CAPM implies that the only two assets that matter to every investor in corporate stocks and bonds are the risk-free Treasury Bill and the market portfolio of world-wide wealth. (True, False, Uncertain and explain your response)

1) The IRS is reevaluating the asset life categories used for ACRS depreciation. The trucks that JK Industries use are currently classified by the IRS as having an asset life of 7 years. Because these trucks actually last for 10 years, the firm’s managers would prefer the IRS to reclassify them as 10-year assets so the firm can keep them longer, spread the cost of depreciation over more years and hence increase earnings.  (True, False, Uncertain and explain your response)

 

 

2) Obsolete Computer Systems, Inc. wants to reemerge as a major producer of computer software. The company has two options: Either it can purchase Upstart Software for $25m now whose products are expected to survive 5 years. Or it can develop an ongoing new line of software via research and development expected to cost $5m per year with implementation costs of $25m in 4 years. Using reasonable cash flow estimates from each product line, the Obsolete CFO has estimated that the internal rate of return from purchasing Upstart Software is 15% and the IRR of in-house R&D is 14%. As a member of Obsolete’s board of directors (and an ERAU alum who knows how misleading IRR analysis can be…hint), you should vote against the CFO’s recommendation to purchase Upstart Software. (True, False, Uncertain and explain your response)

 

3)Managers’ desire for job security and firm growth conflict with maximizing value for shareholders.  (True, False, Uncertain and explain your response)

 

4) Assume that all you have available are data for the following ratios and your firm and your industry.

Total Asset Turnover = Revenues/Assets
Total Margin = EBIT/Revenues
Net Profit Margin = Earnings/Revenues
Times Interest Earned = EBIT/Interest
Return on Equity = Earnings/Equity

 

If you want evaluate the effectiveness of your company’s operating managers and you can only use one of the measures, which one should it be and why?

5) CAPM implies that the only two assets that matter to every investor in corporate stocks and bonds are the risk-free Treasury Bill and the market portfolio of world-wide wealth. (True, False, Uncertain and explain your response)

 

6) Rau Inc. has 6.0 percent coupon bonds on the market with 9 years to maturity.  The bonds make semi-annual payments and currently sell for 110 percent of par.  What is the YTM?

 

You will upload an Excel spreadsheet that shows all of your work and the solution.

 

7)JJ Enterprises is considering the purchase of a new machine that will produce thumb drives.  The new machine will require an initial investment of $800,000 and has an economic life of five years and will be fully depreciated by the straight line method.  The machine will produce 150,000 thumb drives per year with each costing $0.10 to make.  Each will be sold at $2.00.  Assume JJ Enterprises uses a discount rate of 14 percent and has a tax rate of 34 percent. What is the NPV of the project and should JJ Enterprises make the purchase.

 

You will upload an Excel spreadsheet that shows all of your work and the solution.

 

8) A company is building a fuel efficient power plant which will generate its first annual cash flow of $18m exactly 4 years from today. As it ages, the volume it produces will remain constant but competing new technologies will drive prices down further. Hence the cash flows it creates will decline by 1% per year. Exactly 45 years from today, this plant will be scrapped, and the Environmental Protection Agency will require $30m expenditures to dismantle and clean it up. The plant’s OCC is 8%. What is the highest price that a buyer should consider paying for it?

 

9) The returns on QRC stock and an investor’s portfolio over three years are given in the table below.

 

  1. Based on this data, compute the volatility of the portfolio and briefly describe how to interpret it.
  2. Based on this data, calculate the correlation between QRC and the portfolio, and briefly describe what it means. Show your work.
  3. Suppose the portfolio represents the portfolio of all wealth. What is QRC’s market beta?
Year  QRC Portfolio
 1 5.0% 19.0%
 2  -3.0% 14.0%
 3 13.0% 9.0%

You will upload a Word Document that shows all of your work and the solution.

 

10) You are considering buying a bond issued by General Motors with exactly 5.5 years remaining to maturity that just paid a coupon yesterday. It rained on your paper this morning so you do not know what the coupon rate is. However you are able to see that the quoted price is listed as $105-20 and the annualized yield is 7%, with semi-annual compounding. If the coupon is paid semi-annually, what is the quoted annualized coupon rate? Show your work.

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