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solutions to the problems posted before

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FIN 401
Alan Kaplan

Miscellaneous Problems (stuff about Ethics, and stuff that just doesnt seem to fit anywhere else) Multiple Choice 1. Douglas Corp. has issued a perpetual bond. The annual coupon rate is 6.2% based on a nominal par value of the bond of $1000. The bond is currently selling for 91% of par value. What is the annual rate of return on the bond? a) .08578 b) .09314 c) .05722 d) .06813 e) None of the above r = cf/p = 62/910 = .06813 There are three kind of return that can be quoted. The annual return (also called the current yield in bonds), the effective return, and the annual percentage rate, or APR. In bond calculations, the YTM is an APR. The problem is, you may see all three types on a M/C question. Ive noticed quite a few instances where effective yields are given instead of YTMs. You need to be able to switch back and forth. See th th page 154 of the 5 edition or page 160 in the 6 ed. for a review of how to switch back and forth In this problem, they want the annual (current) return. It is the easiest to get- just the coupon divided by the price. 2. Fill in the blank. In order to perform ______________ we change one of the inputs while keeping the others constant. a) Sensitivity analysis b) Simulation analysis c) Scenario analysis d) None of the above From our first week review of FIN 300 topics. It is covered in Chapter 11. I wouldnt worry about it too much. You have enough new material to worry about. 3. Fill in the blank. A firm has to make a decision between two projects. It cannot choose both, even if they are both positive NPV projects, because the firm does not have enough money to fund both. This is an example of _________. a) Break-even Analysis b) Monte Carlo Simulation c) Managerial Options d) Capital Rationing From Chapter 10. See comment above. 4. Stern Stewart Corp. has $100 million in assets, a WACC of 12.5%, and cash flows this year of $15 million. What is Stern Stewarts EVA? a) $1,875,000 b) $2,500,000 c) -$2,500,000 d) $15,000,000 e) None of the above We didnt cover this. It is in an Appendix to Chapter 14. If you get time, there is a simple example you can review at the end of the Appendix. EVA = ($15 million) (.125 * $100 million) = $2.5 million Use the following information to answer the next TWO questions. Oyvey Inc. has expected before-tax operating cash flows of $72,000 each year for the next ten years from a planned project. The Corporate Tax rate is 20% but it has a special deal with the government so that it pays tax for the first four years, but then does not pay tax for the rest of the life of the project. The appropriate discount rate is 20%. 5. What is the Present Value as of now of the AFTER-TAX operating cash flows from the first four years of the project? a) $115,469 b) $121,732 c) $136,427 d) $149,111 e) None of the above N = 4, PMT = $57,600, (72,000*.8), r = .2, Solve PV = $149,111 6. What is the Present Value as of now of the AFTER-TAX operating cash flows from the last six years of the project? (Hint: If a firm is does not pay tax, what is its tax rate?) a) $115,469 b) $136,427 c) $194,231 d) $239,437 e) None of the above A bit trickier. You need to get the PV using your calculator. The problem that is the PV at Year 4, not Year 0. Discount it back to today and youll have the right answer. N = 6, PMT = 72,000, r = .2, PV as of the end of year 4 = $239,437 To get it back to Year 0, either calculate 239,437/ 1.20 = $115,469 or use your financial calculator to get the present value: N = 4, FV = $239,437, r = .2, Solve PV as of now = $115,469. Use the following information for the next 9 questions (number 7 to 15). It is 1898 and you are in Dawson City, Yukon, Canada. You sit down beside the Yukon River for a picnic lunch. You look at the water, and see a glitter of yellow. Its gold; ten tons of it. You plan to mine five tons of it per year for two years. Gold sells for $5 per ounce, there are 16 ounces in a pound, and 2000 pounds in a ton. It will cost you $1 per ounce to mine the gold, and there is a $60,000 one time up-front fee for equipment and permits and stuff. The equipment will be worthless after the ore is mined. In 1898, the Government still hasnt gotten around to the idea of taxes on business income. You can borrow money for 8% per year and investors will buy shares in your new Corporation if they receive on average at least 18% per year. You think that you will finance your firm with equal amounts of debt and equity. All variable revenues and expenses occur at the end of each year. 7. What are your firms annual revenues? a) $160,000 b) $800,000 c) $1,600,000 d) None of the Above 5 tons * $5 per ton * 2000 pounds per ton * 16 ounces per pound 8. Which of the following statements is NOT true? a) The project has a positive NPV b) The cashflows before tax equal the cashflows after tax in this case c) The tax benefit from the CCA deduction is positive in this case d) Annual costs are lower than annual revenues There ISNT a CCA deduction. There is no tax, so there cant be any CCA tax shield. If you dont believe me, write out the formula and enter 0 for the tax rate- everything will cancel out 9. What is the WACC for the project? a) .08 b) .105 c) .13 d) .155 e) .18 WACC = re(we) + rd(wd)(1-t) =(.18*.5)+(.08*.5) = .13 10. Which of the following statements is most true? f) The PV of the operating cashflows will be higher in year one than in year two g) The PV of the operating cashflows will be lower in year one than in year two h) The PV of the operating cashflows in year one will be equal to the PV of the operating cashflows in year two i) We cannot determine the relationship between the size of the operating cashflows in year one versus those in year two without more information than is provided in the case j) None of the Above A tough one. The cash flows are the same in each year. Since the cash flows that occur in year one happen sooner than those in year two, the PV of the cash flows in year one will be greater. 11. What are the annual variable costs? a) $10,000 b) $160,000 c) $800,000 d) $32,000 e) None of the above
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