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Date Posted: 17:25:56 03/12/03 Wed
Author: Rose
Subject: Please help me to solve these problem

1. The probability of a good economy is twice that of a bad economy and the probability of the economy remaining the same is 3 times that of a good economy. With these weights (HINT: set up an algebraic equation to calculate the percentages, think of how you would calculate the amount of debt and equity investment in a company of you are given a debt/equity ratio and the total investment) calculate the return and variance of a portfolio consisting of the following stocks with their respective anticipated returns.


Stock Investment Bad Same Good
OOP 1,500 -.1 .1 .2
USP 3,500 .1 .2 -.1


2. (This looks long but isn’t. Highlight the relevant material and this is pretty straight forward)
ABC Corporation currently has 500,000 shares of stock outstanding which has a current market value of $50 per share. Next year’s dividend will be $5.00, and ABC Corp. has shown a sustained dividend growth rate of 6%. The company also has 100,000 9% coupon bonds outstanding with 10 years to maturity with a current yield of 7.5%. They also have 20,000 shares of 11% preferred stock selling at a premium of $120 per share. ABC’s tax rate is 35%.

The ABC Corporation is looking at building a new 7.25 million-dollar manufacturing plant for a 5-year project. They currently own a manufacturing facility for which they paid $2 million dollars. Currently they are leasing the building for the next 5 years to XYZ Corporation for $20,000 per month. At the end of this time, ABC will sell the current facility for the $2 million they paid for it. For tax purposes, the value of the property is allocated half to the land and half to the building. The building is fully depreciated. In order to build the new manufacturing plant, ABC Corp. will have to evict the current tenet (which is allowed for in the current lease) and demolish the current building. The project has a 15-year life, and will be depreciated using the straight-line method with a salvage value of $0. ABC can sell the plant after 5 years for $4 million dollars. For tax purposes, as above, $1 million is for the value of the land.

The project requires additional working capital of $500,000. There will be fixed costs of $1 million per year. The plan is to manufacture 30,000 computers per year and sell them for $750. The variable production cost is $500 per computer.

What are the NPV and IRR of the above project?

3. Assume that the assumptions underlying the Capital Asset Pricing Model are valid, and the model itself is true. Investor J has a personal wealth of $100,000 and holds a portfolio similar to the world’s portfolio. The world's wealth is $35,000,000,000,000. Company A has 12,000,000 shares outstanding of common stock, and has no debt. The current share price is $50.

a) What is the dollar value of A's stock held by investor J?
b) Assume the CAPM is true, and hold exactly. The expected return of asset
A is 12%, the expected return of the market portfolio is 10% and the beta
of A is 1.4. What is the riskless rate?
c) Assume the CAPM is true and hold exactly, and the riskless rate is the
number calculated in B. Is it possible to have an asset in this economy
with a beta of 1.2 and an expected return of 12%?

4. Fishy fish canning company is considering expanding their product line from canned salmon and tuna to smoked clams and caviar. They believe their old product lines are economy goods while the new product lines are luxury goods. They realize they should not use the same required rate for the new product lines. They find a company that only produces luxury canned seafood and its stock beta is 1.2, and its weight of debt is 40%. Fishy has a weight of debt of 50% and a stock beta of .8 given its current economy fish product line. It also has a cost of debt of 9%, and both firms have a tax rate of 40%. You estimate the risk free rate is 5% and the expected return on the market is 14%.
a. Using the pure play method, what is the estimated asset beta of the luxury good product line?
b. What rate would the stock of Fishy's luxury fish stock require?
c. What required rate should be used to find Net Present Values of the luxury fish line?
d. Would you expect the answer from c to be greater than or less
than the current weighted average cost of capital of Fishy, as it now produces only economy fish products? Why? (No calculations
are needed.)

5. The stock price of Ajax Inc. is currently $100. The stock price 1 year from now will either be $90 or $130 with equal probabilities. The interest rate at which investors can borrow is 10%. Since using the Black-Scholes Model requires knowing to 16 significant figures or ___________________, use the binomial OPM to determine today’s value of a call option with an exercise price of $110 and an expiration date one year from now. (Hint: remember the binomial hedge ratio:
(Pu- Pd)/ (Ou- Od)Which will give you the number of shares of stock per option.

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