a. Complete the following table: [20 Pts. -5 Points for each wrong or absent answer -- Zero minimum]
ASSET A B T-Bills
Expected Return ? ? ?
Standard Dev. of Return ? ? ?
Correlation with Asset A ? ?
Correlation with T-Bills ? ?
Beta Coefficient ? ? ?
b. Suppose you want to form a portfolio from any or all of the assets listed above such that your expected return is 22%. According to portfolio theory, describe the best (most rational)method of constructing such a portfolio and justify (in words) your strategy based on the underlying theory.[5] Wt in A: _________ Wt. in B: ___________ Wt. in T-Bills: __________ [5] Justification:
c. Suppose you plan to invest $20,000 in asset B and $40,000 in Asset A. You intend to finance this position by borrowing $25,000 at the riskfree rate shown above and using $35,000 of your own money. What will be the expected return, standard deviation, and beta coefficient of your position? Show your work? [10]
7. The ABD Co. is considering expanding its production of one product by replacing an existing production line with a newer and larger one. The existing equipment was purchased three years ago for $81,250. It is being depreciated over a total of 5 years to a zero book value using straightline depreciation and can be sold today for $20,000. This equipment generates $75,000 in sales per year and has annual cash expenses of $35,500. It requires $12,000 in working capital consisting of tools, parts, and related items. If this equipment is used for three more years, it is expected to have a market value of $5,000 at the end of that time.
The proposed new equipment has an installed cost of $190,000 and will be depreciated by 3-year ACRS-class rules using these percentages (.3334 in the first year, .4444 in the second year, .1481 in the third year) over the THREE years that the line will be used. The new equipment will require a fixed investment of $23,000 in net working capital. It is expected to generate annual revenue of $130,000 and annual cash expenses of $20,000. If this equipment is used for three more years, it is expected to have a market value of $30,000 at the end of that time. Structural repairs to the area that will be occupied by the new equipment will be carried out at the time that the new line is installed. These repairs include roof repairs and electrical modifications that are required by the government in order to conform to safety standards. These repairs and modification will cost $6,000.
The company's marginal tax rate is 40%. The appropriate discount rate is 12.5%. Answer the following questions. Show all relevant work in the space provided here. LABEL EVERYTHING CLEARLY.
a. Net Cash Outlay at t=0: $_______________ [5]
b. Net Cash Flow at t=1: $_________________ [15 Total]
Net Cash Flow at t=2: $_________________
Net Cash Flow at t=3: $_________________
Based on your answers above, determine:
c. Net Present Value: $________________ [5]
d. Internal Rate of Return (within 1.0%): _________________ [5]
e. MIRR: $______________ [5]
f. Equivalent Annual Annuity [5]
8. The XYZ Company is considering two competing technologies to produce one of is products, air pudding. One production line will cost $400,000 to purchase and it has an expected useful life of 3 years. It will have an annual maintenance cost of $40,000 and will be depreciated on straight-line depreciation over 4 years at $100,000 per year. It has an expected salvage value after three years of $50,000. The other production line costs $600,000 but has an expected life of 5 years. It will also be depreciated over 4 years at $150,000 per year. Its expected annual maintenance cost is $30,000 and it has an expected salvage value at the end of 5 years of $60,000. Both production lines will produce the same amount of air pudding with the same cost of raw material and labor. The tax rate is 34%. The appropriate discount rate is 15% for both projects.
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a. Compute the Equivalent Annual Annuity (EAA) for each project.
[5] EAA for 1st line: _________________
[5] EAA for 2nd line: ________________
b. Which is the better of the two alternatives? Justify your answer by referring to your calculations and any related concepts that we discussed in class. [5]
9. Explain the relationship between the beta for a company and changes in economic factors such as inflation and the general level of interest rates. That is, what is likely to happen to a company's beta if the inflation rate rises or interest rates increase? Be specific, justify your arguments, and don't ramble. [10]
10. Explain in as much detail as you can how you would estimate the NPV of your MBA. That is, you can view your decision to come to the MBA program as an investment that has specific costs and uncertain payoffs. What should be included in this analysis? An example based on personal goals, objective and expectations would be useful. There is obviously no single "right" answer to this question. What I am looking for is the structure and completeness of your proposed analysis. [10]
Answers
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Ask Price = $1,082.17
Bid Price = $1,072.76
Final Price = $952.07
Holding Period Return = 7.14%
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$46.29
ASSET A B T-Bills
Expected Return 10.65 10.65 6.5
Standard Dev. of Return 7.91 2.24 0
Correlation with Asset A .624 0
Correlation with T-Bills 0 0
Beta Coefficient 1 .177 0
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b. Wt. of B = 3.735 and Wt. of T-Bills = - 2.735
c. E(R) = 13.61% SD = 9.89% Beta = 1.244
CF(0) = -176,000 NPV = -6852
CF(1) = 61,138 IRR = 10.3%
CF(2) = 69,574 MIRR = 11.02%
CF(3) = 85,187 EAA = -2877
Question 8:CF(0) -400000 -600000 CF(1) 7600 31200 CF(2) 7600 31200 CF(3) 74600 31200 CF(4) 31200 CF(5) 19800 NPV -338594 -501080 EAA -148296 -149480
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