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# Investment return (in percentage terms) for the year

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1) International investment returns Joe Martinez, a U.S. citizen living in Brownsville, Texas, invested in the common stock of Telmex, a Mexican corporation. He purchased 1,000 shares at 20.50 pesos per share. Twelve months later, he sold them at 24.75 pesos per share. He received no dividends during that time.

a. What was Joe's investment return (in percentage terms) for the year; on the basis of the peso value of the shares?

b. The exchange rate for pesos was 9.21 pesos per US\$1.00 at the time of the purchase. At the time of the sale, the exchange rate was 9.85 pesos per US\$1.00. Translate the purchase and sale prices into US\$.

c. Calculate Joe's investment return on the basis of the US\$ value of the shares.

d. Explain why the two returns are different. Which one is more important to Joe? Why?

2) A firm wishes to assess the impact of changes in the market return on an asset that has a beta of 1.20.
a. If the market return increased by 15%, what impact would this change be expected to have on the asset's return?
b. If the market return decreased by 8%, what impact would this change be expected to have on the assets return?
c. If the market return did not change, what impact, if any, would be expected to have on the assets return?
d. Would this asset be considered more of less risky than the market? Explain

3) Portfolio betas Rose Berry is attempting to evaluate two possible portfolios,
LG5
which consist of the same five assets held in different proportions. She is particu-
larly interested in using beta to compare the risks of the portfolios, so she has
gathered the data shown in the following table.

Portfolio weights
Asset Asset beta -Portfolio A -Portfolio B

1. 1.30 10% 30%
2. 70 30 10
3. 1.25 10 20
4. 1.10 10 20
5. 90 40 20
Totals 100% 100%

a. Calculate the betas for portfolios A and B.
b. Compare the risks of these portfolios to the market as well as to each other.
Which portfolio is more risky?

4) Use the basic equation for the capital asset pricing model (CAPM) to work each of the following problem.
a. Find the required return for an asset with a beta of 0.90 when the risk-free rate and market return are 8% and 12% respectively.
b. Find the risk-free rate for a firm with a required return of 15% and a beta of 1.25 when the market return is 14%.
c. Find the market return for an asset with a required return of 16% and a beta of 1.10 when the risk-free rate is 9%.
d. Find the beta for an asset with a required return of 15% when the risk-free rate and market return are 10% and 12.5% respectively.

5) Edna Recording Studios, Inc., reported earnings available to common stock of \$4,200,000 last year From those earnings, the company paid a dividend of \$1.26 on each of its 1,000,000 common shares outstanding. The capital structure of the company includes 40% debt, 10% preferred stock, and 50% common stock. It is taxed at a rate of 40%.
a. If the market price of the common stock is \$40 and dividends are expected to grow at a rate of 6% per year for the foreseeable future, what is the company's cost of retained earnings financing?
b. If underpricing and flotation costs on new shares of common stock amount to \$7.00 per share, what is the company's cost of new common stock financing?
c. The company can issue \$2.00 dividend preferred stock for a market price of \$25.00 per share. Flotation costs would amount to \$3.00 per share. What is the cost of preferred stock financing?
d. The company can issue \$l,000-par-value, 10% coupon, 5-year bonds that can be sold for \$1,200 each. Flotation costs would amount to \$25.00 per bond. Use the estimation formula to figure the approximate cost of debt financing.
e. What is the WACC?

6) Lang Enterprises is interested in measuring its overall cost of capital. Current investigation has gathered the following data. The firm is in the 40% tax bracket.

Debt The firm can raise an unlimited amount of debt by selling \$1,000-par-
value, 8% coupon interest rate, 20-year bonds on which annual interest
payments will be made. To sell the issue, an average discount of \$30 per bond
would have to be given. The firm also must pay flotation costs of \$30 per bond.

Preferred stock The firm can sell 8% preferred stock at its \$95-per-share
par value. The cost of issuing and selling the preferred stock is expected to be
\$5 per share. An unlimited amount of preferred stock can be sold under these
terms.

Common stock The firms common stock is currently selling for \$90 per share.
The firm expects to pay cash dividends of \$7 per share next year. The firms
dividends have been growing at an annual rate of 6%, and this is expected to
continue into the future. The stock must be underpriced by \$7 per share, and
flotation costs are expected to amount to \$5 per share. The firm can sell an
unlimited amount of new common stock under these terms.

Retained earnings. When measuring this cost, the firm does not concern itself
with the tax bracket or brokerage fees of owners. It expects to have available
\$100,000 of retained earnings in the coming year; once these retained earnings
are exhausted, the firm will use new common stock as the form of common
stock equity financing.
a. Calculate the after-tax cost of debt
b. Calculate the cost of preferred stock
c. Calculate the cost of common stock
d. Calculate the firms weighted average cost of capital using the capital structure weights shown in the following table. Round answers to the nearest .1%
Source of capital Weight

Long-term debt 30%
Preferred stock 20
Common stock equity 50
Total 100%

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#### Solution Preview

Corporate Finance
1) International investment returns Joe Martinez, a U.S. citizen living in Brownsville, Texas, invested in the common stock of Telmex, a Mexican corporation. He purchased 1,000 shares at 20.50 pesos per share. Twelve months later, he sold them at 24.75 pesos per share. He received no dividends during that time.

a. What was Joe's investment return (in percentage terms) for the year; on the basis of the peso value of the shares?

b. The exchange rate for pesos was 9.21 pesos per US\$1.00 at the time of the purchase. At the time of the sale, the exchange rate was 9.85 pesos per US\$1.00. Translate the purchase and sale prices into US\$.

c. Calculate Joe's investment return on the basis of the US\$ value of the shares.

d. Explain why the two returns are different. Which one is more important to Joe? Why?

2) A firm wishes to assess the impact of changes in the market return on an asset that has a beta of 1.20.
a. If the market return increased by 15%, what impact would this change be expected to have on the asset's return?
b. If the market return decreased by 8%, what impact would this change be expected to have on the assets return?
c. If the market return did not change, what impact, if any, would be expected to have on the assets return?
d. Would this asset be considered more of less risky than the market? Explain

3) Portfolio betas Rose Berry is attempting to evaluate two possible portfolios,
LG5
which consist of the same five assets ...

#### Solution Summary

Solution helps in calculating investment return (in percentage terms) for the year

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## Sample Finance Quiz

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Sample Finance Quiz

1. The ______ is the annual rate of interest earned on a security purchased on a given date and held to maturity.
A. Term Structure
B. Yield Curve
C. Risk-free Rate
D. Yield to maturity
2. If a new asset is being considered as a replacement for an old asset, the relevant cash flows would be found by adding the expected cash flows attributed to old asset and the expected cash flows for new asset.
A. True
B. False
3. A firm with limited dollars available for capital expenditures is subject to
A. Capital Dependency
B. Working Capital Constraints
C. Capital Rationing
D. Mutually Exclusive Projects
4. The credit applicants ________ is its ability to repay the requested credit.
A. Collateral
B. Capacity
C. Character
D. Capital
5. When managing accounts receivable, a good strategy to employ without losing future sales is to
A. Tighten the terms
B. Offer cash discounts
C. Send the accounts to a collection agency
D. Make frequent personal visits to the customer
6. The ______ rate of interest is typically the rate of return on a three-month U.S. Treasury bill.
B. Nominal
C. Real
D. Tax treatment risk
7. The risk premium consists of a number of components, including all of the following EXCEPT
A. Liquidity Risk
B. Default Risk
C. Inflationary Risk
D. Tax Treatment Risk
8. The _______ is the amount of time it takes the firm to recover its initial investment
A. Average rate of return
B. Internal rate of return
C. Payback period
D. Net present Value
9. The legal contract setting forth the terms and provisions of a corporate bond is a(n)
A. Promissory note
B. Indenture
C. Loan Document
D. Debenture
10. As an outstanding bond approaches maturity, the price of the bond will always trend toward par value until, at maturity, the bond is worth its face value.
A. True
B. False
11. The ______ is the discount rate that equates the present value of the cash inflows with the initial investment.
A. Average rate of return
B. Internal rate of return
C. Cost of capital
D. Payback period
12. If the required return is less than the coupon rate, a bond will sell at
A. A discount
B. Par
C. Book Value
13. Sunk costs are cash outlays that have already been made and therefore have no effect on the cash flows relevant to the current decision. As a result, sunk costs should not be included in a projects incremental cash flows.
A. False
B. True
14. ______ yield curve reflects higher expected future rates of interest.
A. An upward-sloping
B. A flat
C. A linear
D. A downward-sloping
15. If a firm is subject to capital rationing, it is able to accept all independent projects that provide an acceptable return.
A. False
B. True
16. Bonds are
A. Long-term debt investments
B. A form of equity financing that pays interest.
C. A series of short-term debt instruments.
D. A hybrid form of financing used to raise large sums of money from a diverse group of lenders.
17. _______ is the process of evaluating and selecting long-term investments consistent with the firm's goal of owner wealth maximization.
A. Capital budgeting
B. Recapitalizing assets
C. Restructuring debt
D. Ratio Analysis
18. Mutually exclusive projects are those whose cash flows compete with one another; the acceptance of one does not eliminate the others from further consideration.
A. True
B. False
19. As credit standards are relaxed, sales are expected to ________ and the investment in accounts receivable is expected to _______.
A. Increase; Increase
B. Increase; Decrease
C. Decrease; Decrease
D. Decrease; Increase
20. The aggressive financing strategy is _______ method while the conservative financing strategy is _______ method.
A. A high-profit, high-risk; a low profit, low-risk
B. A low-profit, low-risk; a high-profit, high-risk
C. A low-profit, high-risk; a high-profit, low-risk
D. A high-profit, low-risk; a low-profit, high-risk
21. The _______ feature permits the issuer to repurchase bonds at a stated price prior to maturity.
A. Capitalization
B. Conversion
C. Call
D. Put
22. The ABC Company has two bonds outstanding that are the same except for the maturity date. Bond D matures in 4 years, while Bond E matures in 7 years. If the required return changes by 15 percent
A. Bond E will have a greater change in price.
B. The price change for the bonds will be equal.
C. The price of the bonds will be constant.
D. Bond D will have a greater change in price.
23. If the payback period is less than the maximum acceptable payback period, we would accept a project.
A. True
B. False
24. One way to improve the cash conversion cycle is to
A. Borrow funds.
B. Slow down credit approvals.
C. Speed up collections.
D. Reduce inventory turnover.
25. Certain financing plans are termed conservative when
A. Short-term financing is used frequently.
B. Risk is increased.
C. Working capital is relatively high.
D. Working capital is relatively low.
26. The _______ is an inventory management technique that minimizes inventory investment by having materials inputs arrive at exactly the time they are needed for production.
A. ABC system
B. MRP system
C. JIT system
D. EOQ model
27. An aging schedule breaks down accounts receivable into groups on the basis of the first letter of the name of the company that owes on the account.
A. False
B. True
28. In the EOQ model, if carrying costs increase while all other costs remain unchanged, the number of orders placed would be expected to
A. Remain unchanged
B. Decrease
C. Change without regard to carrying costs
D. Increase
29. 2/15 net 45 translates as
A. 15 percent cash discount if paid in 2 days, net 45-day credit period.
B. 45 percent of account due in 15 days, payment prior to day 15 receives a 2 percent discount.
C. 2 percent cash discount if paid prior to 15 days, if customer does not take a cash discount, the balance is due in 45 days.
D. 2 percent of the balance is due in 15 days, the remaining balance is due in 45 days.
30. A firm is evaluating a proposal which has an initial investment of \$50,000 and has cash flows of \$15,000 per year for five years. The payback period of the project is approximately:
a. 1.5 years
b. 2 years
c. 3.3 years
d. 4 years

31. What is the approximate yield to maturity for a \$1000 par value bond selling for \$1,120 that matures in 6 years and pays 12 percent interest annually?
a. 9.4 percent
b. 8.5 percent
c. 13.2 percent
d. 12.0 percent

32. A firm has an average age of inventory of 20 days, an average collection period of 30 days, and an average payment period of 60 days. The firm's cash conversion cycle is _____ days.
a. 70
b. 50
c. -10
d. 110

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