Cash Flow and Risk Free Asset
1. A company needs to elect 10 directors. A shareholder owns 80 shares. What is the maximum number of votes that he or she can cast for a favorite candidate under (10 points)
a. Straight voting? 80
b. Cumulative voting? 80*10 = 800
2. “If the efficient-market hypothesis is true, the pension fund manager might as well select a portfolio by throwing darts at the Wall Street Journal.” Explain why this is not so. (10 points) This strategy does not consider risk.
3. The NuPress Valet Company has an improved version of its hotel stand. The investment cost is expected to be 72 million dollars and will return 13.50 million dollars for 5 years in net cash flows. The ratio of debt to equity is 1 to 1. The cost of equity is 13%, the cost of debt is 9%, and the tax rate is 34%. What is the NPV of the project? (10 points)
WACC = .5*13+.5*9*(1-.34) = 9.47%
PMT = 13,500,000, i=9.47%, n=5, PV = ?; NPV = PV – 72,000,000 = -20,123,870.16
4. TXI Corporation is a holding company with four main subsidiaries. The percentage of its business coming from each of the subsidiaries, and their respective betas, are as follows: (10 points)
Subsidiary
Percentage of Business
Beta
Electric Utility
60%
0.70
Cable Company
25%
0.90
Real Estate
10%
1.30
International Projects
5%
1.50
a. What is the holding company’s beta?
Β = .6*.7+.25*.9+.10*1.3 + .05*1.5 = 0.85
b. Assume that the risk-free rate is 6 percent and the market risk premium is 5 percent. What is the holding company’s required return?
R = 6 + 0.85(5) = 10.25%
5. The Marx Brewing Company recently installed a new bottling machine. The machine’s initial cost is $2,000, and can be depreciated on a straight line basis to a zero salvage in 5 years. The machine’s per year fixed cost is $1,800, and its variable cost is $0.50 per unit. The selling price per unit is $1.50. Marx’s tax rate is 34%, and it uses a 16% discount rate. (10 points)
a. Calculate the accounting break-even point on the new machine.
a. Straight voting? 80
b. Cumulative voting? 80*10 = 800
2. “If the efficient-market hypothesis is true, the pension fund manager might as well select a portfolio by throwing darts at the Wall Street Journal.” Explain why this is not so. (10 points) This strategy does not consider risk.
3. The NuPress Valet Company has an improved version of its hotel stand. The investment cost is expected to be 72 million dollars and will return 13.50 million dollars for 5 years in net cash flows. The ratio of debt to equity is 1 to 1. The cost of equity is 13%, the cost of debt is 9%, and the tax rate is 34%. What is the NPV of the project? (10 points)
WACC = .5*13+.5*9*(1-.34) = 9.47%
PMT = 13,500,000, i=9.47%, n=5, PV = ?; NPV = PV – 72,000,000 = -20,123,870.16
4. TXI Corporation is a holding company with four main subsidiaries. The percentage of its business coming from each of the subsidiaries, and their respective betas, are as follows: (10 points)
Subsidiary
Percentage of Business
Beta
Electric Utility
60%
0.70
Cable Company
25%
0.90
Real Estate
10%
1.30
International Projects
5%
1.50
a. What is the holding company’s beta?
Β = .6*.7+.25*.9+.10*1.3 + .05*1.5 = 0.85
b. Assume that the risk-free rate is 6 percent and the market risk premium is 5 percent. What is the holding company’s required return?
R = 6 + 0.85(5) = 10.25%
5. The Marx Brewing Company recently installed a new bottling machine. The machine’s initial cost is $2,000, and can be depreciated on a straight line basis to a zero salvage in 5 years. The machine’s per year fixed cost is $1,800, and its variable cost is $0.50 per unit. The selling price per unit is $1.50. Marx’s tax rate is 34%, and it uses a 16% discount rate. (10 points)
a. Calculate the accounting break-even point on the new machine.