MGMT 612 Exam 1 | Complete Solution

Exam 1 PREVIEW. MGMT 612. Spring

These questions are a part of the complete exam set, numbering about 55 short answer or multiple-choice
questions.
1. TVM. For this and the next 3 questions: Your brother just graduated from high school and is seeking
your advice as to whether he should find a job immediately or go to college for 4 years and then find a
job afterward. He estimates that if he gets a job immediately, he will earn $15,000 per year for the next
40 years. If he goes to college first, he estimates that he can earn $30,000 for each of the 36 years after
he graduates. Whether or not he goes to college, he plans to retire 40 years from today. For simplicity,
assume zero growth in income. He estimates that the 4 years of college will cost him $8,000 per year.
Assume a discount rate of 14% (also, assume that he goes to college first, he could also borrow money
at 14%). Assume that all cash flows occur at the end of each period. What is the present value of his
cash flows if he gets a job immediately?
a. $106,575.61
b. $108,588.01
c. $100,057.21
d. $102,430.16
e. None of the above
2. What is the present value of his cash flows if he goes to college first, foregoing therefore the
opportunity to earn an income in the next 4 years?
a. $125,739.86
b. $58,724.48
c. $82,034.17
d. $102,430.16
e. $115,802.33
f. None of the above
3. Suppose your brother’s chances of getting any job in the next 4 years are at best doubtful. In this case,
you should assume that he will be unemployed during this period. What then is the PV of his cash flows
if he goes to college first?
a. $125,739.86
b. $58,724.48
c. $82,034.17
d. $102,430.16
e. $115,802.33
f. None of the above
4. SPREADSHEET ANALYSIS. Now assume income growth rate of 5%. Again, first year income if no college
is $15,000. This amount will then grow at 5% per year. Similarly, first year income after graduating from
college is $30,000, which will then grow at 5% per year. College cost of $8,000 is the same per year.
Given this revised information, what is the present value of the cash flows if this individual chooses to
go to college first, thus foregoing the opportunity to earn any income in the next 4 years?
a. $125,739.86
b. $58,724.48
c. $82,034.17
d. $102,430.16
e. $115,802.33
f. None of the above
Hint: On spreadsheet, grow both sets of incomes by 5% per year. Then use NPV function to find PV.
5. Capital Budgeting. For this and the next 3 questions: The following NPV profiles are for Projects R and
C: Suppose the cost of capital is 12%. Describe the profitability index (PI) of Project C.
NPV Profile
$(4,000)
$(2,000)
$-
$2,000
$4,000
$6,000
$8,000
$10,000
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
22%
Cost of Capital
NPV
Project C
Project R
crossover rate = 12.8%
6. Cash flow estimation. For this and the next 4 questions: Mars, Inc. is considering the purchase of a
new machine, which will reduce manufacturing costs by $5,000 annually. Mars will use the MACRS (5-
year class) method to depreciate the machine, and it expects to sell the machine at the end of its 5-year
life for $10,000 (Rates are 0.20, 0.32, 0.19, 0.12, 0.11, 0.06, respectively). The firm expects to be able to
REDUCE NET WORKING CAPITAL by $15,000 when the machine is installed. Mars’ marginal tax rate is 40
percent, and it uses a 12 percent cost of capital to evaluate projects of this nature. The machine’s net
cost is $60,000. What is the book value of the machine at the end of Year 3? Hint: depreciation
schedule needed. NOTE: This problem is a simpler version of Example 1 in the PP handout entitled
Valuation of Capital Projects.
7. What is the initial net cash flow of the machine (i.e. NCF at t = 0)?
a. -$60,000
b. -$45,000
c. -$75,000
d. None of the above
8. What is the final net cash flow at t = 5?
a. $5,640
b. $15,640
c. $13,080
d. -$1,920
e. None of the above
9. What is the NPV of the project?
10. What is the correct MIRR of the project?
a. 0%
b. –1.22%
c. –16.49%
d. 12%
e. None of the above
11. Risk and Return. For this and the next question. Suppose you purchased $1,000 of Stock A with your
own money. You then borrowed $500 and used this money to buy Stock B. This means that the
portfolio weights are as follows: wA = 1000/1000 = 1.00; wB = 500/1000 = 0.50; wC = -500/1000 = -
0.50. The correlation coefficient between A and B is 0.70; interest rate on the risk-free asset (Security C)
is 5%; variance of Stock A is 0.25; variance of Stock B is 0.49; expected return on Stock A is 10% and
Stock B is 16%. Calculate the expected return of the portfolio comprising securities A, B, C.
a. 13.5%
b. 14.5%
c. 15.5%
d. None of the above
12. Risk and Return. Calculate the variance of a portfolio of the three securities.
a. 0.6175
b. 0.7858
c. 0.5168
d. None of the above
13. Risk and Return. For this and the next 4 questions: The following is a market model regression output
using monthly returns data for Agilent Technologies, Inc. (variable Y) and S&P 500 index return (variable
X). The sample period is January 2000 to December 2009. Please answer the questions that follow.
Regression Statistics
Corr. Coeff: r 0.5661
r-square 0.3205
Adjusted R Square 0.3148
Standard Error 0.1336
Observations 121
ANOVA
df SS MS F P-value
Regression 1 1.0015 1.0015 56.1208 0.0000
Residual 119 2.1237 0.0178
Total 120 3.1252
Coeff. Std. Err. t Stat P-value
Intercept 0.0015 0.0122 0.1198 0.9048
SP500 1.9245 0.2569 7.4914 0.0000
14. The standard deviation of the market index is 0.1614 and the standard deviation of the stock 0.0475.
Given this information, what is the covariance of the stock and the market index?
15. Results of this analysis:
a. Show that the total risk of Agilent is less than that of the market
b. Indicate that Agilent’s systematic risk is almost double that of the market
c. Suggest that the slope of the regression line captures the risk premium of the stock
d. Lead us to conclude that Agilent is less volatile than the market when considered as part of a welldiversified
portfolio
e. None of the above is true
16. Risk and Return. For this and the next question: A money manager is holding the following portfolio.
The risk-free rate is 6% and the portfolio’s required rate of return is 12.5%. Calculate portfolio beta.
Stock Amount
Invested
Beta
1 $300,000 0.6
2 300,000 1.0
3 500,000 1.4
4 500,000 1.8
17. Risk and Return. The manager would like to sell Stock 1 and use the proceeds to purchase more shares of
Stock 4. Calculate the new portfolio beta after the restructuring.
Stock Amount
Invested
Beta
1 $300,000 0.6
2 300,000 1.0
3 500,000 1.4
4 500,000 1.8
a. 1.000
b. 1.300
c. 1.202
d. 1.525
e. None of the above
18. VBM. The following data are obtained for a certain firm: Cost of debt = 10%; Cost of equity = 16%; Tax
rate = 40%; D/E = 1.43; EBIT = $95.5 million; Net investment in operating capital for the current year; =
$50 million. Calculate the firm’s FCF
a. $7.0m
b. $7.1m
c. $7.2m
d. $7.3m
e. None of the above
19. VBM. The following data are obtained for a certain firm: Cost of debt = 10%; Cost of equity = 16%; Tax
rate = 40%; D/E = 1.43; EBIT = $95.5 million; Net investment in operating capital for the current year; =
$50 million. Calculate EVA if the firm’s total operating capital is $255 million.
a. $255m
b. $301.015m
c. $21.581m
d. $31.5056m
e. None of the above
20. Cost of Capital. The following is the output of a log linear regression of a company’s EPS. Calculate the
earnings growth rate based on the results of the log linear regression.
Regression Statistics
R 0.9600
r
2
 0.9217
Adj. r2
0.9105
Standard
Error 0.1198
Sample size 9
ANOVA
df SS MS F P-value
Regression 1 1.1825 1.1825 82.3517 0.0000
Residual 7 0.1005 0.0144
Total 8 1.2831
Coeff. Std. err. t Stat P-value
Intercept -280.4703 30.9094 -9.0739 0.0000
Year 0.1404 0.0155 9.0748 0.0000
a. 14.04%
b. 15.07%
c. 22.74%
d. None of the above
21. Capital Structure and Valuation. For this and the next 2 questions: Cesar Digital Systems has EBIT of
$500,000, a growth rate of 5%, and faces a tax rate of 40%. In order to support growth, Cesar must
reinvest 50 percent of its EBIT in net operating assets. Cesar has $400,000 in 10% debt outstanding. A
similar company with no debt has a cost of equity of 12%. (Note that this problem assumes growth in
earnings, otherwise referred to as MM extension with growth. What is the value of the firm’s tax shield?
a. $228,571.43
b. $714,285.71
c. $285,714.29
d. None of the above
22. Capital Structure and Valuation. According to the MM extension with growth, what is the firm’s
unlevered value?
a. $228,571.43
b. $714,285.71
c. $285,714.29
d. None of the above
23. Bond Refunding. The City of Oxford issued $5 million of 8% coupon, 30-year, semiannual payment, taxexempt
municipal bonds 10 years ago. At time of issue, the bonds had 10 years of call protection. Now
however, the bonds can be called if the city chooses to do so. The call premium is 6% of the face value.
New 20-year, 5%, semiannual payment bonds ($5 million) can be sold at par, but flotation costs on this
new issue would be 1.5%. Calculate the initial cost of refunding. Tax rate = 0%.
a. $30,000
b. $240,000
c. $375,000
d. $693,000
e. None of the above
24. Refer to above problem on Bond Refunding. Calculate the NPV of the bond refunding.
a. $75,000
b. $1,733.607.90
c. $1,882,708.13
d. $1,507,708.13
e. None of the above