FInance Questions

Complete

Final Exam

Read the following overview and instructions carefully.

This exam covers Units 5 - 10. Some questions will relate to concepts, others will require you to

calculate an answer. This is an open book (i.e., use of textbook, slides, lecture videos, and

practice problems are allowed) but you may not use any internet sources outside of the course

canvas site on the FSU webpage unless explicitly stated by professor on the exam.

For math problems, you will be asked to upload your work (e.g., excel, word document, or

screenshot of handwritten work). It is recommended to use Excel for any quantitative problems

to avoid rounding errors. DO NOT hardcode answers (i.e., leave the formulas you used).

Clearly label all final answers. Your formulas should NOT be copied and pasted from the

practice problems. You should be doing all your own work from scratch.

All workbooks should be formatted professionally (i.e., something you would turn over to a

client). Formats should NOT look like my practice problem solutions. You should be formatting

all your own tables from scratch.

When you upload an excel file, it is OK to have separate tabs for each question. Please make

sure tabs are labeled to make it easy to locate your answers. It is also OK to add text boxes to

excel and add any written description along with the problem, but please makes sure that they are

formatted professionally and have used the Spell Check function in Excel.

If Excel is NOT used, round all intermediate results to at least four decimal places to ensure an

accurate response. Only the final answer should be rounded to two decimal places. Clearly label all final answers.

You will be submitting your assignment via TurnItIn which will allow for a plagiarism review.

Questions

Question 1 [40 points]:

Lululemon is considering investing in new machinery that will generate sustainably created

athleisure shirts and pants. The discount rate is 10%, and the initial investment in equipment

$12.5 million. The machinery's economic life is 25 years and the equipment will be depreciated

on a straight-line basis over the project's life and has no salvage value. The following financial

information is estimated for production from the machinery:

Sales price per shirt: $65

Sales price per pant: $115

Variable Costs per shirt: $2.75

Variable Costs per pant: $5.00

Fixed Costs of production per Year: $140,000

Tax Rate=21%

Number of shirts sold per year: 10,100

Number of pants sold per year: 9,750

1. What is the accounting break-even level for production of a) shirts, and b) pants? [5 points]

2. What is the financial break-even level for production of a) shirts, and b) pants? [5 points] 3. What is the base-cash cash flow of this project (i.e., accounting for both shirts and pants)?

[5 points]

4. What is the base-case NPV of this project? [5 points] 5. Assume that your projection for price of shirts, fixed costs, and variable costs of pants

were only accurate within +/- 15%. Calculate the best-case and worst-case NPV figures.

Do you think Lululemon should take on this project? Why or why not? [15 points]

6. What is the sensitivity of the NPV to changes in the fixed costs? Explain what your answer tells you about a $10,000 increase in projected fixed costs for pants. [5 points]

Note: When calculating break-evens for each product type, view each product in isolation (e.g.,

for shirts, assume that all depreciation and costs are attributed to shirts and ignore all pant

specific figures. This solves for a world where only shirts are produced and no pants are

produced).

Note: When asked about the project level, you should be accounting for both shirt and pant

production together.

Question 2 [40 points]:

Note: You are allowed to access the hyperlinks to FINRA Morningstar included in the question.

The following Microsoft bond (Links to an external site.) has a coupon rate of 5.2%. Identify the

Last Trade Yield.

• Would you expect this bond to be trading at a premium or a discount? Why? [10 points]

• Look at the Price/Yield chart on the hyperlinked page. What is the current bond price?

The par/offer price was $100. Is this bond trading at a premium or a discount? How can

you tell? [10 points]

• What is the difference between the coupon rate and the yield on this bond (i.e., what do

they mean for the investor who purchased/held the bond)? [10 points]

• FINRA Morningstar (Links to an external site.) documents the yield curve, which shows

the maturity and yield (in %) for various treasury bonds. The yield curve is found on the

"Market At-A-Glance" tab in the Bond Yield and Performance At-A-Glance section -

"Treasury Yield". The graph on the right depicts this as a line graph for current

compared to 1 year ago. What do you notice about the relationship between maturity and

yield? Which of the bonds has the most interest rate risk? Why? [10 points]

Note: Watch the FINRA Training video in the Course Resource Module.

Question 3 [10 points]:

Lululemon needs to raise $60 million and wants to issue 15-year zero-coupon bonds for this

purpose. Assume the required return on the bond issue will be 4.8% Spear-It's tax rate is

21%. The par value of each bond is $1000. How many bonds would the company need to issue

to raise the money it requires?

Question 4 [10 points]:

Note: You are allowed to access the hyperlink to FRED included in the question.

Identify what the current (i.e., most recent) rate/yield is for the Three-Month Treasury

Bill (Links to an external site.)(TBill) and the rate for October 2019. The Consumer Price Index

("CPI") is commonly used as a measure of inflation. Inflation can be measured as (Year 1 CPI -

Year 0 CPI) / Year 0 CPI.

1) What is the approximate and exact real rate of interest currently? [5 points]

2) What was the approximate and exact real rate of interest in October 2019? [5 points]

Note: Watch the FRED Training video in the Course Resource Module.

Question 5 [ 30 points]

1. Why can dividends be used to value a firm's stock price? Amazon and Facebook do not pay dividends. Why do they choose not to pay dividends and why are investors willing to

purchase their stock even though no dividends are paid? [15 points]

2. Verizon is expected to pay a $2.510 dividend next year. This will grow at 5% a year for the following four years. Afterwards, the company will maintain a constant 1.5% growth

rate in dividends in perpetuity. If the required return on the stock is 6%, what is the

current share price? [10 points]

3. Allstate preferred offers preferred dividend of 7.52% based on a $10 par. This dividend will be paid in perpetuity stating five years from now. If the market requires a 9.05% rate

of return, how much does a share of preferred stock cost today? [5 points]

Question 6 [ 55 points]

Suppose you have $90,000 to invest in a two-stock portfolio. Complete the following eight steps

to gather information about your portfolio: [8 points]

• Pick two publicly traded companies listed on a U.S. stock exchange (excluding Tesla and

Proctor & Gamble).

o View a list of the companies that trade on the NYSE (New York Stock

Exchange)(Links to an external site.) (Links to an external site.)

o View a list of the companies that trade on the NASDAQ(Links to an external

site.) (Links to an external site.)

o View a list of the companies that trade on the AMEX (American Stock

Exchange) (Links to an external site.)

• Download the Monthly historical price data from October 2016 – October 2021

from Yahoo!Finance (Links to an external site.) for each company

• Calculate the monthly returns for each company over the time period using the adjusted

close (Adj Close) price

• Use the average() function in excel to find the average monthly return for each company

over the time horizon. This will reflect the expected return for each stock.

• Use the stdev.s() function in excel to find the standard deviation of the monthly returns

for each company.

• Use the correl() function in excel to find the correlation coefficient between the returns of

each stock

• Find the Beta from the summary information page on Yahoo!Finance (Links to an

external site.)

• Prepare a table that contains the average return, standard deviation, correlation, and beta

information for the two stocks.

Note: Watch the Two-Stock Portfolio Training video in the Course Resource Module which

walks through how to do Steps 2 – 8 above in Excel using Tesla and Proctor & Gamble.

Use the information above to answer the following questions:

1. You can split your $90,000 anyway you want into your two-stock portfolio (i.e., except 100% in one-stock or 50%/50% split between the two). Decide how much of the $90,000

you want to invest in Stock 1 and put the remainder of the $90,000 in Stock 2. Calculate

the weights for each stock in your portfolio [ 7 points]

2. What is the expected return of your portfolio? [ 5 points] 3. What is the standard deviation of your portfolio? [ 10 points] 4. What is the beta of your portfolio? [ 5 points] 5. Forget that you have calculated the expected return above. Assume all you know is each

company’s beta, and that the market risk premium is 5.50% and the risk-free rate is

0.04% (using the 3-month T-bill yield as the risk-free proxy). Using the Capital Asset

Pricing Model (CAPM), what is the expected return for each company? [ 5 points]

6. How does the correlation coefficient of the two stocks impact the standard deviation of your portfolio? Would a positive or negative correlation drive the risk of your portfolio

up, and why? [15 points]

Question 7 [20 points]:

Use the same two companies from above and answer the three questions below.

1. Make a table that includes the trailing and forward P/E Ratios for each of your two companies. [4 points]

2. How do the companies' PE Ratios compare to those of several prominent market indices? [6 points]

3. What are some factors discussed in the lectures that can drive a firm's P/E ratio? Summarize the results of your P/E table and provide a brief overview for what you think

may be driving the differences between the two companies as well as between trailing

and forward P/E ratio for a given company. [10 points]

Note: Review the Price-to-Earnings ("P/E") page in the Course Resource Module which

contains information on how to locate a company's P/E ratio on Yahoo!Finance as well as data

on the P/E ratios for several market indexes (e.g., Dow Jones, S&P 500, etc.).

Note: You must use companies that have positive earnings, otherwise P/E ratio is not

meaningful (and often labeled as N/A or missing). If one or both of your companies has

negative earnings, select different public firms with positive earnings. You cannot use Telsa for

one of your companies.

Question 8 [45 points]:

Spear-It Inc., has the following financing outstanding:

• Debt: 300,000 bonds with a coupon rate of 4.0% and a current price of 120% of par. The

bonds have 20 years to maturity and a par value of $1,000. The bond has semiannual

compounding.

• Equity: 2.7 million shares of common stock with a current price of $130 per share and

the beta of the stock is 1.19.

• Market: The corporate tax rate is 21%, the expected market return is 9.5%, and the risk-

free rate is 0.02%.

Spear-It is considering purchasing Broke N Bored Grill, a privately held restaurant. Broke N

Bored currently has debt outstanding with a market value of $15 million. The EBIT for Broke N

Bored next year is projected to be $13 million. EBIT is expected to grow at 9% per year for the

next five years before slowing to 2% in perpetuity. Change in Net Working Capital, Capital

Spending, and Depreciation as a percentage of EBIT are expected to be 5%, 4%, and 6%,

respectively. Broke N Bored has 12.5 million shares outstanding and the tax rate is 21%.

1. What is the after-tax cost of debt for Spear-It Inc? [5 points] 2. What is the cost of equity for Spear-it Inc? [2.5 points] 3. What is the weight of debt and weight of common stock for Spear-It Inc? [5 points] 4. What discount rate should Spear-It use to evaluate the potential purchase of Broke N

Bored? [2.5 points]

5. What are the Cash Flows for Broke N Bored expected to be in Years 1 - 5 (i.e., what is CF(A) for Years 1 - 5)? [10 points]

6. What is the terminal value of Broke N Bored's cash flows? [10 points] 7. What is the total value of Broke N Bored Grill worth to Spear-It today? [5 points] 8. What is the value of Broke N Bored equity? [2.5 points]

9. What is the maximum price per share Spear-It should be willing to pay for Broke N Bored? [2.5 points]

Completion

To successfully complete the Final Exam, you must answer all questions and submit your

answers by the end of day on Friday in the final week of the course (i.e., Friday 11:59 PM ET).

Upload your written document and excel workbook.