Reference no: EM132079768

Question 1. (Term Structure of Interest Rates) You want to invest your savings of $30,000 in government securities for the next two years. At the present, you can invest either in a security that pays interest of 8% per year for the next two years or in a security that matures in one year and pays 10 percent interest. If you make the latter choice, you would then reinvest your savings at the end of the first year for another year.

a. Why might you choose to make the investment in the one-year security that pays an interest rate of 10 percent, as opposed to investing in the two-year security paying 8 percent? Provide numerical support for your answer. Which theory of term structure have you supported in your answer?

b. Assume your required rate of return on the second-year investment is 7 percent; otherwise, you will choose to go with the two-year security. What rationale could you offer for your preference?

Question 2. (Measuring Cash Flows) Given the information that follows, compute the free cash flows and financing cash flows for the J.B. Chavez Corporation for the year ended December 31, 2008.

J.B. Chavez Corporation, Balance Sheet at 12/31/07 and 12/31/08 ($000)

Assets

	12/31/07	12/31/08
Cash	$225	$175
Accounts receivable	450	430
Inventory	575	625
Current assets	$1250	$1230
Plant and equipment	$2200	$2500
Less: Accumulated depreciation	(1000)	(1200)
Net plant and equipment	$1200	$1300
Total assets	$2450	$2530

Liabilities and Owners' Equity

	12/31/07	12/31/08
Accounts payable	$250	$115
Notes payable-current (9%)	0	115
Current liabilities	$250	$230
Bonds	$600	$600
Owners' equity
Common stock	$300	$300
Paid-in capital	600	600
Retained earnings	700	800
Total owners' equity	$1600	$1700
Total liabilities and owners' equity	$2450	$2530

J.B. Chavez Corporation, Income Statement for the year ending 12/31/07 and 12/31/08

	2007	2008
Sales	$1250	$1450
Cost of goods sold	700	875
Gross profit	$550	$575
Operating expenses	30	45
Depreciation	220	200
Net operating income	$300	$330
Interest expense	50	60
Net income before taxes	$250	$270
Taxes (40%)	100	108
Net income	$150	$162

Question 3. (Ratio Analysis) The balance sheet and income statement for the Simsboro Paper Company are as follows:

Balance Sheet ($000)
Cash	$1,000
Accounts receivable	1,500
Inventories	1,000
Current assets	$3,500
Net fixed assets	$4,500
Total assets	$8 000
Accounts payable	$1,000
Accrued expenses	600
Short-term notes payable	200
Current liabilities	$1,800
Long-term debt	2,100
Owners' equity	$4,100
Total liabilities and owners' equity	$8 000
Income Statement ($000)
Net sales (all credit)	$7,500
Cost of goods sold	(3,000)
Gross profit	$4,500
Operating expenses'	(3,000)
Operating income (EBIT)	$1,500
Interest expense	(367)
Earnings before taxes	$1,133
Income taxes (40%)	(453)
Net income	$ 680

Including depreciation expense of $500 for the year.

Calculate the following ratios:

Current ratio Times interest earned Inventory turnover Total asset turnover Operating profit margin Operating return on assets

Debt ratio Average collection period Fixed asset turnover Gross profit margin Return on equity

Question 4. (Present Value of an Annuity) What is the present value of the following annuities?
a. $3,000 a year for 10 years discounted back to the present at 8%
b. $50 a year for 3 years discounted back to the present at 3%

Question 5. (Solving for PMT in an Annuity) To pay for your child's education, you wish to have accumulated $25,000 at the end of 15 years. To do this, you plan on depositing an equal amount in the bank at the end of each year. If the bank is willing to pay 7% compounded annually, how much must you deposit each year to obtain your goal?

Question 6. (Expected Rate of Return and Risk) Clevenger Manufacturing, Inc., has prepared the following information regarding two investments under consideration. Which investment should be accepted?

Security A		Security B
Probability	Return Probability	Return
.20	-2%	.10	5%
.50	19%	.30	7%
.30	25%	.40	12%
		.20	14%

Question 7. a. (Required Rate of Return Using CAPM) Compute a fair rate of return for Apple
common stock, which has a 1.5 beta. The risk-free rate is 8 percent and the market portfolio (New York Stock Exchange stocks) has an expected return of 16 percent.
b. Why is the rate you computed a fair rate?

Question 8. (Bond Valuation) You own a bond that pays $75 in annual interest, with a $1,000 par value. It matures in 15 years. Your required rate of return is 6 percent.
a. Calculate the value of the bond.
b. How does the value change if your required rate of return (i) increases to 10 percent or (ii) decreases to 4 percent?
c. Explain the implications of your answers in part (b) as they relate to interest rate risk, premium bonds, and discount bonds.
d. Assume that the bond matures in 5 years instead of 15 years. Recompute your answers in part (b).
e. Explain the implications of your answers in part (d) as they relate to interest rate risk, premium bonds, and discount bonds.

Question 9. (Common Stockholder Expected Return) The common stock of Bouncy-Bob Moore Co. is selling for $33.84. The stock recently paid dividends of $3 per share and has a projected constant growth rate of 8.5 percent. If you purchase the stock at the market price, what is your expected rate of return?