8.NetPresentValueandOtherInvestmentCriteria_full_841805431

Chapter 11: The Basics of Capital BudgetingI. What is Capital Budgeting?The process of determining what capital projects to acceptProject Classification is the starting point for determining the appropriate discount rate Replacement to maintain current operationsReplacement to reduce costsExpansion of existing products or marketsExpansion into new products or marketsPure research & development (example: pharmaceutical firms)Exploration (example: energy firms)Safety and /or environmental (government mandated) projectsII. Decision CriteriaWhat are the major investment decision criteria?Net Present Value - NPVInternal Rate of Return - IRRModified Internal Rate of Return - MIRRPayback Period - PaybackDiscounted Payback Period – Discounted PaybackProfitability Index - PIWhat are they used for?To evaluate the cash flows from capital investment projectsTo make the accept or reject decisionA. The NPV Rule:1. Why Is Net Present Value the Best Decision Criteria?- It considers the time value of money(TVM)… a dollar today is worth more than a dollar in the future- It considers all cash flows during the project’s entire life- NPV lets you know exactly how much value is being added by the project- You can set the appropriate require rate of return (discount rate or hurdle rate) depending on a project’s risk2. Calculating Net Present Value (NPV:NPV =CF0+ CF1 + CF2 + ... + CF tt3. The NPV decision (accept/reject) rule:- Accept the project (investment) if NPV > zero- Reject the project if NPV < zero4. What does a positive NPV mean?- The PV of cash inflows > PV of cash outflows- The value of the company is being increased by the amount of NPV- The project meets the required rate of return…and then someA friend asks you to invest $20,000 and promises to pay you $26,000 at the end of 2 years. Your required rate of return is 15%. Do you take the offer?NPV =CF0+ CF2NPV = -20,000 + 26,000 => -20,000 + 19,6601.15 2NPV = $-340 You should reject your friend’s offer!* If this were a capital investment project, acceptance would reduce the value of the company by $340!* Acceptance of the project would not increase the value of the company by $6,000! The key variable here is the required rate of return (or discount rate).The required rate of return (RRR) is:* The hurdle rate* The cost of capital (funds)* The best rate of return the company could expect on other projects of similar risk Note:In a competitive market, positive NPV projects are considered rare and require diligent effort to uncoverTwo projects with identical cash outflows (investment =$1,000) but different timing of cash inflows. Discount rate = 10%NPV for project S: (Large cash inflows come sooner)0 1 2 3 4|---------------|---------------|---------------|--------------|Net CF -1,000 500 400 300 100NPV(S) = $78.82NPV for project L: (Large cash inflows come later)0 1 2 3 4|---------------|---------------|---------------|--------------|Net CF -1,000 100 300 400 500NPV(L) = -$19.12B. The Payback Rule:Time period required for a project to generate enough cash inflows to recover the initial cost.The Payback decision (accept/reject) rule:- Accept if payback period < maximum acceptable payback period.- Reject if payback period > maximum acceptable payback period.Advantages- Easy to understand: the shorter the payback period, the better- Quick indicator of the liquidity risk of the project (how long funds will be tied up) Disadvantages- Ignores time value of money- Ignores cash flows beyond acceptable payback date- Acceptable payback date is usually an arbitrary cutoff point. Risk is not quantified in a required rate of return. The liquid ity risk is simply a “rule ofthumb”Project S:0 1 2 3 4|---------------|---------------|---------------|---------------|Net CF -1,000 500 400 300 100 Cumulative -1,000 -500 -100 200 300NCFPayback = years before + uncovered cost at end of yearfull recovery NCF during following year= 2 + 100/300= 2.33 yearsIf acceptable payback period is 2.33 or more years, you accept project SC. The Discounted Payback Rule:Time period required for a project to generate enough discounted cash inflows to recover the initial cost.The Discounted Payback decision (accept/reject) rule:- Accept if discounted payback period < maximum acceptable payback period.- Reject if discounted payback period > maximum acceptable payback period. Advantages- Easy to understand: the shorter the payback period, the better- Quick indicator of the liquidity risk of the project (how long funds will be tied up) - Does consider the time value of moneyDisadvantages- Ignores cash flows beyond acceptable payback date- Acceptable payback date is usually an arbitrary cutoff point.Project S: Assume a 10 percent discount rate0 1 2 3 4|---------------|---------------|---------------|---------------|Net CF -1,000 500 400 300 100PVNCF -1,000 454 331 225 68Cumulative -1,000 -546 -215 10PVNCFPayback = years before + uncovered cost at end of yearfull recovery NCF during following year= 2 + 215/225= 2.96 yearsIf acceptable payback period is 2.96 or more years, you accept project SD. Internal Rate of ReturnThe IRR is similar to a bond’s yield to maturity. It is the rate that makes the present value of cash inflows (CIF) equal to the present value of cash outflows (COF). Thus, it is the rate of return that results in a zero NPV when it is used as the discount rate.NPV = CF0+ CF1 + CF2 + ... + CF t(1 + r)1 (1 + r)2 (1 + r)t0 = CF0+ CF1 + CF2 + ... + CF t(1 + IRR) 1(1 + IRR) 2(1 + IRR)tIRR Decision Rule- Accept the project if IRR > req’d rate of return (discount rate)- Reject the project if IRR < req’d rate of return (discount r ate)Advantages- Considers TVM- Considers all cash flows- Easy to understandDisadvantages- May use unreasonable discount rate- Can conflict with NPV if projects are mutually exclusiveIRR Examples:IRR for Project S0 1 2 3 4Project S|---------------|---------------|---------------|---------------|-1,000 500 400 300 1000 = -1000 + 500 + 400 + 300 + 100(1+Irr) 1 (1+Irr) 2 (1+Irr) 3 (1+Irr)4Solve for the IRR. That is the discount rate that solves this equation and makes the answer (NPV) equal to zero.IRR for Project S = 14.49%IRR for Project L0 1 2 3 4Project L|---------------|---------------|---------------|----------------|-1,000 100 300 400 5000 = -1000 + 100 + 300 + 400 + 500(1+Irr) 1 (1+Irr) 2 (1+Irr) 3 (1+Irr)4IRR for Project L =9.27%The IRR is the most popular method, after NPV, for evaluating cash flows and is almost as good.Problems with IRR:There are problems with using IRR rather than NPV with you are choosing between mutually exclusive projects:- Independent projects: When evaluating multiple projects and any, none, or all of them can be accepted. Acceptance of any project has no bearing on the acceptance or rejection of another.- Mutually exclusive projects: When evaluating multiple projects and only one can be accepted. Acceptance of one project means rejection of the other(s).There is never a conflict between IRR and NPV criterion when evaluating independent projects. But when choosing between mutually exclusive projects, the IRR choice may conflict with the NPV choice under certain conditions.The Scale Problem: A potential conflict exists when there are significant differences in the size of the cash flows. An example would be if comparing a project with a $100,000 initial investment (COF) with another project with a $1,000,000 initial investment.The Timing Problem: A potential conflict exists when the timing of the cash flows for two projects are radically different. This can result in a conflict between the NPV choice and the IRR choice at low discount rates.Multiple IRRs: Projects with non-normal (non-conventional) cash flows may have multiple IRRs. A normal (or conventional) cash flow is a cash outflow at the beginning of a project, followed by cash inflows thereafter.The NPV Profile: NPV graphed against the discount rateRecall the NPV & IRR acceptance rules:NPV: Accept the project if NPV > zeroIRR: Accept the project if IRR > RRRNPVCash Flows-1000$300 500400300100IRR0 r.1449Any project with a positive NPV will also have an IRR that exceeds the discount rate (required rate of return).NPV Profiles for Mutually Exclusive Projects:NPV Cash FlowsExample: IRR vs NPV for Mutual Exclusive ProjectsCash FlowsA B-10,000 -10,00010,000 1,0001,000 1,0001,000 12,000IRR for A _____________ IRR for B is ___________ NPV at 0% ____________ NPV at 0% ____________ NPV at 10% ___________ NPV at 10% ___________ NPV at 15% ___________ NPV at 15% ___________ Which project is acceptable if they are independent? Why?Which project is acceptable if they are mutually exclusive? Why? E. Modified Internal Rate of Return- Accept the project if M IRR > req’d rate of return (discount rate) - Reject the project if M IRR < req’d rate of return (discount rate) Advantage: Let’s you decide the reinvestment rate!Cost = Terminal Value TGiven: Cost, TVSolve: MIRRF. Profitability Index (PI)PI = (PV of Cash Inflows)/(PV of Cash Outflows)The PI is the ratio of the PV of the project’s cash inflows to the PV of the project’s cash outflows.PI for Project SPVCIF S= 500 + 400 + 300 + 100 = 1,078.82(1+.10)1 (1+.10)2 (1+.10)3 (1+.10)4PVCOF S= 1,000PI S= 1,078.82/1,000 = 1.07882PI Decision Rule- Accept if PI > 1.00- Reject if PI < 1.00Advantages- Considers TVM- Considers all cash flows- Uses reasonable discount rate- Useful when faced with capital rationing.Disadvantages- Cannot distinguish projects of vastly different scale- May conflict with NPV when evaluating mutually exclusive projectsProfitability Index vs NPV for Mutually Exclusive Projects0 1|---------------------|Cash FlowsProject A -$10 $15Project B -$1,000 $1,250A BNPV at .10 $ 3.64 $136.36PI at .10 1.364 1.136According to NPV, you choose B.According to PI, you choose A.。

英语财务笔试题库及答案1. What is the difference between a balance sheet and an income statement?Answer: A balance sheet is a snapshot of a company's financial condition at a specific point in time, showing assets, liabilities, and equity. An income statement, on the other hand, reports a company's financial performance over a period of time, including revenues, expenses, and net income.2. Define the term 'Depreciation'.Answer: Depreciation is the systematic allocation of the cost of a tangible asset over its useful life to reflect the consumption of the asset.3. Explain the concept of 'Accrual Accounting'.Answer: Accrual accounting is a method of accounting where revenues and expenses are recorded when they are earned or incurred, not when cash is received or paid.4. What is 'Capital Budgeting' and why is it important?Answer: Capital budgeting is the process of evaluating investment opportunities to determine whether they are financially viable and beneficial for a company. It is important as it helps in making long-term financial decisions.5. How do you calculate 'Net Present Value' (NPV)?Answer: Net Present Value (NPV) is calculated bysubtracting the present value of cash outflows (includinginitial investment) from the present value of cash inflows over a period of time, using a discount rate.6. What is 'Financial Leverage' and how does it affect a company?Answer: Financial leverage refers to the use of borrowed funds to increase the return on equity. It affects a company by increasing the risk and potential return on investment.7. Describe the 'Time Value of Money'.Answer: The time value of money is the concept that a sum of money is worth more now than the same sum in the future due to its potential earning capacity.8. What is 'Earnings Per Share' (EPS)?Answer: Earnings Per Share (EPS) is a financial metric calculated as the company's net income divided by the outstanding shares of its common stock, indicating the profit allocated to each share.9. Explain the 'Cash Conversion Cycle'.Answer: The cash conversion cycle is the length of time it takes for a company to convert its investment in inventory and receivables into cash.10. What is 'Break-Even Analysis' and how is it used?Answer: Break-even analysis is a method used to determine the number of units a company must sell to cover its costs and make a profit. It is used to evaluate the financial viability of a project or business.11. Define 'Working Capital'.Answer: Working capital is the difference between a company's current assets and current liabilities, representing the funds available for day-to-day operations.12. What is 'Liquidity Ratio' and how is it calculated?Answer: Liquidity ratio is a measure of a company'sability to pay short-term obligations. It is calculated by dividing current assets by current liabilities.13. Explain 'Return on Investment' (ROI).Answer: Return on Investment (ROI) is a financial metric that measures the profitability of an investment. It is calculated by dividing the net profit from the investment by the initial cost of the investment.14. What is 'Inflation' and how does it affect financial statements?Answer: Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. It affects financial statements by reducing the real value of assets and increasing the cost of goods and services.15. Define 'Audit' in the context of finance.Answer: An audit is a systematic review and examination of a company's financial records, typically performed by an independent third party, to ensure accuracy, compliance with regulations, and to detect fraud.。

Chapter 2: Accounting Statements and Cash Flow2.10AssetsCurrent assetsCash $ 4,000Accounts receivable 8,000Total current assets $ 12,000Fixed assetsMachinery $ 34,000Patents 82,000Total fixed assets $116,000Total assets $128,000Liabilities and equityCurrent liabilitiesAccounts payable $ 6,000Taxes payable 2,000Total current liabilities $ 8,000Long-term liabilitiesBonds payable $7,000Stockholders equityCommon stock ($100 par) $ 88,000Capital surplus 19,000Retained earnings 6,000Total stockholders equity $113,000Total liabilities and equity $128,0002.11One year ago TodayLong-term debt $50,000,000 $50,000,000Preferred stock 30,000,000 30,000,000Common stock 100,000,000 110,000,000Retained earnings 20,000,000 22,000,000Total $200,000,000 $212,000,0002.12Total Cash Flow ofthe Stancil CompanyCash flows from the firmCapital spending $(1,000)Additions to working capital (4,000)Total $(5,000)Cash flows to investors of the firmShort-term debt $(6,000)Long-term debt (20,000)Equity (Dividend - Financing) 21,000Total $(5,000)[Note: This table isn’t the Statement of Cash Flows, which is only covered in Appendix 2B, since the latter has th e change in cash (on the balance sheet) as a final entry.]2.13 a. The changes in net working capital can be computed from:Sources of net working capitalNet income $100Depreciation 50Increases in long-term debt 75Total sources $225Uses of net working capitalDividends $50Increases in fixed assets* 150Total uses $200Additions to net working capital $25*Includes $50 of depreciation.b.Cash flow from the firmOperating cash flow $150Capital spending (150)Additions to net working capital (25)Total $(25)Cash flow to the investorsDebt $(75)Equity 50Total $(25)Chapter 3: Financial Markets and Net Present Value: First Principles of Finance (Advanced)3.14 $120,000 - ($150,000 - $100,000) (1.1) = $65,0003.15 $40,000 + ($50,000 - $20,000) (1.12) = $73,6003.16 a. ($7 million + $3 million) (1.10) = $11.0 millionb.i. They could spend $10 million by borrowing $5 million today.ii. They will have to spend $5.5 million [= $11 million - ($5 million x 1.1)] at t=1.Chapter 4: Net Present Valuea. $1,000 ⨯ 1.0510 = $1,628.89b. $1,000 ⨯ 1.0710 = $1,967.15c. $1,000 ⨯ 1.0520 = $2,653.30d. Interest compounds on the interest already earned. Therefore, the interest earned inSince this bond has no interim coupon payments, its present value is simply the present value of the $1,000 that will be received in 25 years. Note: As will be discussed in the next chapter, the present value of the payments associated with a bond is the price of that bond.PV = $1,000 /1.125 = $92.30PV = $1,500,000 / 1.0827 = $187,780.23a. At a discount rate of zero, the future value and present value are always the same. Remember, FV =PV (1 + r) t. If r = 0, then the formula reduces to FV = PV. Therefore, the values of the options are $10,000 and $20,000, respectively. You should choose the second option.b. Option one: $10,000 / 1.1 = $9,090.91Option two: $20,000 / 1.15 = $12,418.43Choose the second option.c. Option one: $10,000 / 1.2 = $8,333.33Option two: $20,000 / 1.25 = $8,037.55Choose the first option.d. You are indifferent at the rate that equates the PVs of the two alternatives. You know that rate mustfall between 10% and 20% because the option you would choose differs at these rates. Let r be thediscount rate that makes you indifferent between the options.$10,000 / (1 + r) = $20,000 / (1 + r)5(1 + r)4 = $20,000 / $10,000 = 21 + r = 1.18921r = 0.18921 = 18.921%The $1,000 that you place in the account at the end of the first year will earn interest for six years. The $1,000 that you place in the account at the end of the second year will earn interest for five years, etc. Thus, the account will have a balance of$1,000 (1.12)6 + $1,000 (1.12)5 + $1,000 (1.12)4 + $1,000 (1.12)3= $6,714.61PV = $5,000,000 / 1.1210 = $1,609,866.18a. $1.000 (1.08)3 = $1,259.71b. $1,000 [1 + (0.08 / 2)]2 ⨯ 3 = $1,000 (1.04)6 = $1,265.32c. $1,000 [1 + (0.08 / 12)]12 ⨯ 3 = $1,000 (1.00667)36 = $1,270.24d. $1,000 e0.08 ⨯ 3 = $1,271.25e. The future value increases because of the compounding. The account is earning interest on interest. Essentially, the interest is added to the account balance at the e nd of every compounding period. During the next period, the account earns interest on the new balance. When the compounding period shortens, the balance that earns interest is rising faster.The price of the consol bond is the present value of the coupon payments. Apply the perpetuity formula to find the present value. PV = $120 / 0.15 = $800a. $1,000 / 0.1 = $10,000b. $500 / 0.1 = $5,000 is the value one year from now of the perpetual stream. Thus, the value of theperpetuity is $5,000 / 1.1 = $4,545.45.c. $2,420 / 0.1 = $24,200 is the value two years from now of the perpetual stream. Thus, the value of the perpetuity is $24,200 / 1.12 = $20,000.pply the NPV technique. Since the inflows are an annuity you can use the present value of an annuity factor.ANPV = -$6,200 + $1,200 81.0= -$6,200 + $1,200 (5.3349)= $201.88Yes, you should buy the asset.Use an annuity factor to compute the value two years from today of the twenty payments. Remember, the annuity formula gives you the value of the stream one year before the first payment. Hence, the annuity factor will give you the value at the end of year two of the stream of payments.A= $2,000 (9.8181)Value at the end of year two = $2,000 20.008= $19,636.20The present value is simply that amount discounted back two years.PV = $19,636.20 / 1.082 = $16,834.88The easiest way to do this problem is to use the annuity factor. The annuity factor must be equal to $12,800 / $2,000 = 6.4; remember PV =C A T r. The annuity factors are in the appendix to the text. To use the factor table to solve this problem, scan across the row labeled 10 years until you find 6.4. It is close to the factor for 9%, 6.4177. Thus, the rate you will receive on this note is slightly more than 9%.You can find a more precise answer by interpolating between nine and ten percent.[ 10% ⎤[6.1446 ⎤a ⎡r ⎥bc ⎡6.4 ⎪ d⎣9%⎦⎣6.4177 ⎦By interpolating, you are presuming that the ratio of a to b is equal to the ratio of c to d.(9 - r ) / (9 - 10) = (6.4177 - 6.4 ) / (6.4177 - 6.1446)r = 9.0648%The exact value could be obtained by solving the annuity formula for the interest rate. Sophisticated calculators can compute the rate directly as 9.0626%.[Note: A standard financial calculator’s TVM keys can solve for this rate. With annuity flows, the IRR key on “advanced” financial c alculators is unnecessary.]a. The annuity amount can be computed by first calculating the PV of the $25,000 which youThat amount is $17,824.65 [= $25,000 / 1.075]. Next compute the annuity which has the same present value.A$17,824.65 = C 507.0$17,824.65 = C (4.1002)C = $4,347.26Thus, putting $4,347.26 into the 7% account each year will provide $25,000 five years from today.b. The lump sum payment must be the present value of the $25,000, i.e., $25,000 / 1.075 =$17,824.65The formula for future value of any annuity can be used to solve the problem (see footnote 11 of the text).Option one: This cash flow is an annuity due. To value it, you must use the after-tax amounts. Theafter-tax payment is $160,000 (1 - 0.28) = $115,200. Value all except the first payment using the standard annuity formula, then add back the first payment of $115,200 to obtain the value of this option.AValue = $115,200 + $115,200 30.010= $115,200 + $115,200 (9.4269)= $1,201,178.88Option two: This option is valued similarly. You are able to have $446,000 now; this is already on an after-tax basis. You will receive an annuity of $101,055 for each of the next thirty years. Those payments are taxable when you receive them, so your after-tax payment is $72,759.60 [= $101,055 (1 - 0.28)].AValue = $446,000 + $72,759.60 30.010= $446,000 + $72,759.60 (9.4269)= $1,131,897.47Since option one has a higher PV, you should choose it.et r be the rate of interest you must earn.$10,000(1 + r)12 = $80,000(1 + r)12= 8r = 0.18921 = 18.921%First compute the present value of all the payments you must make for your children’s educati on. The value as of one year before matriculation of one child’s education isA= $21,000 (2.8550) = $59,955.$21,000 415.0This is the value of the elder child’s education fourteen years from now. It is the value of the younger child’s education sixteen years from today. The present value of these isPV = $59,955 / 1.1514 + $59,955 / 1.1516= $14,880.44You want to make fifteen equal payments into an account that yields 15% so that the present value of the equal payments is $14,880.44.A= $14,880.44 / 5.8474 = $2,544.80Payment = $14,880.44 / 15.015This problem applies the growing annuity formula. The first payment is$50,000(1.04)2(0.02) = $1,081.60.PV = $1,081.60 [1 / (0.08 - 0.04) - {1 / (0.08 - 0.04)}{1.04 / 1.08}40]= $21,064.28This is the present value of the payments, so the value forty years from today is$21,064.28 (1.0840) = $457,611.46se the discount factors to discount the individual cash flows. Then compute the NPV of the project. NoticeYou can still use the factor tables to compute their PV. Essentially, they form cash flows that are a six year annuity less a two year annuity. Thus, the appropriate annuity factor to use with them is 2.6198 (= 4.3553 - 1.7355).Year Cash Flow Factor PV0.9091 $636.371$70020.8264 743.769003 1,000 ⎤4 1,000 ⎥ 2.6198 2,619.805 1,000 ⎥6 1,000 ⎦7 1,250 0.5132 641.508 1,375 0.4665 641.44Total $5,282.87NPV = -$5,000 + $5,282.87= $282.87Purchase the machine.Chapter 5: How to Value Bonds and StocksThe amount of the semi-annual interest payment is $40 (=$1,000 ⨯ 0.08 / 2). There are a total of 40 periods;i.e., two half years in each of the twenty years in the term to maturity. The annuity factor tables can be usedto price these bonds. The appropriate discount rate to use is the semi-annual rate. That rate is simply the annual rate divided by two. Thus, for part b the rate to be used is 5% and for part c is it 3%.A+F/(1+r)40PV=C Tra. $40 (19.7928) + $1,000 / 1.0440 = $1,000Notice that whenever the coupon rate and the market rate are the same, the bond is priced at par.b. $40 (17.1591) + $1,000 / 1.0540 = $828.41Notice that whenever the coupon rate is below the market rate, the bond is priced below par.c. $40 (23.1148) + $1,000 / 1.0340 = $1,231.15Notice that whenever the coupon rate is above the market rate, the bond is priced above par.a. The semi-annual interest rate is $60 / $1,000 = 0.06. Thus, the effective annual rate is 1.062 - 1 =0.1236 = 12.36%.A+ $1,000 / 1.0612b. Price = $30 12.006= $748.48A+ $1,000 / 1.0412c. Price = $30 1204.0= $906.15Note: In parts b and c we are implicitly assuming that the yield curve is flat. That is, the yield in year 5applies for year 6 as well.rice = $2 (0.72) / 1.15 + $4 (0.72) / 1.152 + $50 / 1.153= $36.31The number of shares you own = $100,000 / $36.31 = 2,754 sharesPrice = $1.15 (1.18) / 1.12 + $1.15 (1.182) / 1.122 + $1.152 (1.182) / 1.123+ {$1.152 (1.182)(1.06) / (0.12 - 0.06)} / 1.123= $26.95[Insert before last sentence of question: Assume that dividends are a fixed proportion of earnings.] Dividend one year from now = $5 (1 - 0.10) = $4.50Price = $5 + $4.50 / {0.14 - (-0.10)}= $23.75Since the current $5 dividend has not yet been paid, it is still included in the stock price.Chapter 6: Some Alternative Investment Rulesa. Payback period of Project A = 1 + ($7,500 - $4,000) / $3,500 = 2 yearsPayback period of Project B = 2 + ($5,000 - $2,500 -$1,200) / $3,000 = 2.43 yearsProject A should be chosen.b. NPV A = -$7,500 + $4,000 / 1.15 + $3,500 / 1.152 + $1,500 / 1.153 = -$388.96NPV B = -$5,000 + $2,500 / 1.15 + $1,200 / 1.152 + $3,000 / 1.153 = $53.83Project B should be chosen.a. Average Investment:($16,000 + $12,000 + $8,000 + $4,000 + 0) / 5 = $8,000Average accounting return:$4,500 / $8,000 = 0.5625 = 56.25%b. 1. AAR does not consider the timing of the cash flows, hence it does not consider the timevalue of money.2. AAR uses an arbitrary firm standard as the decision rule.3. AAR uses accounting data rather than net cash flows.aAverage Investment = (8000 + 4000 + 1500 + 0)/4 = 3375.00Average Net Income = 2000(1-0.75) = 1500=> AAR = 1500/3375=44.44%a. Solve x by trial and error:-$8,000 + $4,000 / (1 + x) + $3000 / (1 + x)2 + $2,000 / (1 + x)3 = 0x = 6.93%b. No, since the IRR (6.93%) is less than the discount rate of 8%.Alternatively, the NPV @ a discount rate of 0.08 = -$136.62.a. Solve r in the equation:$5,000 - $2,500 / (1 + r) - $2,000 / (1 + r)2 - $1,000 / (1 + r)3- $1,000 / (1 + r)4 = 0By trial and error,IRR = r = 13.99%b. Since this problem is the case of financing, accept the project if the IRR is less than the required rate of return.IRR = 13.99% > 10%Reject the offer.c. IRR = 13.99% < 20%Accept the offer.d. When r = 10%:NPV = $5,000 - $2,500 / 1.1 - $2,000 / 1.12 - $1,000 / 1.13 - $1,000 / 1.14When r = 20%:NPV = $5,000 - $2,500 / 1.2 - $2,000 / 1.22 - $1,000 / 1.23 - $1,000 / 1.24= $466.82Yes, they are consistent with the choices of the IRR rule since the signs of the cash flows change only once.A/ $160,000 = 1.04PI = $40,000 715.0Since the PI exceeds one accept the project.Chapter 7: Net Present Value and Capital BudgetingSince there is uncertainty surrounding the bonus payments, which McRae might receive, you must use the expected value of McRae’s bonuses in the computation of the PV of his contract. McRae’s salary plus the expected value of his bonuses in years one through three is$250,000 + 0.6 ⨯ $75,000 + 0.4 ⨯ $0 = $295,000.Thus the total PV of his three-year contract isPV = $400,000 + $295,000 [(1 - 1 / 1.12363) / 0.1236]+ {$125,000 / 1.12363} [(1 - 1 / 1.123610 / 0.1236]= $1,594,825.68EPS = $800,000 / 200,000 = $4NPVGO = (-$400,000 + $1,000,000) / 200,000 = $3Price = EPS / r + NPVGO= $4 / 0.12 + $3=$36.33Year 0 Year 1 Year 2 Year 3 Year 4 Year 51. Annual Salary$120,000 $120,000 $120,000 $120,000 $120,000 Savings2. Depreciation 100,000 160,000 96,000 57,600 57,6003. Taxable Income 20,000 -40,000 24,000 62,400 62,4004. Taxes 6,800 -13,600 8,160 21,216 21,2165. Operating Cash Flow113,200 133,600 111,840 98,784 98,784 (line 1-4)$100,000 -100,0006. ∆ Net workingcapital7. Investment $500,000 75,792*8. Total Cash Flow -$400,000 $113,200 $133,600 $111,840 $98,784 $74,576*75,792 = $100,000 - 0.34 ($100,000 - $28,800)NPV = -$400,000+ $113,200 / 1.12 + $133,600 / 1.122 + $111,840 / 1.123+ $98,784 / 1.124 + $74,576 / 1.125= -$7,722.52Real interest rate = (1.15 / 1.04) - 1 = 10.58%NPV A = -$40,000+ $20,000 / 1.1058 + $15,000 / 1.10582 + $15,000 / 1.10583= $1,446.76NPV B = -$50,000+ $10,000 / 1.15 + $20,000 / 1.152 + $40,000 / 1.153= $119.17Choose project A.PV = $120,000 / {0.11 - (-0.06)}t = 0 t = 1 t = 2 t = 3 t = 4 t = 5 t = 6 ...$12,000 $6,000 $6,000 $6,000$4,000$12,000 $6,000 $6,000 ...The present value of one cycle is:A+ $4,000 / 1.064PV = $12,000 + $6,000 306.0= $12,000 + $6,000 (2.6730) + $4,000 / 1.064= $31,206.37The cycle is four years long, so use a four year annuity factor to compute the equivalent annual cost (EAC).AEAC = $31,206.37 / 406.0= $31,206.37 / 3.4651= $9,006The present value of such a stream in perpetuity is$9,006 / 0.06 = $150,100o evaluate the word processors, compute their equivalent annual costs (EAC).BangAPV(costs) = (10 ⨯ $8,000) + (10 ⨯ $2,000) 414.0= $80,000 + $20,000 (2.9137)= $138,274EAC = $138,274 / 2.9137= $47,456IOUAPV(costs) = (11 ⨯ $5,000) + (11 ⨯ $2,500) 3.014- (11 ⨯ $500) / 1.143= $55,000 + $27,500 (2.3216) - $5,500 / 1.143= $115,132EAC = $115,132 / 2.3216= $49,592BYO should purchase the Bang word processors.Chapter 8: Strategy and Analysis in Using Net Present ValueThe accounting break-even= (120,000 + 20,000) / (1,500 - 1,100)= 350 units. The accounting break-even= 340,000 / (2.00 - 0.72)= 265,625 abalonesb. [($2.00 ⨯ 300,000) - (340,000 + 0.72 ⨯ 300,000)] (0.65)= $28,600This is the after tax profit.Chapter 9: Capital Market Theory: An Overviewa. Capital gains = $38 - $37 = $1 per shareb. Total dollar returns = Dividends + Capital Gains = $1,000 + ($1*500) = $1,500 On a per share basis, this calculation is $2 + $1 = $3 per sharec. On a per share basis, $3/$37 = 0.0811 = 8.11% On a total dollar basis, $1,500/(500*$37) = 0.0811 = 8.11%d. No, you do not need to sell the shares to include the capital gains in the computation of the returns. The capital gain is included whether or not you realize the gain. Since you could realize the gain if you choose, you should include it.The expected holding period return is:()[]%865.1515865.052$/52$75.54$50.5$==-+There appears to be a lack of clarity about the meaning of holding period returns. The method used in the answer to this question is the one used in Section 9.1. However, the correspondence is not exact, because in this question, unlike Section 9.1, there are cash flows within the holding period. The answer above ignores the dividend paid in the first year. Although the answer above technically conforms to the eqn at the bottom of Fig. 9.2, the presence of intermediate cash flows that aren’t accounted for renders th is measure questionable, at best. There is no similar example in the body of the text, and I have never seen holding period returns calculated in this way before.Although not discussed in this book, there are two generally accepted methods of computing holding period returns in the presence of intermediate cash flows. First, the time weighted return calculates averages (geometric or arithmetic) of returns between cash flows. Unfortunately, that method can’t be used here, because we are not given the va lue of the stock at the end of year one. Second, the dollar weighted measure calculates the internal rate of return over the entire holding period. Theoretically, that method can be applied here, as follows: 0 = -52 + 5.50/(1+r) + 60.25/(1+r)2 => r = 0.1306.This produces a two year holding period return of (1.1306)2 – 1 = 0.2782. Unfortunately, this book does not teach the dollar weighted method.In order to salvage this question in a financially meaningful way, you would need the value of the stock at the end of one year. Then an illustration of the correct use of the time-weighted return would be appropriate. A complicating factor is that, while Section 9.2 illustrates the holding period return using the geometric return for historical data, the arithmetic return is more appropriate for expected future returns.E(R) = T-Bill rate + Average Excess Return = 6.2% + (13.0% -3.8%) = 15.4%. Common Treasury Realized Stocks Bills Risk Premium -7 32.4% 11.2% 21.2%-6 -4.9 14.7 -19.6-5 21.4 10.5 10.9 -4 22.5 8.8 13.7 -3 6.3 9.9 -3.6 -2 32.2 7.7 24.5 Last 18.5 6.2 12.3 b. The average risk premium is 8.49%.49.873.125.246.37.139.106.192.21=++-++- c. Yes, it is possible for the observed risk premium to be negative. This can happen in any single year. The.b.Standard deviation = 03311.0001096.0=.b.Standard deviation = = 0.03137 = 3.137%.b.Chapter 10: Return and Risk: The Capital-Asset-Pricing Model (CAPM)a. = 0.1 (– 4.5%) + 0.2 (4.4%) + 0.5 (12.0%) + 0.2 (20.7%) = 10.57%b.σ2 = 0.1 (–0.045 – 0.1057)2 + 0.2 (0.044 – 0.1057)2 + 0.5 (0.12 – 0.1057)2+ 0.2 (0.207 – 0.1057)2 = 0.0052σ = (0.0052)1/2 = 0.072 = 7.20%Holdings of Atlas stock = 120 ⨯ $50 = $6,000 ⨯ $20 = $3,000Weight of Atlas stock = $6,000 / $9,000 = 2 / 3Weight of Babcock stock = $3,000 / $9,000 = 1 / 3a. = 0.3 (0.12) + 0.7 (0.18) = 0.162 = 16.2%σP 2= 0.32 (0.09)2 + 0.72 (0.25)2 + 2 (0.3) (0.7) (0.09) (0.25) (0.2)= 0.033244σP= (0.033244)1/2 = 0.1823 = 18.23%a.State Return on A Return on B Probability1 15% 35% 0.4 ⨯ 0.5 = 0.22 15% -5% 0.4 ⨯ 0.5 = 0.23 10% 35% 0.6 ⨯ 0.5 = 0.34 10% -5% 0.6 ⨯ 0.5 = 0.3b. = 0.2 [0.5 (0.15) + 0.5 (0.35)] + 0.2[0.5 (0.15) + 0.5 (-0.05)]+ 0.3 [0.5 (0.10) + 0.5 (0.35)] + 0.3 [0.5 (0.10) + 0.5 (-0.05)]= 0.135= 13.5%Note: The solution to this problem requires calculus.Specifically, the solution is found by minimizing a function subject to a constraint. Calculus ability is not necessary to understand the principles behind a minimum variance portfolio.Min { X A2 σA2 + X B2σB2+ 2 X A X B Cov(R A , R B)}subject to X A + X B = 1Let X A = 1 - X B. Then,Min {(1 - X B)2σA2 + X B2σB2+ 2(1 - X B) X B Cov (R A, R B)}Take a derivative with respect to X B.d{∙} / dX B = (2 X B - 2) σA2+ 2 X B σB2 + 2 Cov(R A, R B) - 4 X B Cov(R A, R B)Set the derivative equal to zero, cancel the common 2 and solve for X B.X BσA2- σA2+ X B σB2 + Cov(R A, R B) - 2 X B Cov(R A, R B) = 0X B = {σA2 - Cov(R A, R B)} / {σA2+ σB2 - 2 Cov(R A, R B)}andX A = {σB2 - Cov(R A, R B)} / {σA2+ σB2 - 2 Cov(R A, R B)}Using the data from the problem yields,X A = 0.8125 andX B = 0.1875.a. Using the weights calculated above, the expected return on the minimum variance portfolio isE(R P) = 0.8125 E(R A) + 0.1875 E(R B)= 0.8125 (5%) + 0.1875 (10%)= 5.9375%b. Using the formula derived above, the weights areX A = 2 / 3 andX B = 1 / 3c. The variance of this portfolio is zero.σP 2= X A2 σA2 + X B2σB2+ 2 X A X B Cov(R A , R B)= (4 / 9) (0.01) + (1 / 9) (0.04) + 2 (2 / 3) (1 / 3) (-0.02)= 0This demonstrates that assets can be combined to form a risk-free portfolio.14.2%= 3.7%+β(7.5%) ⇒β = 1.40.25 = R f + 1.4 [R M– R f] (I)0.14 = R f + 0.7 [R M– R f] (II)(I) – (II)=0.11 = 0.7 [R M– R f] (III)[R M– R f ]= 0.1571Put (III) into (I) 0.25 = R f + 1.4[0.1571]R f = 3%[R M– R f ]= 0.1571R M = 0.1571 + 0.03= 18.71%a. = 4.9% + βi (9.4%)βD= Cov(R D, R M) / σM 2 = 0.0635 / 0.04326 = 1.468= 4.9 + 1.468 (9.4) = 18.70%Weights:X A = 5 / 30 = 0.1667X B = 10 / 30 = 0.3333X C = 8 / 30 = 0.2667X D = 1 - X A - X B - X C = 0.2333Beta of portfolio= 0.1667 (0.75) + 0.3333 (1.10) + 0.2667 (1.36) + 0.2333 (1.88)= 1.293= 4 + 1.293 (15 - 4) = 18.22%a. (i) βA= ρA,MσA / σMρA,M= βA σM / σA= (0.9) (0.10) / 0.12= 0.75(ii) σB= βB σM / ρB,M= (1.10) (0.10) / 0.40= 0.275(iii) βC= ρC,MσC / σM= (0.75) (0.24) / 0.10= 1.80(iv) ρM,M= 1(v) βM= 1(vi) σf= 0(vii) ρf,M= 0(viii) βf= 0b. SML:E(R i) = R f + βi {E(R M) - R f}= 0.05 + (0.10) βiSecurity βi E(R i)A 0.13 0.90 0.14B 0.16 1.10 0.16C 0.25 1.80 0.23Security A performed worse than the market, while security C performed better than the market.Security B is fairly priced.c. According to the SML, security A is overpriced while security C is under-priced. Thus, you could invest in security C while sell security A (if you currently hold it).a. The typical risk-averse investor seeks high returns and low risks. To assess thetwo stocks, find theReturns:State of economy ProbabilityReturn on A*Recession 0.1 -0.20 Normal 0.8 0.10 Expansion0.10.20* Since security A pays no dividend, the return on A is simply (P 1 / P 0) - 1. = 0.1 (-0.20) + 0.8 (0.10) + 0.1 (0.20) = 0.08 = 0.09 This was given in the problem.Risk:R A - (R A -)2 P ⨯ (R A -)2 -0.28 0.0784 0.00784 0.02 0.0004 0.00032 0.12 0.0144 0.00144 Variance 0.00960Standard deviation (R A ) = 0.0980βA = {Corr(R A , R M ) σ(R A )} / σ(R M ) = 0.8 (0.0980) / 0.10= 0.784βB = {Corr(R B , R M ) σ(R B )} / σ(R M ) = 0.2 (0.12) / 0.10= 0.24The return on stock B is higher than the return on stock A. The risk of stock B, as measured by itsbeta, is lower than the risk of A. Thus, a typical risk-averse investor will prefer stock B.b. = (0.7) + (0.3) = (0.7) (0.8) + (0.3) (0.09) = 0.083σP 2= 0.72 σA 2 + 0.32 σB 2 + 2 (0.7) (0.3) Corr (R A , R B ) σA σB = (0.49) (0.0096) + (0.09) (0.0144) + (0.42) (0.6) (0.0980) (0.12) = 0.0089635 σP = = 0.0947 c. The beta of a portfolio is the weighted average of the betas of the components of the portfolio. βP = (0.7) βA + (0.3) βB = (0.7) (0.784) + (0.3) (0.240) = 0.621Chapter 11:An Alternative View of Risk and Return: The Arbitrage Pricing Theorya. Stock A:()()R R R R R A A A m m Am A=+-+=+-+βεε105%12142%...Stock B:()()R R R R R B B m m Bm B=+-+=+-+βεε130%098142%...Stock C:()R R R R R C C C m m Cm C=+-+=+-+βεε157%137142%)..(.b.()[]()[]()[]()()()()()()[]()()CB A m cB A m c m B m A m CB A P 25.045.030.0%2.14R 1435.1%925.1225.045.030.0%2.14R 37.125.098.045.02.130.0%7.1525.0%1345.0%5.1030.0%2.14R 37.1%7.1525.0%2.14R 98.0%0.1345.0%2.14R 2.1%5.1030.0R 25.0R 45.0R 30.0R ε+ε+ε+-+=ε+ε+ε+-+++++=ε+-++ε+-++ε+-+=++= c.i.()R R R A B C =+-==+-==+-=105%1215%142%)1113%09815%142%)137%157%13715%142%168%..(..46%.(......ii.R P =+-=12925%1143515%142%)138398%..(..To determine which investment investor would prefer, you must compute the variance of portfolios created bymany stocks from either market. Note, because you know that diversification is good, it is reasonable to assume that once an investor chose the market in which he or she will invest, he or she will buy many stocks in that market.Known:E EF ====001002 and and for all i.i σσεε..Assume: The weight of each stock is 1/N; that is, X N i =1/for all i.If a portfolio is composed of N stocks each forming 1/N proportion of the portfolio, the return on the portfolio is 1/N times the sum of the returns on the N stocks. Recall that the return on each stock is 0.1+βF+ε.()()()()()()[]()()()()()()()[]()[]()[]()()[]()()()()()j i 2j i 22j i i 2222222222P P P P iP ,0.04Corr 0.01,Cov s =isvariance the ,N as limit In the ,Cov 1/N 1s 1/N s )(1/N 1/N F 2F E 1/N F E 0.10.1/N F 0.1E R E R E R Var 0.101/N 00.1E 1/N F E 0.11/N F 0.1E R E 1/N F 0.1F 0.1(1/N)R 1/N R εε+β=εε+β∞⇒εε-+ε+β=ε∑+εβ+β=ε+β=-ε+β+=-==+β+=ε+β+=ε∑+β+=ε+β+=ε+β+==∑∑∑∑∑∑∑∑()()()()()()Thus,F R f E R E R Var R Corr Var R Corr ii ip P p i j PijR 1i =++=++===+=+010*********002250040002500412212111222.........,,εεεεεεa.()()()()Corr Corr Var R Var R i j i j p pεεεε112212000225000225,,..====Since Var ()()R p 1 Var R 2p 〉, a risk averse investor will prefer to invest in the second market.b. Corr ()()εεεε112090i j j ,.,== and Corr 2i()()Var R Var R pp120058500025==..。

How much value is created from undertaking an investment?
– The first step is to estimate the expected future cash flows.
– The second step is to estimate the required return for projects of this risk level.
Since our goal is to increase owner wealth, NPV is a direct measure of how well this project will meet our goal.

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– The third step is to find the present value of the cash flows and subtract the initial investment.
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NPV Decision Rule
– Year 2: 101,880 – 70,800 = 31,080 still to recover – Year 3: 31,080 – 91,080 = -60,000 project pays
back in year 3
Do we accept or reject the project?
Does the NPV rule account for the risk of the cash flows?