Explore BrainMass
Share

# Finance questions

This content was STOLEN from BrainMass.com - View the original, and get the already-completed solution here!

Brigit Hall has decided to establish a university endowment fund at T.T. Penguin's former university, using an \$8 million donation from Penguin. The fund will be used to construct a new building in five years, which is expected to cost \$10 million at that time. In the interim, Penguin would like to generate end-of-year scholarship payments from the fund. Assume that the invested funds will earn an effective annual return of 6%.
a. How much can be paid in scholarships in each of the next five years, still leaving \$10 million in the fund after five years?
b. The endowment fund will be set up so that \$3 million is invested in 20-year semi-annually paying bonds with a coupon rate of 5% that are currently selling at 89.3843% of par value. What is the yield to maturity on these bonds? What is their expected effective annual return?
c. The other \$5 million will be invested in an equity fund that is expected to pay dividends of \$4 per \$100 of net asset value at the end of this year. The dividends are expected to grow at an annual rate of 4% thereafter. What is the expected return on this equity fund?
d. Assume that the expected standard deviation of the bond is 8%, the expected equity fund standard deviation is 20%, and the correlation of their returns is 0.55. Estimate the portfolio standard deviation.
e. Estimate the beta of this portfolio and determine the required return according to the security market line (SML), given the following information:
? Expected return on the market is 11%.
? Standard deviation of the market is 18%.
? Risk-free rate is 5%.
? Correlation coefficient between the fund's bond returns and the market returns is 0.40.
? Correlation coefficient between the equity fund and the market returns is 0.85.
f. Ignore your answer for part (b) and assume instead that the expected effective annual return equals 6.5%. Similarly, ignore your answer for part (c) and assume instead that the expected return in that part equals 11%. Also assume a capital structure of 37.5% of debt and 62.50% of equity. Does the portfolio lie above or below the SML?
g. Independent of parts (a) to (f) above, Hall is considering investing in a relatively new company whose profitability has been growing at a compound rate of 20% per year. Using the constant growth DDM (dividend discount model), Hall calculates that the share price should be \$60; this is substantially more than the actual market price of the shares [\$40]. What is the most likely reason for the wide disparity between the observed price and that which Hall estimates?

#### Solution Summary

The solution explains some questions relating to finance

\$2.19

## 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!

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.