assignment11 fundamentals of corporate finance, 4th edition brealey

lting assignment on which the ACET is working is with Keep You
Warm Corp (KYC), who has asked ACET for an evaluation of a six year
$924,000 project to sell hi-tech ski glove warmers. There is a zero salvage value
on the project assets which use straight-line depreciation (to zero). Assume that
the CCA is the same as depreciation. The new hi-tech glove warmers will sell for
$34 with a variable cost of $19. Sales are expected to be 130,000 pairs of
gloves per year. Fixed costs are $800,000 per year. KYC has a 35% tax rate
and a 15% cost of capital. Consider this as the base case scenario.
(a)

Calculate the accounting breakeven and the degree of operating leverage
at that point. (4 marks)

(b)

What is the sensitivity of Operating Cash Flows to change in the variable
cost figure? What does your answer suggest about a $1 reduction in the
variable costs? (5 marks)

(c)

Calculate the NPV for the base case (most likely scenario) and do a
sensitivity analysis by identifying the best case and worst case scenarios
by changes to the sales numbers. Explain why you selected these
numbers and what the impacts may be on your decision as to whether or
not to move forward with the project. (8 marks)

Question 5 (10 marks)
Calculate the expected returns, variances, and standard deviations for stock C,
for stock E, and for a portfolio of both stocks C (2/3 weight) and E (1/3 weight).
Scenario

Probability
Happiness
30%
Indifference
50%
Unhappiness
20%

Return on
C
15%
8%
-4%

Return on
E
-5%
4%
10%

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ADMS3530 3.0

Assignment #2

Question 6 (12 marks)
Use the following to answer the questions below:
A market portfolio contains two stocks with the following returns: Aggressive

Stock A, and Defensive Stock D:
Scenario
Bust
Boom

Market
-8%
32

Rate of Return
Aggressive Stock A
-10%
38

Defensive Stock D
-6%
24

(a)

Find the beta of each stock. In what way is stock D defensive? (5 marks)

(b)

If each scenario is equally likely, find the expected rate of return on the
market portfolio and on each stock. (4 marks)

(c)

If the Treasury bill rate is 4 percent, what does the CAPM say about the

fair expected rates of return on the two stocks? (3 marks)

Question 7 (6 marks)
Calculate the nominal return, real return, and risk premium for the following
common stock investment:
Purchase price
$60.00 per share
Dividend
$3.50 per year
Sales price $73.00 per share
Treasury bill yield 8.5%
Inflation rate 7.5%
Question 8 (13 marks)
A company issued $35,000,000 of 15-year, 7.5%, $1,000 par value debt at par
three years ago. Assume semi-annual coupon payments. The yield to maturity
on comparable debt today is 9%. The firm also has 6,000,000 common shares
outstanding, which currently trade at $26.00 per share. The firm’s β is 1.26, the
T-bill rate is 3.5% and the market risk premium is 6.7%. Due to the early stage in
its corporate life cycle, the firm has significant tax-loss carry forwards, resulting in
the firm not expecting to have to pay taxes in the foreseeable future.
(a)

Compute the firm’s weighted average cost of capital (WACC). (6 marks)

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ADMS3530 3.0

Assignment #2

(b)

If the firm were able to issue an additional $26,000,000 in debt ($1,000 par
value) at an 8.5% coupon rate (paid semi-annually) and use the proceeds
to retire 1,000,000 shares, what would be the firm’s WACC? (4 marks)

(c)

How would your answer in part (a) change if the firm were taxable at
35%? (3 marks)

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ADMS3530 3.0

Assignment #2

Atkinson Faculty of Liberal and Professional Studies
YORK UNIVERSITY
Toronto, Ontario, Canada
ADMS3530 3.0
Finance
Professor
Section
Assignment #2
Due Date: Start of the last class, March 28 – April 3, 2007
(please check your class schedule)
Personal Work Statement

I, the undersigned:
• warrant that the work submitted herein is my work and not the work of others
• acknowledge that I have read and understood the Senate Policy on Academic
Honesty
• acknowledge that it is a breach of the University Regulations to give and
receive unauthorized assistance on a graded piece of work
Name (typed or printed)
York Student #
Signature

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