# FINANCE TASK 3

**Prof. Nidhi**

Problem 1

Answer the following questions. Be sure to show all your work- not just the answer. Follow this format: cite the formula, then plug in numbers, then compute to show your final answer.

1. What is the Rule of 72 ?

2. Solve using the Rule of 72: rate = 8%, years = 18, pv = $7,000. Solve for fv.

3. Solve, using the Rule of 72 rate = 4%, years = 18, fv=$8,000. Solve for pv.

4. Solve, using the Rule of 72: rate =6%, pv=$7,000, fv= $56,000. Solve for years.

5. Solve, using the Rule of 72: pv=$10,000; fv=$160,000; years=10. Solve for rate.

Q6-Q9. Use appropriate tvm table

Q6 pv= $7,200 rate = 7% periods = 15 Solve for fv

Q7 fv=$15,000 rate = 15% periods = 10 Solve for pv

Q8 payment = $6,000 interest rate =8% number of periods = 10 Solve for pva

Q9 payment = $4,000 interest rate =10% number of periods = 20 Find fva

For Q10-Q13, you many use tvm tables, a financial calculator, or excel to solve. Be sure to show all the steps in your work: factors & formula if you use the tables; keystrokes if you use a financial calculator; or formulas if you use excel.

Q10. Stressed and penniless after months of day trading, Mr. Baruch decides to invest his savings into a conservative growth mutual fund. He plans to retire in 30 years and wants to make annual deposits into his IRA in order to accumulate a sum of $450,000 at the end of the 30 years. Mr. Baruch expects to earn 10% per year, on average, in his mutual fund. What should be the amount of Baruch's annual contributions ?

Q11. On the way to Stop&Shop, you buy a lottery ticket and win $100,000. The catch is that the money will be paid to to you in two installments: $50,000 today, and $50,000 at the end of 5 years from now.

Q11-a: Assuming an interest rate of 8%, what is the present value of your total lottery payments ?

Q11-b: Suppose that you invest the $50,000 winnings that you receive today and earn 8% annually for the next 5 years. What is the future value of your total lottery payments ?

12. Investor G. Loeb owns a 5-year, $1000 bond with a 5% coupon. If the yield to maturity on similar bonds is currently 10%, what is Mr. Loeb's bond worth today ?

13. A security analyst is forecasting dividends for Boston Electric over the next four years, as follows: $1 (Y1), $1.50 (Y2); $2.00 (Y3); $2.75 (Y4). In addition, the analyst expects that the stock could be sold for $62.25 four years from now. If the required return on the stock is 8%, what is the stock worth today ?

Problem 2

Bender Guitar Corporation, a manufacturer of custom electric guitars, is contemplating a $1,000,000 investment in a new production facility. The economic life of the facility is estimated to be five years, after which the facility will be obsolete and have no salvage value.

To make the new facility operational, building improvements costing $400,000 will be required. In addition, a $50,000 increase in working capital will be needed.

Bender's accounting and marketing departments have provided the following information: the firm will use the straight-line method of depreciation; the Company is in the 30% tax bracket; the weighted average cost of capital is 8%.

Here are Earnings before Interest and Taxes (EBIT) estimates for the new facility:

Year 1.........$80,000

Year 2.......$100,000

Year 3.......$120,000

Year 4........$140,000

Year 5.......$165,000

Your assignment is to answer the following questions:

1. Diagram the cash flows for the project using a time line. For each of Years 1 through 5, include the following data on your diagram (in this order) : EBIT, tax, depreciation, Operating Cash Flow (OCF), and discounted OCF.

2. Indicate the initial investment cost, the present value, the Net Present Value (NPV), and the payback (measured in years based on non-discounted OCF numbers).

3. Evaluate the project's efficacy. Is this facility worthwhile, based upon your calculations ? Why or why not ? What does the NPV decision rule indicate for this project ? If you were Bender's financial manager, what other factors would you consider before deciding whether or not to recommend construction of the production facility ?

Problem 3

Touring Enterprises, Inc., has a capital structure consisting of $18 million in long-term debt and $7 million in common equity. There is no preferred stock outstanding. The interest rate paid on the long-term debt is 10%. The firm is in the 35% tax bracket. On the common equity (stock), the Company pays an annual dividend of $1.20 and expects to increase the dividend by 5% per year. The market price of the stock is $50. Based on this information, answer the following questions:

1. Calculate Touring Enterprises' weighted average cost of capital (WACC). Work as follows: first, compute the after-tax cost of debt, then compute the cost of equity. Cite both formulas, and show all your work. Then, determine the weightings of debt and equity in the capital structure.

Lastly, using your answers to the above questions, calculate the WACC.

2. If Touring Enterprises were to increase the percentage of debt in its capital structure, what would happen to the WACC ? No calculation is necessary- simply provide a short, non-numeric response.

3. Identify and explain the benefits and risks of debt financing. A two-paragraph answer will suffice.

- 8 years ago

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