ACF 103 2014 Exam Revision Exercises
Chapter 3
1. What is the total present value of the following series of cash flows, discounted at 10%?
End of year Cash flow
1 $1,000
2 1,000
3 -2,000
4 3,000
2. At your brother's 20th birthday party, he asks you how much he would have to deposit at the end of every month to finance an $8,500 motorcycle on his 25th birthday. He plans to put the money in a 12% savings account that compounds interest quarterly.
3. Text book Ch 3 question # 9 (p.66)
4. Text book Ch 3 question # 13 (p.67)
5. It is January 1 and you have made a New Year's resolution to invest $5,000 in a savings account at the end of every year for the next 30 years. If your money is compounded at an average annual rate of 9%, how much will you have accumulated at the end of 30 years?
6. Congratulations! You have just won first prize in a raffle and must choose between $50,000 in cash today or an annuity of $12,000 a year for five years. (The annuity payments would come to you at the end of each year.) Which of these two choices is worth more, assuming a 7% discount rate? Show your calculations.
Chapter 4
1. Delphi Products Corporation currently pays a dividend of $2.50 per share, and this dividend
is expected to grow at a 12% annual rate for three years, and then at an 8% p.a. rate forever.
What value would you place on the stock if an 18% rate of return was required?
2. The 9-percent-coupon-rate bonds of the Melbourne Mining Company have exactly
15 years remaining to maturity. The current market value of one of these $1,000-parvalue
bonds is $700. Interest is paid semiannually. Melanie Gibson places a nominal
annual required rate of return of l4 percent on these bonds. What dollar intrinsic value
should Melanie place on one of these bonds (assuming semiannual discounting)?
Chapter 5
1. Salt Lake City Services, Inc., provides maintenance services for commercial buildings.
Currently, the beta on its common stock is 1.08. The risk-free rate is now l0%, and
the expected return on the market portfolio is 15%. It is January l, and the company
is expected to pay a $2 per share dividend at the end of the year, and the dividend is
expected to grow at a compound annual rate of l1% for many years to come. Based
on the CAPM and other assumptions you might make, what dollar value would you place
on one share of this common stock?
2. Sorbond Industries has a beta of 1.45. The risk-free rate is 8% and the expected
return on the market portfolio is 13%. The company currently pays a dividend of
$2 a share, and investors expect it to experience a growth in dividends of l0% per annum for many years to come'
a. What is the stock's required rate of return according to the CAPM?
b. What is the stock's present market price per share, assuming this required return?
Chapters 8-11, Gitman Chs 14-5
1. Hobbit Enterprises expects credit sales of $400 million next year. If the firm can invest funds at the rate of 10% a year, what is the value of collecting accounts payable three days earlier (use a 365-day year)?
2. Chou Dou Fu receives an average of $600,000 a day in payments from its franchisees through the mail. The average time it takes to have funds available at its bank is eight days from the postmark date. The firm has asked you to evaluate the following three alternatives. Which offers the greatest financial benefit to Chou Dou Fu? (Assume that the firm can earn 10% annually on its marketable securities investments.)
a. Bank Shanghai offers concentration banking that will reduce the time to have funds available from eight to five days. Bank Shanghai charges a fee of $105,000 annually to set up and administer the system.
b. Kaifeng Bank offers a system that will reduce the time to available funds to four days. Kaifeng Bank requires a $1,500,000 compensating balance in order to administer the system.
c. Bank of Henan offers to set up an Electronic Funds Transfer system that will reduce the time to available funds to two days. Bank of Henan charges an annual fee of $300,000 for this service.
3. Indo Processing Corp uses 20,000 gallons of solvent a year. The cost of carrying the solvents is $1.62 a gallon per year, while the cost per order is $200. What would the average inventory level if Indio wished to maintain a 400 gallon safety stock?
4. Alexis Limited uses 1,200 units of a product per year on a continuous basis. The product has a fixed cost of $70 per order and its carrying cost is $3 per unit per year. It takes five days to receive a shipment after an order is placed, and the firm wishes to hold in inventory 10 days’ usage as a safety stock.
a. Calculate the EOQ.
b. Determine the average level of inventory.
c. Determine the reorder point.
Chapter 13
1. Your firm is considering two mutually exclusive projects, P and Q, that would each require an initial cash outflow of $10,000. They would generate the following incremental, after-tax, operating cash flows:
Project P Project Q
Year 1 $5,000 $3,000
Year 2 4,000 4,000
Year 3 3,000 6,000
If the firm's required rate of return is 12%, which would you select?
2. A firm is considering two mutually exclusive investment alternatives, both of which cost $5,000. The firm's hurdle rate is 12%. The after-tax cash flows associated with each investment are:
Year Investment A Investment B
1 $2,000 $1,000
2 1,500 1,500
3 1,500 2,000
4 1,000 3,000
For each alternative, calculate the payback period, the net present value, and the profitability index. Which alternative (if any) should be selected?
3. The Capital City Company (CCC) is considering the purchase of a new laundromat to replace the one currently being used. The present machine is expected to last another seven years and have no salvage value. The laundromat in current use has a book value of $700 and can be sold today for $400. CCC pays $300 a year maintenance on the press. The new laundromat will cost $1,500. It is expected to last seven years, at which time it will be sold for $100. The maintenance cost of the new machine is expected to be $150 a year. CCC depreciates its assets on the straight-line basis and pays 30% taxes. If its opportunity cost of funds is 10%, should it buy the new machine?
4. A firm is considering the following projects, all of which are independent of one another. Available funds are limited to $2 million in this capital budgeting period, but future periods will have no capital budget constraints.
Present Value of
Project Initial Outlay Cash Inflows
1 $1,300,000 $1,200,000
2 1,000,000 1,250,000
3 800,000 900,000
4 600,000 700,000
5 500,000 550,000
6 400,000 470,000
7 300,000 280,000
8 100,000 105,000
Which projects should be accepted without exceeding the budget?
5. Text book Ch 13 #9 p.348. See also Ch 12 #3 p.320
Chapter 15
1. Text book Ch 15 #5 p.412
(1) (2) (1) × (2)
After-tax Cost Proportion of Total Financing WACC
Debentures 7.8% 37.5% 2.93%
Preferred Stock 12.0 12.5 1.50
Common Stock 17.0 50.0 8.50
100.0% 12.93% = ko
2. Using the capital-asset pricing model, determine the required return on equity for the
following situations:
Situation Expected return Risk free rate Beta
1 15% 10% 1.00
2 18 14 0.70
3 15 8 1.20
4 17 11 0.80
5 16 10 1.90
What generalisations can you make?
3. K-Far Stores has launched an expansion program that should result in the saturation of
the Bay Area marketing region of California in six years. As a result, the company is
predicting a growth in earnings of 12% for three years and 6% thereafter forever. The company expects to increase its annual dividend per share, most recently $2, in keeping with this growth pattern. What is the expected market price of the stock if the required rate of return is 15%?
If the current market price of the stock is $25, is the stock under-priced, or over-priced?
Chapter 16
1. Majong Corporation currently has 1,000,000 shares of common stock outstanding at a market price of $20 a share, and $20 million in 9% bonds. The company needs to raise $10 million in order to implement a series of investment projects. This amount can be raised by either (1) issuing 500,000 new shares of common at $20 a share, or (2) selling bonds with an 11% yield. If the firm's tax rate is 30%, and the EBIT with the new projects is projected at $6 million, which alternative will result in the highest earnings per share?
2. The Crazy Horse Hotel has a capacity to stable 50 horses. The fee for stabling a horse
is $100 per month. Maintenance, depreciation, and other fixed operating costs total
$1,200 per month. Variable operating costs per horse are $12 per month for hay and
bedding and $8 per month for grain.
a. Determine the monthly operating break-even point (in horses stabled).
b. Compute the monthly operating profit if an average of 40 horses are stabled.
3. Pan Guo has fixed costs of $120,000 directly attributable to producing a particular product. The product sells for $3 a unit and variable costs are $2.40.
What is the break-even point in units produced?
If the firm sold 250,000 units last year and expects volume to increase by 5%, what percentage increase in profits would Pan Guo see with this increase in volume?
What is the Degree of Operating Leverage (DOL) at 250,000 units? At 262,500 units?
Chapter 17
1. Jiang Chan Corporation has earnings before interest and taxes of $4.5 million and a 30% tax rate. It is able to borrow at an interest rate of 12%, whereas its equity capitalization rate in the absence of borrowing is 16%. The earnings of the company are not expected to grow, and all earnings are paid out to shareholders in the form of dividends. In the presence of corporate but no personal taxes, what is the value of the company in an M&M world with no financial leverage? With $5 million in debt? With $10 million in debt?
2. A firm with no debt has a current market value of $50 million. It borrows $10 million at 12%. Management estimates the present value of associated bankruptcy and agency costs at $2.5 million. If the company's tax rate is 30%, what is its new market value?
3. Giant Tricycles Ltd., has $2 million in earnings before interest and taxes. Currently it is all- equity-financed. It can issue $4 million in perpetual debt at 15% interest in order to repurchase stock, thereby recapitalising the corporation. There are no personal taxes.
a. If the corporate tax rate is 30%, what is the income available to all security holders if the company remains all-equity-financed? If it is recapitalised?
b. What is the present value of the debt tax-shield benefits?
c. The equity capitalization rate for the company's common stock is 20% while it remains all-equity-financed.
(i) What is the value of the firm if it remains all-equity financed?
(ii) What is the firm's value if it is recapitalised?