Financial Management, Raymond Brooks, Ph.D.

Solutions to Selected Problems

Romero 340 Section
Chapter 1
1. The cycle of money is the movement of funds from a lender to a borrower and back to
the lender. The participants are the original lender, usually an individual (or household)
through direct investment or through a financial institution, the financial institution that
matches the lender with a borrower or bundles up a set of lenders for a single borrower,
and the borrower such as a company that is using the funds for operating the business or
expanding the business. The objective of every financial transaction is to make all parties
in the transaction better off.
3. Area One: Corporate Finance the financial activities that support the operations of a
business. A typical financial activity in this area is borrowing funds to support a plant
expansion or supplementing short term cash needs.
Area Two: Investments the activities around the buying and selling of financial assets.
A typical activity is the selling of a bond issue such as a school bond for building a new
school.
Area Three: Financial Institutions the organizations that promote and facilitate the cycle
of money. A typical financial activity is issuing checking and savings accounts as well as
selling securities such as certificates of deposit, stocks and bonds.
Area Four: International Finance the financial activities performed in foreign countries
for a domestic company. A typical financial activity is the changing of currency from one
country to another country.
7. The goal of the financial manager is to maximize the current share price or equity
value of the firm. This goal encompasses many good business practices such as a good
working relationship with the surrounding community. If the firm pollutes local streams,
abuses local facilities such as roads, and in general does not participate in the economic
advancement of the local community its share price or equity value will suffer. The local
community may sue the company for its damages and the best local workforce members
may choose not to work for the company. Employees may not be loyal to the company
causing high turnover and increased personal costs for recruiting and training. Finally,
facilities such as roads and utilities may not be repaired or modernized by the local
community impacting the companys ability to produce a profit. A good community
relationship is embedded in the goal of maximizing current share price or the equity value
of the company.

Chapter 2
1b. With TVM formula, and table set-up:
FV = $400.00 x (1.05)5 = $400.00 x (FVIF5%,5)
FV = $17,411.00 x (1.06)30 = $17,411.00 x (FVIF6%,30)
FV = $35,000.00 x (1.10)20 = $35,000.00 x (FVIF10%,20)
FV = $26,981.75 x (1.16)15 = $26,981.75 x (FVIF16%,15)
1c. Time Value of Money Keys or Spreadsheet
Input
Variable
Compute

5
N

5.0
I/Y

-400
PV

0
PMT

Input
Variable
Compute

30
N

6.0
I/Y

-17,411
PV

0
PMT

Input
Variable
Compute

20
N

10.0
I/Y

-35,000
PV

0
PMT

Input
Variable
Compute

15
N

16.0
I/Y

-26,981.75
PV

Present Value
$400.00
$17,411.00
$35,000.00
$26,981.75

FV
510.51
FV
99,999.92
FV
235,462.50
0
PMT

Solutions with TVM Keys or Spreadsheet

Interest Rate
Number of Periods
5.0%
5
6.0%
30
10%
20
16%
15

FV
249,999.97
Future Value
$510.51
$99,999.92
$235,462.50
$249,999.97

3c. Solutions with Calculator TVM Keys or Spreadsheet

Present Value
$500.00
$17,335.36
$35,000.00
$27,651.26
Input
Variable
Compute

Future Value
$1,998.00
$230,000.00
$63,214.00
$225,000.00
18
N

I/Y
8.00

500.00
PV

Number of Periods
18
30
20
15
0
PMT

Interest Rate
8.00%
9.00%
3.00%
15.00%
-1,998.00
FV

Input
Variable
Compute

30
N

Input
Variable
Compute

20
N

Input
Variable
Compute

15
N

I/Y
9.00
I/Y
3.00
I/Y
15.00

17,335.36
PV

0
PMT

-230,000
FV

35,000
PV

0
PMT

-63,214
FV

27,651.26
PV

0
PMT

5.

b. FV = $7,000 x (1.06)5 = $7,000 x (FVIF6%,5) = 9,367.58

d. FV = $7,000 x (1.06)15 = $7,000 x (FVIF6%,15) = 16,775.91

7.

a.
b.
c.
d.
e.

13.

Present Value of Average Employee:

PV = $400,000 x 1/(1.05)22 = $400,000 x (PVIF5%,22)= $136,740

-225,000
FV

PV = $2,500 x 1/(1.07)2 = $2,500 x (PVIF7%,2) = $2,183.60

PV = $2,500 x 1/(1.07)5= $2,500 x (PVIF7%,5)= $1,782.47
PV = $2,500 x 1/(1.07)9 = $2,500 x (PVIF7%,9)= $1,359.83
PV = $2,500 x 1/(1.07)14 = $2,500 x (PVIF7%,14)= $969.54
PV = $2,500 x 1/(1.07)18 = $2,500 x (PVIF7%,18)= $739.66

With 240,000 Employees the total obligations are:

PV Obligation of Pension Fund = 240,000 x $136,740 = $32,817,600,000
(Note, the PV was rounded to nearest dollar prior to multiplying times the
number of employees.)
15.

Fund Ones Rate, r = 11.96%

Fund Twos Rate, r = 15.98%
Fund Two has the higher return but for a shorter period of time. To be appropriate
for comparing performance the funds should be measured over the same period of
time. The first fund may have had a higher return over the last six years than the
second fund but low returns in the earlier years reduced the return below the 16%
return rate of the second fund.

17.

Answer for 5% growth rate in pedestrian traffic: n = 33 years

Answer for 8% growth rate in pedestrian traffic: n = 21 years
Ten Years Maximum would require growth rate of: r = 17.46%

Chapter 3
3.

FV = $250.00 x [(1 + 0.06)10 1] / 0.06 = $250.00 x (FVIFA6%,10) = $3,295.20

FV = $1,387.88 x [(1 + 0.12)20 1] / 0.12 = $1,387.88 x (FVIFA12%,20)= $100,000.14
FV = $600.00 x [(1 + 0.04)25 1] / 0.04 = $600.00 x (FVIFA4%,25)= $24,987.55
FV = $572.25 x [(1 + 0.01)360 1] / 0.01 = $572.25 x (FVIFA1%,360)= $1,999,993.23

7.

Using TVM Keys from a Texas Instrument BAII Plus Calculator and rounded to
two decimal places for interest percent. The P/Y and C/Y variables are set to 1.
INPUT
10
TVM KEYS N
OUTPUT

11.
13.

I/Y
6.00

INPUT
20
TVM KEYS N
OUTPUT

I/Y
12.00

INPUT
30
TVM KEYS N
OUTPUT

I/Y
9.00

INPUT
100
TVM KEYS N
OUTPUT

I/Y
5.00

-3,680.04
PV

500.00
PMT

0
FV

0
PV

-346.97
PMT

25,000
FV

1,946.73
PMT

0
FV

400.00
PMT

-1,044,010.06
FV

-20,000
PV
0
PV

FV = $25,000 x 1.106 = $25,000 x (FVIF10%,6) = $44,289.03

$25,000 = PMT (PVIFA10%,6)

Annual Payment = $5,740.18

15.

Part a. FVA = $50 x (FVIFA7%,25) = $3,162.45

Part b. FVA = $50 x (FVIFA7%,10) = $690.82 so the rainy day fund is $9.18 short
of being able to cover the medical bill.
19.

30,000 = PMT (PVIFA8.5%,10)

21.

First remember to check if the payment is greater than the interest expense for the
period.
PMT > PV x R = $3,900 > $15,000 x 0.2 = $3,000 and now,
on the calculator:
INPUT
?
20.0 $15,000
-$3,900
$0
Variables
N
I/Y
PV
PMT
FV
OUTPUT

PMT= $4,572.23

8.0426 8 payments or 8 years

Note: Most HP calculators get 9, because they round up to nearest integer when solving for n.

Chapter 4
Period
Semi-Annual
Quarterly
Monthly
Daily
1.

Compounding
Per Year
2
4
12
365

APR
8%
9%
7.5%
4.25%

Periodic Rate
4.0%
2.25%
0.625%
0.01164384%

Effective
Annual Rate
8.16%
9.31%
7.76%
4.34%

Periodic Rate = APR / (C/Y) = 0.08 / 2 = 0.04 = 4.0%

Periodic Rate = APR / (C/Y) = 0.09 / 4 = 0.0225= 2.25%
Periodic Rate = APR / (C/Y) = 0.075 / 12 = 0.00625= 0.625%
Periodic Rate = APR / (C/Y) = 0.0425 / 365 = 0.0001164384 = 0.01164384%
EAR = (1 + Periodic Rate)C/Y
EAR = (1 + Periodic Rate)C/Y
EAR = (1 + Periodic Rate)C/Y
EAR = (1 + Periodic Rate)C/Y

- 1 = 1.042 1 = 1.0816 1 = 0.0816 = 8.16%

- 1 = 1.02254 1 = 1.0931 1 = 0.0931= 9.31%
- 1 = 1.0062512 1 = 1.0776 1 = 0.0776 = 7.76%
- 1 = 1.0001164365 1 = 1.0434 1 = 0.0434 = 4.34%

3.

Periodic Rate = 0.0775 / 12 = 0.0064583333

EAR = (1 + Periodic Rate)C/Y - 1 = 1.0064583312 1 = 1.0803 1 = 0.0803 = 8.03%

5.

PV = 18,000
N=6x4
I = 7.5%/4
PMT = ?

Quarterly Payment = $938.26

Change n to 6 x12 & I to 7.5%/12

Monthly Payment = $311.22
Annual Cash Outflow Quarterly Payment = $938.26 x 4 = $3,753.04
Annual Cash Outflow Monthly Payment = $3,734.64
Difference of $18.04
It is lower for the monthly payment because each payment reduces some of the
principal and so over the 3 months between the quarterly payments the average
borrowed amount is lower so that the accumulated interest expense is lower.
9. n = 44 x 12
I = 6%/12
FV = 1,000,000
PMT = ?
Payment = $386.96
25. The decade of the 80s had the highest interest rates and the decade of the 50s had
the lowest rates.

Chapter 5
3. CD Percent Return = ($540 + $0 - $500) / $500 = 0.0800 or 8.00%
Stock Percent Return = ($34 + $2 - $23) / $23= 0.5652 or 56.52%
Bond Percent Return = ($980 + $80 - $1,040) / $1,040 = 0.0192 or 1.92%
Bike Percent Return = ($220 + $0 - $400) / $400 = -0.4500 or -45.00%

Investment
CD
Stock
Bond
Bike

17a.

Original Cost
Selling Price of Distributions
or Invested $
Investment
Received $
Percent Return
$500.00
$540.00
$0.00
8.00%
$23.00
$34.00
$2.00
56.62%
$1,040.00
$980.00
$80.00
1.92%
$400.00
$220.00
$0.00
-45.00%

Expected Return A = 0.35 x 0.04 + 0.50 x 0.04 + 0.15 x 0.04

= 0.0140 + 0.0200 + 0.0060 = 0.0040 or 4.0%
Expected Return B = 0.35 x 0.21 + 0.50 x 0.08 + 0.15 x (-0.01)
= 0.0735 + 0.0400 - 0.0015 = 0.1120 or 11.2%
Expected Return C = 0.35 x 0.30 + 0.50 x 0.20 + 0.15 x (-0.26)
= 0.1050 + 0.1000 - 0.0390 = 0.1660 or 16.6%

17b. Variance of A = 0.35 x (0.04 0.04)2 + 0.50 x (0.04 0.04)2 + 0.15 x (0.04 0.04)2
= 0.35 x 0.0000 + 0.50 x 0.0000 + 0.15 x 0.0000
= 0.0000+ 0.0000 + 0.0000 = 0.0000 or 0.00%
Variance of B = 0.35 x (0.21 0.112)2 + 0.50 x (0.08 0.112)2 + 0.15 x (-0.01 0.112)2
= 0.35 x 0.0096 + 0.50 x 0.0010 + 0.15 x 0.0149
= 0.0034+ 0.0005 + 0.0022 = 0.0061 or 0.61%
Variance of C = 0.35 x (0.30 0.166)2 + 0.50 x (0.20 0.166)2 + 0.15 x (-0.26 0.166)2
= 0.35 x 0.0180 + 0.50 x 0.0012 + 0.15 x 0.1815
= 0.0063 + 0.0006 + 0.0272 = 0.0341 or 3.41%
17c.

Standard Deviation of A = (0.0000)1/2 = 0.0000 or 0.00%

Standard Deviation of B = (0.0061)1/2 = 0.0781 or 7.81%
Standard Deviation of C = (0.0341)1/2 = 0.1846 or 18.46%

Chapter 6
Price = $1,000.00 x 1/(1.06)10 + $80.00 (1 1/(1.06)10)/ 0.06
Price = $1,000.00 x (PVIF6%,10) + $80.00 x (PVIFA6%,10)
Price = $1,147.20
Calculator Keystrokes: FV=1,000 PMT=80 I/Y=6 n=10 PV=?
1.

Price = $1,000.00 x 1/(1.08)10 + $60.00 (1 1/(1.08)10)/ 0.08

Price = $1,000.00 x (PVIF8%,10)+ $60.00 x (PVIFA8%,10)
Price = $865.80
Calculator Keystrokes: FV=1,000 PMT=60 I/Y=8 n=10 PV=?
Price = $5,000.00 x 1/(1.07)20 + $450.00 (1 1/(1.07)20)/ 0.07
Price = $5,000.00 x (PVIF7%,20)+ $450.00 x (PVIFA7%,20)
Price = $6,059.40
Calculator Keystrokes: FV=5,000 PMT=450 I/Y=7 n=20 PV=?
Price = $5,000.00 x 1/(1.05)30 + $600.00 (1 1/(1.05)30)/ 0.05
Price = $5,000.00 x (PVIF5%,30)+ $600.00 x (PVIFA5%,30)
Price = $10,380.36
Calculator Keystrokes: FV=5,000 PMT=600 I/Y=5 n=30 PV=?
2. Check figure for 1st bond:
Assuming P/Y = 1, C/Y =1, and periodic adjustments are made to I & n:
Calculator Keystrokes: FV=1,000 PMT=40 I/Y=3 n=20 PV=? $1,148.77
Or Assuming that P/Y = 2, C/Y = 2:
Calculator Keystrokes: FV=1,000 PMT=40 I/Y=6 n=20 PV=? $1,148.77
5.

(TVM Keys) Set Calculator to P/Y = 1 and C/Y = 1

INPUT
10
?
-1000.00
80.00
KEYS
N
I/Y
PV
PMT
CPT
8.0

1000.00
FV

(TVM Keys) Set Calculator to P/Y = 1 and C/Y = 1

INPUT
10
?
-850.00
60.00
KEYS
N
I/Y
PV
PMT
CPT
8.2619

1000.00
FV

(TVM Keys) Set Calculator to P/Y = 1 and C/Y = 1

INPUT
20
?
-5400.00
450.00
KEYS
N
I/Y
PV
PMT
CPT
8.1746

5000.00
FV

(TVM Keys) Set Calculator to P/Y = 1 and C/Y = 1

INPUT
30
? -4300.00
600.00
KEYS
N
I/Y
PV
PMT
CPT
13.9991

5000.00
FV

6. Check figure for 1st bond:

Set Calculator to P/Y = 1 and C/Y = 1
INPUT
20
?
-1000.00
40.00
1000.00
KEYS
N
I/Y
PV
PMT
FV
CPT
4.0 (then multiply by 2 for annual YTM = 8%)
OR

11a.

Set Calculator to P/Y = 2 and C/Y = 2

INPUT
20
?
-1000.00
KEYS
N
I/Y
PV
CPT
8.0

40.00
PMT

1000.00
FV

At five years to maturity

Price = $1,000.00 x 1/(1.05)10 + $40.00 (1 1/(1.05)10)/ 0.05
Price = $1,000.00 x (PVIF5%,10)+ $40.00 x (PVIFA5%,10)
(TVM Keys) Set Calculator to P/Y = 1 and C/Y = 1
INPUT
10 5.0
?
40.00
KEYS
N
I/Y
PV
PMT
CPT
-922.78

1000.00
FV

OR Set Calculator to P/Y = 2 and C/Y = 2

INPUT
10 10.0
?
40.00
KEYS
N
I/Y
PV
PMT
CPT
-922.78

1000.00
FV

At ten years to maturity

Price = $1,000.00 x (PVIF5%,20)+ $40.00 x (PVIFA5%,20)
(TVM Keys) Set Calculator to P/Y = 1 and C/Y = 1
INPUT
20 5.0
?
40.00
KEYS
N
I/Y
PV
PMT
CPT
-875.38

1000.00
FV

OR Set Calculator to P/Y = 2 and C/Y = 2

INPUT
20 10.0
?
KEYS
N
I/Y
PV
CPT
-875.38

1000.00
FV

40.00
PMT

At fifteen years to maturity

Price = $1,000.00 x (PVIF5%,30)+ $40.00 x (PVIFA5%,30)
(TVM Keys) Set Calculator to P/Y = 1 and C/Y = 1
INPUT
30 5.0
?
40.00
KEYS
N
I/Y
PV
PMT
CPT
-846.28

1000.00
FV

OR Set Calculator to P/Y = 2 and C/Y = 2

INPUT
30 10.0
?
KEYS
N
I/Y
PV
CPT
-846.28

1000.00
FV

40.00
PMT

At twenty years to maturity

Price = $1,000.00 x (PVIF5%,40)+ $40.00 x (PVIFA5%,40)

11b.

(TVM Keys) Set Calculator to P/Y = 1 and C/Y = 1

INPUT
40 5.0
?
40.00
KEYS
N
I/Y
PV
PMT
CPT
-828.41

1000.00
FV

OR Set Calculator to P/Y = 2 and C/Y = 2

INPUT
40 10.0
?
KEYS
N
I/Y
PV
CPT
-828.41

1000.00
FV

40.00
PMT

The longer the maturity of a bond selling at a discount, all else held
constant, the lower the price of the bond!

Chapter 7
1. Use the constant dividend infinite dividend stream model:
Price = Dividend / r
a. Price = $0.50 / 0.05 = $10.00
b. Price = $0.50 / 0.08 = $6.25
c. Price = $0.50 / 0.10 = $5.00
d. Price = $0.50 / 0.13 = $3.85
e. Price = $0.50 / 0.20 = $2.50
5. Use the constant growth dividend model with an infinite dividend stream:
Price = Last Dividend x (1 + g) / (r g)
a.
b.
c.
d.
e.

Price = $0.40 x (1.04) / (0.05 0.04) = $0.4160 / 0.01 = $41.60

Price = $0.40 x (1.04) / (0.08 0.04) = $0.4160 / 0.04 = $10.40
Price = $0.40 x (1.04) / (0.10 0.04) = $0.4160 / 0.06 = $6.93
Price = $0.40 x (1.04) / (0.13 0.04) = $0.4160 / 0.09 = $4.62
Price = $0.40 x (1.04) / (0.20 0.04) = $0.4160 / 0.16 = $2.60

11. Use the constant dividend model with infinite horizon

Price = Dividend / r
a.
b.
c.
d.

Brads Price = $100 x 0.06 / 0.10 = $60.00

Mikes Price = $100 x 0.06 / 0.12 = $50.00
Ricks Price = $100 x 0.06 / 0.15 = $40.00
Juliuss Price = $100 x 0.06 / 0.18 = $33.33

15. The Security Market Line equation is: E(r) = rf + (E(rm) - rf)
The intercept is rf ; The slope is E(rm) - rf ;The market risk premium is E(rm) - rf
a.
b.
c.
d.
e.
f.

The SML is E(r) = 3% + (12% - 3%) = 3% + 9%

The SML is E(r) = 5% + (18% - 5%) = 5% + 13%
The SML is E(r) = 4% + (8%)
The SML is E(r) = 2% + (6%)
The SML is E(r) = 3% + (9%)
The SML is E(r) = 4% + (7%)

17. e. SJN expected return: E(rSJN) = 3% + 0.4 (9%) = 3% + 3.6% = 6.6%

f.GFN expected return: E(rGFN) = 3% + 1.6 (9%) = 3% + 14.4% = 17.4%
g. JE expected return: E(rJE) = 3% + 1.0 (9%) = 3% + 9% = 12%
h. PE expected return: E(rPE) = 3% + 0.0 (9%) = 3% + 0.0% = 3%

19. First find the expected return for the stocks if the betas are correct. Compare with
the listed return. For stocks where the expected return is less than the listed return, the
stock is underpriced. For stocks where the expected return is greater than the listed
return, the stock is overpriced.
Company
TJB
MAB
PMF
CNF
SJN
GFN
JE
PE

Company
Beta
1.2
0.6
0.8
1.4
0.4
1.6
1.0
0.0

Listed
Return
15.10%
9.55%
9.60%
14.45%
5.70%
18.80%
11.00%
3.0%

Expected
Return
2.5% + 1.2 (9.25%) = 13.6%
2.5% + 0.6 (9.25%) = 8.05%
2.5% + 0.8 (9.25%) = 9.90%
2.5% + 1.4 (9.25%) = 15.45%
2.5% + 0.4 (9.25%) = 6.20%
2.5% + 1.6 (9.25%) = 17.30%
2.5% + 1.0 (9.25%) = 11.75%
2.5% + 0.0 (9.25%) = 2.50%

Underpriced or
Overpriced
Underpriced
Underpriced
Overpriced
Overpriced
Overpriced
Underpriced
Overpriced
Underpriced

Chapter 8
1.

Expected Return J = 0.30 x 0.05 + 0.40 x 0.05 + 0.20 x 0.05 + 0.10 x 0.05
= 0.0150 + 0.0200 + 0.0100 + 0.0050= 0.0050 or 5.0%
Expected Return K = 0.30 x 0.24 + 0.40 x 0.12 + 0.20 x 0.04 + 0.10 x (-0.10)
= 0.0720 + 0.0480 + 0.0080 - 0.0100 = 0.1180 or 11.80%
Expected Return L = 0.30 x 0.30 + 0.40 x 0.20 + 0.20 x 0.06 + 0.10 x (-0.20)
= 0.0900 + 0.0800 + 0.0120 + 0.0200 = 0.1620 or 16.20%

3.

Expected Return Portfolio = 0.10 x 0.05 + 0.50 x 0.118 + 0.40 x 0.162

= 0.0050 + 0.0590 + 0.0648 = 0.1288 or 12.88%

Chapter 9
1.

Project A:

Year One: -$10,000 + $4,000 = $6,000 left to recover

Year Two: -$6,000 + $4,000 = $2,000 left to recover
Year Three: -$2,000 + $4,000 = fully recovered
Year Three: $2,000 / $4,000 = year needed for recovery
Payback Period for Project A: 2 and years, ACCEPT!

Project B:

Year One: -$25,000 + $2,000 = $23,000 left to recover

Year Two: -$23,000 + $8,000 = $15,000 left to recover
Year Three: -$15,000 + $14,000 = $1,000 left to recover
Year Four: -$1,000 + $20,000 = fully recovered
Year Four: $1,000 / $20,000 = 1/20 year needed for recovery
Payback Period for Project B: 3 and 1/20 years, REJECT!

Project C:

Year One: -$45,000 + $10,000 = $35,000 left to recover

Year Two: -$35,000 + $15,000 = $20,000 left to recover
Year Three: -$20,000 + $20,000 = fully recovered
Year Three: $20,000 / $20,000 = full year needed
Payback Period for Project B: 3 years, ACCEPT!

Project D:

Year One: -$100,000 + $40,000 = $60,000 left to recover

Year Two: -$60,000 + $30,000 = $30,000 left to recover
Year Three: -$30,000 + $20,000 = $10,000 left to recover
Year Four: -$10,000 + $10,000 = fully recovered
Year Four: $10,000 / $10,000 = full year needed
Payback Period for Project B: 4 years, REJECT!

7.

a. NPV = $59,859.98 and accept the project.

b. NPV = $22,840.31 and accept the project.
c. NPV = -$7,939.82 and reject the project.

Cash Flows
Year one
Year two
Year three
Year four
Year five
Discount Rate
9. NPV =

Project M
$500,000
$500,000
$500,000
$500,000
$500,000
6%
$106,182

Project N
$600,000
$600,000
$600,000
$600,000
$600,000
9%
$333,791

Project O
$1,000,000
$800,000
$600,000
$400,000
$200,000
15%
$197,127

Project P
$300,000
$500,000
$700,000
$900,000
$1,100,000
22%
$-219,414

And the ranking order based on NPVs is,

Project N NPV of $333,790.77
Project O NPV of $197,126.53
Project M NPV of $164,738.34
Project P NPV of -$219,413.98
Swanson Industries should pick Project N.

11.

Enter the keys noted for each project in the CF of a Texas BA II Plus calculator:

Cash Flows
CFO
CO1, F1
CO2, F2
Year three
Year four
Year five
CPT IRR

Project M
-$2,000,000
$500,000, 1
$500,000, 1
$500,000, 1
$500,000, 1
$500,000, 1
7.93%

Project N
-$2,000,000
$600,000, 1
$600,000, 1
$600,000, 1
$600,000, 1
$600,000, 1
15.24%

Project O
-$2,000,000
$1,000,000, 1
$800,000, 1
$600,000, 1
$400,000, 1
$200,000, 1
20.27%

Project P
-$2,000,000
$300,000, 1
$500,000, 1
$700,000, 1
$900,000, 1
$1,100,000, 1
17.72%

15. Find the present value of benefits and divide by the present value of the costs for each
project:
Project Us PI = $2,106,182/ $2,000,000 = 1.05 accept project.
Project Vs PI = $2,333,790.77 / $ 2,500,000 = 0.9335 and reject project.
Project Ws PI = $2,197,126.53 / $2,400,000 = 0.9155 and reject project.
Project Xs PI = $1,780,586.02 / $1,750,000 = 1.0175 and accept project.

17.

Payback Period: -$10,400,000 + $2,600,000 + $2,600,000 + $2,600,000 +

$2,600,000 = $0 (Four years but year five is also an outflow so we need to
continue) -$1,200,000 + $7,500,000 + $7,500,000 = $300,000 so we only need
part of year seven, $4,500,000 / $7,500,000 = 0.6 so total Payback is 7.6 years
and project is rejected with six year cut-off.
NPV = -$2,161,656.25 and reject project under NPV rules.
IRR = (discount rate where NPV = 0)
In calculator solve for r,

CF0 = -10,400,000
C01 = 2,600,000 and F01 = 4
C02 = - 1,200,000 and F02 = 1
C03 = 750,000 and F03 = 3
CPT IRR = 3.1955%

and reject project as IRR is less than 12%

Profitability Index:
Present Value of Benefits = $8,919,256*
*Calculate the NPV, excluding all costs & cash outflows. (Remember to enter in
0 for CF0 and 0 for CF year 5.)
Present Value of Costs: $10,400,000 + $1,200,000/1.125 = $10,400,000 +
$680,912.23 = $11,080,912.23
Profitability Index = $8,919,255.73 / $11,080,912.23 = 0.8049 and reject.

HONORS ONLY:
19. Discount Rate
0%
5%
10%
15%
20%
IRR = 14.77%

NPV
$120,000
$71,290.51
$31,500.58
-$1,357.74
-$28,761.57

NPV Dollars
$120,000

NPV Profile
Of Project L-2

$90,000
$60,000
$30,000
$0
-$30,000

5%

10%
Discount Rates

15%

20%

Chapter 10
5.

Income Statement for the Year Ending 12/13/2004

Sales Revenue

$350,000

COGS

$140,000

Fixed Costs

$ 43,000

SG&A Expenses

$ 28,000

Depreciation

$ 46,000

EBIT

$ 93,000

Interest Expense

$ 18,000

Taxable Income

$ 75,000

Taxes @ 40%

$ 30,000

Net Income

$ 45,000

And with a Dividend payment of $30,000 the remainder of Net Income goes to Retained
Earnings, $15,000. To complete the balance sheet add up all the asset accounts and
subtract off the accumulated depreciation (contra asset account) for a total of $400,000.
Now balance the balance sheet by determining the total liabilities and owners equity
accounts ($353,000) and filling in the difference between this total and total assets as the
balance in Retained Earnings, $47,000.
Balance Sheet 12/31/2003
Assets:
Cash
Accounts Rec.
Inventories
Fixed Assets
Acc. Depreciation
Intangible Assets
Total Assets

$ 16,000
$ 28,000
$ 48,000
$368,000
$142,000
$ 82,000
$400,000

Liabilities:
Notes Payable
Accounts Payable
Long-Term Debt
Owners Equity
Retained Earnings
Common Stock
Total Liab. & OE

$ 14,000
$ 19,000
$190,000
$ 47,000
$130,000
$400,000

Do the same for the year 2004 but now we must first find accumulated depreciation total.
The prior year was $142,000 and the current years depreciation from the income
statement is $46,000 so the accumulated depreciation for 2004 is $188,000. Also,
Retained Earnings went up by Net Income minus dividends paid out so we have an
increase of $15,000 ($45,000 - $30,000).

Assets:
Cash
Accounts Rec.
Inventories
Fixed Assets
Acc. Depreciation
Intangible Assets
Total Assets

Balance Sheet 12/31/2004

Liabilities:
$ 26,000
Notes Payable
$ 19,000
Accounts Payable
$ 53,000
Long-Term Debt
$448,000
Owners Equity
$188,000
Retained Earnings
$ 82,000
Common Stock
$440,000
Total Liab. & O.E.

$ 12,000
$ 24,000
$162,000
$ 62,000
$180,000
$440,000

10. To create the Sources and Uses of Cash (Cash Flow Statement) we need to compute
the changes in the Balance Sheets from 2003 to 2004 (below). (For ease of calculating
the changes in the accounts, the balance sheet is shown below in the top/bottom format,
where assets are listed up top, and liabilities & OE are below. The balance sheet in the
problem is shown as a side by side format, assets on the left; liabs & OE on the right.)
2004

2003

2004-2003

ASSETS
Cash & Equivalents
Accounts Receivable
Inventories
TOTAL CURRENT ASSETS
Gross Fixed Assets
Less: Accumulated Depreciation
Net Fixed Assets
Intangible Assets
TOTAL ASSETS

26,000
19,000
53,000
98,000
448,000
188,000
260,000
82,000
$ 440,000
=======

16,000
28,000
48,000
92,000
368,000
142,000
226,000
82,000
$ 400,000
=======

$ 10,000
(9,000)
5,000
6,000
80,000
46,000

24,000
0
12,000
36,000
162,000
$ 198,000

0
14,000
33,000
190,000
$ 223,000

0
(2,000)
3,000
(28,000)
$ (25,000)

180,000
62,000
242,000
$ 440,000
=======

130,000
47,000
177,000
$ 400,000
=======

50,000
15,000
65,000
$ 40,000

0
$ 40,000

LIABILITIES
Accounts Payable
Accruals
Short-Term Notes Payable
TOTAL CURRENT LIABILITIES
Long-Term Debt
TOTAL LIABILITIES
OWNERS' EQUITY
Common Stock
Retained Earnings
TOTAL OWNERS' EQUITY
TOT LIABILITIES & OWNERS' EQUITY

19,000

5,000

This Sources and Uses of Cash ties out to the change in the cash balance for the year,
therefore we have a target of $10,000 increase in cash (or source) for 2004.
2004 Sources and Uses of Cash (Cash Flow Statement)
Sources and (Uses): Operating Activities
After Tax Net Income
Sources:
Depreciation
Decrease in Accounts Receivable
Increase in Accounts Payable
Uses:
Increase in Inventory
Net Cash Flow from Operating Activities

$ 45,000
46,000
9,000
5,000
- 5,000
$100,000

Sources and (Uses): Investing Activities

Increase in Gross Fixed Assets
Net Cash Flow from Investing Activities

- 80,000
$ - 80,000

Sources and (Uses): Financing Activities

Decrease in Notes Payable*
Decrease in Long Term Debt
Increase in Common Stock
Dividends Paid
Net Cash Flow from Financing Activities

-2,000
-28,000
50,000
-30,000
$ -10,000

Net Change in Cash Account

$ 10,000

*The change in Notes Payable (a current liability) is always included in the financing section.

11. Erosion Cost = ($90 - $35) x 8,000 = $440,000

Net Annual Cash Flow with one bike: ($90 - $35) x 40,000 = $2,200,000
Net Annual Cash Flow with two bikes:
($90 - $35) x (40,000 - 8,000) = $1,760,000
($410 - $360) x 12,000 = $600,000
Net Annual CF = $1,760,000 + $600,000 = $2,360,000
Increase of $160,000 per year so add new off-road bike to production.

15. Annual depreciation is cost of truck divided by five; $29,000/ 5 = $5,800

And for the first and last year we have $5,800 / 2 = $2,900.
a. Depreciation schedule using MACRS;
Year One Depreciation = $29,000 x 0.2000 = $5,800
Year Two Depreciation = $29,000 x 0.3200 = $9,280
Year Three Depreciation = $29,000 x 0.1920 = $5,568
Year Four Depreciation = $29,000 x 0.1152 = $3,340.80
Year Five Depreciation = $29,000 x 0.1152 = $3,340.80
Year Six Depreciation = $29,000 x 0.0576 = $1,670.40
b. Comparing the two depreciation schedules before and after taxes (at 30%):
Year
One
Two
Three
Four
Five
Six
Total

Straight Line
$2,900
$5,800
$5,800
$5,800
$5,800
$2,900
$29,000

MACRS
$5,800
$9,280
$5,568
$3,340.80
$3,340.80
$1,670.40
$29,000

Before Tax
$2,900
$3,480
-$232
-$2,459.20
-$2,459.20
-$1,229.60
$0

After Tax
$870
$1,044
-$69.60
-$737.76
-$737.76
-$368.88
$0

The difference is that the MACRS moves up the tax shield to the early years of
depreciation yet the total tax shield is the same under both depreciation schedules.
17.

The accumulated depreciation after three years using MACRS is:

$29,000 x (0.20 + 0.32 + 0.192) = $20,648.

The basis in the truck is therefore $29,000 - $20,648 = $8,352.
a. If the sales price is $15,000 then the truck had a gain on sale of $15,000
- $8,352 = $6,648 and the tax liability is $6,648 x 0.30 = $1,994.40. The
after tax cash flow is $15,000 - $1,994.40 = $13,005.60
b. If the sales price is $10,000 then the truck had a gain on sale of $10,000
- $8,352 = $1,648 and the tax liability is $1,648 x 0.30 = $494.40. The
after tax cash flow is $10,000 - $494.40 = $9,505.60
c. If the sales price is $5,000 then the truck had a loss on sale of $5,000 $8,352 = $3,352 and the tax credit is $3,352 x 0.30 = $1,005.60. The
after tax cash flow is $5,000 + $1,005.60 = $6,005.60

Chapter 11
1.

Total funds borrowed = $2,000 + $1,500 + $800 = $4,300

WACC = ($2,000 / $4,300) x 0.06 + ($1,500 / $4,300) x 0.08 + ($800 / $4,300) x 0.14
WACC = 0.4651 x 0.06 + 0.3488 x 0.08 + 0.1860 x 0.14
WACC = 0.0279 + 0.0279 + 0.0260 = 0.0819 or 8.19%

3.

A. If the bond sells for $920 we solve for YTM on the calculator:
Set P/Y = 1; C/Y =1
INPUTS
Variables
OUTPUT

40
N

?
-920 40
1000
I/Y
PV PMT FV
4.43% x 2 = 8.86%

OR Set P/Y = 2; C/Y =2

INPUTS
Variables
OUTPUT

40
N

?
-920
I/Y
PV
8.86%

40
PMT

1000
FV

B. If the bond sells for $1000 we have:

set P/Y = 1; C/Y =1
INPUTS
40
Variables
N
OUTPUT
OR set P/Y = 2; C/Y =2
INPUTS
40
Variables
N
OUTPUT

?
-1000 40 1000
I/Y
PV PMT FV
4.00% x 2 = 8%
?
-1000 40 1000
I/Y
PV
PMT FV
8.00%

C. If the bond sells for $1080 we have:

set P/Y = 1; C/Y =1
INPUTS
40
?
-1080 40 1000
Variables
N
I/Y
PV PMT FV
OUTPUT
3.62% x 2 = 7.24%

OR set P/Y = 2; C/Y =2

INPUTS
40
?
-1080 40 1000
Variables
N
I/Y
PV PMT FV
OUTPUT
7.24%
We note that as the price of the bond increases (proceeds from the sale) the lower the cost
of debt. This inverse relationship exists between price and the cost of debt as the future
cash flows of the bond are fixed at issue and thus buyers will to pay more for the fixed
stream of cash flows are lending money at a lower rate to the company.
5. A. If the bond sells for $920 and Kenny pays $25 per bond the net proceeds are $895
set P/Y = 1; C/Y =1
INPUTS
Variables
OUTPUT

40
N

?
-895 40
1000
I/Y
PV PMT FV
4.577% x 2 = 9.15%

OR set P/Y = 2; C/Y =2

INPUTS
Variables
OUTPUT

40
N

?
-895
I/Y
PV
9.15%

40
PMT

1000
FV

B. If the bond sells for $1000 and Kenny pays $25 per bond the net proceeds are $975
set P/Y = 1; C/Y =1
INPUTS
Variables
OUTPUT

40
N

?
-975
40 1000
I/Y
PV PMT FV
4.13% x 2 = 8.26%

OR set P/Y = 2; C/Y =2

INPUTS
Variables
OUTPUT

40
N

?
-975
I/Y
PV
8.26%

40 1000
PMT FV

C. If the bond sells for $1080 and Kenny pays $25 per bond the net proceeds are $1055

set P/Y = 2; C/Y =2

INPUTS
40
?
-1055 40 1000
Variables
N
I/Y
PV PMT FV
OUTPUT
7.47%
OR set P/Y = 2; C/Y =2
INPUTS
Variables
OUTPUT

40
N

?
-1055 40 1000
I/Y
PV PMT FV
7.47%

7. A. Using the security market line we have,

E(ri) = rf + i (E(rm) rf)
Cost of Equity = E(ri) = 0.04 + 0.75 (0.12 0.04)
Cost of Equity = 0.04 + 0.75 (0.08) = 0.04 + 0.06 = 0.10 or 10%
B. Using the security market line we have,
E(ri) = rf + i (E(rm) rf)
Cost of Equity = E(ri) = 0.04 + 0.90 (0.12 0.04)
Cost of Equity = 0.04 + 0.90 (0.08) = 0.04 + 0.072 = 0.112 or 11.2%

9. What is the cost of preferred stock for Kyle?

The dividend is $100 x 0.06 = $6.00
And with a price of $80 the cost of preferred stock is $6/$80 = 0.075 or 7.5%

11.

Market Enterprise Component Weights,

Market Value of Debt = $980 x 3,000 = $2,940,000
Market Value of Equity = $23.40 x 260,000 = $6,084,000
Debt Component = $2,940,000 / ($2,940,000 + $6,084,000) = 0.3258
Equity Component = $6,084,000 / ($2,940,000 + $6,084,000) = 0.6742

WACC for Market = 0.3258 x 8% + 0.6742 x 12% = 10.6968%

13.
a. Adjusted WACC = 0.35 x 14% + 0.15 x 11% + 0.50 x 10% x (1 0.40) =
Adjusted WACC = 4.9% + 1.65% + 3.0% = 9.55%
b. Adjusted WACC = 0.35 x 14% + 0.15 x 11% + 0.50 x 10% x (1 0.30) =
Adjusted WACC = 4.9% + 1.65% + 3.5% = 10.05%

19.
Category
Investment
NWC Change
OCFs
Salvage

T0
-$4,000,000
-$300,000

T1

T2

T3

$1,500,000

$1,500,000

$300,000
$1,500,000
$250,000

At 6% WACC we have,
NPV = $171,309
Accept project if WACC is 6% or lower.
At 8% WACC we have,
NPV = $2,253
Accept project if WACC is 8%.
At 10% WACC we have,
NPV = -$156,499
Reject project if WACC is 10% or higher.

Chapter 12
9.

WACC if she borrows $1,000,000 is

WACC = 0.4 x 8.5% + 0.6 x 9.25% = 3.40% + 5.55% = 8.95%
a. WACC if she borrows $2,000,000 is
WACC = 0.2 x 8.5% + 0.375 x 9.25% + 0.425 x 17%
WACC = 1.7000% + 3.4688% + 7.2250% = 12.3938%

b. She can not borrow $3,000,000 her maximum borrowing is $2,450,000.

WACC at $2,450,000 is,
WACC = 0.1633 x 8.5% + 0.3061 x 9.25% + 0.5306 x 17%
WACC = 1.3878% + 2.8316% + 9.0204% = 13.2398%

Chapter 13
1.

Business Cycle = Production Cycle + Collection Cycle

Business Cycle = 35 Days + 21 Days = 56 Days
Cash Conversion Cycle = Business Cycle Payment Cycle
Cash Conversion Cycle = 56 Days 14 Days = 42 Days

Reducing Production Cycle by one week (7 days) reduces cash conversion cycle
by one week (7 Days) to 35 days.
Reducing Collection Cycle by one week (7 days) reduces cash conversion cycle
by one week (7 Days) to 35 days.
Increasing Payment by one week (7 days) reduces cash conversion cycle by one
week (7 Days) to 35 days.
3. Average Production Cycle:
Average Inventory = (Beginning Inventory + Ending Inventory) / 2
Average Inventory for Corporate Seasonings = ($55,000 + $59,000) / 2 = $57,000
The second step is to determine how quickly we turn over the inventory. To do
this, we take the cost of goods sold for the year, COGS, and divide by the average
inventory:
Inventory Turnover = COGS / Average Inventory
Inventory Turnover for Corporate Seasonings = $570,000 / $57,000 = 10 times
Average Production Cycle = Days in Year / Inventory Turnover
Average Production Cycle = 365/10 = 36.5 Days
5.Average Collection Cycle:
Average Accounts Receivable = (Beginning A/R + Ending A/R) / 2
Average A/R for Corporate Seasonings = ($38,000 + $46,000) / 2 = $42,000
Step two is to determine the Accounts Receivable turnover rate:
Accounts Receivable Turnover Rate = Credit Sales / Average Accounts Receivable
A/R Turnover for Corporate Seasonings = $672,000 / $42,000 = 16 times
The third and final step is to estimate the collection cycle by dividing the number of
days in a year by the Accounts Receivable turnover rate:
Collection Cycle = 365 / Accounts Receivable Turnover Rate
Rians Collection Cycle = 365 / 16 = 22.8125 Days

7.Average Accounts Payable Cycle:

Average Accounts Payable = (Beginning of the year A/P + End of Year A/P) / 2
Average A/P = ($27,000 + $25,000) / 2 = $26,000
The second step is to determine the Accounts Payable Turnover and here we use the
COGS as the cost of production.
Accounts Payable Turnover = COGS / Average A/P
Rians A/P Turnover = $570,000 / $26,000 = 21.9231 times
The third and final step is to determine the number of days that Corporate Seasonings
takes to pay its suppliers:
Accounts Payable Cycle = 365 / Accounts Payable Turnover
Rians A/P Cycle = 365 / 21.9231 = 16.6491 days
19.
Find the incremental cash flows by year
CF0 = $3,500,000 plus $500,000 outflow or -$4,000,000
CF1 through CF4 = $1,000,000
CF5 = $1,000,000 plus $500,000 plus $250,000 or $1,750,000
NPV at 12%
NPV = $30,346
And the project is a go!