (after tax) for Spear?

5. What is meaning of Weighted Average Cost of Capital (after tax)? Why do we usually apply it as the discount rate for expected future cash flows in capital budgeting decisions?

Let the information on your portfolio be given as follows. You have three funds in the basket. The "beta's" among them that are estimated by using S&P 500 index are given as follows; = 1.47, = 1.03 = 0.96. Answer the following questions;

1. Why do we need these "beta's" to construct the portfolio?

2. If the risk-free rate is given as 2%, what are the required returns for fund 1 and fund 2 if the market rate of return is expected to have 15%?

3. Is it possible to construct a risk-free (or zero-beta) portfolio by combining asset 1 and asset 2? If yes, what is the required return for this portfolio? If the transaction cost for this portfolio requires 2.5% of commission, will you do it?

4. If you'd like to form a portfolio with fund 1 and fund 2 that replicates fund 3s beta, what are the weights of this portfolio? What are the assumptions needed for the construction of such portfolio?

Company Wii gives you the following information for its operation. The expected income available for dividends is $50 million next year before the firm has any debts. Suppose there is a 20% corporate income tax imposed on the company. Company Wii has no debt originally. There are 6 million shares of common stocks outstanding. Let the market price for the stock be $42.5 per share before debt. Suppose that there is no expansion plan for the company to either spend on working capital vs. long-term investment or to apply the accumulated retained earning. Answer the following questions:

a) What is the possible dividend per share for the common stock before company Wii has debt? What is the cost of equity for Company Wiis stock before debt? Suppose that Company Wii now has issued some bonds with 4% coupon rate recently. Let Company Wiis total debts (with the above coupon bond) be $84 million and let this coupon rate represent the cost of debt, how much will be the value of stockholders equities under Modigliani and Millers proposition 2?

Proposition 2 of the Capital Structure Theory indicates: IF theres corporate income tax, then debt is good! More debts=more value

c) What is the weighted average cost of capital after Company Wii has debts?

d) Suppose the risk-free rate is 2%, S&P 500 index return is 12%, what is the beta of Company Wiis common stock after issuing debts?

e) Explain the M&M proposition 2 in words and intuition. Do not copy the equations given in the class. What are the limitations of M&M proposition 2?

8. (20 points) You are given with the following information of a firm "Hunger Game" in food industry. Assume that the firm did not issue preferred stocks while the firm may have some foreign subsidiaries overseas. The firm is making hi-tech instruments for medication. That is, the firm is in the healthcare industry. This industry tends to have gross profit margin such as 22% and other set-up costs are also relatively high due to the production and technology. The R&D (Research and Development) costs are entirely reported as operating expenses according to the GAAP.

Balance Sheet (in millions)

2013 20142015

Assets

Cash 130 210 70

Marketable securities 51 2001000

Accounts Receivable 220 350 200

Inventory 10621078 450

Plant, Building, and Equipment (net)187322031790

Investments in affiliates 0 430 329

Total Assets 333644713839

Liabilities

Short-term debts 107 130 30

Advances from customers 121 326 534

Accounts payable 5851092 357

Interest payable 75 298 62

Tax payable 147 120 128

Other Accrued Expenses 20 15 35

Bonds payable 10281076 450

Stockholders' Equity

Common stock 10011201 1975

Additional paid-in capital 74 154 144

Retained earning 178 59 124

Total liabilities and equities 333644713839

Income Statement(in millions)

2013 20142015

Net Sales652954186083

Cost of Goods Sold241521092310

Selling and General Expenses 771 8121059

Depreciation Expense 213 169 484

Interest Expense 397 109 221

Income Tax Expense 275 237 304

Net Income2458 19821705

1. Perform the Ratio Analysis for the firm. (Present all ratios you know.) Will the accounting policy on revenue recognition influence the ratios? Why or why not?

2. Show the Common-Size Statements for Company Hunger Game.

3. Given your result in a), what is your opinion on the firm's performance so far? What is the firm's strategy in raising capital? What are the firm's possible business and financial strategies in your opinions?

4. Given the above information, what will be possible dividend per share for 2015 of Company Hunger Game? Suppose the firm has 6 million shares of stock issued in the market, what is the possible required rate of return for their stock if you based on the shareholders equity of 2015?

9. (20 points) Consider the following claims. Answer them with True or False and your explanation. No credit will be given if no explanation is shown.

1. All firms can issue debts if their asset values are sufficient enough. In particular,

the values of the firms will always increase as they raise more debts since interests on corporate debts are tax-deductible.

b) If the capital market is so efficient that all essential information for the firms values is disclosed in the public, then there is no chance for any investor to make a profit.

c) One of the drawback of Net Present Value principle is that one will easily tend to accept the project(s) that have less years of cash flows - if other things being equal.

d) The expected rate of return for a stock when determined by the Capital Asset Pricing Model (CAPM) is the goal (or target) of the rate of return for the firms equity. Hence, if the stock returns actually reach this rate, it is good enough already.

e) Capital budgeting is to determine the best capital structure for the firm in raising capital from the capital market.

f) To calculate the weighted average cost of capital is to assume that expected rates of return from different sources are evaluated according to relative contributed proportions on entire capitalization without references to where and who contributed the fund.

g) The yield to maturity of the corporate bond is always the expected rate for return for bondholders, regardless of their intended holding horizons of the bonds.

10.Suppose that youre given the following information of rates of return for the stock market as assessed by your financial analyst in mutual fund. Answer the following questions:

1. What are the means, standard deviations for each fund? Why does the mean of the rate of return represent the expectation on the risky asset?

2. What are the co-variances for these funds? Are these funds mutually diversifiable? Why or why not?

3. Explain the assumption(s) and reason(s) why the expected rate of return of investor can be represented by the expected value of the rate of return.

d) Suppose that Fund A represents the Market Portfolio. Let the risk-free rate be 2%, what are the required rates of return for Fund B, and Fund C?

States of the world	Probability	Fund A	Fund B	Fund C
Boom	1/2	12%	36%	18%
Recovery	1/4	16%	12%	8%
Recession	1/4	-4%	-12%	2%

e) Explain the M&M proposition 1 in words and intuition. Do not simply copy the equations given in the class or from investopedia and other sources.