Final Exam Questions Ch 12 Ch 22 MGF 301 On January 6 2002 Argentina changed its 10 year policy of pegging its peso to the U S dollar Overnight the value of the peso changed from 1 peso per dollar to 1 55 pesos per dollar Which of the following is true a the Argentinian peso became stronger compared to the U S dollar b the U S dollar became stronger compared to the Argentinian peso c there is no change in the foreign exchange rate between the U S dollar and the Argentinian peso d none of the above are true An American investor buys 100 shares of London Bridges at a price of 23 or 23 UK pounds when the exchange rate is 2 1 or 2 dollars 1 pound A year later the company paid a dividend of 2 and the stock was selling for 20 after the dividend What is the one year overall rate of return to the American investor if the exchange rate is 2 1 1 after one year 6 points Investment 23 x 100 2300 x 2 4 600 Dividend 2 x 100 200 x 2 1 420 Ending Investment 20 x 100 2000 x 2 1 4 200 Overall Return 4200 4600 420 4600 00435 or 435 The total book value of WTC s equity is 10 million The stock of WTC is currently selling for a price of 30 per share and there are 500 000 shares outstanding The bonds of WTC have a face value of 6 million and sell at a price of 90 percent of face value The yield to maturity on the bonds is 8 percent and the firm s tax rate is 35 percent If the required return on equity is 14 calculate the WACC 6 points Market value of equity 30 x 500 000 15 million Market value of debt 9 x 6 million 5 4 million WACC 15 20 4 x 14 5 4 20 4 x 08 x 1 35 1029 01376 1167 or 11 67 percent If the company above is considering expanding into a foreign country to produce its current product is the WACC appropriate as the discount rate for its NPV calculation Explain 6 points The WACC is appropriate only if 1 the expansion is financed using the same mix of debt and equity as the firm currently uses and 2 there is no additional risk from legal rules changing in the new country as compared to the U S FORMULAS Exact Return using known probabilities E r p1r1 p2r2 pnrn Estimated Return using actual returns E r r1 r2 rn n Exact Variance using known probabilities Var r p1 r1 E r 2 p2 r2 E r 2 pn rn E r 2 Estimated Variance using actual returns Var r r1 E r 2 r2 E r 2 rn E r 2 n Std Dev square root of Var Actual Return or holding period return P1 P0 Div P0 Capital Gain P1 P0 P0 Dividend Yield Div P0 Accounting Break Even Level of Sales Fixed costs Depreciation Variable Margin where variable margin is the profit from selling an additional unit or dollar Economic Profit Accounting Profit Additional Cost of Capital Economic Profit Accounting Profit Opportunity Cost of Capital Depreciation Opportunity Cost of Capital Initial investment Annuity Factor where annuity factor is calculated for the life of the project at the discount rate CAPM Ri RF i RM RF EAR 1 r m m 1 PV CT 1 r T or PV FVT 1 r T FVT C0 x 1 r T or FVT PV x 1 r T Perpetuity PV C1 r Growing Perpetuity PV C1 r g Annuity PV C1 x 1 r 1 r 1 r T 1 real interest rate 1 nominal interest rate 1 inflation rate 2 Bond rate of return coupon income price change investment Expected return on stock r DIV1 P1 P0 P0 Dividend Discount Model P0 DIV1 1 r 1 DIV2 1 r 2 DIVH PH 1 r H No Growth Dividend Discount Model P0 DIV1 r or P0 EPS1 r Constant Growth Dividend Model P0 DIV1 r g where Expected rate of return r DIV1 P0 g g sustainable growth rate return on equity x plowback ratio PVGO PV of firm with growth options PV of firm without growth options Direct Exchange Rate 1 foreign currency unit x dollars Indirect Exchange Rate x foreign currency units 1 dollar Direct Exchange Rate 1 Indirect Exchange Rate WACC D V x 1 Tc x rD E V x rE 3