Revision

1. Harold and Helen Nash are saving for the college education of their newborn daughter, Susan. The Nashes
estimate that college expenses will run $30,000 per year when their daughter reaches college in 18 years. The
annual interest rate over the next few decades will be 14 percent. How much money must they deposit in the
bank each year so that their daughter will be completely supported through four years of college?

2. Stuart Gabriel, a second-year MBA student, has just been offered a job at $80,000 a year. He anticipates his
salary increasing by 9 percent a year until his retirement in 40 years. Given an interest rate of 20 percent, what
is the present value of his lifetime salary?

3. You’re trying to choose between two different investments, both of which have up-front costs of $75,000.
Investment G returns $125,000 in six years. Investment H returns $185,000 in 10 years. Which of these
investments has the higher return?

4. What is the present value of an annuity of $5,500 per year, with the first cash flow received three years from
today and the last one received 25 years from today? Use a discount rate of 8 percent.

5. Compute the internal rate of return for the cash flows of the following two projects:

6. Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation
Corporation (BRC). Both projects require an annual return of 14 percent.

As a financial analyst for BRC, you are asked the following questions:

a. If your decision rule is to accept the project with the greater IRR, which project should you choose?
b. Because you are fully aware of the IRR rule’s scale problem, you calculate the incremental IRR for the cash
flows. Based on your computation, which project should you choose?

c. To be prudent, you compute the NPV for both projects. Which project should you choose? Is it consistent
with the incremental IRR rule?

7. An investment project provides cash inflows of $790 per year for eight years. What is the project payback
period if the initial cost is $3,200? What if the initial cost is $4,800? What if it is $7,300?
8. An investment project has annual cash inflows of $5,000, $5,500, $6,000, and $7,000, and a discount rate
of 12 percent. What is the discounted payback period for these cash flows if the initial cost is $8,000? What if
the initial cost is $12,000? What if it is $16,000?
9. Hanmi Group, a consumer electronics conglomerate, is reviewing its annual budget in wireless technology.
It is considering investments in three different technologies to develop wireless communication devices.
Consider the following cash flows of the three independent projects available to the company. Assume the
discount rate for all projects is 10 percent. Further, the company has only $40 million to invest in new projects
this year.

a. Based on the profitability index decision rule, rank these investments.

b. Based on the NPV, rank these investments.

c. Based on your findings in (a) and (b), what would you recommend to the CEO of the company and why?

10. Watters Umbrella Corp. issued 15-year bonds 2 years ago at a coupon rate of 5.9 percent. The bonds make
semiannual payments. If these bonds currently sell for 105 percent of par value, what is the YTM?

11. Even though most corporate bonds in the United States make coupon payments semiannually, bonds issued
elsewhere often have annual coupon payments. Suppose a German company issues a bond with a par value of
€1,000, 15 years to maturity, and a coupon rate of 4.5 percent paid annually. If the yield to maturity is 3.9
percent, what is the current price of the bond?

12. You find a zero coupon bond with a par value of $10,000 and 17 years to maturity. If the yield to maturity
on this bond is 4.9 percent, what is the dollar price of the bond? Assume semiannual compounding periods.

13. Union Local School District has bonds outstanding with a coupon rate of 3.7 percent paid semiannually
and 16 years to maturity. The yield to maturity on these bonds is 3.9 percent, and the bonds have a par value
of $5,000. What is the dollar price of the bond?

14. The Frush Corporation has two different bonds currently outstanding. Bond M has a face value of $30,000
and matures in 20 years. The bond makes no payments for the first six years, then pays $800 every six months
over the subsequent eight years, and finally pays $1,000 every six months over the last six years. Bond N also
has a face value of $30,000 and a maturity of 20 years; it makes no coupon payments over the life of the bond.
If the required return on both these bonds is 6.4 percent compounded semiannually, what is the current price
of Bond M? Of Bond N?

15. Shiller Corporation will pay a $2.75 per share dividend next year. The company pledges to increase its
dividend by 5 percent per year, indefinitely. If you require a return of 11 percent on your investment, how
much will you pay for the company’s stock today?

16. Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next
nine years, because the firm needs to plow back its earnings to fuel growth. The company will pay a dividend
of $17.50 per share in 10 years and will increase the dividend by 5.5 percent per year thereafter. If the required
return on this stock is 12 percent, what is the current share price?
17. Phillips Co. is growing quickly. Dividends are expected to grow at a rate of 25 percent for the next three
years, with the growth rate falling off to a constant 5 percent thereafter. If the required return is 12 percent and
the company just paid a dividend of $3.10, what is the current share price?
18. Four years ago, Bling Diamond, Inc., paid a dividend of $1.51 per share. The company paid a dividend of
$1.87 per share yesterday. Dividends will grow over the next five years at the same rate they grew over the
last four years. Thereafter, dividends will grow at 5 percent per year. What will the company’s cash dividend
be in seven years?
19. Fhloston Manufacturing uses 1,860 switch assemblies per week and then reorders another 1,860. If the
relevant carrying cost per switch assembly is $6.25, and the fixed order cost is $730, is the company’s
inventory policy optimal? Why or why not?

20. The Trektronics store begins each week with 675 phasers in stock. This stock is depleted each week and
reordered. If the carrying cost per phaser is $73 per year and the fixed order cost is $340, what is the total
carrying cost? What is the restocking cost? Should the company increase or decrease its order size? Describe
an optimal inventory policy for the company in terms of order size and order frequency.

21. Shadow Corp. has no debt but can borrow at 6.5 percent. The firm’s WACC is currently 9.8 percent, and
the tax rate is 35 percent. a. What is the company’s cost of equity? b. If the company converts to 25 percent
debt, what will its cost of equity be? c. If the company converts to 50 percent debt, what will its cost of equity
be? d. What is the company’s WACC in part (b)? In part (c)?

22. Given the following information for Huntington Power Co., find the WACC. Assume the company’s tax
rate is 35 percent.

Debt: 5,000 6 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 105 percent
of par; the bonds make semiannual payments

Common stock: 175,000 shares outstanding, selling for $58 per share; the beta is 1.10.

Market: 7 percent market risk premium and 5 percent risk-free rate

23. Titan Mining Corporation has 9.3 million shares of common stock outstanding and 260,000 6.8 percent
semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 per share and
has a beta of 1.20, and the bonds have 20 years to maturity and sell for 104 percent of par. The market risk
premium is 7 percent, T-bills are yielding 3.5 percent, and Titan Mining’s tax rate is 35 percent. a. What is the
firm’s market value capital structure? b. If Titan Mining is evaluating a new investment project that has the
same risk as the firm’s typical project, what rate should the firm use to discount the project’s cash flows?