This is the first test taken in my Corporate Finance class.
I was given a copy of every test that I put on my web page. None
of them were taken without permission.
1. (15 points) Hank Hill won $16,000,000 in the Texas Lottery and the prize consists of receiving a check for $800,000 each year for the next 20 years. The first payment will arrive exactly one year from today. Hank will quit his job as a propane salesman and enjoy the good life; however, Hank needs cash today. Armadillo Finance Corporation will buy Hank's Texas Lottery claim today and give him the Present Value payment that is calculated at an annual discount rate of 7.75%. How much cash will Hank receive today when he sells his Lottery claim?
| PVAN | = | PMT(PVIFA i,n) |
| = | 800,000(PVIFA 7.75%, 20) | |
| = | 8,002,823 |
2. (15 points)Shiner Brewery Corporation has just paid out all of this year's Free Cash Flow (FCF) of $3.50 per share as a dividend, and the FCF and dividend are expected to grow at 20% per year for the next 2 years and then at 5% per year forever according to a financial analyst. The required return on Shiner's common stock is 14%. What should be the price of one share of Shiner common stock? Calculate all answers by using financial formulas.
| D0 | = | $3.50 | ||||||
| D1 | = | 3.50(1 + .20) | = | $4.20 | ||||
| D2 | = | 4.20(1 + .20) | = | $5.04 | ||||
| D3 | = | 5.04(1 + .05) | = | $5.292 | ||||
| P0 | = | [4.20/(1 + 0.14)] | + | [5.04/(1 + 0.14)2} | + | [5.292/(0.14-0.05)][1/(1 + 0.14)2] | = | $52.81 |
3. (10 points)Barilla S.p.A. of Parma, Italy has a new project to build a new pasta plant in Canada. The project would cost $10 million today if accepted. The project will generate future cash flows of $3 million, $4 million, $4 million, and $2 million for each of the following four years, respectively. Investors require a 14% return on this investment. What should the decision be regarding this new project? You can use either NPV, IRR, or PI to reach a decision.
I/YR or "r" is 14% per year for cost of capital of project
CF0 = -10
CF1 = 3
CF2 = 4
CF3 = 4
CF4 = 2
NPV = -0.4064, the IRR = 11.93%, and the PI = 0.9594.
This project should be rejected
4. (10 points)Giovanni wants to buy a bond issued by Coca-Cola that has 10 years remaining until maturity. The coupon interest is paid annually and is 9% of par. The face or par value of the bond is $1000. The current yield to maturity (YTM) of this bond is 8%. What should be the market price of this bond?
FV |
= | $1,000 | ||
PMT |
= | $90 | ||
I/Y |
= | 8% | ||
n |
= | 10 | ||
PV |
= | solve | = | $1,067.10 |
5. George Costanza buys a car and finances most of the car purchase with a $20,000 loan. This loan is for 60 months and the interest rate is quoted as 8% APR (annual nominal, compounded monthly). The loan payments will be made monthly.
A. (5 points) Calculate George's monthly payment on the loan?
PV |
= | -$20,000 | ||
I/Y |
= | 8% | ||
n |
= | 60 | ||
*P/YR |
= | 12 | ||
PMT |
= | solve | = | $405.53 |
*This is very important. You must change the payments per year to 12 for these particular steps to work. Don't forget to change it back to 1 payment per year after you are finished with the calculation, or all other answers will be incorrect.
B. (5 points)Calculate the effective annual interest rate that George is paying?
| EAR | = | [1 + (i/n)n] - 1 |
| = | [1 + (.08/12)12] - 1 | |
| = | 0.082999 or 8.3% |
6. (10 points, and this is a Chapter 3, two period style model) Foghorn Leghorn has $40,000 now and will receive $50,000 one year from now. Interest rates are 8%. What is Foghorn's current wealth?
Total wealth (also the maximum that can be consumed today) is:
40,000 + [50,000/(1 + 0.08)] = $86,296.30
7. A U.S. Treasury bond that matures in August 2026 with a par value of $100,000 has an annual coupon rate of 6.25% and pays interest semiannually. (no calculation is necessary)
A. (5 points) What do we know about the current price of this bond if the current interest rate or Yield-To-Maturity is 5.9%? (i.e., is it selling at a discount or premium to par value)
Anytime the YTM is less than the coupon rate, the bond sells at a premium to par value, i.e., the price is below the par or face value.
B. (5 points) What will happen to the price of this bond if the interest rate or Yield-To-Maturity rises to 5.95% tomorrow?
Anytime the YTM or current market interest rate rises, the bond price will fall.
8. (10 points) How can shareholders attempt to control the behavior of managers so that the managers will act in the best interest of the shareholders.
The answer to this was more of a short essay type question. If I have time, I will look up the answer and post it....
9. (5 points) In order for a corporation to create wealth for its owners; what is the important characteristic that all new capital expenditures (real asset projects) must have?
New projects must have a positive Net Present Value.
10. (5 points) The cost of capital is 14%. Two mutually exclusive projects exist. Project A has an IRR of 16.5% and an NPV of $1.5 million. Project B has an IRR of 17.5% and an NPV of $1.3 million. What should be the decision of the corporation regarding these two projects.
Choose project A. It has the highest NPV of the two projects.