Finc201 - Spring10 - Quiz1 Quiz 1 - Solutions-

17. You are saving for retirement. To live comfortably, you decide that you will need $2.5

million dollars by the time you are 65. If today is your 30th birthday, and you decide, starting today, and on every birthday up to and including your 65th birthday, that you will deposit the same amount into your savings account. Assuming the interest rate is 5%, the amount that you must set aside each and every year on your birthday is closest to: A. $71,430 B. $27,680 C. $26,100 D. $26,260

PV (age 29) = 2500000 / (1.05)36 = 431643.54

PV = 431,643.54 FV = 0 I = 5 N = 36

Compute PMT = $26,086

18. Your son is about to start kindergarten in a private school. Currently, the tuition is

$12,000 per year, payable at the start of the school year. You expect annual tuition

increases to average 6% per year over the next 13 years. Assuming that you son remains in this private school through high school and that your current interest rate is 7%, then the present value of your son's private school education is closest to: A. $332,300 B. $137,900 C. $155,800 D. $156,000

??1?.06?1?1??$12,000 ×

.07?.06??1?.07???13?? = $137,893

??19. If the current inflation rate is 5%, then the nominal rate necessary for you to earn an 8%

real interest rate on your investment is closest to: A. 13.0% B. 13.4% C. 4.9% D. 3.0%

nominal = (1 + inflation)(1 + real) - 1 = (1.05)(1.08) - 1 = .134 or 13.4%

20. Consider an investment that pays $1000 certain at the end of each of the next four years.

If the investment costs $3,500 and has an NPV of $74.26, then the four year risk-free interest rate is closest to: A. 4.5% B. 4.58% C. 4.55%

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D. 4.53%

NPV = 74.26 = -3500 + 1000 / (1.05)1 + 1000 / (1.048)2 + 1000 / (1.046)3 + 1000 / (1 + x)4

3574.26 - 1000 / (1.05)1 + 1000 / (1.048)2 + 1000 / (1.046)3 = 1000 / (1 + x)4

837.60 = 1000 / (1 + X)4 ==>> (1 + X)4 = 1000 / 837.60 ==>> X = .0453 or 4.53%

Bonus Question:

21. Which of the following statements is false?

A. If there is a fixed supply of resource available, you should rank projects by the profitability index, selecting the project with the lowest profitability index first and working your way down the list until the resource is consumed. B. Practitioners often use the profitability index to identify the optimal combination of projects when there is a fixed supply of resources. C. If there is a fixed supply of resources available, so that you cannot undertake all possible opportunities, then simply picking the highest NPV opportunity might not lead to the best decision. D. The profitability index is calculated as the NPV divided by the resources consumed by the project.

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Section B: (5 Questions – 60 points)

Answer all questions and show necessary work.

1. Consider the following financial statements for Well Known Corporation. (15 points)

Well Known Corporation

2007 and 2008 Balance Sheets

($ in millions)

________________________________________________________ 2007 2008 Assets

________________________________________________________

Current assets Cash 310 315

Account receivable 355 310 Inventory 507 328 Total 1,172 953 Fixed assets

Net plant and equipment 6,185 6,627 Total Assets $7,357 $7,580

________________________________________________________

Liabilities and Owners’ Equity

Current Liabilities Account payable 307

398 Notes payable 1,715 1,527 Total 2,022 1,925 Long-term debt 1,987

2,308

Owners’equity Common stock and 1,000 1,000 paid-in surplus

Retained earnings 2,348 2,347 Total 3,248 3,347 Total liabilities and owners’equity $7,357 $7,580 _______________________________________________________

Well Known Corporation 2008 Income Statement

($ in millions)

_________________________________________________________

Sales

$4,053 Cost of goods sold 2,780 Depreciation 550

Earnings before interest and taxes 723 Interest paid 502 Taxable income 221 Taxes (34%) 75 Net income $146 Dividends

$47

Addition to retained earnings

$99

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A. Calculate the following ratio for 2008: (10 points)

1. Current ratio: _________________________________________________ 2. Quick ratio: __________________________________________________ 3. Cash ratio: ___________________________________________________ 4. Inventory turnover: ____________________________________________ 5. Receivables turnover: __________________________________________ 6. Days’ sales in inventory: ________________________________________ 7. Days’ sales in receivables: _______________________________________ 8. Total debt ratio: _______________________________________________ 9. Long-term debt ratio: ___________________________________________ 10. Profit margin: _________________________________________________

B. What is the return on equity and return on asset for Well Known Corporation? (5 points)

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