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4. Consider the following cases Case Amount of Initial deposit $Stated Annual Rate, r (%) Compounding Frequency, m (times/year)Deposit Period (years) A 2,500 6 2 5 B 50,000 12 6 3 C 1,000 5 1 10D 20,000 16 4 6 a. Calculate the future value at the end of thespecified deposit period. (2 POINTS) b. Determine the effectiveannual rate (EAR). (2 POINTS) c. Compare the stated annual rate (r)to the effective annual rate (EAR). What relationship existsbetween compounding frequency and the stated and effective annualrates?

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29 Sep 2018

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1. If a firm wants to grow at a rate faster than its sustainablegrowth rate, it could _____.
I. issue new equity shares
II. increase its debt ratio
III. increase its dividend payout ratio
IV. reduce its return on sales
A. I and II only
B. III and IV only
C. I, II and III only
D. II and III only
E. I, II, III and IV

2. The box Store has an inventory period of 50 days, areceivables period of 55 days and a payables period of 40 days.Compute the cash cycle time.
A. 35 days
B. 45 days
C. 65 days
D. 105 days
E. 145 days

3. What is the sustainable growth rate for a firm with netincome of $2.5 million, cash dividends of $1.5 million, and acurrent and expected return on equity of 18%?
A. 18.0%
B. 15.4%
C. 10.8%
D. 7.2%
E. 4.9%

4. As of the most recent fiscal year end, Box GoTo (BGT) hadtotal assets of $500 million, a current and expected ROE of 13%, adividend payout ratio of 35%, and a ratio of equity to total assetof 40%. BGT projects sales growth of 15% for the current year. Whatis BGT's estimated total external financing need?
A. zero
B. $75 million
C. $58.1 million
D. $46.7 million
E. $32.75 million

5. Consider the situation where you have won a $10 millionlottery to be received in 25 annual equal payments of $400,000.What will happen to the present value of these winnings if theinterest rate increases during the next 25 years?
A. it will not change
B. it will be worth more
C. it will be worth less

6. When you receive your monthly statement regarding your bankcredit card, it shows that the monthly rate of interest is 1.8%.What is the annual effective rate of interest you are being chargedon your credit card?
A. 22.87%
B. 23.87%
C. 14.98%
D. 1.8%
E. 21.6%

7. Calculate the NPV of the following cash flows: you invest$3,000 today and receive back $300 one year from now, $700 twoyears from now and $1,100 four years from now. (Note: nothing threeyears from now) Assume that the interest rate is 7%.
A. $1,269
B. -$4,731
C. -$1,269
D. $4,731
E. $5,470

8. The earnings of BGB Computers have grown from $3.20 (yr0) to$6.90 (yr6) in 6 years. Determine the annual compound rate(CAGR).
A. 8.8%
B. 12.1%
C. 13.7%
D. 46%
E. 16.6%

9. A rule of thumb with using the internal rate of return is toinvest in a project if the IRR is _____________ than theopportunity cost of capital.
A. greater
B. less
C. less than or equal to
D. indeterminate relative to

10. Consider a zero coupon bond (one with zero interestpayments). If the bond has a maturity value in seven years of $1000and you would currently pay $850 for the bond, what is the yield tomaturity?
A. -3.5%
B. -2.35%
C. 23.5%
D. 2.35%
E. 17.6%

11. If you purchased a $10,000 certificate of deposit (CD) todaywith a nominal annual interest rate of 12%, with monthlycompounding, what would be the CD worth when it matures in 6years?
A. $20,471
B. $21,159
C. $20,191
D. $20,208
E. $10,615

12. The manufacturing manager of CyberProducts Inc. estimatesthat she can save the company $16,000 cash per year over the next 8years by implementing a recycling plan. What is the value of thesavings today if the appropriate interest rate for the firm is 9%?Assume cash flows occur at the end of the year.
A. $68,460
B. $117,600
C. $73,020
D. $115,500
E. $88,557

13. You take out a $350,000, 30 year mortgage (monthly paymentsand compounding) at an annual 8 percent rate. The scheduled monthlypayment will be what amount (rounded to nearest dollar)?
A. $28,000
B. $2,591
C. $2,568
D. $2,333
E. $12,911

14. If the exchange rate between the U.S. dollar and theJapanese yen is $0.00745 per yen, the dollar interest rate is 6%per year, and the Japanese interest rate is 7% per year, what isthe "break-even" value of the future dollar/yen exchange rate oneyear from now (the rate at which the returns will have equalvalue)?
A. $135.49 per yen
B. $135.23 per yen
C. $0.00752 per yen
D. $0.00738 per yen
E. $0.00745 per yen

15. What is the real interest rate (rounded to nearest 100th ofa percent) if the nominal interest rate is 9% per year and the rateof inflation is 6% per year?
A. 6.75%
B. 2.75%
C. 2.83%
D. 8.50%
E. 9.00%

16. Suppose your child is 9 years old and you are planning toopen a fund to provide for the child's college education.Currently, tuition for one year of college is $22,000. How muchmust you invest now in order to pay enough for the first year ofcollege nine years from now, if you think you can earn a rate ofinterest that is 4% more than the inflation rate? Assume thattuition moves with inflation.
A. $8,500
B. $10,129
C. $16,988
D. $15,457
E. $21,154

17. You have determined the present value of an expected cashinflow stream. Which of the following would cause the stream tohave a higher present value?
A. The discount rate increases.
B. Total cash flows remain the same but are paid over a shorterperiod of time.
C. The discount rate decreases.
D. Statements (b) and (c) are both correct.
E. Statements (a) and (b) are both correct.

18. Lucinda is currently thirty years old and she plans toretire at age sixty (30 more years to work). She is expected tolive to age eighty-five (25 years of retirement). Her labor incomeis $45,000 per year and she intends to maintain a constant level ofreal consumption spending over the next fifty-five years. Assuminga real interest rate of 4% per year, no taxes, and no growth inreal labor income, what is the value of Lucinda's humancapital?
A. $35,196
B. $40,005
C. $994,888
D. $778,141
E. $45,000

19. Let us suppose you have a choice between investing in a banksavings account which pays 9% compounded annually (Bank Yearly) andone which pays 8.5% compounded daily (Bank Daily). (Assume this isbased on 365 days). What is the Bank Daily effective annual rate(EAR), and using only effective annual rates, which bank would youprefer? (round EARs to 100th of a percent)
A. 8.87%, Bank Yearly
B. 8.87%, Bank Daily
C. 9.00%, either Bank Yearly or Bank Daily (indifferent)
D. 8.50%, Bank Daily
E. 8.50%, Bank Yearly

20. You are 60 years old and are considering whether it pays tobuy an annuity from an insurance company. For a cost of $25,000,the insurance company will pay you $3,000 per year for the rest ofyour life starting one year from now. Assume you can earn 8% peryear on your money in a bank account and you expect to live untilage 80 (another 20 years). What implied interest rate is theinsurance company paying you and should you buy the annuity?
A. Greater than 10%; Yes, buy
B. Greater than 10%; No, don't buy
C. Less than 8%; Yes, buy
D. Less than 8%; No, don't buy
E. Between 8% & 10%; No, don't buy

21-25 are short answer

21. You have just taken out a $300,000, 30 year mortgage(monthly payments and compounding) at an annual 8 percent rate.Scheduled monthly payments are $2,201.29. You decide to pay anadditional $100 each month towards the mortgage (you make thescheduled payment plus an extra $100 each month). How many paymentsmust you make before the mortgage is paid off? (round up to thenext whole payment)

22. If you can at most afford $1,200 a month and current annualmortgage rates are 6%, what is the most you can borrow to be repaidover 30 years? (Assume monthly payments/compounding and round yourfinal answer to the nearest dollar)

23. You want to buy a new Subaru Forester. You plan to borrow theentire purchase price of $25,000. Subaru offers two choices: (i) animmediate $1500 rebate and financing at the regular rate of 7.2%APR for 48 months, or (ii) low percentage financing for 48 months.What financing rate (stated per annum, APR) would make you beindifferent between the rebate and the low percentage loan? (assumemonthly compounding & payments and round your final answer to100th of a percent)

24. Your financial planning client wishes to have investmentsavings in 20 years that will provide $1.0 million dollars ofpurchasing power, measured in today's (real) dollars. The currentbalance of the client's investment account is $75,000. Nominalinvestment rates of return are 9.2% per annum, the expectedinflation rate is 4% per annum, and the real rate of return is 5%per annum. In today’s (real) dollars, how much must the client saveper month starting at the end of the current month to accomplishthis goal, given these rates of return? Assume monthly compounding.(round your final answer to the nearest dollar)

25. What is the value today of a security that promises to pay$1,000 in one quarter, with payments increasing at 1% per quarterthereafter? Payments are made each quarter forever. Our opportunitycost of capital is 12% per annum. (round your final answer to thenearest dollar)

1. All of the following are characteristics of currentliabilities except:

a. they may involve estimated amounts. b. they are due withinone year or within the operating cycle, whichever is longer. c.they may be replaced with a new short-term liability rather thanbeing paid in cash. d. all three of the above are characteristic ofcurrent liabilities.

2. Which of the following is an example of a contingentliability?

a. A corporate long-term employment contract with the chiefexecutive officer. b. A lawsuit pending against a restaurant chainfor improper preparation of food. c. A liability for notes payablewith interest included in the face amount. d. The liability forfuture warranty repairs on computers sold during the currentperiod

. 3. A company will have to pay a $50,000 liability in 4 years.How much must be deposited now into a bank account earning 8%compounded semiannually to fully fund the future payment? HINT: PVof $1 The solution to this problem requires time value of moneycalculations. Reference to Tables 9-1 through 9-4 in the text isnecessary to complete the calculations.

a. $35,500 b. $36,535 c. $36,665 d. $34,000

4. On October 1, Lawrence Company borrowed $60,000 from FourthNational Bank on a 1-year, 7% note. If the company's fiscal yearends as of December 31, Lawrence should make an entry toincrease

a. interest payable, $1,050. b. prepaid interest, $3,150. c.notes payable, $1,050. d. interest expense, $4,200.

5. Warranty expenses are the result of the selling company’sestimate of the number of units sold during the current year thatmay become defective and need repair or replacement during thewarranty period.

a. True b. False

6. Estimated liability for product warranties to be paid in thefuture is a long term liability.

a. True b. False

7. The future value of equal semi-annual payments of $500 at 8%compounded semiannually for 4 years is HINT: FV of Annuity of $1The solution to this problem requires time value of moneycalculations. Reference to Tables 9-1 through 9-4 in the text isnecessary to complete the calculations.

a. $ 868 b. $9,320 c. $2,000 d. $4,607

8. What is the correct classification of the account: Discounton Notes Payable?

a. a revenue b. a contra liability c. an asset d. an expense

9. If the annual interest is 12%, but the compounding is donequarterly, then the interest rate is 3% per period.

a. True b. False

10. A convertible bond is one where a. the issuer can convertfrom

a fixed interest rate to a floating one. b. the issuer canconvert it from long-term to short-term. c. the issuer can retirethe bond before its specified due date. d. the holder can convertthe bond into common stock at a future time.

11. Which of the following statements regarding serial bonds istrue?

a.They are likely to be issued by food companies.

b. They have shorter lives than term bonds.

c.They are strongly backed by the issuer's collateral.

d. The bonds do not all mature on the same date.

12. Bonds are a popular source of financing because

a.bond interest expense is deductible for tax purposes, whiledividends paid on stock are not.

b. financial analysts tend to downgrade a company that hasraised large amounts of cash by frequent issues of stock.

c. a company having cash flow problems can postpone payment ofinterest to bondholders.

d. the bondholders can always convert their bonds into stock ifthey choose.

13. When determining the amount of interest to be paid on abond, which of the following information is not necessary?

a.The face amount of the bonds

b. The selling price of the bonds

c.The face rate of interest on the bonds

d. The length of the interest period, annually or semiannually14. Which of the following statements is correct?

a.Bonds are issued at a price that reflects the stated rate ofinterest on the day the bond is purchased.

b. If the face rate of interest on a bond is not equal to themarket rate of interest, then the company desiring to issue thebonds must reprint its bond certificates.

c.The actual issue price of a bond represents the present valueof all future cash flows related to the bond.

d. The market rate of interest has no bearing on the sellingprice of the bonds.

15. Endeavor Company issued 20-year bonds with a coupon rate of6% when the market rate of interest was 9%. This means that thebonds were issued

a.at a premium. b. at a discount. c.at the face value. d. withan additional 3 years of interest.

16. Which of the following statements regarding leases isfalse?

a. Lease agreements are a popular form of financing the purchaseof assets because leases do not require a large initial outlay ofcash.

b. Accounting recognizes two types of leases--operating andcapital leases.

c. If a lessor classifies a lease as a capital lease, then thelessee records a lease liability on its balance sheet.

d. If a lease is classified as an operating lease, the lesseerecords a lease liability on its balance sheet.

17. Which of the following accounts would not appear on thebalance sheet of a lessee company recording a capital lease?

a. Accumulated depreciation on the leased asset

b. Lease obligation in the current liability section

c. Lease obligation in the long-term liability section

d. Rent expense on the income statement

DOZIER INDUSTRIES (B)

Richard Rothschild, the chief financial officer of DozierIndustries, was still contemplating how best to manage the exchangerisk related to the company's new sales contract. The £1,057,500balance of the contract was due in three months on April 14, 1986,creating a long position in British pounds. Rothschild had spokenpreviously to John Gunn, an officer in the International Divisionof Southeastern National Bank, about hedging his long poundexposure. Gunn had explained two alternatives available to Dozierto reduce the exchange risk: a forward contract or a spottransaction. Either transaction would ensure that Dozier receive aset dollar value for its pound receivable, regardless of any changein the value of the pound. Given his previous analysis of theforeign exchange market, Rothschild was concerned that both ofthese hedging alternatives would lock in a profit margin below the6% he had originally anticipated for the contract. He wondered ifthere were some way to get the upside potential without all therisk.

The pound had weakened since his bid submission date on December3 (see Exhibit 1), but he was not entirelyconvinced it would continue to fall, or at least not as much as theforward rate indicated. If the future spot rate were greater thanthe current forward rate, an unhedged position could lead to again, whereas a hedged position would create an opportunity lost.Rothschild wondered if other alternatives were available, and heagain called John Gunn at the bank for advice.

Gunn explained that Rothschild could also use currency optionsto hedge against his uncertain foreign exchange exposure. Optionsprovide a means of hedging against volatility without taking aposition on expected future rates. Gunn explained that there aretwo basic varieties of options contracts: "puts" and "calls." A putgives the holder the right, but not the obligation, to sell foreigncurrency at a set exercise or "strike" price within a specifiedtime period. A call gives the holder the right to buy foreigncurrency at a set price. In comparison with a forward or futurescontract, the holder of an option does not have to transact at theagreed-upon price, but has the choice or option to do so. Gunn toldRothschild that options are complicated and increase the front endcost of hedging in comparison with a forward hedge. He saidRothschild could find the prevailing option contract prices in theWall Street Journal (see Exhibit 2).

EXHIBIT 1

HISTORICAL SPOT RATE AND FORWARD POUND IN U.S DOLLARS

DATE SPOT 3- MONTH FORWARD RATE

07/08/85 1.3640 1.3490

07/16 1.3880 1.3744

07/23 1.4090 1.3963

07/30 1.4170 1.4067

08/6 1.3405 1.3296

08/13 1.3940 1.3828

08/20 1.3900 1.3784

08/27 1.3940 1.3817

09/4 1.3665 1.3553

09/10 1.3065 1.2960

09/17 1.3330 1.3226

09/24 1.4200 1.4089

10/1 1.4120 1.4005

10/8 1.4155 1.4039

10/15 1.4120 1.4007

10/22 1.4290 1.4171

10/29 1.4390 1.4270

11/5 1.4315 1.4194

11/12 1.4158 1.4037

11/19 1.4320 1.4200

11/26 1.4750 1.4628

12/3 1.4820 1.4704

12/10 1.4338 1.4214

12/17 1.4380 1.4249

12/23 1.4245 1.4114

12/30 1.4390 1.4260

01/7/86 1.4420 1.4284

1/14/86 1.4370 1.4198

EXHIBIT 2

FOREIGN CURRENCY OPTIONS ON JANUARY 14,1986

OPTION& STRIKEPRICE CALLS-LAST PUTS-LAST

UNDERLYING CENT PERUNIT JAN. FEB.MAR. JAN. FEB. MAR.

Bpound 130 S R 13.50 S R R

144.41 135 S R 9.20 S 0.20 0.50

144.41 140 S 4.50 4.75 S 0.80 1.55

144.41 145 s 1.35 2.50 s 3.10 4.40

144.41 150 s 0.40 0.90 s r r

r- not traded s- no option offered. andLast is premium (purchase price)

Dozier Industries (B)

FOREIGN CURRENCY IPTIONS ON DECEMBER 3,1985

OPTIONS& STRIKEPRICE CALLS-LAST PUTS-LAST

UNDERLYING CENT PERUNIT DEC. JAN. MAR. DEC. JAN. MAR.

Bpound 120 29.00 S 28.95 R S R

148.86 130 19.10 R R R R R

148.86 135 13.80 R 14.60 0.05 R R

148.86 140 8.80 R 10.00 0.05 R S

148.86 145 4.00 4.50 5.70 0.20 1.05 3.20

148.86 150 0.65 1.65 3.35 R R 5.60

148.86 155 R 0.50 1.70 R R R

R- NOTTRADED S- NO OPTIONS OFFERED. LAST IS THE PREMIUM(PURCHASE PRICE)

Case B: Additional Information
1. You should treat January 14, 1986 as the date when you areperforming your analysis and acting on the analysis (hedging or nothedging).
2. To reduce risk, Dozier will take the 10% initial deposit(pounds) and sell the pounds in the spot market on Jan 14.
3. Any dollars that Dozier receives on Jan 14 are deposited in thebank for 90 days.
4. For the purpose of your calculations, you may ignore the factthat currency option contracts for the pound come in 12,500 poundincrements. However, you may discuss this limitation qualitativelyin making your recommendation (last discussion question)below.
5. None of the option contracts mature on Apr 14, 1986. Ideally,Dozier would want an option that matures on that date for thepurpose of hedging. In deciding which option maturity is best (Febor Mar), you should consider this problem and choose the maturitythat best meets Dozier’s hedging objective. First choose the optionmaturity that best meets Dozier’s objective. Then in yourcalculations below, you may treat the options as if they mature Apr14. Qualitatively, however, you should consider this maturitymismatch in making your recommendation (last discussion question)below.
6. In exhibit 2, 144.41 U.S. cents per pound refers to the spotrate for the pound on Jan 14. This is inconsistent with what isreported elsewhere in both the A and B parts of this case. Continueto use the spot rate given in part A of this case for 1/14/86. Forthe rest of the table the rows correspond to a strike price between130 cents and 150 cents per pound. The columns correspond to eithercall options or put options with either Jan, Feb, or Marchmaturities. Any entry in the table (for example 0.50 cents perpound) is the option premium. In this example, 0.50 cents per poundis the premium for a put option with a March maturity and a strikeprice of 135 cents per pound.

First read the “B” case, and then address the followingquestions:
1. Do you recommend using a call or put option to hedge theexchange rate risk? Explain.
2. Do you recommend an option with expiration in Feb. orMarch?
3. Calculate the U.S. dollar profit or loss for each possibleoutcome; there will be more than one possible outcome for eachoption. Recall that with an option, the option does not have to beexercised; the holder may choose to trade in the future spotmarket. The holder’s choice depends on the future spot rate. Note:You will do these calculations for either all of the call optionsor all of the put options and for either all of the Feb or all ofthe March options, depending on your answer to the first twoquestions above. Hint: Since Dozier’s motive is hedging, you firstcalculate the revenue in dollars that Dozier will receive for thePound receivable. Then subtract Dozier’s Costs given in Case Aexhibit 3.
4. Which option do you recommend? Explain. Note: You must nowselect one of the options with a given maturity and strikeprice.
5. Compare the option hedge to the forward hedge (in the A case)and to remaining unhedged. Which do you recommend? Explain.

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