CFIN300 Class 13

1.

Answers to Review 02 - Problems

C. $125. Subject: Change in Net Working Capital

NWC = NWC2006 NWC2005 = (2790 660) (2545 540) = 125

2.

D. $860. Subject: Non-cash Expenses. Depreciation is a non-cash expense

3.

E. $2,340. Subject: Net Capital Spending

Net Capital Spending = NFA2006 NFA2005 + Depreciation = 4,660 3,180 + 860 = 2,340

4.

C. $1,830. Subject: Operating Cash Flow.

OCF = EBIT + Taxes Depreciation = 1,330 360 + 860 = 1,830

5.

A. -$635. Subject: Cash Flow from Assets

Cash Flow from Assets = OCF Change in Net Working Capital Net Capital Spending
= 1,830 125 2,340 = -635

6.

E. $1,315. Subject: Net New Borrowing. Net New Borrowing = 3,480 2,165 = 1,315

7.

A. -$1,045. Subject: Cash Flow to Creditors

Cash Flow to Creditors = Interest Net New Borrowing = 270 1,315 = -1,045

8.

D. $660. Subject: Dividends Paid

Dividends = Net Income Addition to Retained Earnings = 700 (1,060 1,020) = 660

9.

B. $410. Subject: Cash Flow to Stockholders

Cash Flow to Stockholders = Dividends Net New Equity = 660 (2,250 2,000) = 410

10.

E. 80%. Subject: Retention Ratio. R = 1,560 / 1,950 = 80%

11.

E. $56,376.81. Subject: Full Capacity Sales

Full Capacity Sales = $38,900 / 0.69 = $56,376.81

12.

B. 0.90. Subject: Capital Intensity

Capital intensity ratio = Assets / Full Capacity Sales = 43,200 / ($38,900 /0.81) = 0.9

13.

C. $1,716. Subject: Addition to Retained Earnings

Profit Margin = 1,950 / 38,900 = 5.013%. Projected Sales = 38,900 1.1 = 42,790
Net Income = 42,7905.013% = 2,145 Addition to Retained Earnings = 2,14580% = $1,716

14.

A. -$736. Subject: EFN

Projected sales = 38,9001.2 = $46,680. Full Capacity Sales = 38,900/0.82 = $47,439
Changes in the asset side:
Current Assets = 13,8000.2 = $2,760.
NFA = 0 (as Projected sales is smaller than Full Capacity Sales)
Total Assets = $2,760 + 0 = $2,760
Changes in the liabilities and equity side:
Accounts payable = $8,1200.2 = $1,624
Net Income = $46,6805.013% = $2,340 Addition to Retained Earnings = $2,34080% = $1,872
Total liabilities and equity = $1,624 + $1,872 = $3,496
EFN = $2,760 $3,496 = -$736

Page 1

CFIN300 Class 13

15.

Answers to Review 02 - Problems

A. 3.75%. Subject: Internal Growth Rate

ROA = 1,950 / 43,200 = 4.51%
Internal Growth Rate = RROA / (1 RROA) = 80%4.51% / (1 80%4.51%) = 3.75%

16.

A. $0. Subject: Capacity Utilization and Increase in Fixed Assets

Projected sales = 38,9001.3 = $50,570. Full Capacity Sales = 38,900/0.75 = $51,867
NFA = 0 (as Projected sales is smaller than Full Capacity Sales)

17.

D. $82,500. Subject: Present Value Annuity

2

7.8% 12
Monthly quoted rate, EPR = 1 +
1 = 0.6397%
2

Loan = 586.84

1
(1 + 0.006397) 360
= $82,500
0.006397

Calculator:
n = 360; I% = 7.8; PMT = -586.84; FV = 0; P/Y = 12; C/Y = 2. Compute PV = 82500
18.

B. $2,577.10. Subject: Present Value Annuity

1

PV = 1,000

1
(1 + 0.08)3
= $2,577.10
0.08

Calculator:
n = 3; I% = 8; PMT = -1000; FV = 0; P/Y = 1; C/Y = 1. Compute PV = 2577.10
19.

D. $772.45. Subject: Present Value Annuity

Loan balance today = 2,0001.14 = 2,928.20
Payment = 2,928.20

0.1
= $772.45
1
1 5
1.1

Calculator:
Step 1: n = 4; I% = 10; PV = -2000; PMT = 0; P/Y = 1; C/Y = 1. Compute FV = 2928.2
Step 2: n = 5; I% = 10; PV = 2928.2; FV = 0; P/Y = 1; C/Y = 1. Compute PMT = -772.45
20.

C. $3,349. Subject: Present Value with Zero Interest

0.02
= $111.62
1
1
1.0230
(Calculator: n = 30; I% = 24; PV = 2500; FV = 0; P/Y = 12; C/Y = 12. Compute PMT = -111.62)
Monthly payment = 2,500

Price if zero-financing = $111.6230 = $3,349

21.

B. $849. Subject: Present Value with Zero Interest

Price if zero-financing = $3,349 (see Question 20)
Change in price = $3,349 $2,500 = $849

Page 2

CFIN300 Class 13

22.

Answers to Review 02 - Problems

C. $214.21. Subject: Annuity Payment

Monthly rate = 12%/12 = 1%. EAR = (1 + 12%/12)12 1 = 12.68%
1
1
(1 + 0.1268) 25
= $748,642
Step 1: Funds needed for withdrawals: PV = 100,000
0.1268

Step 2: Monthly deposit = 748,642

0.01
= $214.21
1.01360 1

Calculator:
Step 1: n = 25; I% = 12; PMT = -100000; FV = 0; P/Y = 1; C/Y = 12. Compute PV = 748642
Step 2: n = 360; I% = 12; PV = 0; FV = 748642; P/Y = 12; C/Y = 12. Compute PMT = -214.21
23.

B. $6,988.91. Subject: Present Value Annuity Due

1
0.08

= $6,988.91
1
1
.
08
1
1.084
Calculator: n = 4; I% = 8; PV = 25000; FV = 0; P/Y = 1; C/Y = 1. Compute PMT = -6988.91 (Be
sure to select BGN for beginning cash flows.)
Annual withdrawal = 25,000

24.

B. $1,000,000. Subject: Growing Perpetuities

PV = 10,000 / (10% 9%) = $1,000,000

25.

A. $128,740. Subject: Loan Payments

Loan = 0.820,000,000 = 16,000,000. Monthly rate = 9%/12 = 0.75%

Monthly payment = 16,000,000

0.75%
= $128,740.
1
1
(1 + 0.75%)360

Calculator: n =360; I% = 9; PV = 16000000; FV = 0; P/Y = 12; C/Y = 12. Compute PMT = -128740
26.

C. $244,835. Subject: Future Value of Annuities

EAR = 8% (given). P/Y (and C/Y) = 12 months / 18 months = 2/3 = 0.6667

Total number of payments = 18 years 2/3 per year = 12

1
APR = (2 / 3) (1 + 8% )2 / 3 1 = 8.15793%

EPR for each 18-month period = APR / (2/3) = (1 + 8% )2 / 3 1 = 12.2369%

1

FV = 10,000

(1 + 12.2369%)12 1
= $244,835
12.2369%

Calculator:
Step 1: (Use the Conversion menu). n = 0.6667 (i.e. 2/3); I% = 8. Compute APR = 8.15793
Step 2:
n=12; I%=12.2369 [ = 8.15793 / (2/3) ]; PV=0; PMT=-10000; P/Y=1; C/Y=1. Compute FV = 244835.
Alternatively (this only works on TI BAII+ or any calculator that accepts non-whole numbers for P/Y and
C/Y): n=12; I%= 8.15793; PV=0; PMT=-10000; P/Y= 0.6667; C/Y = 0.6667. Compute FV = 244835.
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CFIN300 Class 13

27.

Answers to Review 02 - Problems

D. $191,557.57. Subject: Mortgage Balance

Loan = 250,00090% = 225,000. APR = 6.25%. P/Y = 24; C/Y = 2.

Number of payments = 2024 = 480
2

0.002568
6.25% 24
= $816.0186
EPR = 1 +
1 = 0.2568%. PMT = 225,000
1
2

1
1.002568480
Balance at the end of the 5 years is the present value of the 360 remaining PMTs (for 15 years)
PV = 816.0186

1
1.002568360 = $191,557.57
0.002568

Calculator:
Step 1: (Use the Cash Flow or TVM menu)
n = 480; I% = 6.25; PV = 225000; FV = 0; P/Y = 24; C/Y = 2. Compute PMT = -816.0186

Step 2:
Either (Use the Cash Flow or TVM menu)
n = 360; I% = 6.25; PMT = -816.0186; FV = 0; P/Y = 24; C/Y = 2. Compute PV = 191557.57

or (Use the Amortization menu)

Casio: PM1 = 1; PM2 = 120; n = 480; I% = 6.25; PV = 225000; PMT = -816.0186; FV = 0; P/Y =
24; C/Y = 2. (Only inputs for PM1 and PM2 are needed. The other inputs are retained after Step 1)
Compute BAL = 191557.57
TI BA II+: P1 = 1; P2 = 120. Compute BAL = 191557.57

28.

B. $166,688.95. Subject: Mortgage Interest

Total payments = $816.0186 480 = $391,688.95.

Total interest = $391,688.95 $225,000 = $166,688.95
Calculator: Continue from Step 2 in Question 27.
Casio: Only change PM2 = 480. Compute INT = -166688.95
TI BA II+: Only change P2 = 480. Compute INT = -166688.95
29.

D. 3.5 years. Subject: Annuities Due, Number of Periods

PMT (1 + r )
25 (1 + 0.5%)
ln
ln

PMT (1 + r ) PV r
25 (1 + 0.5%) 3000 0.05%
= 182.23 weeks
=
n=
ln(1 + r )
ln(1 + 0.05%)

(Calculator: I% = 0.5; PV = 3000; PMT = -25; FV = 0; P/Y = 1; C/Y = 1. Compute n = 182.23.

Be sure to select BGN for beginning cash flows.)
Number of years = 182.23 weeks / 52 = 3.5 years
30.

C. $17.16. Subject: Implicit Interest of Zero-Coupon Bond

1

1,000 20
st
r =
1 = 8% 1 year interest = 8%214.55 = $17.16
214
.
55

Page 4

CFIN300 Class 13

31.

Answers to Review 02 - Problems

A. $505.40. Subject: Implicit Interest and Price of Zero-Coupon Bond

1

1,000 15
Implicit interest rate: r =
1 = 6 .4 % .
394.34

Price @ Yr4 = 394.341.0644 = 505.40 (as FV of the current price compounded for 4 years) or
Price @ Yr4 = 1,000 / 1.06411 = 505.40 (as PV of the face value discounted for 11 years)
Calculator:
Step 1: n = 15; PV = -394.34; PMT = 0; FV = 1000; P/Y = 1; C/Y = 1. Compute I% = 6.4
Step 2: n = 4; I% = 6.4; PV = -394.34; PMT = 0; P/Y = 1; C/Y = 1. Compute FV = 505.40
or n = 11; I% = 6.4; PMT = 0; FV = 1000; P/Y = 1; C/Y = 1. Compute PV = -505.40
32.

C. 86.4%. Subject: Bond Valuation

1
Bond price = 70

1
1,000
(1 + 0.068)30
+
= 886.37 + 138.95 = 1,025.32
0.068
(1 + 0.068)30

Calculator:
Step 1: Calculate PV of Coupons
n = 30; I% = 6.8; PMT = 70; FV = 0; P/Y = 1; C/Y = 1. Compute PV = -886.37
Step 2: Calculate Bond price
n = 30; I% = 6.8; PMT = 70; FV = 1000; P/Y = 1; C/Y = 1. Compute PV = -1025.32
PV of Coupons / Bond price = 886.37 / 1,025.32 = 86.4%.
33.

A. $901.03. Subject: Bond Prices

1

Bond A: PriceA = 1,098.96 = 45

1
1,000
(1 + y ) 40
+
y
(1 + y ) 40

Semiannual YTM, y = 4% (Use calculator, see below)

1

PriceB = 35

1
1,000
(1 + 4%) 40
= $901.03
+
4%
(1 + 4%) 40

Calculator:
Step 1: n = 40; PV = -1098.96; PMT = 45; FV = 1000; P/Y = 1; C/Y = 1. Compute I% = 4
(i.e. semiannual YTM)
Step 2: n = 40; I% = 4; PMT = 35; FV = 1000; P/Y = 1; C/Y = 1. Compute PV = -901.03

Alternatively,
Step 1: n = 40; PV = -1098.96; PMT = 45; FV = 1000; P/Y = 2; C/Y = 2. Compute I% = 8
(i.e. annual YTM)
Step 2: n = 40; I% = 8; PMT = 35; FV = 1000; P/Y = 2; C/Y = 2. Compute PV = -901.03

Page 5

CFIN300 Class 13

34.

Answers to Review 02 - Problems

B. 131%. Subject: Bond Valuation

1

1,000 18
r =
1 = 10%
179.86

(Calculator: n = 18; PV = -179.86; PMT = 0; FV = 1000; P/Y = 1; C/Y = 1. Compute I% = 10)

New r = 10%/2 = 5%
New price = 1,000 / 1.0518 = 415.52
(Calculator: n = 18; I% = 5, PMT = 0; FV = 1000; P/Y = 1; C/Y = 1. Compute PV = -415.52)
% Price = (415.52 179.86) / 179.86 = 131%
35.

E. 7.27%. Subject: Yield to Maturity

1

Price = 1,234.93 = 100

1
1,000
(1 + Y )14
YTM = 7.27% (See below)
+
Y
(1 + Y )14

Calculator:
n = 14; PV = -1234.93; PMT = 100; FV = 1000; P/Y = 1; C/Y = 1. Compute I% = 7.27
36.

E. -18.06%. Subject: Interest Rate Risk

Semiannual YTM and coupon rate = 4%/2 = 2%.
New semiannual YTM = 2% + 1.5%/2 = 2.75%
1
1
1,000
(1 + 2.75%) 40
New price = 20
+
= 819.41
2.75%
(1 + 2.75%) 40

(Calculator: n = 40; I% = 5.5, PMT = 20; FV = 1000; P/Y = 2; C/Y = 2. Compute PV = -819.41)
% Price = (819.41 1,000) / 1,000 = -18.06%
37.

E. $70.00. Subject: Coupon Rate

Interest = 7%1,000 = $70

38.

A. $21.25. Subject: Effective Annual Yield and Interest Payments

Effective annual yield (i.e. EAR) = 4.295%

1
Annual YTM (i.e. APR) = 2 (1 + 4.295% )2 1 = 4.25% = Coupon rate (for par bonds)

(You can use the Conversion function in the calculator: n = 2; I% =4.295. Compute APR = 4.25)
Semiannual interest = 1,000 4.25% / 2 = $21.25

Page 6

CFIN300 Class 13

39.

Answers to Review 02 - Problems

C. 8.13%. Subject: Bond Yields

For par bonds, Coupon rate = YTM.
1

Price = 989 = 40

1
1,000
(1 + y ) 30
Semiannual YTM, y = 4.064% (See below)
+
y
(1 + y ) 30

Calculator:
n=30; PV= -989; PMT=40; FV=1000; P/Y = 1; C/Y = 1. Compute I% = 4.064 (semiannual YTM)
Yearly coupon rate for new bonds (at par) = 4.064%2 = 8.13%
Alternatively,
n = 30; PV = -989; PMT = 40; FV = 1000; P/Y = 2; C/Y = 2. Compute I% = 8.13 (annual YTM)
40.

C. 423. Subject: Number of Bonds

Price = 1,000 / (1 + 6.5%)10 = 532.73.

Number of bonds = 225,000 / 532.73 = 423 (rounded).
41.

E. 19.70%. Subject: Holding Period Yield

Semiannual YTM = 5%/2 = 2.5%.
Semiannual coupon payment = 1,000 6% / 2 = 30
Years to maturity = 17 (or 34 semiannual periods).
1
1
1,000
(1 + 2.5%) 34
+
= $1,113.62
Bond Price today = 30
2 .5 %
(1 + 2.5%) 34
Semiannual Holding Period Yield (HPY) is the solution of the following equation:
30
30
30
30
30
30
1,113.62
765 =
+
+
+
+
+
+
2
3
4
5
6
1 + HPY (1 + HPY)
(1 + HPY)
(1 + HPY)
(1 + HPY)
(1 + HPY)
(1 + HPY) 6
or
30
30
30
30
30
30
1,113.62
0 = 765 +
+
+
+
+
+
+
2
3
4
5
6
1 + HPY (1 + HPY)
(1 + HPY)
(1 + HPY)
(1 + HPY)
(1 + HPY)
(1 + HPY) 6

Semiannual HPY = 9.85% or Annual HPY = 9.85%2 = 19.70%

(Note that you can use the IRR function in the calculator to solve for Semiannual HPY =
9.85% with the following list of cash flows: -765, 30, 30, 30, 30, 30, and 1143.62
[=30+1113.62], but its a bit more cumbersome than the steps shown below.)
Calculator:
Step 1: n = 34; I% = 5; PMT = 30; FV = 1000; P/Y = 2; C/Y = 2. Compute PV = -1113.62
Step 2: n = 6; PV = -765; PMT = 30; FV = 1113.62; P/Y = 2; C/Y = 2. Compute I% = 19.70
42.

D. 15.50 years. Subject: Time to Maturity of Zero Coupon Bond

1,000
FV
ln
ln

PV
267.8

n=
=
= 15.50 years.
ln(1 + r ) ln(1 + 8.87%)

Calculator: I% = 8.87; PV = -267.8; PMT=0; FV = 1000; P/Y=1; C/Y=1. Compute n = 15.50.

Page 7

CFIN300 Class 13

43.

Answers to Review 02 - Problems

C. $15. Subject: Negative Dividend Growth Valuation

P=

D0 (1 + g ) 2.5 [1 + (0.04)]
=
= $15
rg
0.12 (0.04)

44.

D. 12.00%. Subject: Required Returns

D
D (1 + g )
1.5 1.05
r = 1+g = 0
+g =
+ 0.05 = 12%
P
P
22.5

45.

B. The price will likely rise by less than 100%. Subject: Dividend Growth Model

% Price = (2.5 1.5) / 1.5 = 67%

46.

A. $1.21. Subject: Nonconstant Dividend Growth

P30 = D31 / r = 12 / 15% = 80 P0 = 80 / 1.1530 = $1.21

47.

C. $2.01. Subject: Nonconstant Dividend Growth

P30 = D31 / (r g) = 12 / (15% 6%) = 133 P0 = 133 / 1.1530 = $2.01

48.

A. $11.47. Subject: Stock Valuation

PV @ Year 0 (today) of Year 3 special dividend = 5/1.123 = 3.56
PV @ Year 3 of dividends starting from Year 4 = 1 / (12% 3%) = 11.11
P0 = 3.56 + 11.11 / 1.123 = $11.47

49.

D. $28.89. Subject: Supernormal Growth

PV of Year 1 dividend
PV of Year 2 dividend
PV of Year 3 dividend

= 21.15 / 1.15
2

= 21.15 / 1.15
2

= (21.15 )1.12 / 1.15

= 1.95

PV of dividends starting from Year 4 = {[(21.152)1.12)1.06] / (15% 6%)}/1.153 = 22.94

Price today
= 28.89
50.

E. 9.5%. Subject: Supernormal Growth Valuation

P2 =

D2 (1 + g )
(1 1.052 ) (1 + g )
1.1025 (1 + g )
22 =
22 =
rg
0.15 g
0.15 g

Solve this equation for g = 9.5%

51.

C. $295,000. Subject: Opportunity Costs

52.

A. $177,000. Subject: Relevant Cash Flows

Relevant sales = Sales of lower-priced shoes Lost sales of higher-priced shoes

= 5,000 pairs $49 1,000 pairs $68 = $177,000

53.

C. $494,500. Subject: Relevant Cash Flows

Initial cost = 237,000 + 28,000 + 229,500 = $494,500

54.

D. $450,000. Subject: Erosion Cost

Erosion Cost is the loss in the upper-end current sales.

55.

B. $18,100,000. Subject: Erosion Cost. Erosion Cost is the lost sales for Class A and Class C.

Total lost sales = $125,000 (1,000 950) + $39,500 (2,500 2,201) = $18,100,000
56.

C. $25,000. Subject: UCC. UCC1 = 50,000 / 2 = $25,000

Page 8

CFIN300 Class 13

57.

Answers to Review 02 - Problems

D. $25,500. Subject: UCC

UCC2 = C(1 d/2)(1 d)n-2 = 100,000(1 30%/2)(1 30%)0 = 85,000

CCA2 = 85,00030% = $25,500
58.

E. $5,772.69. Subject: UCC

UCC5 (ending Yr4 = beginning Yr5) = C(1 d/2)(1 d)n-2

= 19,800(1 30%/2)(1 30%)5-2 = $5,772.69
59.

A. The tax due on the sale is $5,458.59. Subject: Salvage Value and CCA Recapture

UCC4 (ending Yr3 = beginning Yr4) = C(1 d/2)(1 d)n-2

= 135,000(1 25%/2)(1 25%)4-2 = $66,445.31
Recapture = 82,500 66,445.31 = 16,054.69. Tax due = 16,054.69 0.34 = $5,458.59
60.

D. $38,516. Subject: Project OCF

UCC2 = C(1 d/2)(1 d)n-2 = 72,000(1 30%/2)(1 30%)0 = 61,200

CCA2 = 61,20030% = $18,360
OCF = (Sales Costs) (1 Tax rate) + Depreciation Tax rate
= (136,800 87,900)(1 0.34) + 18,3600.34 = $38,516
61.

C. $12,446. Subject: Net Present Value

PV of After-tax Operating Income

1 1 3
1.1
= 11,500
0.1

28,599

(Calculator: n = 3; I% = 10; PMT = -11500; FV = 0; P/Y = 1; C/Y = 1. Compute PV = 28599)

PV of NWC investment
PV of NWC recovery

= 5,000 / 1.1

PV of Machine costs
PV of salvage value
PV of CCATS =

62.

-5,000

3,757

= -20,000
3

= 2,000 / 1.1

1,503

3,588

NPV =

12,446

20,000 0.15 0.34 1 + 0.5 0.1 2,000 0.15 0.34 1

3

0.15 + 0.1
1 + 0.1
0.15 + 0.1
1.1

A. 10.90 percent; A. Subject: Crossover Rate and NPV

NPVA

= 87,600 +

35,800 37,400 43,100

+
+
1+ r
(1 + r ) 2 (1 + r ) 3

NPVB

= 50,000 +

20,000 25,000 25,000

+
+
1+ r
(1 + r ) 2 (1 + r ) 3

NPVA NPVB

= 37,600 +

15,800 12,400 18,100

+
+
1+ r
(1 + r ) 2 (1 + r ) 3

(1)

At crossover, NPVA = NPVB or NPVA NPVB = 0.

Crossover rate = 10.90% (i.e. the IRR for the following incremental cash flows: -37,600;
15,800; 12,400; and 18,100).
Page 9

CFIN300 Class 13

Answers to Review 02 - Problems

If r < Crossover rate, Equation (1) will have a positive value (as PV of the cash inflows will
rise), or NPVA NPVB > 0, or NPVA > NPVB. Choose A.
If r > Crossover rate, Equation (1) will have a negative value (as PV of the cash inflows will
fall), or NPVA NPVB < 0, or NPVA < NPVB. Choose B.

Proof:
At r = 10%, NPVA = $8,236.21; and NPVB = $7,625.85
At r = 11%, NPVA = $6,521.28; and NPVB = $6,588.36
63.

D. Machine B is better because its EAC is -$75.66, which is less than the EAC of -$84.60 for
A. Subject: Equivalent Annual Cost
1
1
2
0.15
= 84.60
PV of Costs of A: = 40 60 1.15 = 137.54 EACA = 137.54
1
0.15
1
1.152
1
1
3
0.15
= 75.66
PV of Costs of B: = 70 45 1.15 = 172.75 EACB = 172.75
1
0.15
1
1.153
Calculator:
Machine A
Step 1: Calculate NPV@15% for the following list: -40; -60; -60. NPV = -137.54
Step 2: n = 2; I% = 15; PV = -137.54; FV = 0; P/Y = 1; C/Y = 1. Compute PMT = 84.60
Machine B
Step 1: Calculate NPV@15% for the following list: -70; -45; -45; -45. NPV = -172.75
Step 2: n = 3; I% = 15; PV = -172.75; FV = 0; P/Y = 1; C/Y = 1. Compute PMT = 75.66

64.

A. $197,320. Subject: Bid Price

PV of Equipment costs

-1,600,000

PV of Salvage value

397,741

PV of NWC

-120,000

PV of NWC recovery

59,661

PV of CCATS

248,860

PV of After-tax Net Revenues

1,013,738

Annual After-tax Net Revenues

302,414

= 800,000 / 1.155
= 120,000 / 1.155
(Using the PV of CCATS formula)
= 1,013,7380.15 / (1 1/1.155)
(Calculator: n = 5; I% = 15; PV = -1013738; FV
= 0; P/Y = 1; C/Y = 1. Compute PMT = 302414)

Annual Pre-tax Net Revenues

458,203

Fixed costs

700,000

Variable costs

815,000

Gross revenues

$1,973,203

Minimum bid price =

197,320

= 302,414 / (1 0.34)
= 1081,500
= 1,973,203 / 10
Page 10

CFIN300 Class 13

Answers to Review 02 - Problems

Notes: For detailed answers to questions 65-79, refer to the Excel spreadsheet.
65.

D. Since both projects pay back, the NPV of both must be positive. Subject: Payback Rule

66.

C. 15.4%. Subject: Crossover Rate

67.

C. Based on the PI rule, project A is preferable. Subject: Profitability Index Rule

68.

D. With a payback cutoff of 1.75 years, only Project A is acceptable. Subject: Payback Rule

69.

C. Based on the PI, project A is preferable. Subject: Profitability Index

70.

B. 0.0%. Subject: Crossover Rate

71.

D. $34,737. Subject: Net Present Value

72.

D. 4.0 years. Subject: Payback

73.

D. six years. Subject: Discounted Payback

74.

D. 16.3%; no. Subject: Internal Rate of Return

75.

D. 1.04; yes. Subject: Profitability Index

76.

D. $261.37. Subject: Net Present Value

77.

E. 3.0% per month. Subject: Internal Rate of Return

78.

E. 3.0% per month. Subject: Internal Rate of Return

79.

C. Profitability index. Subject: Capital Budgeting Techniques

80.

E. 12.51%. Subject: Nominal Rate of Return

1
1
1,000
(1 + 0.045) 4

= 1,053.81
60
+
Price today =
0.045
(1 + 0.045) 4
(Calculator: n = 4; I% = 4.5; PMT = 60; FV = 1000; P/Y = 1; C/Y = 1. Compute PV = -1053.81)

Dollar return = 60 + (1,053.81 990) = 123.81.

Nominal return = 123.81 / 990 = 12.51%
81.

B. 1.13%. Subject: Real Rate of Return

1
Price today = 70

1
1,000
(1 + 0.08)5
+
= 960.07
0.08
(1 + 0.08)5

(Calculator: n = 5; I% = 8; PMT = 70; FV = 1000; P/Y = 1; C/Y = 1. Compute PV = -960.07)

Dollar return = 70 + (960.07 987) = 43.07

Nominal return = 43.07 / 987 = 4.36%.
Real return = (1 + 4.36%) / (1 + 3.2%) 1 = 1.13%

82.

C. 9.25 Subject: Arithmetic Average

Arithmetic Average = (11% + 14% + 3% + 9%) / 4 = 9.25%

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CFIN300 Class 13

83.

Answers to Review 02 - Problems

C. 5.7%. Subject: Geometric Average

Return
Year
1
2
3
4

Price
$14.20
$14.64
$13.92
$15.08

Dividend
$0.50
$0.52
$0.55

$$$

$0.94 = 14.64 14.20 + 0.50

-$0.20 = 13.92 14.64 + 0.52
$1.71 = 15.08 13.92 + 0.55

6.62% = 0.94/14.20
-1.37% = -0.20/14.64
12.28% = 1.71/13.92

Geometric Average = [(1 + 6.62%)(1 1.37%)(1 + 12.28%)]1/3 1 = 5.7%

84.

A. 0.50%. Subject: Probability Distributions

A return of -26.9% will be 3 standard deviations [= (-26.9% - 11.5%)/12.8%] away from the
mean. So the probability of having a return smaller than -26.9% is 0.5% (half of the range
outside the 99% confidence interval).

85.

D. 0.128. Subject: Expected Return

E(RB) = 0.60.08 + 0.40.2 = 0.128

86.

C. 0.0490. Subject: Standard Deviation

E(RA) = 0.60.15 + 0.40.05 = 0.11

Standard Deviation of A =
87.

(0.15 0.11) 2 0.6 + (0.05 0.11) 2 0.4 = 0.049

C. 0.121. Subject: Portfolio Expected Return

E(RP) = 0.40.11 + 0.60.128 = 0.121

88.

B. 0.093. Subject: Portfolio Expected Return

1
E(RP) = (0.11 + 0.128 + 0.04) = 0.093
3

89.

D. 7.70%. Subject: Portfolio Return

Weights: WeightGIC = (387+387)/387 = 200%; WeightDads loan = -387/387 = -100%

E(RP) = 200%0.0485 100%0.02 = 7.7%.

Proof:

GIC interest = ($3872)4.85% = $37.539. Interest on Dads loan = $3872% = 7.74

Net dollar interest = $37.539 $7.74 = $29.779.
Percent return on the original amount of $387 = $29.779 / $387 = 7.7%
90.

B. 44%. Subject: Portfolio Beta

Let xf be the weight of T-bill investment.
So, the weight of the risky asset is (1 xf).

P = xf 0 + (1 xf)1.8 = 1 (=M) 1 xf = 1/1.8 xf = 1 1/1.8 = 44%

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CFIN300 Class 13

91.

Answers to Review 02 - Problems

D. $9,750. Subject: Portfolio Weights and Portfolio Beta

X = 0.6; Y = 1.3; Z = 1.2.

xX = 78,000 / 260,000 = 30%. xY = 65,000 / 260,000 = 25%.
So the investments in Z and the risk-free asset together account for 45% (= 1 30% 25%)
of the portfolio.
Let xf be the weight of the investment in the risk-free asset. So, xZ = 0.45 xf .

P = 0.30.6 + 0.251.3 + (0.45 xf)1.2 + xf 0 = 1 (=M)

0.505 + 0.451.2 xf 1.2 = 1 xf 1.2 = 0.045 xf = 0.045 / 1.2 = 3.75%
Investment in the risk-free asset = $260,0003.75% = $9,750
Proof
Security
X
Y
Z
Risk-free asset
Total
92.

Investment
$78,000
$65,000
$107,250
$9,750
$260,000

Weight
30.00%
25.00%
41.25%
3.75%
100.00%

Beta
0.6
1.3
1.2
0.0

Beta Weight
0.180
0.325
0.495
0
1

C. 10 percent invested in a stock with a beta of 1.0 and 90 percent invested in a stock with a
beta of 1.40. Subject: Systematic Risk

A = 0.50 + 0.51 = 0.5

B = 0.20 + 0.80.8 = 0.64
C = 0.11 + 0.91.4 = 1.36
D = 11 = 1
E = 10 = 0
93.

C. X is undervalued, while Y is properly valued by the CAPM. Subject: SML

E(RX) = rf + Market risk premium X = 3% + 8%1.4 = 14.2% < 14.75% undervalued

E(RY) = rf + Market risk premium Y = 3% + 8%0.6 = 7.8% = 7.8% properly valued
E(RZ) = rf + Market risk premium Z = 3% + 8%1.13 = 12.04% > 11.2% overvalued
94.

E. 6.00%. Subject: SML

The intercept point of the security market line is the risk-free rate.

E(Ri) = rf + [E(RM) rf ]i
0.12 = rf + (0.11 rf)1.2.
95.

Solve this equation for rf = 6.00%

A. 7.86%. Subject: SML

The slope of the Security Market Line is the Reward-to-Risk Ratio.

Reward-to-Risk Ratio =

E ( Ri ) rf

0.16 0.05
= 7.86%
1.4

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CFIN300 Class 13

96.

Answers to Review 02 - Problems

B. 1.32. Subject: SML

E(RB) = rf + Market risk premium B = 0.04 + 0.080.87 = 0.1096

E(RP) = xAE(RA) + xBE(RB)
0.1312 = 0.6E(RA) + 0.40.1096.

Solve this equation for E(RA) = 0.1456

E(RA) = rf + Market risk premium A

0.1456 = 0.04 + 0.08A.
97.

Solve this equation for A = 1.32

C. 10.40%. Subject: CAPM

E(Ri) = rf + [E(RM) rf ]i = 0.02 + (0.08 0.02)1.4 = 10.4%

98.

E. 6.75%. Subject: CAPM

E(Ri) = rf + [E(RM) rf ]i
0.06 = 0.03 + [E(RM) 0.03)0.8
Solve this equation for E(RM) = 6.75%
99.

D. 6.77%. Subject: Risk Premium

Risk Premium = [E(RM) rf ] = (10% - 4.5%) 1.23 = 6.77%

100. D. B; because it has the same return as stock A and is less risky. Subject: Expected Returns

E(RA) = 0.70.15 0.30.08 = 8.1%

E(RB) = 0.70.09 + 0.30.06 = 8.1%

A = (0.15 0.081) 2 0.7 + (0.08 0.081) 2 0.3 = 10.54%

B = (0.09 0.081) 2 0.7 + (0.06 0.081) 2 0.3 = 1.375%
Tip: After calculating the two expected returns, which are the same, you can observe that
Stock A has bigger fluctuations (15% and -8%) than Stock B (9% and 6%), and hence higher
risk. No need to calculate standard deviations in this obvious case.

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