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Question;Your;firm spends $473,000 per year in regular maintenance of its equipment. Due to;the economic downturn, the firm considers forgoing these maintenance expenses;for the next 3 years. If it does so, it expects it will need to spend $1.9;million in year 4 replacing failed equipment. What is the IRR of the decision;to forgo maintenance of the equipment?;The;IRR of the decision is 15.94%;The;IRR of the decision is 14.18%;The IRR of the decision is 15.32%.;The;IRR of the decision is 18.36%;Your;firm spends $473,000 per year in regular maintenance of its equipment. Due to;the economic downturn, the firm considers forgoing these maintenance expenses;for the next 3 years. If it does so, it expects it will need to spend $1.9;million in year 4 replacing failed equipment. Does the IRR rule work for this;decision?;Only;if the replacement cost is below $2 million.;No.;Yes.;The;last four years of returns for a stock are as follows;Year;1;Year;2;Year;3;Year;4;-3.9%;+27.6%;+11.5%;+3.8%;Note;Notice that the average return and standard deviation must be entered in;percentage format. The variance must be entered in decimal format. What is the;average annual rate? (Round to two decimal places.);The;average return is 10.15%.;The;average return is 10.25%.;The;average return is 10.05%.;The average return is 9.95%.;In;mid-2009, Rite Ad had CCC-rated, 20-year bonds outstanding with a yield to;maturity of 17.3%. At the time, similar maturity Treasuries had a yield of 3%.;Suppose the mark risk premium is 5% and you believe Rite Aid's bonds have a;beta of 0.38. If the expected loss rate of these bonds in the event of default;is 58%. What annual probability of default would be consistent with the yield;to maturity of these bonds in mid-2009?;The;required return for this investment is 4.90%. The annual probability of default;is 23.38%.;The;required return for this investment is 4.90%. The annual probability of default;is 20.38%.;The;required return for this investment is 4.90%. The annual probability of default;is 22.38%.;The required return for this investment is 4.90%. The annual;probability of default is 21.38%.;Weston;Enterprises is an all-equity firm with two divisions. The soft drink division;has an asset beta of 0.54, expects to generate free cash flow of $66 million;this year, and anticipated a 3% perpetual growth rate. The individual chemicals;division has an asset beta of 1.15, expects to generate free cash flow of $71;million this year, and anticipates a 4% perpetual growth rate. Suppose the risk;free rate is 2% and the market premium is 5%. Estimate Weston's current cost of;capital.;Weston's;current cost of capital is 4.70%.;Weston's;current cost of capital is 3.70%.;Weston's current cost of capital is 5.70%.;Weston's;current cost of capital is 2.70%.;Consider;an investment with the following returns over four years;Year;1;2;3;4;Return;15%;7%;9%;11%;Which;is a better measure of the investment's past performance? If the investment's;returns are independent and identically distributed, which is a better measure;of the investment's expected return next year?;Arithmetic;average is a better measure of the investment's past performance while CAGR is;a better measure of the investment's expected return next year.;CAGR is a better measure of the investment's past performance while;arithmetic average is a better measure of the investment's expected return next;year.;Pisa;Pizza, a seller of frozen pizza, is considering introducing a healthier version;of its pizza that will be low in cholesterol and contain no trans fats. The;firm expects that sales of the new pizza will be $15 million per year. While;many of these sales will be to new customers, Pisa Pizza estimates that 27%;will come from customers who switch to the new, healthier pizza instead of;buying the original version. Assume customers will spend the same amount on;either version. What level of incremental sales is associated with introducing;the new pizza?;The;incremental sales are $3 million.;The;incremental sales are $9 million.;The;incremental sales are $15 million.;The incremental sales are $11 million.;You;need to estimate the equity cost of capital for XYZ Corp. Unfortunately, you;only have the following data available regarding past returns;Year;Risk-free;Return;Market;Return;XYZ;Return;2007;4%;6%;8%;2008;1%;-43%;-50%;Estimate;XYZ's historical alpha.;XYZ's historical alpha is 1.1%.;XYZ's;historical alpha is 1.6%.;XYZ's;historical alpha is 1.9%.;XYZ's;historical alpha is 1.3%.;The;figure below shows the one-year return distribution of Startup, Inc.;Probability;40%;20%;20%;10%;10%;Return;-100%;-75%;-50%;-30%;1,000%;Calculate;the standard deviation of the return.;The standard deviation is 324%.;The;standard deviation is 330%.;The;standard deviation is 328%.;The standard deviation is 326%.;A bicycle;manufacturer currently produces 356,000 units a year and expects output levels;to remain steady in the future. It buys chains from an outside supplier at a;price of $2.10 a chain. The plant manager believes that it would be cheaper to;make these chains rather than buy them. Direct in-house production costs are;estimated to be only $1.50 per chain. The necessary machinery would cost;$290,000 and would be obsolete after 10 years. This investment could be;depreciated to zero for tax purposed using a 10-year straight-line depreciation;schedule. The plant manager estimates that the operation would require;additional working capital of $40,000, but argues that this sum can be ignored;since it is recoverable at the end of the 10 years. Expected proceeds from;scrapping the machinery after 10 years are $21,750. If the company pays tax at;a rate of 35% and the opportunity cost of capital is 15%, what is the net;present value of the decision to produce the chains in-house instead of;purchasing them from the supplier?;Compute;the NPV of buying the chains from the FCF.;The;NPV of buying the chains from the FCF is $-438,850.;The;NPV of buying the chains from the FCF is $-438,820.;The;NPV of buying the chains from the FCF is $-1,438,820.;The NPV of buying the chains from the FCF is $-2,438,820.;Consider;an investment with the following returns over four years;Year;1;2;3;4;Return;15%;7%;9%;11%;What;is the average annual return of the investment over the four years?;The;average annual return is 1.50%.;The;average annual return is 0.50%.;The average annual return is 10.50%.;The;average annual return is 5.50%.;Bay Properties;is considering starting a commercial real estate division. It has prepared the;following four-year forecast of free cash flows for this division;Year;1;Year;2;Year;3;Year;4;Free;cash flow;$-122,000;$-9,000;$100,000;$219,000;Assume;cash flows after year 4 will grow at 3% per year, forever. If the cost of;capital for this division is 17%, what is the value today of this division?;The;value today is $528,283.;The value today is $928,283.;The;value today is $228,283.;The;value today is $728,283.;You;need to estimate the equity cost of capital for XYZ Corp. Unfortunately, you;only have the following data available regarding past returns;Year;Risk-free;Return;Market;Return;XYZ;Return;2007;4%;6%;8%;2008;1%;-43%;-50%;Would;you base your estimate of XYZ's equity cost of capital on historical return or;expected return?;Expected return because the CAPM provides a better estimate of;expected returns.;Historical;return because the average past returns provides a better estimate of expected;returns.;You;need to estimate the equity cost of capital for XYZ Corp. Unfortunately, you;only have the following data available regarding past returns;Year;Risk-free;Return;Market;Return;XYZ;Return;2007;4%;6%;8%;2008;1%;-43%;-50%;Compute;the market's and XYZ's excess returns for each year. Estimate XYZ's beta.;The market's excess return for 2007 is 2%. The market's excess;return for 2008 is -44%. XYZ's excess return for 2007 is 4%. XYZ's excess;return for 208 is -51%. XYZ's beta is 1.20.;The;market's excess return for 2007 is 2%. The market's excess return for 2008 is;-44%. XYZ's excess return for 2007 is 4%. XYZ's excess return for 2008 is -51%.;XYZ's beta is 1.40.;The;market's excess return for 2007 is 2%. The market's excess return for 2008 is;-44%. XYZ's excess return for 2007 is 4%. XYZ's excess return for 2008 is -51%.;XYZ's beta is 1.10.;The;market's excess return for 2007 is 2%. The market's excess return for 2008 is;-44%. XYZ's excess return for 2007 is 4%. XYZ's excess return for 208 is -51%. XYZ's;beta is 1.30.;The;last four years of returns for a stock are as follows;Year;1;Year;2;Year;3;Year;4;-3.9%;+27.6%;+11.5%;+3.8%;Note;Notice that the average return and standard deviation must be entered in;percentage format. The variance must be entered in decimal format. What is the;variance of the stock's returns? (Round to five decimal places.);The;variance of the returns is 0.01602.;The;variance of the returns is 0.01702.;The;variance of the returns is 0.01902.;The variance of the returns is 0.01802.;Consider;an investment with the following returns over four years;Year;1;2;3;4;Return;15%;7%;9%;11%;What;is the compound annual growth rate (CAGR) for this investment over the four;years?;The compound annual growth rate is 10.46%.;The;compound annual growth rate is 10.36%.;The;compound annual growth rate is 10.26%.;The;compound annual growth rate is 10.16%.;Weston;Enterprises is an all-equity firm with two divisions. The soft drink division;has an asset beta of 0.54, expects to generate free cash flow of $66 million;this year, and anticipated a 3% perpetual growth rate. The individual chemicals;division has an asset beta of 1.15, expects to generate free cash flow of $71;million this year, and anticipates a 4% perpetual growth rate. Suppose the risk-free;rate is 2% and the market premium is 5%. Estimate Weston's current equity beta.;Weston's current equity beta is 0.74.;Weston's;current equity beta is 0.66.;Weston's;current equity beta is 0.79.;Weston's;current equity beta is 0.70.;You;are considering opening a new plant. The plant will cost $100.3 million;upfront. After that, it is expected to produce profits of $31.9 million at the;end of every year. The cash flows are expected to last forever. Calculate the;NPV of this investment opportunity if your cost of capital is 7.1%.;The NVP of this investment opportunity is $349.0 million.;The;NVP of this investment opportunity is $349.0 million.;The;NVP of this investment opportunity is $349.0 million.;The;NVP of this investment opportunity is $349.0 million.;You;need to estimate the equity cost of capital for XYZ Corp. Unfortunately, you;only have the following data available regarding past returns;Year;Risk-free;Return;Market;Return;XYZ;Return;2007;4%;6%;8%;2008;1%;-43%;-50%;What;was XYZ's average historical return?;XYZ's;average historical return was -18.0%.;XYZ's;average historical return was -15.0%.;XYZ's average historical return was -21.0%.;XYZ's;average historical return was -20.0%.;Weston;Enterprises is an all-equity firm with two divisions. The soft drink division;has an asset beta of 0.54, expects to generate free cash flow of $66 million;this year, and anticipated a 3% perpetual growth rate. The individual chemicals;division has an asset beta of 1.15, expects to generate free cash flow of $71;million this year, and anticipates a 4% perpetual growth rate. Suppose the;risk-free rate is 2% and the market premium is 5%. Estimate the value of each;division.;The;estimated value of the soft drink division is $70.3 million and the estimated value;of the industrial chemicals division is $76.3 million.;The estimated value of the soft drink division is $3,882.4 million;and the estimated value of the industrial chemicals division is $1,893.3;million.;The;estimated value of the soft drink division is $3,796.2 million and the;estimated value of the industrial chemicals division is $8,774.5 million.;The;estimated value of the soft drink division is $1,893.3 million and the;estimated value of the industrial chemicals division is $3,882.4 million.;A bicycle;manufacturer currently produces 356,000 units a year and expects output levels;to remain steady in the future. It buys chains from an outside supplier at a;price of $2.10 a chain. The plant manager believes that it would be cheaper to;make these chains rather than buy them. Direct in-house production costs are;estimated to be only $1.50 per chain. The necessary machinery would cost;$290,000 and would be obsolete after 10 years. This investment could be;depreciated to zero for tax purposed using a 10-year straight-line depreciation;schedule. The plant manager estimates that the operation would require;additional working capital of $40,000, but argues that this sum can be ignored;since it is recoverable at the end of the 10 years. Expected proceeds from scrapping;the machinery after 10 years are $21,750. If the company pays tax at a rate of;35% and the opportunity cost of capital is 15%, what is the net present value;of the decision to produce the chains in-house instead of purchasing them from;the supplier?;Project;the annual free cash flows (FCF) of buying the chains.;The;annual free cash flows for years 1 to 10 of buying the chains is $-482,940.;The annual free cash flows for years 1 to 10 of buying the chains is;$-485,940.;The;annual free cash flows for years 1 to 10 of buying the chains is $-486,940.;The;annual free cash flows for years 1 to 10 of buying the chains is $-489,940.;The;last four years of returns for a stock are as follows;Year;1;Year;2;Year;3;Year;4;-3.9%;+27.6%;+11.5%;+3.8%;Note;Notice that the average return and standard deviation must be entered in;percentage format. The variance must be entered in decimal format. What is the;standard deviation of the stock's returns? (Round to two decimal places.);The;standard deviation is 13.99%.;The;standard deviation is 14.79%.;The;standard deviation is 14.99%.;The standard deviation is 13.79%.;You;are considering a safe investment opportunity that requires a $920 investment;today, and will pay $690 two years from now and another $640 five years from;now. If you are choosing between this investment and putting your money in a;safe bank account that pays an EAR of 5% per year for any horizon, can;you make the decision by simply comparing this EAR with the IRR of the;investment? Explain.;No;because the timing of the cashflows are different.;Yes, you can always compare IRRs of riskless projects, and an;investment in the back is riskless.;No;this is like comparing the IRR of two projects.;Yes;because the EAR is the same at all horizons, so the two "projects;have the same riskiness, scale, and timing.;You;are considering a safe investment opportunity that requires a $920 investment;today, and will pay $690 two years from now and another $640 five years from;now. What is the IRR of this investment?;The;IRR of this investment is 8.65%.;The;IRR of this investment is 6.92%.;The;IRR of this investment is 22.29%.;The IRR of this investment is 11.74%.;A;bicycle manufacturer currently produces 356,000 units a year and expects output;levels to remain steady in the future. It buys chains from an outside supplier;at a price of $2.10 a chain. The plant manager believes that it would be;cheaper to make these chains rather than buy them. Direct in-house production;costs are estimated to be only $1.50 per chain. The necessary machinery would;cost $290,000 and would be obsolete after 10 years. This investment could be;depreciated to zero for tax purposed using a 10-year straight-line depreciation;schedule. The plant manager estimates that the operation would require;additional working capital of $40,000 but argues that this sum can be ignored;since it is recoverable at the end of the 10 years. Expected proceeds from;scrapping the machinery after 10 years are $21,750. If the company pays tax at;a rate of 35% and the opportunity cost of capital is 15%, what is the net;present value of the decision to produce the chains in-house instead of;purchasing them from the supplier?;Compute;the FCF in years 1 through 9 of producing the chains.;The;FCF in years 1 through 9 of producing the chains is $-338,950.;The;FCF in years 1 through 9 of producing the chains is $-336,950.;The FCF in years 1 through 9 of producing the chains is $-342,950.;The;FCF in years 1 through 9 of producing the chains is $-339,950.;A;bicycle manufacturer currently produces 356,000 units a year and expects output;levels to remain steady in the future. It buys chains from an outside supplier;at a price of $2.10 a chain. The plant manager believes that it would be;cheaper to make these chains rather than buy them. Direct in-house production;costs are estimated to be only $1.50 per chain. The necessary machinery would;cost $290,000 and would be obsolete after 10 years. This investment could be;depreciated to zero for tax purposed using a 10-year straight-line depreciation;schedule. The plant manager estimates that the operation would require;additional working capital of $40,000 but argues that this sum can be ignored;since it is recoverable at the end of the 10 years. Expected proceeds from;scrapping the machinery after 10 years are $21,750. If the company pays tax at;a rate of 35% and the opportunity cost of capital is 15%, what is the net;present value of the decision to produce the chains in-house instead of;purchasing them from the supplier?;Compute;the NVP of producing the chains from the FCF.;The;NVP of producing the chains from the FCF is $-3,007,692.;The NVP of producing the chains from the FCF is $-2,007,692.;The;NVP of producing the chains from the FCF is $-4,007,692.;The;NVP of producing the chains from the FCF is $-1,007,692.;IDX;Tech is looking to expand its investment in advanced security systems. The;project will be financed with equity. You are trying to assess the value of the;investment, and must estimate its cost of capital. You find the following data;for a publicly traded firm in the same line of business;Debt;outstanding (book value, AA-rated);$392.4;million;Number;of shares of common stock;77.2;million;Stock;price per share;$14.67;Book;value of equity per share;$5.55;Beta;of equity;1.32;What;assumptions do you need to make? (Select all the choices that apply.);Assume;comparable assets have same risk as project.;Assume debt is risk-free and market value = book value.;Assume;comparable assets have same cost.;Assume;debt is risk-free and market value > book value.;IDX;Tech is looking to expand its investment in advanced security systems. The;project will be financed with equity. You are trying to assess the value of the;investment, and must estimate its cost of capital. You find the following data;for a publicly traded firm in the same line of business;Debt;outstanding (book value, AA-rated);$392.4;million;Number;of shares of common stock;77.2;million;Stock;price per share;$14.67;Book;value of equity per share;$5.55;Beta;of equity;1.32;What;is your estimate of the project's beta?;The;project beta is 1.98.;The project beta is 0.98.;The;project beta is 2.98.;The;project beta is 1.48.;Your;firm spends $473,000 per year in regular maintenance of its equipment. Due to;the economic downturn, the firm considers forgoing these maintenance expenses;for the next 3 years. If it does so, it expects it will need to spend $1.9;million in year 4 replacing failed equipment. For what costs of capital (COC);is forgoing maintenance a good idea?;For;costs of capital that are less than the replacement costs.;For;costs of capital that are greater than the NPV.;For;costs of capital that are less than the IRR.;For costs of capital that are greater than the IRR.;In;mid-2009, Rite Ad had CCC-rated, 20-year bonds outstanding with a yield to;maturity of 17.3%. At the time, similar maturity Treasuries had a yield of 3%.;Suppose the mark risk premium is 5% and you believe Rite Aid's bonds have a;beta of 0.38. If the expected loss rate of these bonds in the event of default is 58%. In mid-2012, Rite Aid's bonds a had a;yield of 8.2%, while similar maturity Treasuries had a yield of 0.8%. What;probability of default would you estimate now?;The;probability of default will be 10.48%.;The;probability of default will be 8.48%.;The probability of default will be 11.48%.;The;probability of default will be 9.48%.;Bay;Properties is considering starting a commercial real estate division. It has;prepared the following four-year forecast of free cash flows for this division;Year;1;Year;2;Year;3;Year;4;Free;cash flow;$-122,000;$-9,000;$100,000;$219,000;Assume;cash flows after year 4 will grow at 3% per year, forever. If the cost of;capital for this division is 17%, what is the continuation value in year 4 for;cash flows after year 4?;The continuation value is $1,611,214.;The;continuation value is $1,601,214.;The;continuation value is $611,214.;The;continuation value is $1,621,214.;A;bicycle manufacturer currently produces 356,000 units a year and expects output;levels to remain steady in the future. It buys chains from an outside supplier;at a price of $2.10 a chain. The plant manager believes that it would be;cheaper to make these chains rather than buy them. Direct in-house production;costs are estimated to be only $1.50 per chain. The necessary machinery would;cost $290,000 and would be obsolete after 10 years. This investment could be;depreciated to zero for tax purposed using a 10-year straight-line depreciation;schedule. The plant manager estimates that the operation would require;additional working capital of $40,000 but argues that this sum can be ignored;since it is recoverable at the end of the 10 years. Expected proceeds from;scrapping the machinery after 10 years are $21,750. If the company pays tax at;a rate of 35% and the opportunity cost of capital is 15%, what is the net;present value of the decision to produce the chains in-house instead of;purchasing them from the supplier?;Compute;the difference between the net present values of buying the chains and producing;the chains.;The;net present value of producing the chains in-house instead of purchasing them;from the supplier is $431,128.;The net present value of producing the chains in-house instead of;purchasing them from the supplier is $331,128.;The;net present value of producing the chains in-house instead of purchasing them;from the supplier is $131,128.;The;net present value of producing the chains in-house instead of purchasing them;from the supplier is $231,128.;You;are considering opening a new plant. The plant will cost $100.3 million;upfront. After that, it is expected to produce profits of $31.9 million at the;end of every year. The cash flows are expected to last forever. Should you make;the investment?;Yes;because the project will generate cash flows forever.;No;because the NVP is not greater than the initial costs.;Yes, because the NVP is positive.;No;because the NVP is less than zero.;A;bicycle manufacturer currently produces 356,000 units a year and expects output;levels to remain steady in the future. It buys chains from an outside supplier;at a price of $2.10 a chain. The plant manager believes that it would be;cheaper to make these chains rather than buy them. Direct in-house production;costs are estimated to be only $1.50 per chain. The necessary machinery would;cost $290,000 and would be obsolete after 10 years. This investment could be;depreciated to zero for tax purposed using a 10-year straight-line depreciation;schedule. The plant manager estimates that the operation would require additional;working capital of $40,000, but argues that this sum can be ignored since it is;recoverable at the end of the 10 years. Expected proceeds from scrapping the;machinery after 10 years are $21,750. If the company pays tax at a rate of 35%;and the opportunity cost of capital is 15%, what is the net present value of;the decision to produce the chains in-house instead of purchasing them from the;supplier?;Compute;the FCF in year 10 of producing the chains.;The;FCF in year 10 of producing the chains is $-182,613.;The;FCF in year 10 of producing the chains is $-282,813.;The FCF in year 10 of producing the chains is $-182,813.;The;FCF in year 10 of producing the chains is $-282,613.;A;bicycle manufacturer currently produces 356,000 units a year and expects output;levels to remain steady in the future. It buys chains from an outside supplier;at a price of $2.10 a chain. The plant manager believes that it would be;cheaper to make these chains rather than buy them. Direct in-house production;costs are estimated to be only $1.50 per chain. The necessary machinery would;cost $290,000 and would be obsolete after 10 years. This investment could be;depreciated to zero for tax purposed using a 10-year straight-line depreciation;schedule. The plant manager estimates that the operation would require;additional working capital of $40,000, but argues that this sum can be ignored;since it is recoverable at the end of the 10 years. Expected proceeds from;scrapping the machinery after 10 years are $21,750. If the company pays tax at;a rate of 35% and the opportunity cost of capital is 15%, what is the net;present value of the decision to produce the chains in-house instead of;purchasing them from the supplier?;Compute;the initial FCF of producing the chains.;The;initial FCF of producing the chains is $-335,000.;The;initial FCF of producing the chains is $-339,000.;The;initial FCF of producing the chains is $-340,000.;The initial FCF of producing the chains is $-330,000.;You;are considering opening a new plant. The plant will cost $100.3 million;upfront. After that, it is expected to produce profits of $31.9 million at the;end of every year. The cash flows are expected to last forever. Use the IRR to;determine the maximum deviation allowable in the cost of capital estimate to make;the investment.;The;maximum deviation allowable in the cost of capital is 28.65%.;The;maximum deviation allowable in the cost of capital is 21.60%.;The maximum deviation allowable in the cost of capital is 24.70%.;The;maximum deviation allowable in the cost of capital is 18.45%.;The;figure below shows the one-year return distribution of Startup, Inc.;Probability;40%;20%;20%;10%;10%;Return;-100%;-75%;-50%;-30%;1,000%;Calculate;the expected return.;The;expected return is 30.0%.;The;expected return is 31.2%.;The expected return is 32.0%.;The;expected return is 30.7%.;You;are considering opening a new plant. The plant will cost $100.3 million;upfront. After that, it is expected to produce profits of $31.9 million at the;end of every year. The cash flows are expected to last forever. Calculate the;IRR.;The;IRR of the project is 30.60%.;The;IRR of the project is 28.80%.;The;IRR of the project is 33.70%.;The IRR of the project is 31.80%.;Pisa;Pizza, a seller of frozen pizza, is considering introducing a healthier version;of its pizza that will be low in cholesterol and contain no trans fats. The;firm expects that sales of the new pizza will be $15 million per year. While;many of these sales will be to new customers, Pisa Pizza estimates that 27%;will come from customers who switch to the new, healthier pizza instead of;buying the original version. Suppose that 39% of customers who switch from Pisa;Pizza to its healthier pizza will switch to another brand if Pisa Pizza does;not introduce a healthier pizza. What level of incremental sales is associated;with introducing the new pizza in this case?;The incremental sales are $11 million.;The;incremental sales are $8 million.;The;incremental sales are $6 million.;The;incremental sales are $13 million.

 

Paper#51207 | Written in 18-Jul-2015

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