You wrote a piece of software that does a better job of allowing computers to

network than any other program designed for this purpose. A large
networking company wants to incorporate your software into their systems
and is offering to pay you $501,000 today, plus $501,000 at the end of each
of the following six years for permission to do this. If the appropriate interest
rate is 8 percent, what is the present value of the cash flow stream that the
company is offering you? (Round answer to the nearest whole dollar, e.g.
5,275.)

PV of cash flow today = PV
0
= 501,000
PV of cash flows of 501,000 per year at 8% = PV of annuity
(8%,6)
=
(

) (

()

)

C = cash flow per year = 501,000
r = interest rate = 8%
n = number of payments = 6

Total PV = PV
0
+ PV of annuity
(8%,6)

= 501,000 + (

) (

()

)
= 501,000 + 2,316,062.71
= 2,817,062.71

Input the following into calculator to find PV of annuity
(8%,6)
:
N = 6
I = 8
PV = 0
PMT = -501,000
FV = 0

Solve for PV.

Present Value
Barbara is considering investing in a stock and is aware that the return on
that investment is particularly sensitive to how the economy is performing.
Her analysis suggests that four states of the economy can affect the return on
the investment. Using the table of returns and probabilities below, find the
expected return and the standard deviation of the return on Barbaras
investment. What is the expected return on Barbaras investment? (Round
answer to 3 decimal places, e.g. 0.076.)

Outcome Probability Return
Boom 0.1 25%
Good 0.4 15%
Level 0.3 10%
Slump 0.2 -5%

Expected Return, E(R
i
) = sum of [probability for each outcome*(return for each
outcome)]

E(R
i
) = (0. 1)(0. 25) + (0. 4)(0. 15) + (0. 3) (0. 1) + (0. 2)(0. 05) = 0. 105

Variance of the return (^2) = sum of [probability for each outcome*(return
for each outcome - E(R
i
))^2]

Std. deviation of the return () = ^2


^2 = (0.1)(0.25 0.105)^2 + (0.4)(0.15 0.105)^2 + (0.3)(0.1 0.105)^2
+ (0.2)(0.5 0.105)^2
= 0.00773
Std. deviation, = ^2 = 0.00773 = 0.08789


Expected Return
Trevor Price bought 10-year bonds issued by Harvest Foods five years ago for
$968.42. The bonds make semiannual coupon payments at a rate of 8.4
percent. If the current price of the bonds is $1,096.44, what is the yield that
Trevor would earn by selling the bonds today? (Round intermediate
calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal
places, e.g. 15.25%.)
Because the bonds are semi-annual, you have to multiply the years to
maturity of the bond by 2, divide the payments by 2, and multiply the interest
rate by 2 to get YTM. Payments equal the coupon rate times the face value of
the bonds. The present value of the bond equals its current market price.

N = 5*2 = 10
PV = -968.42
PMT = (0.084*1,000)/2 = 42
FV = 1,096.44
I = ? = interest rate

Plug the above values into your financial calculator or into excel to get:
I = 5.37%

YTM = 5.37*2 = 10.74%


Effective Annual Yield
The First Bank of Ellicott City has issued perpetual preferred stock with a $100
par value. The bank pays a quarterly dividend of $1.65 on this stock. What is
the current price of this preferred stock given a required rate of return of 11.0
percent? (Round answer to 2 decimal places, e.g. 15.25.)

Div = Quarterly dividend = $1.65
R
E
= required rate of return = 11%
n = time of payment of dividend = 4

Use the formula:
P = (Div*n)/R
E


Plug in the values:
P = (1.65*4)/0.11 = $60.00

Current Price
Trigen Corp. management will invest cash flows of $764,771, $388,567,
$652,392, $818,400, $1,239,644, and $1,617,848 in research and development
over the next six years. If the appropriate interest rate is 7.02 percent, what is
the future value of these investment cash flows six years from today? (Round
answer to 2 decimal places, e.g. 15.25.)
FV = C(1+r)^n
()

()

()

()

()

()

For the Cash Flow Series
Future Value = $6,264,854.68

Cash Flow Stream Detail
Period Cash Flow Future Value
1 764,771.00 1,073,633.72
2 388,567.00 509,712.99
3 652,392.00 799,656.49
4 818,400.00 937,336.47
5 1,239,644.00 1,326,667.01
6 1,617,848.00 1,617,848.00
Total: 6,264,854.68

Future Value
Genaro needs to capture a return of 40 percent for his one-year investment in
a property. He believes that he can sell the property at the end of the year for
$150,000 and that the property will provide him with rental income of
$25,000. What is the maximum amount that Genaro should be willing to pay
for the property?
A. $137,500
B. $150,000
C. $112,500
D. $125,000

0.4(X) = 25,000 + (150,000 X)
0.4(X) = 175,000 X
1.4(X) = 175,000
X = 125,000

How firms estimate their cost of capital: The WACC for a firm is 19.75
percent. You know that the firm is financed with $75 million of equity and $25
million of debt. The cost of debt capital is 7 percent. What is the cost of
equity for the firm?
A. 19.75%
B. 32.50%
C. 58.00%
D. 24.00%

Use the following formula:

)( )

WACC = the weighted average cost of capital = 19.75%
V = total financing = equity + debt = 75 + 25 = 100 million
E/V = percentage of firm financed by equity = 75/100 = 75%
D/V = percentage of firm finance by debt = 25/100 = 25%
R
E
= cost of equity = ?
R
D
= cost of debt = 7%
t = not given so assume it equals zero

Plug the above into the formula to get:
(

) ()
(

)

(

)

(

)


The cost of debt: Bellamee, Inc., has semiannual bonds outstanding with five
years to maturity and are priced at $920.87. If the bonds have a coupon rate
of 7 percent, then what is the YTM for the bonds?
A. 4.5%
B. 9.2%
C. 7.0%
D. 9.0%


Use the following formula to find the YTM:

C = coupon/interest payment = 70
F = face value of the bond = $1,000
P = price of the bond = $920.87
n = years to maturity = 5

Plug the above values into the formula to get:

The cost of debt: Beckham Corporation has semiannual bonds outstanding
with 13 years to maturity and are currently priced at $746.16. If the bonds
have a coupon rate of 8.5 percent, then what is the after-tax cost of debt for
Beckham if its marginal tax rate is 35%? Assume that your calculation is made
as on Wall Street.
A. 8.125%
B. 6.250%
C. 12.890%
D. 12.500%

Because the bonds are semi-annual, you have to multiply the years to
maturity of the bond by 2, divide the payments by 2, and multiply the interest
rate by 2 to get YTM. The face value of the bonds is 1,000 and this also the
future value of the bonds. Payments equal the coupon rate times the face
value of the bonds. The present value of the bond equals its current market
price.

N = 13*2 = 26
PV = -746.16
PMT = (0.085*1,000)/2 = 42.5
FV = 1,000
I = ? = interest rate

Plug the above values into your financial calculator or into excel to get:
I = 6.25%

YTM = 6.25*2 = 12.5%


To find the after-tax cost of debt you must use the formula:
K
Debt after-tax
= K
Debt pre-tax
(1 t)

K
Debt after-tax
= after-tax cost of debt = ?
K
Debt pre-tax
= YTM of the bonds = 12.5%
T = tax rate = 35%

Plug the above values into the formula to get:
K
Debt after-tax
= 0.125(1 0.35)
K
Debt after-tax
= 0.125(065)
K
Debt after-tax
= 0.08125 or 8.125%



The cost of equity: Radical VenOil, Inc., has a cost of equity capital equal to
22.8 percent. If the risk-free rate of return is 10 percent and the expected
return on the market is 18 percent, then what is the firm's beta if the firm's
marginal tax rate is 35 percent?
A. 1.0
B. 1.60
C. 1.28
D. 4.10

Cost of equity capital equation:
R
E
= r
f
+ (r
m
r
f
)*

R
E
= the rate of return on equity or cost of equity capital = 22.8%
r
f
= the risk free rate = 10%
r
m
= the expected return on the market = 18%
= the beta coefficient =?

Plug the above values into the equation to get:
0.228 = 0.10 + (0.18 0.10)*
0.128 = (0.08)*
0.128/0.08 =
1.60 =