AMME

Individual Assignment #2

FORMAT: You can use a Word document, an Excel spreadsheet or both. If you use Excel, submit the Excel file rather than embedding Excel into a Word document. Please use single-space, 11 pt. or 12 pt. font.

Multiple Choice: Select the best response (3 points each). You may add comments to explain your reasons.

1. If the correlation coefficient is 0,

A) You can completely eliminate risk by short selling the riskier asset and investing the proceeds in the less risk one. B) You can completely eliminate risk by investing positive amounts in each security. C) You cannot completely eliminate the risk.

ANSWER IS C

2. Which factor(s) influence a firm’s business

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(6) Delve Mining and Gold Metals are two firms both considering a silver exploration project. Delve Mining is in the mining business and has a weighted average cost of capital (WACC) of 12.8%. Gold Metals is in the gold retail business and has a WACC of 10.6%. The silver project has initial costs of $575,000 and annual cash inflows of $102,000 per year for 10 years. Which firm(s), if either, should accept the project?

Gold metals should accept the project (because net NPV > 0) Delve Mining should decline the project (because net NPV < 0)

SEE ATTACHED SPREADSHEET FO COMPLETE CALCULATION

4. (10) In an M&M world with NO TAXES (perfect capital markets), Dozer Inc. is a no growth firm and pays out all of its earnings as dividends. It is originally all equity financed (unlevered). The firm decides to issue $2,700,000 in debt to repurchase stock. The return on debt is 10%. Fill in the table

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(11)

Bar plans to finance a new project with $2M in bonds, $1M in preferred stock and $5M in retained earnings. • The zero coupon bonds have a 5-year life and sold for $680.58. • The preferred stock has a $2.70 annual dividend. The preferred stock has a price of $30 but issue costs are $3 per share. • Bar knows the Treasury bill rate is 3% and the market risk premium is 9%. The common stock has a beta of 1.20. The tax rate is 30%. • The project has a 5-year planning horizon. It costs $8,000,000 and generates $2,100,000 in after-tax cash flows every year for 4 years followed by an after-tax cash flow of $4,100,000 in year 5. Find the net present value of the project using the WACC.

NPV = $1,459,989

SEE ATTACHED SPREADSHEET FO COMPLETE CALCULATION

8. (6) RLS has 30% debt in its capital structure. Currently, the levered equity beta is 1 and the debt beta is 0. The T-bill rate is 4% and the expected return on the market is 14%. The firm plans to issue additional debt. The debt moves the firm to its target debt level of 40%. What is the new return on