Professor Nisan Langberg

Instructions

You have three hours to complete this exam. Please write your answers clearly in the body of the exam. You may use a simple/financial calculator only. You may bring two A4 sheets to the exam.

Question 1 [5 points]: You wish to borrow $10,000 from your bank for one year. Which alternative shall you choose?

(a) 4.25% APR compound quarterly

(b) 4.25% EAR

Question 2 [5 points]: Identify each of the following risks as either systematic risk or diversifiable risk:

(a) The risk that the CEO of your firm is killed in a plane accident

(b) The risk that the economy slows, decreasing demand for your firm’s products

(c) The risk that your best employees will be hired away

(d) The risk that the new product you expect your R&D division to produce will not materialize.

Question 3 [5 points]: Suppose the market risk premium is 6% and the risk-free interest rate is 2.7%. What is the expected annual return of investing in Microsoft’s stock according to the CAPM if its beta is 1.24?

Question 4 [15 points]: Fast Track Bikes, Inc., is thinking of developing a new composite road bike. An initial investment of $1,000,000 is required (at time t=0). Profits are expected to be $70,000 this year (at time t=1) and will grow at rate of 3% afterwards forever. Fast Track Bikes has a cost of capital of 12%.

(a) What is the IRR of this investment

(b) Is it a good idea for Fast Track Bikes to invest in this project (what is the NPV of the project)?

Question 5 [25 points]: You are saving for retirement. To live comfortably, you decide you will need to save $2 million by the time you are 65. Today is your 30th birthday and you have accumulated $45,000 in savings so far. You decide that starting at the end of this year and continuing on every birthday up to and including your 65th birthday, that you will put the same amount into a savings account. If the interest rate is 4%, how much must you set aside each year to make sure