# FIN6406 Final Exam

1.   This exam is worth a total of 100 points.

2.   You should electronicallysubmityour final examwith detailedcalculationsvia email to zlin@fiu.edu.  You willtitlethe email “YOUR NAME – FINAL.  You will title the document YOUR NAME – FINAL.  You will putyour name on atitlepage.  Good luck!

Problem1 [10 points]

100

Stock

137

51

Bond (rF=2%)

102

100

102

Call(E=87)

50

C

0

1-yearcalloption,S=100,E=87, rF=2%(annual)

1 stepperyear

How much shouldthe calloption worth?

Iftotal returnafter taxona certain project is 7.5%,and thereare fivefinancingchoices available to investors:

(1)7%interest rateand a60%LTVratio; (2)7.8%interest rateand a70%LTVratio; (3)8.5%interestrateand a80%LTVratio; (4)9.25%interest rateand a90%LTV ratio; (5)9.75%interest rateand a95%LTV ratio;

Supposethat there arethreetypes of investors(A,Band C) whosetaxratesare15%, 25% and

35%, respectively. Questions:

(1)        Find outthe financingchoiceforeach typeof investor and the correspondingafter-tax return on equity.

(2)       Which typeof investor has the highest after-taxreturn on their equity?

You currentlyhave\$2,500,000. You want to invest it in the followingthreeassets: 10-year US Treasurybondwith coupon rate 3.5%,BlandyandGourmangestocks, whohavethe following historical annual returns:

 Year Blandy Gourmange 1 26.0% 47.0% 2 15.0% -54.0% 3 -14.0% 15.0% 4 -15.0% 7.0% 5 2.0% -28.0% 6 -10.0% 40.0% 7 22.0% 17.0% 8 30.0% -23.0% 9 -32.0% -4.0% 10 28.0% 75.0% 11 28.6% 51.7% 12 16.5% -59.4% 13 -15.4% 16.5% 14 -16.5% 7.7% 15 2.2% -30.8% 16 -11.0% 44.0% 17 62.2% 18.7% 18 33.0% -25.3% 19 -35.2% -4.4% 20 50.8% 82.5% 21 23.4% 42.3% 22 13.5% -48.6% 23 -12.6% 13.5% 24 -13.5% 6.3% 25 1.8% -25.2% 26 -9.0% 36.0% 27 18.8% 15.3% 28 27.0% -20.7% 29 -28.8% -3.6% 30 25.2% 67.5%

Yourgoal is tohavetheexpected annual return of7.2%with a minimum portfolio risk. How much moneyshouldyouallocate to thesethree assets?

Problem4 [30 points]

A real estate investor hasthe followinginformation on an apartment building:

PurchasePriceis \$1,125,000 with acquisition costsof \$35,000

33,600 leasable squarefeet

Initial rent of \$1.5/sq. ft. permonthand willincrease at thebeginningofeachyearfor

5 percent peryear.For example, the firstyear rent from month 1 to month12 is

\$1.5/sq. ft., the 2ndyear rent from month 1 to month 12is \$1.575 (\$1.5*(1+5%)), and so on.

Vacancyrateof 5%ofgross rent permonth.

Operatingexpenses are25%of effectivegross income

Threefinancingchoices:

1.   Mortgagewith75%LTV ratio, 20years, monthlypayments and 5%annual rate;

2.   Mortgagewith80%LTV ratio, 20years, monthlypayments and 6% annual rate;

3.   Mortgagewith85%LTV ratio, 20years, monthlypayments and 6.5% annual rate;

Holdingperiod is 3years(36 months) and the capital improvement expenditureis assumed to be \$20,000 atthe end of the firstyearonly(12 months).

Expected increasein valueis 50%in total when soldinyear 3 (36 months), 5%

sellingexpenses

75%depreciable with monthlydepreciation.

Investor’s taxrate is 35%, and capitalgain taxrateis 15%.

Questions:

1.   Compute equityafter-tax cash flows from month1 to month 36for each financingchoice.

2.   What is the equityafter-taxannualreturn (internal rate ofreturn)foreach financingchoice and which choicewouldyou liketo make?

Problem5 [15 points]

Based on theCapital Asset PricingModel (CAPM) and the diagram below,what is the return of the stock if its beta is 1.5 or 0.5?

10%

3 %

RF    3.5%

1

RM   12%

Problem6 [15 points]

ComputetheIRR, NPV,PI, and payback period for thefollowingtwo projects.  Assume the required return is 12%.

 ProjectA ProjectB Year Cashflow Cashflow 0 -2500 -2500 1 900 50 2 800 600 3 1600 150 4 100 900 5 50 500 6 300 2500

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