# Finance Questions

10.33 The risk-free rate is 7.6 percent. Potpourri Inc. stock has a beta of 1.7 and an expected return of 16.7 percent. Assume the capital-asset-pricing model holds.

1. What is the expected market risk premium?

2. Magnolia Industries stock has a beta of 0.8. What is the expected return on the Magnolia stock?

3. Suppose you have invested $10,000 in a combination of Potpourri and Magnolia stock. The beta of the portfolio is 1.07. How much did you invest in each stock? What is the expected return of the portfolio?

39) The Tuft Company is generating cash flow of $333,000 per year. If they invest in a new press, they expect to increase their cash flow to $400,000 per year. The cash outflow for the new press is $250,000; to accept or reject the investment they have to consider the

A) press cost of $250,000 and total cash flow of $400,000 per year.

B) press cost of $250,000 and incremental cash flow of $67,000 per year.

C) current cash flow of $333,000 and the cost of $250,000

40) What is the nominal rate of interest given a real rate of interest of 5.0% and an inflation rate of 7.0%? (express your answer with one significant figure)

Ans. _______%

41) You have been asked to evaluate two pollution control devices. The wet scrub costs $100 to set up and $50 per year to operate. It must be completely replaced every 3 years, and it has no salvage value. The dry scrub device costs $200 to set up and $30 per year to operate. It lasts for 5 years and has no salvage value. Assuming pollution control equipment is replaced as it wears out, which method do you recommend if the cost of capital is 10%? Determine the equivalent annuity cost (EAC) and show your decision by marking your choice. All revenues are assumed to be the same.

43) ABC Inc. is considering the purchase of a $500,000 computer with an economic life of five years. The computer will be depreciated fully over five years using the straight line method. The market value of the computer is $100K in five years. The computer will replace five office employees whose combined annual salaries are $120K. The machine will also lower

the firms required net working capital (NWC) by $100K. This amount of NWC will need to be replaced once the machine is sold. Tc = 34%, discount rate is 12%. Determine the NPV to see if it is worth it?

Yr-0 Yr-1 Yr-2 Yr-3 Yr-4 Yr-5

Annual salary savings 120,000

Depreciation 100,000

Pre-tax income

Taxes 6,800

Operating C/F 113,200

ΔNWC -100,000

Investment -500,000 66,000

Total C/F 113,200

https://brainmass.com/business/annuity/finance-questions-204572

#### Solution Preview

10.33 The risk-free rate is 7.6 percent. Potpourri Inc. stock has a beta of 1.7 and an expected return of 16.7 percent. Assume the capital-asset-pricing model holds.

1. What is the expected market risk premium?

Using the CAPM equation

Expected return = Rf + (Rm-Rf) X beta

Where (Rm-Rf) is the market risk premium

16.7% = 7.6% + (Rm-Rf) X 1.7

(Rm-Rf) = (16.7%-7.6%)/1.7 = 5.35%

2. Magnolia Industries stock has a beta of 0.8. What is the expected return on the Magnolia stock?

Using the CAPM equation with market risk premium = 5.35%

Expected return = 7.6% + 5.35%X0.8

= 11.88%

3. Suppose you have invested $10,000 in a combination of Potpourri and Magnolia stock. The beta of the portfolio is 1.07. How much did you invest in each stock? What is the expected return of the portfolio?

The beta of a portfolio is the weighted average beta of individual stocks. Let A% be invested in Potpourri, then (100-A%) would be invested in Magnolia. The weighted average beta is

Portfolio beta = Proportion of Potpourri X beta of potpourri + Proportion of Magnolia X beta of magnolia

1.07 = A% X 1.7 + (100-A%) X 0.8

This gives A as 30%, so investment in Potpourri is 10,000X30%=$3,000 and the investment in Magnolia will be $7,000

Expected return = 0.3X16.7% + 0.7 X 11.88% = 13.33%

39) The Tuft Company is generating cash flow of $333,000 per year. If ...

#### Solution Summary

The solution has various finance questions relating to Risk premium, Magnolia beta, nominal rate of interest, EAC and NPV.

Answers to Various Financial Questions

Jenny just married Tim. Jenny remains to work as a cashier for a restaurant, and her monthly income has averaged $2,840 a month over the past year. Tim is working as a computer programmer and earns $3,000 a month. Their shared monthly income let them to live comfortably. Yet they have been unable to save any money for urgent situation.

According to Tim, "It's hard to believe, but we don't even have a savings account because we spend almost everything we make." Every month, they deposit each of their paychecks in separate checking accounts. Tim pays the rent and makes the car payment. Pam buys the groceries and pays the utilities. They use the money left over to purchase new clothes and the other "necessities" for enjoying life.

In an effort to make wise use of credit, the Turner have examined various sources that could serve their current and future financial needs. In the assessment process, they compared the APR along with various fees and potential charges.

Tim and Jenny are also learning about various actions that might be useful if they encounter credit troubles. Their discussions with friends and money management advisers provided expanded knowledge of credit counseling and bankruptcy alternatives.

Life Situation Financial Data

Recently Married

Pam, 26

Josh, 28

Renting an Apartment Monthly income $5,840

Living expenses $3,900

Assets $13,500

Liabilities $4,800

Emergency fund $1,000

Q1. What is the minimum amount that the Turner should have in an emergency fund? What actions might be taken to increase the amount in this fund?

1. Lucy lacks cash to pay for a $720 dishwasher. She could buy it from the store on credit by making 12 monthly payments of $65. The total cost would then be $780. Instead, Lucy decides to deposit $60 a month in the bank until she has saved enough money to pay cash for the dishwasher. One year later, she has saved $770.40—$720 in deposits plus interest. When she goes back to the store, she finds the dishwasher now costs $849.60. Its price has gone up 18 percent, the current rate of inflation.

From the financial standpoint, was postponing her purchase a good trade-off for Lucy?

Yes ___

No ___

2. Malou is trying to decide whether she can afford a loan she needs in order to go to chiropractic school. Right now Malou is living at home and works in a shoe store, earning a gross income of $3250 per month. Her employer deducts a total of $150 for taxes from her monthly pay. Malou also pays $100 on credit card debt each month. The loan she needs for chiropractic school will cost an additional $140 per month.

Calculate her debt payments-to-income ratio without college loan. Remember to convert your answer to a percentage!

Make sure to include zeros and the period in your answer.

Round your answer to 2 decimal places. i.e. 16.55, 12.32

Your Answer: ______

3. Sally is trying to decide whether she can afford a loan she needs in order to go to chiropractic school. Right now Sally is living at home and works in a shoe store, earning a gross income of $2990 per month. Her employer deducts a total of $200 for taxes from her monthly pay. Sally also pays $100 on credit card debt each month. The loan she needs for chiropractic school will cost an additional $100 per month.

Calculate her debt payments-to-income ratio with college loan. Don't forget to convert your answer to a percentage.

Make sure to include zeros and the period in your answer.

Round your answer to 2 decimal places. i.e. 20.12, 31.89

Your Answer: ________

4. A few years ago, Josh purchased a home for $137000. Today the home is worth $158000. His remaining mortgage balance is $57000.

Assuming Josh can borrow up to 76 percent of the market value of his home, what is the maximum amount he can borrow?

Round your answer to the nearest whole number.

Your Answer: __________

5. What would be the net annual cost of the following checking account?

Monthly fee : $11.55

Processing fee: $0.64 per check

Checks written: Average of 78 a month

Round your answer to the nearest whole number.

Your Answer:_______