## ReviewTest2

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## ReviewTest2

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- Pages:
- 3
- School:
- University of Texas at Austin
- Course:
- Fin 357 - Business Finance

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REVIW TEST 2 by M L Poloskey These are some questions that I wrote for another text that you can use for practice Note Not all topics in our current text are covered here 1 Using the following information from Capstone Corporation what price would CAPM predict that this company s stock will trade for 1 year from today if you assume a risk free rate of 3 and a market risk premium of 8 Beta 65 Current Price 64 61 Estimated Forward Annual Dividend 1 92 2 How are covariance and correlation different 3 Calculate the beta of this portfolio and use the capital asset pricing model CAPM to determine its expected rate of return The market expected rate of return is 15 and the riskfree rate is 7 Stock A B C Investment 200 000 300 000 500 000 Beta 1 50 65 1 25 4 What would you recommend to an investor who is considering an investment which according to its beta plots below the security market line SML 5 Why does an investor want a diversified portfolio Can an investor eliminate all risk 6 Testco Corp is considering adding a new product line The cost of the factory and equipment to produce this product is 1 780 000 and the company expects increased cash flows from the sale of this product to be 450 000 for each of the next eight years If the company uses a discount rate of 12 percent what is the net present value of this project What is the internal rate of return of this project 7 Flowers Unlimited is considering purchasing an additional delivery truck The cost of the new truck will be 42 000 Cost savings are expected to be 12 800 for the next two years and 8 900 for the following two years and 5 000 for the last 3 years of the truck s useful life What is the payback period for this project What is the discounted payback period for this project assuming a discount rate of 10 percent 8 What is the average accounting rate of return ARR on equipment that will initially cost 1 2 million and will result in pretax cost savings of 380 000 for the next three years and then 280 000 for the following three years The machinery will be depreciated to a salvage value of 0 over 6 years using the straight line method The company s tax rate is 32 percent and the firm s acceptance decision on any project is based on an ARR of 20 percent Should this machinery be purchased 9 If a project has a positive NPV what do we know about that project s IRR 10 Which of the following are relevant cash flows in the evaluation of a proposed capital budgeting project to produce a new product a Decrease in the cash flows of a substitute product b Alternative of leasing an existing building that will be used for manufacturing this product c The cost of a new machine to produce this product d Salvage value of the new machine at the end of its useful life e Increase in net working capital at the beginning of the project s life f Cost to develop a product prototype last year 11 A division of Blakewell Manufacturing is considering purchasing an auto insert machine to load computer components on mother boards for 1 500 000 The machine will have annual operating costs of 50 000 and save the company 370 000 in labor costs each year The machine will have a useful life of 10 years For tax purposes straight line depreciation will be used with an estimated salvage value of 300 000 which will be the market value at that time The discount rate is 12 and the corporate tax rate is 32 What is the NPV of this proposal 12 After examining a potential project s NPV analysis the manager advises that the initial fixed capital outlay be increased by 480 000 The initial fixed capital outlay is fully depreciated straight line over a twelve year life The tax rate is 35 percent and the required rate of return is 10 percent No other changes are made to the analysis What is the effect on the project NPV 13 Central Embroidery needs to purchase a new monogram machine and is considering two options The first machine costs 100 000 and is expected to last 5 years and the second machine costs 160 000 and is expected to last 8 years Assume that the opportunity cost of capital is 8 percent Which machine should Central Embroidery purchase 14 You have inherited an apple orchard and want to sell it in the next four years An expert in this type of valuation has estimated the after tax cash flow you would receive as follows 1 000 000 if sold in one year 1 300 000 if sold in two years 1 500 000 if sold in three years and 1 600 000 if sold in four years Your opportunity cost of capital is 10 percent When should you sell the orchard 15 Howard Electric Telecomm groups its product and service offerings into the following divisions What is the beta of Howard Electric Telecomm Division Building Construction Power Telecommunications Beta 1 5 8 2 3 MV of Assets 250 000 000 325 000 000 675 000 000 16 Is preferred stock classified as debt or equity 17 Burnes Inc is a mature firm that is growing at a constant rate of 5 5 percent per year The firm s last dividend was 1 50 If the required rate of return is 12 percent what is the market value of this stock assuming dividend growth equals the growth rate of the firm 18 Abacus Corp will pay dividends of 2 25 2 95 and 3 15 for the next three years After three years the firm will grow at a constant rate of 4 percent If the required rate of return is 14 5 percent what is the current value of the stock

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