PROBLEM SET 5
Emily Mung
Student Name __________________________
Instructions
a. There are twelve (12) questions on this problem set. You have until 10:00 am on December 2 to submit it.
A late submission will not be accepted. Show your work next to each question.
b. The maximum possible score on this problem set is 10 points.
c. To get credit on a question, you have to not only get the right answer but also show all the steps that you
used to arrive at the answer. Make sure you write CLEARLY and NEATLY.
QUESTIONS:
1. (1 point) MMK’s common stock has a beta of 1.50. The expected return on the market is 11% and the risk-free
rate, rf, is 4%. MMK expects to pay a dividend of $3.00 next year, and the dividend is expected to grow at 4% per
year forever. The price of MMK common stock should be $________.
re vg
=
=. 04 +
=
B(rm vs)
+
3
-
I
Co
1.5(.11-.04)
=
g) 5OCH)
=
-
0.145
28.ST14
=
$28.57
=
2. (0.5 point) If you believe the market will go down over the next year, then you would prefer a stock with which
of the following betas. Why?
A negative beta has
a. 1.20
b. -0.20
8
c. 1.50
d. -0.10
e. 0.50
for
so
a market
negative
that is
B
beta. And
inverse
an
relationship
to the market
going down, you would
the
is
want
largest negative beta
a
which
this market.
3. (0.5 point) A manufacturer of soft drinks wants to increase production at a facility. Their discount rate is 10.00%
p.a. The five-year project will require an initial investment of $300,000. The expected end-of-year cash flows are:
lead
will
to
the
biggest growth
Reject, because
Year 1: $50,000
Year 2: $60,000
Year 3: $80,000
Year 4: $90,000
Year 5: $100,000
which means
a
good
in
7.49% (10%
IRR
expected
<required rate
is
less
than
of return
required
so it is not
investment
The IRR is ____%. As per the IRR rule, should you take the project? Why or why not?
(fo
&
=
20.
-
=
300,000
50,000
fo, 1
=
CO2
for
CO3
=
60,000
=
1
=
80,000
f0z 1
=
Ton 90,000
=
1
-Ou
=
Cus
=
100,000
fOg 1
=
1
I
=
10%
IRR 7.4862%
=
Or
7.219%
USE THE DATA BELOW TO ANSWER QUESTIONS 4-7
Ray Sports Products wants to expand its business by selling a new type of soccer ball that is more durable than its
current offering. The CFO of Ray has collected the following pieces of information.
vThe sale of the new ball will generate $7,800,000 in sales each year for the next 8 years. A portion of these new
sales, $800,000, will come from existing customers who would have bought the old ball.
-Because of the expansion, operating costs will increase by $1,500,000 per year. This number reflects the cost
reduction of producing fewer of the old balls.
X The firm spent $1,000,000 on testing various types of balls.
vThe company uses straight-line depreciation. The project has an economic life of 8 years. Total cost of the plant
and equipment that will be required for the project is $16,000,000, which will be depreciated to a salvage value of
$2,000,000 and is expected to be sold for $3,500,000 in 8 years.
vRay will increase net working capital by $1,750,000 at the beginning of the project, and it will be liquidated at the
end of the project.
v
 Accounting plans to allocate supervisory and management costs of 60,000 per year to the project No new
supervisory or management personnel will be required.
rRay’s marginal tax rate is 21%.
-Ray’s weighted average cost of capital (WACC) is 10%.
4. (1 point) The initial net cash flow of the project is $ _______.
114,000,000 1,750,000
+
$17,750,000
5. (1 point) The project’s incremental operating cash flow in year 3 is $ ________.
-2,000,000
↑o
(7,000,000 1,500,000) (1-.21) + 1,750,000 (.21
$H,712,508
=
=
1,750,000
8
6. (1 point) The project’s total incremental unlevered cash flow in year 10 is $ _______.
1,712,300 + 3,500,000
-
13,300,000
-
2,000,000) (.21)
+
$9,647,500
7. (0.5 point) The NPV of this project is $ _______.
CF
-
CF0
C01
50
17,750,000
4,712,500
=
-
=
=
7
CO2 9,647,500
:
fOe
I
=
NPV
1
10
=
2
=
$9,693,053.65
1,750,000
8. (0.5 point) A firm must choose one of two mutually exclusive projects. Both projects have a 10-year life. The firm
should choose the project with the highest _____. Why?
a. Profitability Index (PI)
b. Internal Rate of Return (IRR)
c. Net Present Value (NPV)
&
d. Payback Period (PP)
e. Discounted Payback Period
Net
you
Present value
the most
because
it
going to
is
constant highest
rate of
give
return
USE THE FOLLOWING INFORMATION TO ANSWER QUESTIONS 9-11
A firm is 70% equity and 30% debt. The firm’s marginal tax rate is 34%. Their bonds trade for $1,050, mature in 10
years, have a par value of $1,000, an annual coupon rate of 9.00% and pay semi-annually. The firm’s common stock
trades for $40 and just paid a dividend of $4.00. Dividends are expected to grow at 4% forever.
9. (1 point) The firm’s after-tax cost of debt is _____%.
) 45
N = 20
8.2658(1 0.34)
↓
-
=
PNT = US
fV = 1,000
Pv 1058
5.4488
=
Y
4
=
5.4 3%
4.1279.2
=
8.2258
10. (1 point) The firm’s cost of equity is _____%.
40
4(0.04)
=
Re
=
=
0.142
121.4's.
11. (1 point) The firm’s WACC is ___%.
WAL
0.3.8.2558(1-.34)+.7 (14.4)
=
=11. T14 L
=11.71%.
3
12. (1 point) Cherry Log Lumber, Inc. is considering the purchase of new equipment. There are two options. The
GEB7 costs $40,000 today, will generate operating cash flows of $1,800 per year for eight years, and will be sold
for $6,000 after taxes at the end of eight years. The SJB4 costs $45,000 today, will generate operating cash flows
of $1,500 per year for ten years, and will be sold for $7,000 after taxes at the end of ten years. The equivalent
annual series (EAS) of the best choice is $_____. Use a discount rate of 10% p.a.
NPU: -27,598.0883
GEB7:
(fo: -40,000
C0, 1,500
=
50 7
CO2 7,500
+02 1
=
=
N= 8
YY
=
Pv
=
10
-
27,598.0886
fV 0
=
=
I
SJB4:
10
=
CF
- -
(fo: 45,000
C. 1,500
PUTIEAS="5, 173.096
NPV
=
-33,084.3463
-
=
+01
=
N8
=
9
1/4
(0z 8500
=
-Oz
1
Best
=
10
-
33,
084.3463
fV=8
=
I 10
=
PV
=
PMT/EAS $5,384.3250
choice: $15,384.33
4
=
(SJB4)