Finance 200
Midterm Problem Set
Due: November 25, 2014
This problem set is due at the beginning of class on Tuesday November 25, 2014. You may work on this assignment with one other student (or you may do it by yourself). To receive credit on the numerical questions, please show some of your work, or describe your calculations. Do not just list “the answer.” There are 26 points on this quiz. In addition, you will receive a 0.5 bonus point if your answer sheets are stabled together. The assignment will be evaluated on a scale of 25 points.
1. (3 Points) A $1000 face value bond with 10 years to maturity sells for $963. The bond has a 4 percent coupon, with interest paid semi-annually.
A. What is the bond’s yield to maturity?
B. What is the bond’s current yield (Hint: Look in the book!)?
C. Explain in one or two complete sentences why the bond sells for a discount.
2. (3 Points) During the past year, Angkaw Inc. recorded $750 in depreciation expense on its income statement. In addition, the company had the following changes to its working capital accounts:
Inventory = $600 increase
Accounts Payable = $160 decrease
Accounts Receivable = $950 decrease
Was the firm’s net income higher or lower than its “Cash Provided by Operating Activities” on its Statement of Cash Flows? What was the dollar difference between these two amounts?
3. (3 Points) On the distant planet of Zurg, the stock market had a return last year of -60% (negative 60%). This year, due to an economic recovery, the stock market had a return of +100%. What was an investor’s effective (economic) annual return over this two year period? Assume that no dividends were paid and that an investor bought the investment at the beginning of this two-year holding period and sold it at the end of the two-year holding period. If the investor requires an annual return of 10% to be happy, is the investor happy?
4. (3 Points) Harley’s Dog Food Company just paid a $1.75 dividend. The dividend is expected to increase by 20% next year (year 1), and 15% during the next year (year 2). After that, the dividend will increase at a 3% annual rate, forever. If the discount rate is 8.5%, how much should Harley’s stock sell for today?
5. (4 Points, plus bonus) Answer the following questions about Microsoft.
A. Assume that you purchased MSFT stock on July 1, 2001, and held the stock until June 30, 2011. What would your effective annual return have been? (Use the Yahoo dividend adjustment).
B. What was MSFT’s effective annual growth rate in sales and net income between 2001 and 2011?
C. (Bonus: 0.5 Point) Why was it possible for MSFT to have a lousy stock return over this period, even though it had positive growth in sales and net income?
6. (4 Points) Company XYZ has two bonds outstanding. Both bonds have a $1,000 face value, a 5% coupon rate (paid annually), and a maturity date that is ten years from today.
A. Bond A is a secured bond (it has collateral); it currently has a yield to maturity of 5.5%. What is the price of the bond today?
B. Bond B is a subordinated debenture; its price today is $943.72. What is the yield to maturity of this bond?
C. Does the information provided in parts A and B make sense, given that the bonds are issued by the same firm?
7. (6 Points) Use Excel on this part! You will also need to use the “Goal Seek” function. Cass Widget Company is considering an investment of $8,400,000 to build a new factory. This investment will be depreciated (to zero) on a straight-line basis over a 6-year useful life. The following estimates apply to each of the project’s 6-year life. Fixed costs are $2,300,000 per year (and they will remain stable). A Widget will cost $10 to manufacture (variable manufacturing costs), and can be sold for $14. Each year, the number of Widgets sold will be 5% greater than in the previous year. Assume that this project requires a working capital investment of $500,000 (paid at t = 0, and recovered at t = 6) and that the salvage value of the new factory is zero. The opportunity cost of capital (the discount rate) is 7%, and the tax rate is 34%.
A. Assume that the firm will sell an incremental 950,000 Widgets in the first year.
· What is the project’s NPV? Should the firm accept the project?
· What is the project’s IRR?
B. What is the minimum number of Widgets the firm can sell in the first year for this project to be worthwhile? (That is, how many units must be sold in the first year for the project to have a NPV of zero?) Assume that the growth rate in unit sales remains 5% in all future years.
