exam 2

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Monroe College *

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FA30544

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Economics

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Apr 3, 2024

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Week 7 - Chapter 7 o Submitted 92.84/100 Total points awarded Help E> 1 The level of the Syldavian market index is 21,600 at the start of the year and 26,100 at the end. The dividend yield on the index is 4.3%. a. What is the return on the index over the year? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) 20/20 [Return [ 2513@[% | points awarded eBook b. If the interest rate is 5%, what is the risk premium over the year? (Do not round intermediate calculations. Enter your answer as a e percent rounded to 2 decimal places.) References Risk Premium 2013@[% | c. If the inflation rate is 7%, what is the rea/return on the index over the year? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Real Return 1695@[% | The Costaguanan stock market provided a rate of return of 97%. The inflation rate in Costaguana during the year was 84%. In Ruritania the stock market return was 13%, but the inflation rate was only 2%. a. Calculate the real rate of return for Costaguanan stock market? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) 13.33/20 points awarded Real rate of return for Costaguanan stock 7.07 o % market i Scored eBook Print References b. Calculate the real rate of return for Ruritania stock market? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Real rate of return for Ruritania stock market 1078 @ |% Suppose that the standard deviation of returns from a typical share is about 0.45 (or 45%) a year. The correlation between the returns of each pair of shares is about 0.2. a. Calculate the variance and standard deviation of the returns on a portfolio that has equal investments in 2 shares, 3 shares, and so on, up to 10 shares. (Use decimal values, not percents, in your calculations. Do not round intermediate calculations. Round the 19,5120 "Variance" answers to 6 decimal places. Round the "Standard Deviation" answers to 3 decimal places.) points awarded No. of i Standard Scored Shares Deviation(%) 1 0.202500 @ 0.450 @ 2 0.121500 @ 0.349 @ k et 3 0.094500 @ 0307 @ Print 4 0.081000 & 0.285 @ References 5 0.072900 & 0270 @ 6 0.067500 @ 0.260 @ 7 0.063643 @ 0.252 @ 8 0.060750 @ 0.246 @ 9 0.058500 @ 0.242 @ 10 0.056700 @ 0.238 @

3 19.51/20 points awarded Scored eBook Print References 4 20/20 points awarded eBook Print References 5 20/20 points awarded c. Now assume that the correlation between each pair of stocks is zero. Calculate the variance and standard deviation of the returns on a portfolio that has equal investments in 2 shares, 3 shares, and so on, up to 10 shares. (Use decimal values, not percents, in your calculations. Do not round intermediate calculations. Round the "Variance" answers to 6 decimal places. Round the "Standard Deviation" answers to 3 decimal places.) oo Variance St_an_dard Shares Deviation(%) 1 0.202500 @ 0450 @ 2 0101250 @ 0318 @ 3 0.067500 @ 0260 @ 4 0.050625 @ 0225 @ 5 0.040500 @ 0201 @ 6 0033750 @ 0184 @ 7 0.028929@ | 0170 @] 8 0025313 @ 0.159 @ 9 0.022500 @ 0.150 @ 10 10.020250 @ 0142@ Hyacinth Macaw invests 68% of her funds in stock | and the balance in stock J. The standard deviation of returns on | is 13%, and on J it is 20%. (Use decimals, not percents, in your calculations.) a. Calculate the variance of portfolio returns, assuming the correlation between the returns is 1. (Do not round intermediate calculations. Round your answer to 4 decimal places.) ‘Portfolio variance 0.0232@ ‘ b. Calculate the variance of portfolio returns, assuming the correlation is 0.5. (Do not round intermediate calculations. Round your answer to 4 decimal places.) Portfolio variance ‘ 0.0176 @ c. Calculate the variance of portfolio returns, assuming the correlation is 0. (Do not round intermediate calculations. Round your answer to 4 decimal places.) ‘ Portfolio variance ‘ 0.0119@ ‘ In which of the following situations would you get the largest reduction in risk by spreading your investment across two stocks? The two shares are perfectly correlated. There is no correlation. There is modest negative correlation. There is perfect negative correlation. @

Week 8 - Chapter 8 o Submitted 100/100 Total points awarded ~ Help Exit Explanation Ebenezer Scrooge has invested 55% of his money in share A and the remainder in share B. He assesses their prospects as follows: 20/20 n g int ded points awarde Expected return (%) 15 24 Standard deviation (%) 19 27 Scored Correlation between returns 0.6 eBook a. What are the expected return and standard deviation of returns on his portfolio? (Do not round intermediate calculations. Enter - your answers as a percent rounded to 2 decimal places.) rin References Expected retumn 19.05 @ |% Standard deviation 2023 @ (% b. How would your answer change if the correlation coefficient were O or —0.607? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.) Correlation Correlation Coefficient 0 Coefficient —0.60 Standard priapiiviiin 16.03 @ |% 1023 @ |% c. Is Mr. Scrooge’s portfolio better or worse than one invested entirely in share A, or is it not possible to say? Better @ Worse Not possible to say Explanation a. rp = (8.55 x ©.15) + (8.45 x ©.24) = 0.1905, or 19.05% op = [(0.552 x 0.192) + (8.45% x ©.27%) + 2(8.55)(0.45)(0.6)(0.19)(0.27)]°-> op = ©.2023, or 20.23% b P12 = @: op = [(0.552 x 0.192) + (8.45% x 8.27%) + 2(8.55)(0.45)(0)(6.19)(0.27)]%-5 Op = ©.1603, or 16.03% p12 = -0.60: op = [(8.552 x ©.192) + (0.452 x 0.27%) + 2(0.55)(0.45)(-0.6)(0.19)(0.27)]%-> op = ©.1022, or 10.22% [ N Mr. Scrooge’s portfolio is superior to Portfolio A because it has a higher expected return (19.05 percent versus 15 percent) with the same level of risk (0 =16.03 percent) given a correlation coefficient of zero.

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[ Snow correct answ 2 20/20 b. What is the risk premium on the market? (Enter your answer as a percent rounded to 1 decimal place.) points awarded €. What is the required return on an investment with a beta of 1.4? (Enter your answer as a percent rounded to 2 decimal places.) d. If an investment with a beta of 0.78 offers an expected return of 9.4%, does it have a positive NPV? @ e. If the market expects a return of 10.4% from stock X, what is its beta? (Round your answer to 2 decimal places.) The Treasury bill rate is 3.9%, and the expected return on the market portfolio is 11.8%. Use the capital asset pricing model. eBook b. |Risk premium 79@ | % Print c. Required return 14.96 @ |% References d. Does it have a positive NPV? No (] e. |Beta 082@ LApIGlIaUVI a. Market risk premium = rp - rf Market risk premium = 0.118 — 0.039 Market risk premium = 0.079, or 7.9% b. r =rf+ B(rym - rf) r=0.039 +1.4(0.118 — 0.039) r= 01496, or 14.96% [ For any investment, we can find the opportunity cost of capital using the security market line. With = 0.78, the opportunity cost of capital is: r=rg+ B(rm - rf) r=0.039 + 0.78(0.118 — 0.039) r=0.1006, or 10.06% No; The opportunity cost of capital is 10.06 percent and the investment is expected to earn only 9.4 percent. Therefore, the investment has a negative NPV. d. r =rg+ B(ryp - rf) 0104 = 0.039 + 3(0.118 — 0.039) p=0.82 3 20/20 B boints awarded B eBook The figure below purports to show the range of attainable combinations of expected return and standard deviation. Fl L Print c References L (@ (b) a. Which diagram is incorrectly drawn? Figure (a) Figure (b) @

=. VWhich diagr=Sarnm Figure (=) Figure (b)) €& Bl I figure (=) wwhicach i Limne AB & Lime B Explanation imncorrecctiy drassv~swrmn o i=s the efficient set of portfolio=s—=— Figure (b) is incorrectly drawn. Diversification reduces risk (e.g., a mixture of portfolios A and B would have less risk than the average of A and B). b. The efficient portfolios are located along line AB in figure (a). Here are returns and standard deviations for four investments. 20/20 points awarded Standard Return Deviation Scored (%) (%) Treasury bills 3.5 2} Stock P 11.5 18 Stock Q 13.5 35 eBook stock R 23.5 28 Print References Calculate the standard deviations of the following portfolios. a. 50% in Treasury bills, 50% in stock P. (Enter your answer as a percent rounded to 2 decimal places.) Standard deviation 900@[% | b. 50% each in Q and R, assuming the shares have: (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.) Standard Deviation Perfect positive correlation 31.50 @ | % Perfect negative correlation 350 @ % No correlation 2241 @

Explanation a. o =(0.5 x 0) + (0.5 x 0.18) = 0.0900, or 9.00% b. With perfect positive correlation: o = [(©.52 x ©.352) + (©.52 x ©.282) + 2(©.5 x ©.5 x 1 x ©.35 x ©.28)]19-5 = ©.3150, or 31.50% With perfect negative correlation: o = [(©.52 x ©.352) + (©.52 x ©.282) + 2(©.5 x ©.5 x (-1) x ©.35 x ©.28)]2-5 = 90.e350, or 3.50% With no correlation: c = [(8.52 x ©.352) + (©.52 x ©.282) + 2(©.5 x ©.5 x @ x ©.35 x 0.28)]19-5 = ©.2241, or 22.41% 5 a. The APT factors cannot reflect diversifiable risks. True @ R False points awarded b. The market rate of return cannot be an APT factor. eBook TS Print False @ References c. There is no theory that specifically identifies the APT factors. True @ False d. The APT model could be true but not very useful, for example, if the relevant factors change unpredictably. True @ False Explanation a. True. By definition, the factors represent macro-economic risks that cannot be eliminated by diversification. b. False. The APT does not specify the factors. c. True. Different researchers have proposed and empirically investigated different factors, but there is no widely accepted theory as to what these factors should be. d. True. To be useful, we must be able to estimate the relevant parameters. If this is impossible, for whatever reason, the model itself will be of theoretical interest only.

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Week 9 - Chapter 9/10 o Submitted 85.83/100 Total points awarded Help You are given the following information for Golden Fleece Financial: Long-term debt outstanding: $440,000 Current yield to maturity (rgebt): 6% Number of shares of common stock: 17,000 10110 Price per share: $ 50.40 points awarded Book value per share: $ 28 Expected rate of return on stock (requity): 13% Calculate Golden Fleece's company cost of capital. Ignore taxes. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) eBook P n Cost of capital 1062@[% | A company is 46% financed by risk-free debt. The interest rate is 11%, the expected market risk premium is 9%, and the beta of the company’s common stock is 0.56. What is the after-tax WACC, assuming that the company pays tax at a 40% rate? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) 0/10 oints awarded | After-tax WACC 1.70 @ ‘% ‘ EZCUBE Corp. is 59% financed with long-term bonds and 41% with common equity. The debt securities have a beta of 0.24. The company’s equity beta is 1.16. What is EZCUBE’s asset beta? (Do not round intermediate calculations. Round your answer to 2 decimal places.) [ Asset p | 062@] 10/10 points awarded You run a perpetual encabulator machine, which generates revenues averaging $26 million per year. Raw material costs are 50% of revenues. These costs are variable—they are always proportional to revenues. There are no other operating costs. The cost of capital is 11%. Your firm’s long-term borrowing rate is 8%. Now you are approached by Studebaker Capital Corp., which proposes a fixed-price contract to supply raw materials at $13.00 million 3/10 per year for 11 years. t ded : . A . . nis awarde a. What happens to the operating leverage and business risk of the encabulator machine if you agree to this fixed-price contract? Scored Operating leverage and business risk increases @ eBook Operating leverage and business risk decreases 5 Indicate whether the following statements are true or false. a. The company cost of capital is the correct discount rate for all projects because the high risks of some projects are offset by the low risk of other projects. /10 True dints awarded eBook False @ b. Distant cash flows are riskier than near-term cash flows. Therefore long-term projects require higher risk-adjusted discount rates. Print True False @ References c. Adding fudge factors to discount rates undervalues long-lived projects compared with quick-payoff projects. True @ False

7 Which of these projects is likely to have the higher asset beta, other things equal? a. The sales force for project A is paid a fixed annual salary. Project B’s sales force is paid by commissions only. Project A @ /10 oints awarded Project B b. Project C is a first-class-only airline. Project D is a well-established line of breakfast cereals. Book Project C @ Project D Print 8 Indicate whether the following statements are true or false. a. Sensitivity analysis is unnecessary for projects with asset betas that are equal to zero. True 10/10 points awarded False @ eBook Print True @ False b. Sensitivity analysis can be used to identify the variables most crucial to a project's success. References c. If only one variable is uncertain, sensitivity analysis gives "optimistic" and "pessimistic”" values for project cash flow and NPV. True @ False d. The break-even sales level of a project is higher when break-even is defined in terms of NPV rather than accounting income. True @ False e. Risk is reduced when most of the costs are fixed. True False @ f. Monte Carlo simulation can be used to help forecast cash flows. True &@ False of $235,000 will be made one year hence after the shipment arrives by snow train. Unfortunately, there is a good chance of a coup d'état in which case the new government will not pay. Mom and Pop's controller therefore decides to discount the payment at 30%, rather than at the company's 11% cost of capital. 9 Mom and Pop Groceries has just dispatched a year's supply of groceries to the government of the Central Antarctic Republic. Payment 010 a. Is it proper to use 40% as the discount rate in this situation? boints awarded & i Yes eBook b. How much is the $235,000 payment really worth if the odds of a coup d'état are 15%7 (Do not round intermediate calculations. Round your answer to 2 decimal places.) Print References Payment value Js 179,954.95 @ |

variable costs are $200 per unit. The initial investment of $10,000 will be depreciated straight-line over its useful life of five years to a 1 O Modern Artifacts can produce keepsakes that will be sold for $220 each. Nondepreciation fixed costs are $3,800 per year, and final value of zero, and the discount rate is 10%. a. What is the accounting break-even level of sales if the firm pays no taxes? b. What is the NPV break-even level of sales if the firm pays no taxes? (Do not round intermediate calculations. Round your final answer to the nearest whole number.) c. What is the accounting break-even level of sales if the firm’s tax rate is 20%? Scored d. What is the NPV break-even level of sales if the firm’s tax rate is 20%7? (Do not round intermediate calculations. Round your final answer to the nearest whole number.) 0/10 oints awarded eBook a. Accounting break-even level of sales 290 @ |units print b. |NPV break-even level of sales 322 @ |units References c. Accounting break-even level of sales 290 @ |units d. NPV break-even level of sales 330 @ |units Week 10 - Chapter 12 €9 Submitted Select the missing words: 50/50 A project’s economic income for a given year equals the project’'s points awarded cash flow (] lless its Ieoonomic (] |depreciation. New projects may take several years to reach full profitability. In these cases, @ book income is less @ |than economic income early in the project’s life and greater @ |than economic income later in its life. 2 50/50 a. U.S. CEOs are paid much more than CEOs in other countries. points awarded e False Indicate whether the following statements are true or false. eBook - b. A large fraction of compensation for U.S. CEOs comes from grants of restricted shares or performance shares. References True @ False c. Stock-option grants give the manager a certain number of shares delivered at annual intervals, usually over five years. True False @ d. U.S. accounting rules now require recognition of the value of stock-option grants as a compensation expense. True @ False Explanation a., b., and d. are True. c. False. Stock options give managers the right (but not the obligation) to buy their company’s shares in the future at a fixed price.

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