Which of the following is closest to the annualized rate of return on a stock pu

Question

Which of the following is closest to the annualized rate of return on a stock purchased for $6,000 and sold for $6,100 ninety (90) days later?

100%

1%

7%

Very close to 0%

61%

At an interest rate of 8%, what comes closest to the amount of time it takes for a deposit of $7,599 to double in value?

3.25 years

2.56 years

8.02 years

1.56 years

9.01 years

Sam invests the amount of $22,750 in the bank today and, in addition, starting a year from today, she will invest an annual annuity of $21,950 for 17 consecutive years. Which of the following comes closest to the value of these investments at the end of year 17 if the interest rate is 11.1%?

$712,554

$911,229

$614,569

$1,245,666

$1,122,159

Bryant Industries is a firm with $850 million in assets and no debt financing. The shareholders of Bryant have convinced the management to take advantage of the tax deductibility of debt interest payments by issuing $100 million in new debt at 9% interest, and using the $100 million proceeds from the debt to repurchases that same amount of equity. The corporate tax rate is 28%. What is the new value of Bryant after the debt issue?

$850 million

$912 million

$878 million

$750 million

$712 million

Top Up is a levered firm with assets valued at $300,000, has $25,000 of debt issued at 7% interest, and 2,000 shares of stock outstanding. Suppose that corporate profits are subject to a tax rate of 25%. Which of the following comes closest to the earnings before interest and tax (EBIT) of Top Up if its earnings per share (EPS) is $0.50?

$1,226

$1,753

$1,508

$3,083

$3,750

In class we held a discussion about a firm that was in financial distress, paid high property taxes, had a long term union contract with its workers, and was the defendant in a high profile lawsuit. In this example the firm was considering a project that had a small chance of a significant payout, but a large chance of returning zero. What was the justification of accepting the project and funding the project with new debt capital?

Debt is a riskier form of capital compared with equity, so that the financing risk better matches the risk of the project.

Debt leads to better diversification for investors who wish to form medium sized portfolios.

Debt is easier to raise compared with equity, especially in this particular scenario.

Debt is tax deductible and firms with leverage pay less in tax compared with unlevered firms.

Debt pays a fixed rate of interest, such that the project’s success would not have to be split with any new shareholders.

Prime Moon, Corp. is currently unlevered with $100 million of assets. They plan to expand by tripling the size of the firm, with all capital coming in the form of debt. After this expansion, approximately what must the percentage fall in assets be before all the equity in the firm is wiped out?

50%

100%

75%

33%

25%

RCT is a firm in financial distress. They have extremely high financial leverage, pay high property taxes, pay high wages, and find themselves the defendant in a lawsuit that has the potential of a large settlement against the firm. In addition the firm is considering raising a significant amount of funds to use to drill for oil on land that they own, a project considered to have a negative NPV and be very risky. Which of the following actions was argued both in class and in the text as best from the standpoint of RCT’s shareholders at this time?

The firm would be indifferent between any of the above choices.

Reject the oil drilling project because it’s too risky.

Accept the oil drilling project and try to raise the needed funds through new equity.

Accept the oil drilling project and try to raise the needed funds through new debt.

Reject the oil drilling project because it has a negative NPV.

a.

100%

b.

1%

c.

7%

d.

Very close to 0%

e.

61%

Explanation / Answer

Answer:

1.

Annualized Rate of Return (ARR) = {(Principal + Gain) / Principal)(365 / days) – 1

therefore, in the given question; ARR = {($ 6,000 + $ 100) / $ 6,000)(365 / 90) - 1 = 0.07 approx that is

So, option c 7% is correct answer.

2.

At an interest rate of 8% the future value factor for 9 years comes to 1.99 {(1 + 0.08)9 = 1.99} and for 9.01 years it shall be very close to 2.00. Therefore, to double an amount of $ 7,599 at the interest rate of 8% the closest time period shall be 9.01 years.

3.

Sam invests the amount of $22,750 in the bank today and, in addition, starting a year from today, she will invest an annual annuity of $21,950 for 17 consecutive years. The value closest to the value of these investments at the end of year 17 if the interest rate is 11.1% shall be calculated by using future value formula for $ 22,750 and Future Value of Annuity Formula for periodic payments of $ 21,950 as under;

Future Value of Cash Flow = Cash Outflow (1 + interest rate)no. of periods = $ 22,750 (1 + 0.111)18 = $ 151,298.44

Future Value of Annuity = Periodic Payments [(1 + interest rate)no. of periods - 1] / interest rate

                                   = 21,950 [(1 + 0.111)17 - 1] / 0.111 = $ 985,970.27

The sum of above two values will be the total value of given investment at the end 17 years that is $ 1,137,268 and the closest value to this is $1,122,159. Therefore, option e is the correct answer.

4.

In the given case the Company has issued $ 100 million of new debt at 9% interest and used the proceeds to repurchase $ 100 million of equity. Therefore, the total value of the Company shall not change as far as monetary value is considered under given scenario. But, the involvement of debt in the capital structure shall have an impact on shareholders expectations and at the same time the interest payable in debt shall have tax benefits as it is chargeable against the taxable income of the Company.

So, in absence of any information about changes in expectations of shareholders, marjet value of equity shares and other factors, the total value of Company shall be $ 850 million ($ 850 million + $ 100 million from debt issue - $ 100 million used in repurchase of equity). The correct option is a.

5.

The earning before interest and tax can be calculated by reverse calculation from Earnings after Tax;

Suppose the Company's Earning before interest and Tax is 'y' , then

y - interest - tax on y + tax saving on interest = Earnings per share;

y - $ 1,750 - 25% 0f y + $ 437.50 = $ 1,000

y - 0.25y = $ 2312.50

y = $ 2312.50 / 0.75 = $ 3083.33

Working;

Interest on Debt = 7% of $ 25,000 = $ 1,750

Tax saving on interest expense = 25% of $ 1,750 = $ 437.50

Earnings per Share of Top Up is $ 0.50 that is its Earnings after Tax = $ 0.50 x 2000 sahres = $ 1,000

So, the correct answer is option d. $ 3083.

6.

In the given scenario the most appropriate justification for acceptance of the project shall be option b. Debt leads to better diversification for investors who wish to form medium sized portfolios.

This is so because for a project that had a small chance of a significant payout, but a large chance of returning zero an investment in the form of debt will attract the investors with a fixed rate of return.

7.

In the proposed expansion the firm will raise $ 200 million from debt to make total asset base of $ 300 million that is equal to three times the current asset base of $ 100 million. In the new structure the equity contribution in total assets will be 33.33% ( $ 100 million / $ 300 million).

Therefore, after this expansion, the approximate percentage of fall in assets before all the equity in the firm is wiped out shall be 33% so that the whole asset base shall be backed by debt funds of $ 200 million.

So, option d. 33% is the correct answer.

8.

The best action to be argued both in class and in the text from the standpoint of RCT’s shareholders at this time shall be Option e. that is to Reject the oil drilling project because it has a negative NPV.

It is so because the firm is already in an extremely high financial leverage, paying high property taxes, paying high wages, and have found themselves the defendant in a lawsuit that has the potential of a large settlement against the firm. In such a case accepting a very risky project and with a negative NPV shall add to hardships of the Firm. If the Firm would not have been a high financila levered firm then it might have an advice to accept the project by raising debts funds but, depending on other factors also.

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