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Gates Computers

1. Gates Computers has the following data for the previous year: Net income = \$200; Net operating profit after taxes (NOPAT) = \$300; Total assets = \$1,000; and Total net operating capital = \$800. The information for the current year is: Net income = \$500; Net operating profit after taxes (NOPAT) = \$400; Total assets = \$1,300; and Total net operating capital = \$900. What is the free cash flow for the current year?

Gates Computers recently reported the following data:
Net income = \$600,000
Tax rate = 40%
Interest expense = \$200,000
Operating capital = \$9 million
After-tax cost of capital = 10%

A) What is the company's EVA?

2. Stock A had an average return over a 5 year period of 11.3, with a standard deviation of 20.79. Stock Z had an average return of 11.3, with a standard deviation of 20.78. The correlation between the returns of the 2 stocks is 0.88.

A) If you formed a portfolio consisting of 50% Stock A and 50% Stock Z, calculate the average return and the standard deviation for the portfolio.

B) If you are risk averse, would you prefer to invest all in Stock A, all in Stock Z, or in the portfolio? Why?

3. The risk free rate (rRF) is 6% The market rate of return (rM) is 12% and the market standard deviation is 4%. Stock Y has a standard deviation of 5% and the correlation if its return with the market return is 0.8.

A) What is the Stock Y's beta?
B) What is Stock Y's required return based on CAPM?
C) Assuming the current price of Stock Y is such that its return is 10%, what would likely happen to its price?
D) Is Stock Y undervalued or overvalued?
E) Suppose an investor has a portfolio with a portfolio standard deviation of 10%, what is the required portfolio return, based on CAPM?

4. The risk free rate (rRF) is 6% The market rate of return (rM) is 12% and the market standard deviation is 4%. Assume an investor can borrow and lend at the risk free rate.

A) If investor wanted a portfolio that will have a return of 15%, how will he invest in the market portfolio and the risk free security?

B) What would be the portfolio's standard deviation?

5. Investors require a 15% rate of return on IBM's stock.
A) What will be the stock price if the previous dividend was D0 =\$2 and if investors expect dividends to grow at a constant compound annual rate of 5%?

B) What will be the stock price if investors expect dividends to grow at a compound annual rate of 5% for the next 3 years and then grow at a compound annual rate of 3% on the 4th year and thereafter?

6. Bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have a \$1,000 par value, and the coupon interest rate is 8% The bonds have a yield to maturity of 9%.

A) What is the current market price of these bonds?
B) The Government has issued bonds that have a 10% coupon rate, payable semi-annually. The bonds mature in 8 years, have a face value of \$1,000, and a yield to maturity of 8.5% What is the price of the bonds?

C) The Government issued a 10 year 12% semi-annual coupon bond with a par value of \$1,000. The bond sells for \$1,100 (Assume the bond has just been issued):

D) What is the bond's yield to maturity?
E) What is the bond's current yield?

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Please see ** ATTACHED ** file(s) for complete solutions and details!!

Hi, you can think of face value as the standard amount that you will receive from bond at the maturity date.

1. Gates Computers has the following data for the previous year: Net income = \$200; Net operating profit after taxes (NOPAT) = \$300; Total assets = \$1,000; and Total net operating capital = \$800. The information for the current year is: Net income = \$500; Net operating profit after taxes (NOPAT) = \$400; Total assets = \$1,300; and Total net operating capital = \$900. What is the free cash flow for the current year?

Free cash flow = NOPAT - Net investment in operating capital
Free cash flow = \$400 - (\$900 - \$800) = \$300

Gates Computers recently reported the following data:
Net income = \$600,000
Tax rate = 40%
Interest expense = \$200,000
Operating capital = \$9 million
After-tax cost of capital = 10%

A) What is the company's EVA?

Earnings before interest and tax 1,200,000
Interest Expense 200,000
Earning before tax 1,000,000
Tax rate (40%) 400,000
Net income 600,000

NOPAT = EBIT(1 - Tax) = 1,200,000(1 - 0.40) = 720,000

EVA = NOPAT - WACC% * (TC)
EVA = 720,000 - (10%)(\$9 million) = -\$180,000

2. Stock A had an average return over a 5 year period of 11.3, with a standard deviation of 20.79. Stock Z had an average return of 11.3, with a standard deviation of 20.78. The correlation between the returns of the 2 stocks is 0.88.

A) If you formed a portfolio consisting of 50% Stock A and 50% Stock Z, calculate the average return and the standard deviation for the portfolio.

Average return = (0.50)(11.3%) + (0.50)(11.3%) = 11.3%

Standard deviation
= &#8730;(0.50)2(0.2079)2 + (0.50)2(0.2078)2 + (0.50)(0.50)(0.88)(0.2079)(0.2078)
= 17.64%

B) If you are risk averse, would you prefer to invest all in Stock A, all in Stock Z, or in the portfolio? Why?

If I am risk averse, I will invest in the portfolio. We can see that the ...

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This solution is comprised of a detailed explanation to answer what is the company's EVA.

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