FIN6406 Final Exam

READ THESEINSTRUCTIONS!

1.   This exam is worth a total of 100 points.

2.   You should electronicallysubmityour final examwith detailedcalculationsvia email to zlin@fiu.edu.  You willtitlethe email “YOUR NAME – FINAL”.  You will title the document “YOUR NAME – FINAL”.  You will putyour name on atitlepage.  Good luck!

Problem1 [10 points]

100

Stock

137

51

Bond (rF=2%)

102

100

102

Call(E=87)

50

C

0

1-yearcalloption,S=100,E=87, rF=2%(annual)

1 stepperyear

How much shouldthe calloption worth?

Iftotal returnafter taxona certain project is 7.5%,and thereare fivefinancingchoices available to investors:

(1)7%interest rateand a60%LTVratio; (2)7.8%interest rateand a70%LTVratio; (3)8.5%interestrateand a80%LTVratio; (4)9.25%interest rateand a90%LTV ratio; (5)9.75%interest rateand a95%LTV ratio;

Supposethat there arethreetypes of investors(A,Band C) whosetaxratesare15%, 25% and

35%, respectively. Questions:

(1)        Find outthe financingchoiceforeach typeof investor and the correspondingafter-tax return on equity.

(2)       Which typeof investor has the highest after-taxreturn on their equity?

You currentlyhave$2,500,000. You want to invest it in the followingthreeassets: 10-year US Treasurybondwith coupon rate 3.5%,BlandyandGourmangestocks, whohavethe following historical annual returns:

Yourgoal is tohavetheexpected annual return of7.2%with a minimum portfolio risk. How much moneyshouldyouallocate to thesethree assets?

Problem4 [30 points]

A real estate investor hasthe followinginformation on an apartment building:

    PurchasePriceis $1,125,000 with acquisition costsof $35,000

    33,600 leasable squarefeet

    Initial rent of $1.5/sq. ft. permonthand willincrease at thebeginningofeachyearfor

5 percent peryear.For example, the firstyear rent from month 1 to month12 is

$1.5/sq. ft., the 2ndyear rent from month 1 to month 12is $1.575 ($1.5*(1+5%)), and so on.

    Vacancyrateof 5%ofgross rent permonth.

    Operatingexpenses are25%of effectivegross income

    Threefinancingchoices:

1.   Mortgagewith75%LTV ratio, 20years, monthlypayments and 5%annual rate;

2.   Mortgagewith80%LTV ratio, 20years, monthlypayments and 6% annual rate;

3.   Mortgagewith85%LTV ratio, 20years, monthlypayments and 6.5% annual rate;

      Holdingperiod is 3years(36 months) and the capital improvement expenditureis assumed to be $20,000 atthe end of the firstyearonly(12 months).

    Expected increasein valueis 50%in total when soldinyear 3 (36 months), 5%

sellingexpenses

    75%depreciable with monthlydepreciation.

    Investor’s taxrate is 35%, and capitalgain taxrateis 15%.

Questions:

1.   Compute equityafter-tax cash flows from month1 to month 36for each financingchoice.

2.   What is the equityafter-taxannualreturn (internal rate ofreturn)foreach financingchoice and which choicewouldyou liketo make?

Based on theCapital Asset PricingModel (CAPM) and the diagram below,what is the return of the stock if its beta is 1.5 or 0.5?

10%

3 %

RF    3.5%

          1             

RM   12%