FINA1310JKL

Group Problem Set 1

Deadline for Submission: 19:30, Friday, March 8th, 2024.

Submission Method: upload to the course Moodle.

Submissions after the deadline above will NOT be accepted and students will get zero
points for the exercise.

Both typed and hand-written submissions are acceptable. Please number your answers
according to the question number (e.g., Q1.1, Q1.2, etc.) Please scan your work properly and
combine them into one consolidated pdf file. Each group needs to submit one paper only. Do
not forget to indicate your name, email and UID clearly:

Group
Name Email UID
Member
01
02
03
04
05

There are 14 questions, with varying point values. The total point of the problem set is 150. For
each question, you have to write down the formula you use and the final answer (just like the
way the suggested solutions are presented in the review exercises). Do NOT just write down
the final answer. Solutions with only the final correct answer, but not showing the
calculations, will get zero credit. Partial credit may be given to incorrect solutions but
possibly correct logic.

In all of the questions below, all the terms “interest rate,” “return” and “yield-to-maturity” are on
an annual basis unless specified otherwise. The terms “cost of capital”, “required return”, and
“discount rate” are all equivalent.
Question 1. (10 points) You have just made your first $5,500 contribution to your retirement
account.

1. Assuming you earn a return of 10% per year and make no additional contributions, what will
your account be worth when you retire in 45 years?

2. What if you wait 10 years before contributing for the first time?

3. If you waited 10 years before contributing, how much more would you have to begin
contributing 10 years from now to end up with the same balance after 45 years from now?

Question 2. (16 points) Find the APR, or stated rate, in each of the following cases:

Stated Rate (APR) Number of Times Compounded Effective Rate (EAR)

Semiannually 14.2%
Monthly 18.4
Weekly 11.1
Infinite 8.9

Question 3. (12 points) You want to buy a new sports coupe for $84,500, and the finance office at
the dealership has quoted you an APR of 4.7 percent for a 60-month equal-payment loan to buy the
car. At the end of the loan, you will own the car and you expect it to be valued at $10,000.

1. What is the effective annual interest rate on this loan?

2. What will your monthly payments be?

3. What if you could lease it instead, for an APR of 3.4 percent, but had to return the car at the end
of the lease. Would you rather buy or lease the car? Why?

Question 4. (12 points) Pedro has just taken a $1,000,000, 20-year mortgage at 1.8% with a fixed
amount of principal to be repaid at the end of every year for the next 20 years.

1. Prepare an amortization table. What will be Pedro’s payment for year 3?

2. At the beginning of year 4 Max is offered the opportunity to renegotiate the loan for the
remaining 16 years to repay the loan with equal annual payments at the same interest rate.
Should Max take the renegotiation offer?

3. Why or why not?

Question 5. (12 points) You are looking at an investment that has an effective annual rate of 14.3
percent.

1. What is the effective semiannual return?

2. The effective quarterly return?

3. The effective monthly return?

Question 6. (4 points) A company issued 25-year bonds two years ago at a coupon rate of 5.6
percent. The bonds make semiannual payments.

1. If these bonds currently sell for 97 percent of par value, what is the YTM?

Question 7. (12 points) You are considering the following two different bonds to add to your
investment portfolio:
 Maracas Company bonds have a face value of $20,000 and pay $400 every quarter.
 Zildijian Company bonds are 10% coupon bonds with a face value of $20,000. Its coupons
will be paid on a quarterly basis.
Maracas bonds have a maturity of 8 years and Zildijian bonds have a maturity of 6 years. Both
bonds currently have a rating of AA from Standard and Poor’s. However, due to recent economic
downturn, analysts suggested that the bonds may downgrade to a rating of BBB.

The following table summarizes the yield to maturity for bonds with various ratings:

Rating AAA AA A BBB BB

Yield (APR compounded quarterly) 4.3% 4.9% 5.6% 6.8% 8%

1. What are the prices of the bonds if they maintain a rating of AA?

2. What will the price of the bonds be if they are downgraded to a rating of BBB?

3. Please explain which bond has higher interest rate risk (Price risk)?

Question 8. (4 points) A company has a bond outstanding with a coupon rate of 2.9 percent paid
semiannually and 16 years to maturity. The yield to maturity on this bond is 2.7 percent, and the
bond has a par value of $5,000.

1. What is the dollar price of the bond?

Question 9. (4 points) A company is growing quickly. Dividends are expected to grow at a rate of
30 percent for the next three years, with the growth rate falling off to a constant 4 percent thereafter.
The required return is 10 percent, and the company just paid a dividend of $2.65.

1. What is the current share price?

Question 10. (12 points) The Michner Corporation is trying to choose between the following two
mutually exclusive design projects:

Year Cash Flow (A) Cash Flow (B)

0 −$82,000 −$21,700
1 37,600 11,200
2 37,600 11,200
3 37,600 11,200

1. If the required return is 10 percent and the company applies the IRR decision rule, which project
should the firm accept?

2. If the company applies the NPV decision rule, which project should it take?

3. Explain why your answers in parts (a) and (b) are different.

Question 11. (20 points) Consider the following two mutually exclusive projects:

Year Cash Flow (A) Cash Flow (B)

0 −$291,000 −$41,600
1 37,000 20,000
2 55,000 17,600
3 55,000 17,200
4 366,000 14,000

Whichever project you choose, if any, you require a return of 11 percent on your investment.

1. If you apply the payback criterion, which investment will you choose? Why?

2. If you apply the accounting rate of return criterion, which investment will you choose? Why?

3. If you apply the NPV criterion, which investment will you choose? Why?

4. If you apply the IRR criterion, which investment will you choose? Why?

5. Based on your answers in parts (a) through (d), which project will you finally choose? Why?
Question 12. (4 points) Integrity Materials is considering expanding on some land that it currently
owns. The initial cost of the land was $364,500 and it is currently valued at $357,900. The company
has some unused equipment that it currently owns valued at $29,000 that could be used for this
project if $8,200 is spent for equipment modifications. Other equipment costing $157,900 will also
be required.

1. What is the amount of the initial cash flow for this expansion project?

Question 13. (16 points) Zimlick, Inc, a US pasta-machine manufacturer, is considering a $2.1
million device from United Technologies Corporation to automate pasta-machine quality inspection.
The device will be depreciated according to the straight-line method over three years. The useful
life of the device is 5 years, with an estimated sale value at year 5 of $300,000. The project will
allow less pasta machines to be scrapped because of low quality, generating pretax earnings of
$900,000 per year, and will not change the risk level of the firm. Zimlick’s cost of capital is 18%.
The tax rate is 30%.

1. Show a forecast of the cash flows for the project

2. What is the net present value of the project?

3. What is the IRR of the project?

4. Would you undertake the investment? Why or why not?

Question 14. (12 points) A new molding machine is expected to produce operating cash flows of
$109,000 per year for 4 years. At the beginning of the project, inventory will decrease by $8,700,
accounts receivables will increase by $9,500, and accounts payable will decrease by $5,200. All net
working capital will be recovered at the end of the project. The initial cost of the molding machine
is $319,000. The equipment will be depreciated straight-line to a zero book value over the life of the
project. The equipment will be salvaged at the end of the project, creating an aftertax cash inflow of
$51,600. Use a discount rate of 10% and a 20% tax rate.

1. Show a forecast of the cash flows for the project

2. What is the net present value of the project?

3. Would you undertake the investment? Why or why not?