Question 1
Please see below finance questions Question 1 Using a payback period investment criterion tends to bias us toward what kind of investments? Select one: a. riskier investment b. less risky investments c. longer-term investments d. shorter-term investments e. lower return investments Question 2 If the cutoff point were forever, then the discounted payback rule would be the same as which of the following investment criteria? Select one: a. Net Present Value b. Profitability Index c. Average Accounting Return d. Internal Rate of Return e. both a and b Question 3 Which of the following is NOT a disadvantage of the average accounting return criterion? Select one: a. it is not a true rate of return b. it uses an arbitrary benchmark cutoff rate c. it is based on book values and not market values d. it may lead to incorrect decisions when comparing mutually exclusive investments e. none of the above Question 4 Ultimately, a good capital budgeting criterion must tell us two things. What are they? It should tell us if a particular project is a good investment. If there is more than one good mutually exclusive project, it should tell us which one to take. If there is more than one investment criteria used, it should tell us which one is best. Select one: a. I and II b. I and III c. II and III d. I, II, and III e. None of the choices are valid. Question 5 To break-even in an accounting sense, a firm would use the _________ investment criterion. Select one: a. net present value b. profitability index c. payback period d. discounted payback period e. none of the above Question 6 A project has an initial cash outlay of $750,000 and an annual cash inflow of $220,000 for the next 5 years. The assets involved in the project can be sold for $50,000 when the project is completed. The required rate of return on the project is 15%. Should the project be accepted based on the NPV rule? Select one: a. No, the project should not be accepted as the NPV is -$37,385. b. No, the project should not be accepted as the NPV is -$12,526. c. Yes, the project should be accepted as the NPV is $0. d. Yes, the project should be accepted as the NPV is $12,333. e. Yes, the project should be accepted as the NPV is $37,474. Question 7 ABC Company has a project that will yield cash inflows of $50,000, $60,000, $70,000, $60,000, and $50,000 in the next 5 years. The project requires an initial cash outlay of $205,000 and a required return of 11%. The company uses the payback period investment criterion. Should ABC invest in this project if its payback cutoff is 4 years? Select one: a. Yes, because the payback period of 2 years and 4 months is shorter than the payback cutoff. b. No, because the payback period of 3 years and 4 months is shorter than the payback cutoff. c. Yes, because the payback period of 3 years and 5 months is shorter than the payback cutoff. d. No, because the payback period of 4 years and 4 months is longer than the payback cutoff. e. Yes, because the payback period of 4 years and 5 months is longer than the payback cutoff. Question 8 DEF Ltd. has the opportunity to invest in a project with the cash flow stream below. What is the discounted payback period on this project if the required return is 15%? year cash flow 0 -1,000,000 1 450,000 2 550,000 3 350, 000 4 350,000 Select one: a. 2 years and 8 months b. 2 years and 10 months c. 3 years and 8 months d. 3 years and 10 months e. 4 years and 8 months Question 9 GHI Inc. has a project with the following payoff structure and a required return of 16%. What is the IRR of this project and should the firm accept or reject it? Year Cash Flow 0 -1,250,000 1 450,000 2 550,000 3 350,000 4 350,000 Select one: a. 14%; accept b. 14.5%; reject c. 15%; accept d. 15.5%; reject e. 16%; accept A project has an initial cash outlay of $100,000 and cash inflows of $20,000 for the next 10 years. If the required return is 10%, what is the profitability index of this project and should it be accepted or rejected? Select one: a. 2; accept b. 1.35; reject c. 1.58; accept d. 1.74; reject e. 1.23; accept
Question 2
VALUING AND AMERIAN OPTION J&B Drilling Company has recently acquired a lease to drill for natural gas in a remote region of southwest Louisiana and southeast Texas. The area has long been known for oil and gas production, and the company is optimistic about the prospects of the lease. The lease contract has a three-year life and allows J&B to begin exploration at any time up until the end of the three-year term. J&Bs engineers have estimated the volume of natural gas they hope to extract from the leasehold and have placed a value of $25 million on it, on the condition that explorations begin immediately. The cost of developing the property is estimated to be $23 million (regardless of when the property is developed is developed over the next three years). Bases on historical volatilities in the returns of similar investments and other relevant information, J&Bs analysts have estimated that the value of the investment opportunity will evolve over the next three years. The risk-free rate of interest is currently 5%, and the risk-neutral probability of an uptick in the value of the investment is estimated to be 46.26%. A.Evaluate the value of the leasehold as an American call option. What is the Lease worth today?
Question 3
ATERWAYS CONTINUING PROBLEM: WCP22 (This is a continuation of the Waterways Problem from Chapters 14 through 21.) Waterways Corporation uses very stringent standard costs in evaluating its manufacturing efficiency. These standards are not ?ideal? at this point, but the management is working toward that as a goal. At present, the company uses the following standards. Materials Item Per Unit Cost Metal 1 lb. 58? per lb. Plastic 12 oz. 96? per lb. Rubber 4 oz. 80? per lb. Direct Labor Item Per Unit Cost Labor 12 min. $8.00 per hr. Predetermined overhead rate based on direct labor hours = $4.28 The January figures for purchasing, production, and labor are: The company purchased 229,000 pounds of raw materials in January at a cost of 74? a pound. Production used 229,000 pounds of raw materials to make 115,500 units in January. Direct labor spent 15 minutes on each product at a cost of $7.75 per hour. Overhead costs for January totaled $54,673 variable and $63,800 fixed. Instructions Answer the following questions about standard costs. (a) What is the materials price variance? (b) What is the materials quantity variance? (c) What is the total materials variance? (d) What is the labor price variance? (e) What is the labor quantity variance? (f) What is the total labor variance? (g) What is the total overhead variance? (h) Evaluate the variances for this company for January. What do these variances suggest to management?
Question 4
Walt Disney Company's Sleeping Beauty Bonds In July 1993, the Walt Disney Company issued $300,000,000 in senior debentures (bonds). The debentures carried an interest rate of 7.55%, payable semiannually, and were priced at "par." They were due to be repaid on July 15, 2093, a full 100 years after the date of issue. However, at the company's option, the debentures could be repaid (in whole or in part) any time after July 15, 2023 or 30 years after the issue date. Beauty, the fairy tale princess and heroine of a popular Disney animated film, according to legend, slept under enchantment in a magic castle for 100 years. The Disney 100-year debentures were immediately dubbed the "Sleeping Beauties." The issue caused a lot of comment among traders and portfolio managers. "It's crazy," said William Gross, head of fixed-income investments at Pacific Management Company. "Look at the path of Coney Island over the last 50 years and see what happens to amusement parks."1 Scott Jacobson, head of fixed-income research at Piper Capital Management, felt that the bonds were too risky for his clients, but "if corporate treasurers can get away with it, why not?"2 Others interpreted the successful sale of the bonds as a vote of confidence in the Disney Company and U.S. economic policy. "It shows that people believe the Mouse will still be singing and dancing in 100 years," said Tom Deegan (head of corporate communications at Disney).3 And Alan Greenspan, Chairman of the Federal Reserve Board of Governors called the bonds "one of the more important indicators of the long-term inflation expectations that have so bedeviled our economy and financial markets seem to be receding . . . a very good sign."4 As long-term interest rates declined in 1992 and 1993, companies and investors began to show renewed interest in very long-term maturities. The Tennessee Valley Authority (a government-owned hydroelectric power company) sold a 50-year bond in April 1992. Ford, Boeing, Texaco and Conrail followed with their own 50-year issues (irreverently dubbed "Methuselah" bonds) in 1993. The Disney bonds were the first 100-year bonds to be issued since 1954, when the Chicago & Eastern Railroad (a subsidiary of Union Pacific) issued 5% bonds due in 2054. However, the award for longest lasting liability went to the Canadian Pacific Corporation, which was paying 4% on a 1,000-year bond, issued by the Toronto Grey and Bruce Railway in 1883, and due to be repaid in 2883!5 The idea for the 100-year bond came from an institutional investor. As reported in the Wall Street Journal, an institution approached Morgan Stanley with a request for a 100-year corporate bond to balance its short-term holdings and lengthen the duration of its portfolio. Thus, according to some observers, the 100-year bonds "were conceived by quantitative analysts tucked away in cramped rooms crowded with computer screens."6 The issue was priced on July 20, 1993 to yield .95% (95 basis points) over the benchmark 30- year Treasury bond. Analysts estimated that this was .15% to .20% more than Disney would have paid had it issued 30-year bonds. And Disney had the right to call the bonds after 30 years for 103.02% of face value. Thus 30 years hence, the company had the best of both worlds. If prevailing interest rates were low, it could call the bonds and replace them with a cheaper issue. But if interest rates were high, the bonds could remain out, continuing to pay 7.55%, for 70 more years! The bonds were rated Aa3 by Moody's and AA- by Standard & Poor's. Demand was so brisk that the company doubled the size of the issue from $150 million of $300 million. As co-manager of the Disney offering, Merrill Lynch perceived an overflow of interest for very-long-maturity bonds. According to Grant Kvalheim, a managing director at Merrill Lynch & Co., "We went to Coke and showed them the [Disney] bonds."7 Three days later Coca-Cola Co. went to market with its own 100-year issue of $150 million. The Coke 100-year bonds were priced to yield 7.455% or just 80 basis points over the benchmark Treasury, but, unlike the Disney bonds, were not callable. The primary buyers of both the Disney and Coca Cola bonds were large institutions, especially insurance companies and pension funds with defined liabilities. There was also speculation that some Wall Street houses would find it advantageous to break up the bonds into their component parts and sell the pieces separately. At the end of the week, professionals were still divided over whether the two 100-year bond issues were indicators of a trend and (as Greenspan claimed) evidence of confidence in the economy, or merely two novelty items that enlivened a dull week in July, before everyone headed off on vacation! Questions 1. What are the cash payments associated with the Sleeping Beauties? Who gets how much and when, per $100 of bonds issued? Consider the following dates: the issue date, the delivery date, the date of the first, second, etc. interest payments, the maturity date. (Assume the bonds remain outstanding through 2093.) 2. Open the Sleeping Beauty Excel Workbook, which contains a number of worksheets. Double-click on the Basic Spreadsheet. It contains a list of years and payments made each year on the Sleeping Beauties. (For simplicity, we are ignoring the fact that U.S. debentures, by convention, pay interest semiannually.) The NPV function in Excel calculates values of cash flow streams for a given interest rate. Cell F15 in a box titled Present Value contains the formula, and shows the resulting price of the bonds. What interest rate was used to calculate the price? Was it higher or lower than 7.55%? 3. Suppose on the day after the Sleeping Beauties were sold, the prevailing interest rate increased one percentage point, i.e., from 7.55% to 8.55%. a. What events might cause such a change? b. What would be the new price of the Sleeping Beauties? 4. If the interest rate dropped by one percentage point, what would the price of the Sleeping Beauties become? 5. The next spreadsheet in the Workbook is called Interest Rates. Column D in the Interest Rates spreadsheet contains a list of interest rates, ranging from 2% to 20%. a. Is this a reasonable range of interest rates to consider over a 100-year horizon? b. Calculate the value of the Sleeping Beauties for each of the interest rates shown. (Hint: Copy the NPV formula in Cell E6. Paste the formula in Cells E7 through E27. Note that the cash flow stream in the formula is "absolute," i.e., each cell reference is preceded by a $ sign.) 6. The next sheet in the Workbook is called "Maturity." The first three columns are identical to the Basic Spreadsheet. The next column contains cash flows for a bond that is just like Sleeping Beauty, but lasts only 10 years ("Napping Beauty"). Column F contains the same list of interest rates as in the Basic Spreadsheet. Columns G and H contain prices for the Sleeping and Napping bonds that correspond to the different interest rates. (You can check your answers to Question 5 against the values in Column F.) a. Compare the prices of the Sleeping and Napping bonds at the initial interest rate of 7.55%. Why are they the same? What does this say about the expected price path of the Sleeping Beauties as time passes, if interest rates remain around 7.55%? b. Suppose interest rates fluctuate wildly during the next two years and then stabilize again at around 7.55%. What do you predict would happen to the price of each of the bonds? 7. Compare the value of the Sleeping and Napping bonds for interest rates greater than 7.55%. a. Which is worth more? Why? b. Do the same for interest rates below 7.55%. Which bond is more sensitive to interest rate fluctuations? Why? c. Flip to the next sheet of the Workbook to see the graphed values for the Sleeping and Napping bonds. 8. The next sheet in the Workbook is a Chart of the Sleeping and Napping Beauties prices as a function of interest rates. 9. In July 1993, the Walt Disney Company's common stock was trading in the range $36 to $41 per share. It paid dividends of $ .25 per share annually, on earnings of $1.80 (estimated for the fiscal year ending in September 1993). a. What pattern of cash flows do holders of Disney common stock expect? How does this pattern compare to the Sleeping Beauties? b. If Disney bonds pay 7.55%, what rate of return should one expect for holding Disney common stock? c. How much must Disney's stock price go up this year to give an investor that rate of return? d. How fast must Disney increase its dividends, to merit such an increase in its stock price? 10. Is Disney a good candidate for a leveraged recapitalization? Why or why not?
Question 5
36/37 36. A shareholder?s adjusted basis in the shareholder?s stock is used to make determinations with respect to which of the following? a. the extent to which a distribution made by the corporation to the shareholder is taxable. b. the amount of losses that shareholders may deduct in a given year. c. the shareholder?s realized gain or loss upon the sale or exchange of the stock. d. all of the above. 37. In the current year, Sue received a liquidating distribution of real estate from UTSRQ Partnership, a general partnership. The real estate had an adjusted basis to the partnership of $35,000 and a fair market value of $90,000 on the date of the distribution. Sue?s adjusted basis in her 20 percent interest in UTSRQ Partnership was $50,000. How much gain or loss did Sue recognize on receipt of the distribution and what is her basis in the real estate? a. 0 gain or loss recognized and a $50,000 basis in the real estate. b. ($15,000) loss recognized and a $35,000 basis in the real estate. c. 0 gain or loss recognized and a $35,000 basis in the real estate. d. $40,000 gain recognized and a $90,000 basis in real estate. e. $15,000 gain recognized and a $50,000 basis in real estate.
