Reference no: EM13670971

Question 1

To qualify as official development assistance (ODA), development loans must have a grant element of at least 25 percent, calculated using a stated annual interest rate of 10 percent. Consider the following loan:

$100 million, to be amortized over 8 years by 16 semi-annual payments, after a grace period of 4 years during which only interest would be paid semi-annually. The first world country would charge interest at a stated annual rate of 6 percent. Determine whether or not this loan would qualify as ODA. What is the maximum interest rate the first world country could charge for this loan to qualify as ODA?

Question 2

Risk and Return

a) Consider the following investment alternatives.

State of Economy	Probability	Investment A	Investment B
Bust	5%	-20.00%	20.00%
Below average	25%	-5%	5%
Average	30%	10%	6%
Above average	30%	20%	-3%
Boom	10%	40%	-10%
Total	100%

Which of these investments moves with the economy?

Calculate the expected rate of return and standard deviation on each alternative. Identify which investment offers better expected returns and which offers higher risk.

Determine the covariance and correlation between investment A and B

Assume a two-stock portfolio with $30,000 in investment A and $70,000 in investment B. What is the portfolio expected rate of return and standard deviation?

b) The following is a scenario for three stocks constructed by Professor Wiseman's students:

			Scenario Return
Stock	Price	Recession	Average	Boom
A	$10	-15%	20%	30%
B	$15	25%	10%	-10%
C	$50	12%	15%	12%

Construct an arbitrage portfolio using these stocks.

Question 3

Bond Refunding

With Canadian interest rates at historical lows, McGraw-Hill Ryerson (MHR) is considering whether to refund an old issue of $30 million, 12 percent coupon (paid yearly) 20-year bonds that were sold 5 years ago. A new issue of $30 million, 15-year bonds can be sold with a coupon rate of 9 percent (paid yearly).

A call premium of 10 percent will be required to retire the old bonds and floatation costs of $2 million will apply to the new issue. The marginal tax rate applicable is 50 percent and MHR expects that there will be a one month overlap during which any funds can be invested in t-bills yielding 8 percent. Should MHR refund?

Question 4

Canadian Tradition/APT

4a.The following table provides values of sensitivities and expected returns for portfolios of U, V and W. Suppose portfolio returns can be described by a 2-factor model with intercept (3 factors including intercept), and the weights have to be greater than or equal to 0. Determine the equation that describes the equilibrium returns for the following portfolios. 

Portfolio	OH	13i2	Expected Return r/o)
U	0.5	0.6	12.5
V	0.8	1.2	15.7
W	1.6	1.5	20.2

4b. Assume there is a portfolio X with βX1= 1.2. What is the equilibrium return on portfolio X? What is the sensitivity of portfolio X to factor 2 βX2? What is the relationship of portfolio X to factor 2?

4c. Suppose there is another portfolio Y with the following characteristics: Actual Return 18.5 %; βY1= 1.35 and βY2= 0.95. Would you recommend investment in portfolio Y? Why?

Question 5

Financial Planning

Consider the following income statement and balance sheet for the WINTER Corporation:

WINTER CORPORATION
Income Statement

Sales                                                   $70,000

Costs                                                   $20,000

Interest expense                                   $7,000

Taxable income                                    $43,000

Taxes (34%)                                        $14,620

Net income                                           $28,380

Dividends                                             $20,000

Addition to retained earnings                  $8,380

 

WINTER CORPORATION
Balance Sheet

Assets                                             Liabilities and Owners' Equity

Percentage of                                                            Percentage of

Sales                                                                                     Sales

Current assets                                                        Current liabilities

Cash                      $ 6,000                                    Accounts payable             $ 5,000

Accounts                $ 10,000                                   Notes payable                 $ 6,000

receivable

Inventory               $ 7,000                                       Total                         $ 11,000

Total                     $23,000                              Long-term debt                 $ 24,000

Fixed assets                                                           Owners' equity

Net plant and          $35,000                                              Common stock and paid- $ 15,000

equipment                                                                                  in surplus

Retained earnings            $ 8,000

Total assets               $58,000                                       Total                         $ 23,000

Total liabilities and             $ 58,000

owners' equity

Assume costs vary with sales and the dividend payout ratio is constant. What is the projected addition to retained earnings?

Assume that all assets and accounts payable vary with sales, whereas notes payable, interest expense and LT debt do not.

Prepare a pro forma income statement balance sheet showing EFN, assuming a 50 percent increase in sales, no new external debt or equity financing. The plant is operationg at full capacity.

Question 6

Capital Budgeting

PTP Inc. projects unit sales for a new opera tenor emulation implant as follows:

Year	Sales
1	109,000
2	123,000
3	135,000
4	156,000
5	95,500

Production of the implants will require $800,000 net working capital to start and additional net working capital of investments each year equal to 40 percent of the projected sales increase for the following year.

(Because sales are expected to fall in 5 year, there is no NWC cash flow occurring for year 4.) Total fixed costs are $192,000 per year, variable production costs are $295 per unit, and unit are priced at $395 each. The equipment needed to begin production has an installed cost of $19.5 million. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus falls in to the class 8 for tax purpose (20 percent). In the five years, this equipment can be sold for about 30% of its acquisition cost. PTP is in the 40% marginal tax bracket and has a required return on all its projects of 23%. Based on these preliminary project estimates, what is the NPV of the project? What is IRR?