NAME: Bui Thanh Huyen

ID: 1385876
FIN 3332
ASSIGNMENT 1
DUE DATE: FRIDAY 10/4/2014 23.59p.m
NET INCOME AND CASH FLOW Last year Rattner Robotics had $6 million in
operating income (EBIT). The company had net depreciation expense of $1
million and an interest expense of $1 million; its corporate tax rate was 40
percent At year-end, it had $15 million in current assets, $3 million in
accounts payable, $1 million in accruals, and $15 million in net plant and
equipment. Assume that Rattners only noncash item was depreciation.
a. What was the companys net income?
1.

EBIT
Interest
EBT
Taxes (40%)
Net Income

$6,000,00
0
1,000,00
0
$5,000,00
0
2,000,00
0
$3,000,00
0

b. What was its net working capital (NWC)?

Notes: FCF=EBIT(1-tax rate)+Depreciation-(capital expenditure+change in
net working capital)
capital expenditure = net plant and equipment at year end - net plant and
equipment at beginning of the year + depreciation during the year
NWC

= Current Asset (Payables + Accruals)

= $15,000,000 ($3,000,000 + $1,000,000)
= $11,000,000

c. Rattner had $13 million in net plant and equipment the prior year. Its net
working capital has remained constant over time. What is the companys
free cash flow (FCF) for the year that just ended?
FCF

Capital + Increase net

( expenditures
working capital )

( EBIT ( 1T ) + Depreciation )

= ($6,000,000 x (0.6) + $1,000,000) ($2,000,000 + 0)

= $4,600,000 - $2,000,000
1

= $2,600,000
d. If the firm had $4.5 million in retained earnings at the beginning of the
year and paid out total dividends of $1.2 million, what was its retained
earnings at the end of the year? Assume that all dividends declared were
actually paid.
Balance of retained earningsBOY
Add: Net income
Less:: Common dividends
Balance of retained earningsBOY

$4,500,00
0
3,000,00
0
1,200,00
0
$6,300,00
0

2. RATIO ANALYSIS The following data apply to A.L. Kaiser & Company
(millions of
dollars):
$100.00
283.50
1,000.00
60.00
115.00
3.00

Cash and equivalents

Fixed assets
Sales
Net income
Current liabilities
Current ratio
DSOa
days

41.7
12.00%

ROE

aThis calculation is based on a 365-day year.

Kaiser has no preferred stockonly common equity, current liabilities, and
long-term debt.
Find Kaisers (1) accounts receivable, (2) current assets, (3) total assets, (4)
ROA,
(5) common equity, (6) quick ratio, and (7) long-term debt.
(1)

DSO =

Accounts receivable
Sales /365

41.7 =

A /R
Sales/365

A/R
(2)

= 41.7 ($1,000/365) = 41.7 ($2.7397) = $114.25 million

Current ratio

Current assets
Current liabilities
2

= 3.0

Current assets
$ 115

= 3.0

Current assets = 3.0 ($115) = $345 million

(3)

Total assets
= Current assets + Fixed assets
= $345 + $283.5 = $628.50 million

(4)

ROA = Profit margin x Total assets turnover

=
=

Net income
Sales
x
Sales
Total assets
$ 60
$ 1,000
x
$ 1 , 000
$ 628.5

= 0.06 x 1.591 = 0.0955 = 9.55%

(5)

Assets
Equity

ROE = ROA x

12% = 9.55% x

Equity

$ 628.5
Equity

(9.55 )($ 628.5)

12

= $500.18 million
(6)
Current assets = Cash and equivalents + Accounts receivable
+ Inventories
$345 = $100 + $114.25 + Inventories
Inventories

= $130.75 million

Quick ratio

=
(7)

Current assetsInventories
Current liabilities

$ 345$ 130.75
$ 115

= 1.86

Total assets
= Total claims = $628.5 million
Current liabilities + Long-term debt + Equity = $628.5 million
$115 + Long-term debt + $500.18
= $628.5 million
Long-term debt = $628.5 - $115 - $500.18 = $13.32 million

3. FUTURE VALUE It is now January 1, 2009. Today you will deposit $1,000
into a savings
account that pays 10%.
a. If the bank compounds interest annually, how much will you have in your
account on
January 1, 2012?
$1,000 is being compounded for 3 years; so your balance on January 1,
2012, is $1,331:
FVN = PV (1 + I)N = $1,000 (1 + 0.1)3 = $1,331
b. What will your January 1, 2012, balance be if the bank uses quarterly
compounding?
FVN

= PV

1+

I NOM
M

NM

= FV12 = $1,000 (1.025)12 = $1,344.89

c. Suppose you deposit $1,000 in three payments of $333.333 each on

January 1 of 2010,
2011, and 2012. How much will you have in your account on January 1,
2012, based on
10% annual compounding?
FVAN = PMT

( 1+ I )N 1
I

= $333.333

( 1+0.1 )31
0.1

= $1,103.33

d. How much will be in your account if the three payments begin on January
1, 2009?
FVAdue

= FVAordinary (1 + I) = $1,103.33 (1.1) = $1,213.66

4. TIME VALUE OF MONEY It is now January 1, 2009; and you will need
$1,000 on January 1,
2013, in 4 years. Your bank compounds interest at an 12% annual rate.
a. How much must you deposit today to have a balance of $1,000 on
January 1, 2013?
PV =

FV N
(1+ I )

$ 1 , 000
4
(1.12)

= $635.52

b. If you want to make four equal payments on each January 1 from 2010
through 2013 to
accumulate the $1,000, how large must each payment be? (Note that the
payments
begin a year from today.)
N = 4, I/YR = 12, PV = 0, FV = 1000, and PMT =?
PMT =
4

c. If you have only $700 on January 1, 2010, what interest rate, compounded
annually for
3 years, must you earn to have $1,000 on January 1, 2013?
N = 3, PV = -700, PMT = 0, FV = 1000, and I/YR =?
I/YR =
5. EFFECTIVE ANNUAL RATES Bank A offers loans at an 12% nominal rate (its
APR) but
requires that interest be paid quarterly; that is, it uses quarterly
compounding. Bank B
wants to charge the same effective rate on its loans but it wants to collect
interest on a
monthly basis, that is, use monthly compounding. What nominal rate must
Bank B set?
Bank As effective annual rate is:
Effective annual rate

1+

0.12
4

- 1.0

= (1.03)4 1.0
= 0.1255 = 12.55%
Now Bank B must have the same effective annual rate:
12
I
- 1.0 = 0.1255
1+ NOM
12

(
(

1+

1+

I NOM
12

I NOM
12

I NOM
12

12

= 1.1255

= (1.1255)1/12 = 1.0099

= 0.0099

INOM = 0.1188 = 11.88%

6. INFLATION AND INTEREST RATES The real risk-free rate of interest, r*, is
2.5%; and it is
expected to remain constant over time. Inflation is expected to be 1.5% per
year for the
next 3 years and 4% per year for the next 5 years. The maturity risk
premium is equal to
5

0.1 (t 1)%, where t = the bonds maturity. The default risk premium for a
BBB-rated
bond is 1.3%.
a. What is the average expected inflation rate over the next 4 years?
Average inflation over 4 years = (1.5% + 1.5% + 1.5% + 4%)/4 =
2.125%
b. What is the yield on a 4-year Treasury bond?
T4

=
=
=
=

rRF + MRP4
r* + IP4 + MRP4
2.5% + 2.125% + (0.1)3%
4.925%

c. What is the yield on a 4-year BBB-rated corporate bond with a liquidity

premium
of 0.5%?
C4,BBB = r* + IP4 + MRP4 + DRP + LP
= 2.5% + 2.125% + 0.3% + 1.3% + 0.5%
= 6.725%
c. What is the yield on an 8-year Treasury bond?
T8

= r* + IP8 + MRP8
= 2.5% + (3 x 1.5% + 5 x 4%)/8 + 0.7%
= 6.2625%

e. If the yield on a 9-year Treasury bond is 7.3%, what does that imply about
expected
inflation in 9 years?
T9
= r* + IP9 + MRP9
7.3% = 2.5% + IP9 + 0.8%
IP9
= 4%
4%
X

= (3 x 1.5% + 5 x 4% + X)/9
= 11.5%

7. PURE EXPECTATIONS THEORY The yield on 1-year Treasury securities is

6.1%, 2-year
securities yield 6.2%, and 3-year securities yield 6.3%. There is no maturity
risk premium.
Using expectations theory, forecast the yields on the following securities:
a. A 1-year security, 1 year from now
6

T1 = 6.1%; T2 = 6.2%; T3 = 6.3%; MRP = 0

Yield of 1-year security 1 year from now is:
(1.062)2
= (1.061)(1 + X)
(1.062)2
X
=
1
1.061
X

= 0.063 = 6.3%

b. A 1-year security, 2 years from now

Yield of 1-year security 2 years from now is:
(1.063)3
= (1.062)2(1 + X)
3
(1. 063)
X
=
1
(1.062)2
X

= 0.065 = 6.5%

8. BOND VALUATION The Pennington Corporation issued a new series of

bonds on January 1, 1985. The bonds were sold at par ($1,000); had a 12%
coupon; and mature in 30 years, on December 31, 2014. Coupon payments
are made semiannually (on June 30 and December 31).
a. What was the YTM on January 1, 1985?
Penningtons bonds were sold at par; therefore, the original YTM equaled
the coupon rate of 12%.
b. What was the price of the bonds on January 1, 1990, 5 years later,
assuming that interest rates had fallen to 8%?
50

$ 120/2
$ 1 , 000
+
t
0.08
0.08 50
t =1
1+
1+
2
2
N = 50; I/YR = 4; PMT = 60; FV = 1,000; and PV =?8931.32
VB

) (

9.
REALIZED RATES OF RETURN
historical returns:

Stocks A and

B have

Year

Stock As Returns, rA

Stock Bs Returns, rB

2004
2005
2006
2007
2008

(20.25%)
18.50
38.67
14.33
30.00

3.00%
26.73
48.25
(4.50)
35.00

the following

a. Calculate the average rate of return for each stock during the period
2004 through 2008. Assume that someone held a portfolio consisting of
50% of Stock A and 50% of Stock B. What would the realized rate of
return on the portfolio have been in each year from 2004 through 2008?
7

What would the average return on the portfolio

that period?

have

been during

The average return for Stock A is:

rAvg A = (-20.25% + 18.50% + 38.67% + 14.33% + 30%)/5
= 16.25%
The average return for Stock B is:
rAvg B = (3% + 26.73% + 48.25% + -4.5% + 35%)/5
= 21.7%
The realized rate of return on a portfolio made up of Stock A and
Stock B is:
Year
Portfolio ABs Return,
rAB
2004
2005
2006
2007
2008

(8.63%)
22.62
43.46
4.92
32.5
rAvg = 18.97%

b. Calculate the standard deviation of returns for each stock and for
the portfolio. Use Equation 8-2a.
Estimate

(rt r Avg)2
t =1

N1
For Stock A, the estimated

is:

(20.25 16.25 ) + ( 18.5 16.25 ) + ( 38.67 16.25 ) + ( 14.33 16.25 ) + ( 30 16.25 )

A=
51
= 22.54%
For Stock B, the estimated

is:

(3 21.7 ) + ( 26.73 21.7 ) + ( 48.25 21.7 ) + (4.5 21.7 ) + ( 35 21.7 )

B=
51
= 22.04%
For Portfolio AB, the estimated is:

(8.63 18.97 ) + ( 2 2.62 18.97 ) + ( 43.46 18.97 ) + ( 4.92 18.97 ) + ( 32.5 18.97 )
AB =
51
= 20.95%
Stock A

Stock B
8

Portfolio AB

Standard
deviation

22.54%

22.04%

20.95%

10. BETA AND THE REQUIRED RATE OF RETURN ECRI

holding company with four main subsidiaries. The
capital invested in each of the sub- sidiaries (and
betas) are as follows:
Subsidiary
Percentage of
Capital
Electric utility
60
Cable company
2
Real
estate
1
International/special
5
projects
a. What is the holding companys beta?
b

Corporation is a
percentage of its
their respective
Beta
0.5
0.90
1.30
1.50

= (0.6)(0.5) + (0.02)(0.90) + (0.01)(1.30) + (0.05)(1.50)

= 0.406

b. If the risk-free rate is 6% and the market risk premium is 5%, what is the
holding companys required rate of return?
rRF = 6%; RPM = 5%; b = 0.406
rP = 6% + (5%)(0.406)
= 8.03%
c. ECRI is considering a change in its strategic focus; it will reduce its
reliance on the electric utility subsidiary, so the percentage of its capital
in this subsidiary will be reduced to 50%. At the same time, it will
increase its reliance on the international/special projects division, so the
percentage of its capital in that subsidiary will rise to 15%. What will the
companys required rate of return be after these changes?
bN = (0.5)(0.5) + (0.02)(0.9) + (0.01)(1.3) + (0.15)(1.5)
= 0.506
r

= 6% + (5%)(0.506)
= 8.53%

11. CONSTANT GROWTH STOCK VALUATION Fletcher Companys current

stock price is $36.00, its last dividend was $1.50, and its required rate of
return is 12%. If dividends are expected to grow at a constant rate, g, in the
future and if rS is expected to remain at 12%, what is Fletchers expected
stock price 5 years from now?
D
D (1+ g)
^
P0=P0 = 1 = 0
r sg
r sg

$36

$ 1.5(1+ g)
0.12g

4.32 36g = 1.5 + 1.5g

g
= 0.0752 = 7.52%
The firms expected stock price 5 years from now is:
6
D0 ( 1+ g )6
$ 1.5(1+0.0752)
^
=
P 5=
r sg
0.120.0752

= $51.73

12. NONCONSTANT GROWTH STOCK VALUATION Snyder Computers Inc. is

experiencing rapid growth. Earnings and dividends are expected to grow at a
rate of 15% during the next 2 years, at 13% the following year, and at a
constant rate of 6% during Year 4 and thereafter. Its last dividend was $1.15,
and its required rate of return is 12%.
a. Calculate the value of the stock today (P0).
D1
D2
D3

= $1.15(1.15)
= $1.3225
= $1.3225(1.15) = $1.5209
= $1.5209(1.13) = $1.7186

PV D

$ 1.3225 $ 1. 5209 $ 1.7186

+
+
1.12
1.122
1.123

= $3.62

b. Calculate P1 and P2
D
D (1+g)
^
P 3= 4 = 3
r s g
r sg

PV

$ 1.7186(1.06)
0.120.06

^
P3

10

$ 30.36
3
1.12

= $30.36
= $21.61