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Practice for Final

1. What is the expected return on the following portfolio?

Expected Number Stock
Stock Return of Shares Price
A 8% 520 $25
B 15% 300 $48
C 6% 250 $26


2. What is the beta of a portfolio comprised of the following securities?


Stock Amount Invested Security Beta
A $2,000 1.20
B $3,000 1.46
C $5,000 0.72
Market Portfolio (SP500) $10,000
3 Month T-Bill $5,000


3. Jacks Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with
similar characteristics are yielding 8.5 percent. The company also has 4 million shares of common
stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. Treasury bill is
yielding 4 percent and the market risk premium is 8 percent. Jacks tax rate is 35 percent. What is
Jacks weighted average cost of capital?


4. Douglass Enterprises has a capital structure which is based on 40 percent debt and 60 percent
common stock. The after-tax cost of debt is 6 percent and the cost of common stock is 9 percent. The
company is considering a project that is equally as risky as the overall firm. This project has initial
costs of $125,000 and cash inflows of $76,000 a year for two years. What is the projected net present
value of this project?


5. The Rothschild Winery is considering an investment in new manufacturing equipment. The
equipment costs $200,000. The equipment will depreciate 10,000 per year for ten years. At the end
of the 10th year, they will sell the equipment for a before tax market price of $125,000. They are
going to put this equipment in a building that they already own. They bought the land that the
building is on five years ago for $50,000. It cost them $10,000 to build the building, five years ago.
Last week, the building and the land were appraised for $200,000. Initial net working capital
(NWC) investment is $10,000 and the balance in NWC will maintain a level equal to $15,000 each
year thereafter. They expect that the equipment will provide additional annual after-tax Operating
Cash Flows of $150,000 at the end of each of the next 10 years. Currently the firms equity is
selling at $20 per share and there are 100,000 shares outstanding. The firm issued $500,000 worth
of bonds 3 years ago. These bonds are currently selling at 110 percent of face value. The firms beta
is 1.5 and its pre-tax cost of debt is 7%. The firms tax rate is 40%. The current yield on 3 month T-
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Bills is about 4% and the historical average market risk premium has been about 9.5%. Assume the
project is of approximately the same risk as the firm.
a. What is the market value of equity?
b. What is the market value of debt?
c. What is the market value of the firm?
d. What is the required rate of return on equity?
e. What is the after tax cost of debt?
f. What is the firm's WACC?
g. What is the Total (incremental) Cash Flow in year 0, year 1, year 2 and year 10
h. What is the NPV of the proposed project?



6. The total annual returns on large company common stocks averaged 12.4% from 1926 to 2008,
small company stocks averaged 17.5%, long-term government bonds averaged 5.8%, while Treasury
Bills averaged 3.8%.

a. What was the average risk premium earned by long-term government bonds?
b. What was the average risk premium earned by small company stocks?

7. The returns for Johnny Applesticks over the last 3 years were:
Year 1 return = 10%, Year 2 return = -5%, Year 3 return = 12%. No dividends were paid.

a. What was the 3-year holding period return?
b. What was the geometric average return?
c. What was the arithmetic average return?

8. A stock had the following prices. No dividends were paid. What was the return in year 2?

Year Price
1 $23.19
2 $20.90
3 $25.18

9. Twelve months ago, you purchased 400 shares of Pucks Backyard Grill stock at a price of $54.90 a
share. The company pays quarterly dividends of $.50 a share. Today, you sold all of your shares for
$49.30 a share.
a. What was your total dollar return on this investment over the twelve months?
b. What was your dividend yield over the twelve months?
c. What was your capital gains yield over the twelve months?
d. What was your total percentage return over the twelve months?


10. Given the following information, what is the market value of the firm?
Common Stock: 9 million shares outstanding, price = $28 per share.
Bond Issue 1, Par Value (Face value) $1000: $200 million Total Face Value, Price per Bond =
108% of face value.
Bond Issue 2, Par Value $1000: $60 million total face value, price = $775 per bond

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11. A companys zero coupon bond issue matures in 16 years and has a yield to maturity of 10.60%.
Each zero has a face value of $1,000 and there are 4,000 of the bonds outstanding. If the market
values the equity at $1,800,000, what capital structure weight for debt would you use in calculating
the WACC, assuming the firms only debt consists of the zeros?

12. Carrie has developed a new method to produce her throat soothing tea. The required investment cost
is expected to be 10 million dollars immediately (Year 0) and will return 15 million dollars per year
starting next year (Year 1) for 10 years in after tax operating cash flows. The ratio of debt to equity
for the project is 1 to 1. The cost of equity is 13% and the pre-tax cost of debt is 9% for the project.
The tax rate is 34%. Assume that there will be no additions to NWC and the market value of the
equipment at the end of the 10th year will be zero. What is the NPV of the project?