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Title Title Description

Topic

1Q
1A

Question 1
Answer 1

Time Value of Money


Time Value of Money

2Q
2A

Question 2
Answer 2

Time Value of Money


Time Value of Money

3Q
3A

Question 3
Answer 3

Capital Budgeting
Capital Budgeting

4Q
4A

Question 4
Answer 4

Capital Budgeting Model


Capital Budgeting Model

5Q
5A

Question 5
Answer 5

Capital Budgeting Model


Capital Budgeting Model

6Q
6A

Question 6
Answer 6

Bonds
Bonds

7Q
7A

Question 7
Answer 7

Stocks
Stocks

8Q
8A

Question 8
Answer 8

Capital Asset Pricing Model


Capital Asset Pricing Model

9Q
9A

Question 9
Answer 9

Portfolios and Diversification


Portfolios and Diversification

Content

Description

Given: Deposit Information


Find: Present value
Future value
Annual, quarterly, and continuous compounding values
Given: Retirement information
Find: Present value of a lump sum for a delayed annuity
Payment per year for a lump sum
Present value of a delayed perpetuity
Given: Expected cash flows for mutually exclusive and independent projects
Find: Net present value (NPV)
Internal rate of return (IRR)
Profitability index (PI)
Modified internal rate of return (MIRR)
Crossover rate
NPV profile
Which project should be accepted and why
Given: Project's potential values
Find: Cash outflow
Operating cash flows each year
Terminal cash flow
NPV
IRR
Given: Project's potential values and MACRS table
Find: Operating cash flows each year
The initial outlay
After tax salvage
NPV
IRR
PI
Scenario summary evaluating NPV, IRR, and PI
Given: Semiannual bond values
Find: Highest price to pay for that bond
Yield to maturity
Current yield
Yield to call
Given: Stock paying annual dividend information
Find: Expected dividend and value for a specific year
Current value of one share of that stock today
Expected price in a specific year
Given: Treasury bill values
Find: The risk premium on the market
Required return with different betas
Slope of the security market line
Expected rate of return using the dividend discount model
The required rate of return using the capital asset pricing model
Determining if the stock is over, under, or fair priced
Equilibrium price for the stock.
Given: Funds probability and estimated return in different stages
Find: Expected return and standard deviation for both
Covariance
Correlation
Covariance matrix
Minimum variance portfolio using solver
Variance
Standard deviation
Expected return

Eleven years ago your parents opened a savings account in your name. The balance today is $260,000
a) How much did they deposit 11 years ago at 8% annual interest rate
b) How much will be in your account in 7 years from today if you continue to earn 8% annual interest?
c) How much would they have had to deposit 11 years ago so you can end up with $260,000 today if
they were earning 8% compounded quarterly rather than
annually?
d) How much would they have had to deposit 11 years ago so you can end up with $260,000 today if
they were earning 8% compounded continuously rather
than annually?
e) What was the account balance last year if your parents had been earning 8% compounded annually?

60,000

annual interest?
60,000 today if

60,000 today

if

unded annually?

a)

b)

c)

d)

e)

FV $
260,000.00
i 8%
n 11
PV $
260,000.00
i 8%
n7
FV $
260,000.00
i 8%
n 11
m4
FV $
260,000.00
i 8%
n 11
FV $260,000.00
i 8%
n1

PV(0)

$111,509.54

FV(7)

$445,594.31

PV(0)

$108,784.19

PV(0)

PV(10):

Answers
a)
b)
c)
d)
e)

107,843.56

$240,740.74 or

PV $111,509.54
i 8%
n 10

PV(10):

Answers

$111,509.54
$445,594.31
$108,784.19
107,843.56
$240,740.74

$240,740.74

Suppose you wish to retire 35 years from today. You determine that you need $120,000 per year after
you retire, with the first retirement funds withdrawn one year from the day you retire and that you will
need to make 25 such withdrawals. Assuming that you can earn 5% per year on your retirement funds
for the next 60:
a) How much must you deposit in an account today so that you may have enough funds for
retirement?
b) If you cannot afford to make a single lump sum deposit today to support your retirement,
how much must you deposit at the end of each year in an account so that you have enough funds for
your desire retirement? Assuming the last deposit will be made on
the day you retire in 35 years.
c) What if you want to make a withdrawal of $120,000 after you retire but have these
payments come in forever?

$120,000 per year after


u retire and that you will
n your retirement funds

have enough funds for

pport your retirement,


have enough funds for
you retire in 35 years.
but have these

Retire year
Wthdrl Year
pmt
n
i

Delayed Annuity for 35 Years


35
36
$
120,000.00
25
5%
PVA(35)
$1,691,273.35
PV(0) of lump sum
Yearly Deposit for Lump Sum
35
$306,611.43
5%
PMT

n
PV(0)
i

n
i
pmt(36)
PV(35)
PV(0)

$
$

Delayed Perpetuity
36
5%
120,000.00
2,400,000.00
$435,096.68
PV(0)

a) PVLS(0)
b) PMT
c) PVDP(0)

$306,611.43

$18,725.28

$435,096.68

Answers
$306,611.43
$18,725.28
$435,096.68

ers
per year

You are considering projects A, B, and C. A and B are mutually exclusive and C is independent. Assume n
capital rationing with a required rate of return of 11% for all 3 projects.
a) Calculate NPV for each project.
b) Calculate IRR(s) for each project.
c) Calculate PI for each project.
d) Using cost of capital, as a financing and reinvestment rate, calculate MIRR for each project.
e) If A&B profiles cross, calculate the exact crossover point between project A & B.
f) Which of the three projects, if any, should be accepted and why?
g) NPV profile showing all three projects
Year

Project A
Project B
Project C
0 $ (60,000.00) $ (40,000.00) $ (20,000.00)
1 $
- $ 40,000.00 $ 35,000.00
2 $ 82,000.00 $ 40,000.00 $ 30,000.00
3 $ 60,000.00 $ 20,000.00 $
2,000.00
4 $ 20,000.00 $ 10,000.00 $ (40,000.00)

dependent. Assume no

RR for each project.


t A & B.

Year Project A
Project B
Project C
0 $
(60,000.00) $ (40,000.00) $
(20,000.00)
1 $
- $
40,000.00 $
35,000.00
2 $
82,000.00 $
40,000.00 $
30,000.00
3 $
60,000.00 $
20,000.00 $
2,000.00
4 $
20,000.00 $
10,000.00 $
(40,000.00)
I
11%
Year Project A-B
Project B-A
Project C Cash Inflow
Project C Cash Outflow
0 $
(20,000.00) $
20,000.00 $
$
20,000.00
1 $
(40,000.00) $
40,000.00 $
35,000.00 $
2 $
42,000.00 $ (42,000.00) $
30,000.00 $
3 $
40,000.00 $ (40,000.00) $
2,000.00 $
4 $
10,000.00 $ (10,000.00) $
$
40,000.00
$
57,342.59 $
46,349.24

a)
b)

NPV
IRR(s)

c)
d)
e)

PI
MIRR
Crossover Rate

f)
g)

Answers
Project A
Project B
$
63,599.14 $
48.11%
2.06
32.98%
24.33%

NPV at
Crossover Rate $
32,645.84
Choose?
Choose Project A
Project A
-10% $ 154,022.25
0% $ 102,000.00
10% $
66,507.75
20% $
41,311.73
30% $
22,833.23
40% $
8,908.79
50% $
(1,827.16)
60% $ (10,268.55)
70% $ (17,019.19)
80% $ (22,498.09)
90% $ (27,003.02)
100% $ (30,750.00)
110% $ (33,898.74)
120% $ (36,569.22)
130% $ (38,852.99)

Project C
49,712.07 $
76.98%
2.24
35.84%
24.33%

$
32,645.84
because it has the highest NPV
Project B
Project C
$
96,503.58 $
$
70,000.00 $
$
51,277.92 $
$
37,507.72 $
$
27,042.47 $
$
18,871.30 $
$
12,345.68 $
$
7,033.69 $
$
2,638.38 $
$
(1,050.14) $
$
(4,183.82) $
$
(6,875.00) $
$
(9,208.30) $
$
(11,248.55) $
$
(13,046.12) $

10,993.35
-8.19%
Err:523
1.24
17.07%

(2,296.91)
7,000.00
10,793.66
11,867.28
11,579.78
10,622.66
9,358.02
7,978.52
6,586.73
5,236.24
3,953.55
2,750.00
1,628.59
587.73
(376.54)

NPV Profile
$200,000.00

$150,000.00

$100,000.00

$50,000.00

-20%

$-

0%

20%

40%

60%

$(50,000.00)
Axis Title

80%

100%

120%

Project A
Project B
Project C

100%

120%

140%

Consider the following project being evaluated by your company:


* Initial price of the asset is $200,000 and will require $15,000 transportation and
$5,000 installation
* Will be straight line depreciated over 4 years to a $5,000 salvage
* Market value for the asset at end of 5 years is expected to be $12,000 (asset
operated for 5 years)
* Net investment in net working capital in year 0 of $30,000
* Sales, first year, expected to be generated by the project will be $130,000
* Annual cost of goods sold is 60% of sales
* Annual sales growth rate is 4%
* Marginal tax rate is 30%
* Cost of capital is 10%
a) Calculate the project cash outflow in year 0
b) Calculate annual operating cash flows for i for years 1-5
c) Calculate the project's terminal cash flow in year 5
d) Calculate the project's NPV, IRR

year
Revenues
Less COGS
EBDT
Less Dep
EBT
Less Taxes
Net Income
Plus dep
OCF
Asset
Change NWC
Project Cash

0
$
$
$
$
$
$
$
$
$
$ (220,000.00)
$ (30,000.00)
$ (250,000.00) $

Price of asset
Trans Cost
Install Cost
S/L
Salvage
Market Value
Economic Life
1st Year Sales
Sales Growth
Cost of Goods
Tax Rate
WACC

$
$
$

Cost of Asset
Annual Dep.
Change NWC

$
$

220,000.00
$53,750.00
30,000.00

Acc Dep.
Book Value
Gain
Tax Consumpt.
Market Value
After Tax Slvg

$
$
$
$
$
$

215,000.00
5,000.00
7,000.00
2,100.00
12,000.00
9,900.00

$
$
$

1
130,000.00
78,000.00
52,000.00
53,750.00
(1,750.00)
(525.00)
(1,225.00)
53,750.00
52,525.00

52,525.00

200,000.00
15,000.00
5,000.00
4 years
5,000.00
12,000.00 end of 5 years
5 years
130,000.00
4%
60%
30%
10%

$
$
$
$
$
$
$
$
$

2
135,200.00
81,120.00
54,080.00
53,750.00
330.00
99.00
231.00
53,750.00
53,981.00

$
$
$
$
$
$
$
$
$

3
140,608.00
84,364.80
56,243.20
53,750.00
2,493.20
747.96
1,745.24
53,750.00
55,495.24

53,981.00

55,495.24

Answers
a)
b)

c)
d)

CO (0)
OCF(1)
OCF(2)
OCF(3)
OCF(4)
OCF(5)
TCF (5)
NPV
IRR
PI

Dep base-salvage
dep base-accumulated depreciation
market value-book value
gain/loss*Tax rate
market value-tax consumption

$
$
$
$
$
$
$
$
$

4
146,232.32
87,739.39
58,492.93
53,750.00
4,742.93
1,422.88
3,320.05
53,750.00
57,070.05

$
$
$
$
$
$
$
$
$
$
$
57,070.05 $

$(250,000.00)
$ 52,525.00
$ 53,981.00
$ 55,495.24
$ 57,070.05
$ 42,582.85
$ 39,900.00
($25,748.24)
6.14%
$
0.90

5
152,081.61
91,248.97
60,832.65
60,832.65
18,249.79
42,582.85
42,582.85
9,900.00
30,000.00
82,482.85

A company is considering the purchase of a new machine that will enable it to increase its expected
sales. The machine will have a price of $120,000. In addition, the machine must be installed and
tested. The costs of the installation and testing will amount to $30,000. The machine will be
depreciated using 5-years MACRS. (Use MACRS table provided)

The equipment will, be operated for 5 years. The sales for the first year of operation are expected to be
$260,000. Then, sales will grow by 5% a year. The annual operating costs (before depreciation) will
consist of fixed operating costs of $25,000 plus variable operating costs equal to 75% of sales.
To support the increased level of production, the inventory of raw materials will have to be increased
from $40,000 to $50,000 when the machine is purchased. The additional inventory will be carried until
the machine is scrapped following the 5 years of operation.
At the end of the 5 year operating life of the project, it is assumed that the equipment will be sold for
$50,000. The tax rate is 40% and the company's weighted average cost of capital is 9.5%. Build a
capital budgeting model to answer the following questions:
a) What is the operating cash flow in year 1-5?
b) What is the initial outlay in year 0?
c) What is the after tax salvage at the terminal year?
d) Calculate NPV, IRR, and PI for the project.
e) Generate a scenario summary showing NPV, IRR, and PI for this project using the following
information:
Best Case: Variable cost is 50% and Cost of capital is 6%
Expected case: Variable cost is 75% and Cost of capital is 9.5%
Worst case: Variable cost is 85% and Cost of capital is 12%

increase its expected


st be installed and
achine will be

ration are expected to be


ore depreciation) will
to 75% of sales.

l have to be increased
ntory will be carried until

uipment will be sold for


ital is 9.5%. Build a

ct using the following

0
Revenues
Less COGS
Less Fixed Costs
EBDT
Less Dep
EBT
Less Taxes
Net Income
Plus dep
OCF
Asset
Change NWC
Project cash
NPV
IRR
PI

$
$
$
$
$
$
$
$
$
$
$ (150,000.00)
$ (10,000.00)
$(160,000.00) $
$ (54,682.29)
-1.03%
0.66

Price of Asset
Install
S/L
Operating Life
First Year Sales
Sales Growth
Fixed Costs
COGS
Inventory
Market Value
Tax Rate
WACC

$
$

Dep. Base
Acc. Dep
Salvage
Change NWC

$
$
$
$

$
$
$
$

1
260,000.00
221,000.00
25,000.00
14,000.00
30,000.00
(16,000.00)
(6,400.00)
(9,600.00)
30,000.00
20,400.00

20,400.00 $

120,000.00
30,000.00
5 years
5 years
260,000.00
5%
25,000.00
85% of Sales
10,000.00 increase
50,000.00
40%
12.00%
150,000.00
141,300.00
8,700.00
10,000.00

$
$
$
$
$
$
$
$
$
$

2
273,000.00
232,050.00
25,000.00
15,950.00
48,000.00
(32,050.00)
(12,820.00)
(19,230.00)
48,000.00
28,770.00

$
$
$
$
$
$
$
$
$
$

3
286,650.00
243,652.50
25,000.00
17,997.50
28,800.00
(10,802.50)
(4,321.00)
(6,481.50)
28,800.00
22,318.50

28,770.00

22,318.50

Acc. Dep
Market Value
Book Value
Gain/Loss
Tax Cons.
Tax Salvage

$ 141,300.00
$ 50,000.00
$
8,700.00
$ 41,300.00
$ 16,520.00
$ 33,480.00

Inv. Before
Inv. After
$
40,000.00 $ 50,000.00

MACRS Table

Year
1
2
3
4
5
6
7
8
9
10
11

3-year
0.333
0.445
0.148
0.074

5-year
0.2
0.32
0.192
0.115
0.115
0.058

$
$
$
$
$
$
$
$
$
$

4
300,982.50
255,835.13
25,000.00
20,147.38
17,250.00
2,897.38
1,158.95
1,738.43
17,250.00
18,988.43

$
$
$
$
$
$
$
$
$
$
$
$
18,988.43 $

5
316,031.63
268,626.88
25,000.00
22,404.74
17,250.00
5,154.74
2,061.90
3,092.85
17,250.00
20,342.85
33,480.00
10,000.00
63,822.85

$ 141,300.00
$
8,700.00
Gain

Table

7-year
0.143
0.245
0.175
0.125
0.089
0.089
0.089
0.045

10-year
0.1
0.18
0.144
0.115
0.092
0.074
0.066
0.066
0.065
0.065
0.033

ANSWERS
a)
CF(1)
CF(2)
CF(3)
CF(4)
CF()
b)
IO(0)
c)
ATS
d)
NPV
IRR
PI
e)

$ 20,400.00
$ 28,770.00
$ 22,318.50
$ 18,988.43
$ 20,342.85
$160,000.00
$ 33,480.00
$(54,682.29)
-1.03%
0.66

Changing Cells:
COGS
WACC
Result Cells:
NPV
IRR
PI

Scenario Summary
Best
50%
6.00%
$ 249,055.69
57.62%
2.92

Summary
Expected

Worst

75%
9.50%

85%
12.00%

$ 48,987.32 $ (24,682.29)
21.66%
5.10%
1.38
0.81

As an investor, you are considering buying a bond that pays 7% semiannual coupon. This bond
has a $1,000 face value and will mature in 25 years.
a) If your required rate of return is 5.5% for bonds in this risk class, what is the highest
price you would be willing to pay?

On Aug 15th, 2016 you are offered the following bond:


*Face value $400 (par value)
*Coupon rate 6%
*Coupon frequency semiannual (8/15 & 2/15)
*Maturity date Aug 15, 2049
*First call date February 15, 2023
*Call premium 4% of the face value
*Bond current market price $460
b) Calculate the yield to maturity.
c) What is the current yield
d) Calculate Yield to call

upon. This bond

is the highest

SD
MD
Par
CR
Years
YTM
Freq
100s in par

1/1/2010
1/1/2035
1000
7%
25
5.50%
2 Semiannual
10
Price
$
1,202.48

SD
8/15/2016
MD
8/15/2049
Par
$
400.00
CR
6%
PMT
$
24.00
Callable Date
2/15/2023
Freq
2 Semiannual
Market Price
$
460.00
100s in par
4
PR (in yield func)
115
Call Premium
4%
YTM
5.06%
Current Yield
5.22%
YTC
3.91%

a)
b)
c)
d)

Answers
P
$1,202.48
YTM
5.06%
CY
5.22%
YTC
3.91%

Wheat Inc. has just paid its annual dividends of $2.10. The company is expected to pay
the same $2.10 dividend for year 1 and 2. After that, dividends are expected to grow at
an annual rate of 18% for 3 years then at 12% for 2 years, then it will grow at a constant
rate of 5% indefinitely. Required rate of return ion Wheat Inc. stock is 14%
a) What is the expected dividend in year 5?
b) What is the expected value for the stock in year 7?
c) What is the current value of one share of Wheat Inc. stocks today?
d) Calculate the expected stock price in year 14.

D(0)
k
g

Year
Growth
Dividend $
V(7)
Total $

2.10
14%
5%
1

2.10 $

2.10 $

3
18%
2.48 $

2.10 $

2.10 $

2.48 $

4
5
6
7
8
18%
18%
12%
12%
5%
2.92 $ 3.45 $ 3.86 $ 4.33 $ 4.54
$ 50.49 $ 53.02
2.92 $ 3.45 $ 3.86 $ 54.82

Year
11
12
13
14
15
Growth
5%
5%
5%
5%
5%
Dividend $ 5.26 $ 5.52 $ 5.80 $ 6.09 $ 6.39
V(7) $ 61.38 $ 64.45 $ 67.67 $ 71.05
V(0)
$32.32
V(14)

D(15)
V(14)

$ 6.39 D(8)*(1+g)^(15-8)
$ 71.05 D(15)/(K-G)

V(14)

$ 71.05 V(7)*(1+5%)^(15-8)

V(14)

$ 71.05 V(8)*(1+g)^(14-8)

9
5%
$
4.77 $
$ 55.67 $

10
5%
5.01
58.45

Answers
a) D(5)
$
3.45
b) V(7)
$
50.49
c) V(0)
$32.32
d) V(14)
$
71.05

The Treasury bill rate is 4%, and the expected return on the market portfolio is 12%. On the basis of
the capital asset pricing model:
a) What is the risk premium on the market?
b) What is the required return on an investment with a beta of 1?
c) What is the required return on an investment with a beta of 0?
d) What is the required return on an investment with a beta of 1.6?
e) What is the slope of the SML?
The Treasury bill rate is 4% and the expected return on the market portfolio is 12%. Consider a stock
with a beta of 1.2 that is selling for $50 and is expected to pay year end dividend of $5. Dividend is
expected to grow at a constant rate of 3% indefinitely.
f1) Based on the current price of the stock and using the DDM, what is the expected rate of
return for this stock?
On the basis of the capital asset pricing model:
f2) What is the required rate of return for this stock?
f3) Is this stock fairly priced, overpriced, or underpriced?
f4) What is the equilibrium price for this stock?

12%. On the basis of

12%. Consider a stock


nd of $5. Dividend is

he expected rate of

DDM
CAPM

Km=(D1/V0)+g
Km=Rf+B(Rm-Rf)
Answer

Rf
E(Rm)
B
B
B

4%
12%
1
0
1.6

a)
b)
c)
d)
e)

Risk Premium
Required Return B(1)
Required Return B(0)
Required Return B(1.6)
Slope SML

8.00%
12.00%
4.00%
16.80%
8%

Rf
Rm
V(0)
D(1)
g
B

4%
12%
$ 50.00
$
5.00
3%
1.2

f1)
f2)
f3)
f4)

Expected rate
Required Rate
Stock is:
Equilibrium Price

13.00%
13.60%
Overpriced
$
47.17

Consider the following two funds and their estimated returns under different states of the economy:

State of economy
Probability
Est. Return (Fund A)
Est. Return (Fund B)
Great
30%
10%
25%
Average
30%
15%
11%
Poor
40%
20%
15%
Calculate the following:
a) Expected return for fund A and for fund B
b) Standard deviation of returns for fund A and fund B
c) Covariance between returns of fund A and fund B
d) Correlation between returns of fund A and fund B
If you invest $2,000 in Fund A and $6,000 in Fund B, Calculate the following:
e) Portfolios Expected Return
f) Portfolios Standard Deviation
g) Construct the complete covariance matrix for A and B
h) Find the min variance portfolio using solver and report its variance, standard deviation, and
expected return

ates of the economy:

(Fund B)

tandard deviation, and

State
Great
Average
Poor
Invest amt
Weight

a) Exp R

Probability
Rtrn Fund A Dv(Ai-EA))
Sqrt
Rtrn Fund B Dv(Bi-E(B))
30%
10%
-5.50% 0.003025
25%
8.20%
30%
15%
-0.50% 0.000025
11%
-5.80%
40%
20%
4.50% 0.002025
15%
-1.80%
$ 2,000.00 $ 6,000.00
25%
75%
Answers
Fund A
Fund B
15.50%
16.80%
0.001725
0.003156
4.15%
5.62%

Var
b) Std Dev
c) Covar
-0.00159
d) Correl
-0.68145
e) E(Rp)
16.48%
Var (P)
0.00129
f) St Dev(P)
3.59%
g) Covarience Matrix for A and B
A
B
A
0.001725
-0.00159
B
-0.00159 0.003156
h) Solver to find Min Var:
W(A)
58.88%
W(B)
Sum
1.00
Var
0.00036174
Std Dv
1.90%
E(R)
16.03%

41.12%

Sqrt
0.006724
0.003364
0.000324

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