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1.) You are considering three insurance settlement offers. The first offer includes annual payments of $5,000, $10,000, $15,000, etc., where the payment for each year is $5,000 more than the payment for the previous year, over the next ten years. The first payment of $5,000 will be made exactly one year from today and the last payment, equal to $50,000 will be made ten years from today. The second offer is the payment of one lump sum amount today. The third offer is to receive an equal amount at the end of each year, over the next ten years. Assume there are no tax effects and your discount rate is 12% per year. What is the minimum amount that you will accept today if you are to select the lump sum offer? What is the minimum amount of each of the 10 equal annual payments that you should be willing to accept?

2.) Joan Collins wishes to choose the best of four immediate-retirement annuities available to her. In each case, in exchange for paying a single premium today, she will receive equal annual end-of-year cash benefits for a specified number of years. She considers the annuities to be equally risky and is not concerned about their differing lives. Her decision will be based solely on the rate of return she will earn on each annuity. The key terms of each of the four annuities are shown in the following table.

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Calculate the rate of return on each of the four annuities Joan is considering. Given Joan's stated decision criterion, which annuity would you recommend?

3.) Junior Sayou, a financial analyst for Chargers Investments, a mutual fund management company, must evaluate the risk and return of two stocks, X and Y. The firm is considering adding these stocks to its diversified stock portfolio. To assess the return and risk of each stock, Junior gathered data on the annual dividends and beginning- and end-of-year prices of each stock over the immediately preceding 10 years, 2002-2011. These data are summarized in the accompanying table. Junior's investigation suggests that both stocks, on average, will tend to perform in the future just as they have during the past 10 years. He therefore believes that the expected annual return can be estimated by finding the average annual return for each stock over the past 10 years. Junior believes that each stock's risk can be assessed in two ways: in isolation and as part of the firm's diversified portfolio of stocks. The risk of the stocks in isolation can be found by using the standard deviation and coefficient of variation of returns over the past 10 years. The capital assets pricing model (CAPM) can be used to assess the stock's risk as part of the firm's portfolio of stocks. Applying some sophisticated quantitative techniques, Junior estimated betas for stocks X and Y of 1.60 and 1.10, respectively. In addition, he found that the risk-free rate is currently 7% and that the market return is 10%. Note: you may find it easier and time effective to solve the problems using Excel or any other spreadsheet software. If you do, please use the drop box to submit your spreadsheet file.

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a) Calculate the annual rate of return for each stock in each of the 10 preceding years, and use those values to find the average annual return for each stock over the 10-year period.

b) Use the returns calculated in part (a) to find (i) the standard deviation and (ii) the coefficient of variation of the returns for each stock over the 10-year period 2002-2011.

c) Use your findings in parts (a) and (b) to evaluate and discuss the return and risk associated with each stock. Which stock appears to be preferable? Explain.

d) Use the CAPM to find the required return for each stock. Compare this value with the average annual returns calculated in part (a).

e) Compare and contrast your findings in parts (c) and (d). What recommendations would you give Junior with regard to investing in either of the two stocks? Explain to Junior why he is better off using beta rather than the standard deviation and coefficient of variation to assess the risk of each stock.

4.) Assume that you have been hired as a consultant by S- Corporation, a major producer of chemicals and plastics, including plastic grocery bags, Styrofoam cups, and fertilizers, to estimate the firm's weighted average cost of capital. S-Corporation has 500 million shares of common stock outstanding, 75 million shares of preferred stock outstanding, and 25 million 11% semiannual coupon bonds outstanding, par value $1,000 each. The common stock currently sells for $40 per share and has a beta of 1.2, the preferred stock currently sells for $75 per share and pays an annual dividend of $7 per share, and the bonds have 15 years to maturity and sell for 93.5 percent of par. The market risk premium is 6%, the yield on Treasury bills is 4%, and S Corporation's tax rate is 35%. What is the firm's weighted average cost of capital?

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Solution Summary

Insurance settlement payments are analyzed.

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Finance questions on different concepts

1. Which of the following statements concerning common stock and the investment banking process is not correct?

A. The preemptive right gives each existing common stockholder the right to purchase his or her proportionate share of a new stock issue.
B. If a firm sells 1,000,000 new shares of Class B stock, the transaction occurs in the primary market.
C. Listing a large firm's stock is often considered to be beneficial to stockholders because the increases in liquidity and reputation probably outweigh the additional costs to the firm.
D. Stockholders have the right to elect the firm's directors, who in turn select the officers who manage the business. If stockholders are dissatisfied with management's performance, an outside group may ask the stockholders to vote for it in an effort to take control of the business. This action is called a tender offer.
E. The announcement of a large issue of new stock could cause the stock price to fall. This loss is called "market pressure," and it is treated as a flotation cost because it is a cost to stockholders that is associated with the new issue.

2. Which of the following statements about listing on a stock exchange is most correct?

A. Listing is a decision of more significance to a firm than going public.
B. Any firm can be listed on the NYSE as long as it pays the listing fee.
C. Listing provides a company with some "free" advertising, and it may enhance the firm's prestige and help it do more business.
D. Listing reduces the reporting requirements for firms, because listed firms file reports with the exchange rather than with the SEC.
E. The OTC is the second largest market for listed stock, and it is exceeded only by the NYSE.

3. Heavy use of off-balance sheet lease financing will tend to

A. make a company appear more risky than it actually is because its stated debt ratio will be increased.
B. make a company appear less risky than it actually is because its stated debt ratio will appear lower.
C. affect a company's cash flows but not its degree of risk.
D. have no effect on either cash flows or risk because the cash flows are already reflected in the income statement.
E. affect the lessee's cash flows but only due to tax effects.

4. Sutton Corporation, which has a zero tax rate due to tax loss carry-forwards, is considering a 5-year, $6,000,000 bank loan to finance service equipment. THe loan has an interest rate of 10% and would be amortized over 5 years, with 5 end-of-year payments. Sutton can also lease the equipment for 5 end-of-year payments of $1,790,000 each. How much larger or smaller is the bank loan payment than the lease payment?

A. $177,169
B. $196,854
C. $207,215
D. $217,576
E. $228,455

5. Europa Corporation is financing an ongoing construction project. The firm will need $5,000,000 of new capital during each of the next 3 years. The firm has a choice of issuing new debt or equity each year as the funds are needed, or issue only debt now and equity later. Its target capital structure is 40% debt and 60% equity, and it wants to be at that structure in 3 years, when the project has been completed. Debt flotation costs for a single debt issue would be 1.6% of the gross debt proceeds. Yearly flotation costs for 3 separate issues of debt would be 3.0% of the gross amount. Ignoring time value effects, how much would the firm save by raising all of the debt now, in a single issue, rather than in 3 separate issues?

A. $79,425
B. $83,606
C. $88,006
D. $92,406

6. The State of Idaho issued $2,000,000 of 7% coupon, 20-year semiannual payment, tax-exempt bonds 5 years ago. The bonds had 5 years of call protection but now the state can call the bonds if it chooses to do so. The call premium would be 5% of the face amount. Today 15-year, 5%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2%. What is the net present value of the refunding?

A. $278,606
B. $292,536
C. $307,163
D. $322,521
E. $338,647

7. The basic doctrine of fairness under bankruptcy provisions states that claims must be recognized in order of their legal and contractual priority.

A. True
B. False

8. Which of the following is generally not true and an advantage of going public.

A. Facilitates stockholder diversification.
B. Increases the liquidity of the firm's stock.
C. Makes it easier to obtain new equity capital.
D. Establishes a market value of the firm.
E. Makes it easier for owner-managers to engage in profitable self-dealings.

9. Which of the following statements is not correct?

A. When a corporation's shares are owned by a few individuals who own most of the stock or are part of the firm's management, we say that the firm is "closely, or privately held."
B. "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.
C. Publicly owned companies have sold shares to investors who are not associated with management, and they must register with and report to a regulatory agency such as the SEC.
D. When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public," and the market for such stock is called the new issue market.
E. It is possible for a firm to go public and yet not raise any additional new capital.

10. What would be the priority of the claims as to the distribution of assets in a liquidation under Chapter 7 of the Bankruptcy Act? From highest to lowest.

(1) Trustee's costs to administer and operate the firm.
(2) Common Stockholders.
(3) General, or unsecured, creditors.
(4) Secured creditors, who have a claim to the proceeds from the sale of specific property pledged to secure a loan.
(5) Taxes due to federal and state governments.

A. 1, 4, 3, 5, 2
B. 5, 4, 1, 3, 2
C. 4, 1, 5, 3, 2
D. 5, 1, 4, 2, 3
E. 1, 5, 4, 3, 2

11. Which of the following statements is most correct?

A. In a private placement, securities are sold to private (individual) investors rather than to institutions.
B. Private placements occur most frequently with stocks, but bonds can be sold in private placement.
C. Private placements are convenient for issuers, but the convenience is offset by higher flotation costs.
D. The SEC requires that all private placements be handled by a registered investment banker.
E. Private placements can generally bring in funds faster than is the case with public offerings.

12. Dakota Trucking Company (DTC) is evaluating a potential leas for a truck with a 4 year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000. If DTC buys the truck,m it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year. DTC's tax rate is 40%. What is the NAL? (Note: MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07.)

A. $849
B. $896
C. $945
D. $997
E. $1,047

13. Rainier Bros. has 12% semiannual coupon bonds outstanding that mature in 10 years. Each bond is now eligible to be called at a call price of $1,060. If the bonds are called, the company must replace them with new 10-year bonds. The flotation cost of issuing new bonds is estimated to be $45 per bond. How low would the yield to maturity on the new bonds have to be in order for it profitable to call the bonds today?

A. 9.29%
B. 9.78%
C. 10.29%
D. 10.81%
E. 11.35%

14. Bankruptcy plays no role in settling labour disputes and product liability suits. Such issues are outside the bounds of bankruptcy law and are covered by other statutes.

A. True.
B. False.

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