# Finance questions

See the attached practice problems.

1. P5-3 Risk preferences Sharon Smith, the financial manager for Barnett Corporation,

wishes to evaluate three prospective investments: X, Y, and Z. Currently, the firm earns 12% on its investments, which have a risk index of 6%. The expected return and expected risk of the investments are as follows:

Expected Expected

Investment return risk index

X 14% 7%

Y 12 8

Z 10 9

a. If Sharon were risk-indifferent, which investments would she select?

Explain why.

b. If she were risk-averse, which investments would she select? Why?

c. If she were risk-seeking, which investments would she select? Why?

d. Given the traditional risk preference behavior exhibited by financial managers,

which investment would be preferred? Why?

2. P5-4 Risk analysis Solar Designs is considering an investment in an expanded product line. Two possible types of expansion are being considered. After investigating the possible outcomes, the company made the estimates shown in the following table:

Expansion A Expansion B

Initial investment $12,000 $12,000

Annual rate of return

Pessimistic 16% 10%

Most Likely 20% 20%

Optimistic 24% 30%

a. Determine the range of the rates of return for each of the two projects.

b. Which project is less risky? Why?

c. If you were making the investment decision, which one would you choose?

Why? What does this imply about your feelings toward risk?

d. Assume that expansion B's most likely outcome is 21% per year and that all

other facts remain the same. Does this change your answer to part c? Why?

3. P5-13 Portfolio analysis You have been given the return data shown in the first table on three assets?F, G, and H?over the period 2007-2010.

Expected return

Year Asset F Asset G Asset H

2007 16% 17% 14%

2008 17 16 15

2009 18 15 16

2010 19 14 17

Using these assets, you have isolated the three investment alternatives shown in the following table:

Alternative Investment

1 100% of asset F

2 50% of asset F and 50% of asset G

3 50% of asset F and 50% of asset H

a. Calculate the expected return over the 4-year period for each of the three alternatives.

b. Calculate the standard deviation of returns over the 4-year period for each of the three alternatives.

c. Use your findings in parts a and b to calculate the coefficient of variation for each of the three alternatives.

d. On the basis of your findings, which of the three investment alternatives do you recommend? Why?

4. Ch. 10 P10-4 Basic sensitivity analysis Murdock Paints is in the process of evaluating two mutually exclusive additions to its processing capacity. The firm's financial analysts have developed pessimistic, most likely, and optimistic estimates of the annual cash inflows associated with each project. These estimates are shown in the following table.

Project A Project B

Initial investment (CFo) $8000 $8000

Outcome Annual cash inflows (CF)

Pessimistic $ 200 $ 900

Most Likely 1000 1000

Optimistic 1800 1100

a. Determine the range of annual cash inflows for each of the two projects.

b. Assume that the firm' s cost of capital is 10% and that both projects have 20-year lives. Construct a table similar to this for the NPVs for each project. Include the range of NPVs for each project.

c. Do parts a and b provide consistent views of the two projects? Explain.

d. Which project do you recommend? Why?

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#### Solution Summary

The solution explains various problems in finance relating to risk preferences; risk analysis; portfolio analysis and basic sensitivity analysis

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:_______