FE 323 Midterm Version A Fall 2006 Student Name Student ID Section X1 Section X2 Section X3 Section X4 Section X5 Section X6 Section X7 Section X8 Section X9 Chadwick Chadwick Osher Osher Griswold Griswold Santini Santini Griner Please circle your section above Show your work Writing out either your calculator keystroke entries or the underlying equations at each step in the process will be sufficient All interest rates should be accurate to at least four decimal places ie 1584 Dollar amounts must be accurate to the penny Capital Budget amounts to the nearest dollar Please write neatly and CIRCLE ANSWERS Points add up to 100 Long answers total 70 points multiple choice totals 30 points Time Value of Money 21 points 1 5 points You just bought a policy that will pay you and your heirs 14 000 a year forever beginning one year from today You paid 325 000 for this policy What rate of return are you earning on this policy 2 5 points As part of the contract with their new CEO Giant Sunflowers Inc agreed that beginning today to put 125 000 per year for five years five payments total into a special account on the anniversary of Ms Smith s hiring today The account will earn 6 5 interest APR compounded quarterly Ms Smith will receive the total proceeds principal and interest on the fifth anniversary of her hiring How much will she receive on her fifth anniversary 2 3 5 points A young BU graduate bought a condo in Back Bay five years ago by obtaining a 25 year adjustable rate mortgage for 150 000 The initial interest rate was 4 8 APR compounded monthly Tomorrow the fifth anniversary of the mortgage is the first time the interest rate will be adjusted The new rate will be 6 4 APR compounded monthly What will be the new monthly payment 4 6 points You recently won a personal injury law suit You have received three settlement options as follows years beginning Option A 12 000 on the first day of each year for 20 today Option B 995 on the first day of each month for 22 years beginning one year from today Option C 130 000 as a lump sum payment today You can earn a 7 5 Effective Annual Rate on your investments You do not care if you personally receive the funds or if they are paid to your heirs should you die within the next 22 years Which option do you prefer and why 3 Bonds 16 points 5 5 points Tulip Industries has a semi annual bond outstanding that has a 5 5 coupon rate 1 000 face value and a market price of 967 29 The market required rate of return on a bond with comparable risk is 5 8 APR compounded semi annually How many years will it be until this bond matures 6 5 points Portulaccas Inc wants to raise 11 million to expand their business To accomplish this they plan to sell 30 year 1 000 face value zero coupon bonds The bonds will be priced with a yield to maturity of 6 percent Assume semi annual compounding What is the minimum number of bond they must sell to raise the 11 million they require 7 6 points Settum Mums issued 12 5 million of 15 year 7 5 coupon bonds four years ago to finance a high tech hot house they constructed in LaConner Washington Your bought 5 bonds for 5 000 The bonds were issued at par and pay interest annually Since being issued the required rate of return on these bonds has increased by 1 percentage point If you sell these bonds today what would your holding period yield be 4 Stocks 15 points 8 5 points Lavender Enterprises just paid an annual dividend of 3 00 a share on their common stock Next year the dividend is expected to be 3 18 a share The company s board of directors recently voted to have a constant rate of growth dividend policy What will a share of Lavender Enterprises common stock be worth five years from now if the applicable discount rate is 14 percent assuming the dividend discount model of stock valuation 9 5 points Good Herbs Corp announced today that they will begin paying annual dividends The first dividend will be paid in one year in the amount of 0 35 per share The following annual dividends per share will be 0 40 0 60 and 1 00 a share respectively After that dividends are projected to increase by 3 5 per year How much are you willing to pay for one share of this stock if your desired rate of return is 13 and you use the dividend discount model for stock valuation 5 10 5 points You just purchased a stock for 42 per share The last dividend was 3 50 per share The long term growth rate for the stock is expected to be 3 5 What is the implied required rate of return for this stock assuming the dividend discount model of stock valuation Investment Criteria 9 points each subpart 1 5 points 11 Review the two mutually exclusive projects below Project 333 70 000 Today In 1 year 19 000 In 2 years 51 000 In 3 years 25 000 Project 222 70 000 Today In 1 year 13 000 In 2 years 16 000 In 3 years 72 000 The relevant discount rate is 11 5 a b c d e What is the NPV for Project 222 What is the NPV for Project 333 Over what range of discount rates would Project 222 be preferred Over what range of discount rates would Project 333 be preferred At what discount rate crossover rate would you be indifferent between Project 222 and Project 333 f At what discount rate would both projects be rejected 6 Estimating Project Cash Flows 10 points 12 10 points Stargazer Works is considering a new irrigation system with an initial cost of 300 000 The cost will be depreciated to zero on a straight line basis over the project s five year life at the end of which the irrigation system is likely to be sold for 30 000 The new irrigation system is expected to save the firm 80 000 excluding depreciation per year in operating expense on a pre tax basis The system will require an initial investment in working capital net of 25 000 If the tax rate is 40 and the discount rate is 10 what are the NPV and IRR of this project 7 Student Name Multiple Choice 2 5 points each 30 points total Indicate Multiple Choice Answers Below 1 2 3 4 5 6 7 8 9 10 11 12 8 2 The interest rate charged per period multiplied by the number of period per years is Multiple Choice 30 points total 2 5 points each Note there is no partial credit under any circumstances 1 A discount bond will yield higher returns than a premium bond always sell at a discount have greater risk than a premium bond have a higher yield …