Corporate Finance Assignment (6 Problems) #5

1 FIN 6406 – Corporate Finance Len Lin Spring 2017 FINAL EXAM Due: 11:59pm EST on 3/3/2017(Friday ) READ THESE INSTRUCTIONS! 1. This exam is worth a total of 100 points. 2. You should electronically submit your final exam with detailed calculations via email to [email protected] . You will title the email “YO UR NAME – FINAL ”. You will title the document “YO UR NAME – FINAL ”. You will put your name on a title page. Good luck! Problem 1 [10 points] Stock 100 137 51 Bond (r F=2%) 100 102 102 Call ( E= 87 ) C 50 0 1 -year call option, S=100, E= 87 , rF=2% (annual) 1 step per year How much should the call option worth? 2 Problem 2 [15 points] If total return after tax on a certain project is 7.5%, and there are five financing choices available to investors: (1) 7 % interest rate and a 60% LTV ratio; (2) 7 .8% interest rate and a 70% LTV ratio; (3) 8 .5% interest rate and a 80% LTV ratio; (4) 9 .25% interest rate and a 90% LTV ratio; (5) 9 .75% interest rate and a 95% LTV ratio; Suppose that there are three types of investors (A, B and C) whose tax rates are 15%, 25% and 35%, respectively. Questions: (1) Find out the financing choice for each type of investor and the corresponding after -tax return on equity. (2) Which type of investor has the highest after -tax return on their equity? 3 Problem 3 [15 points] You currently have $2,5 00,000. You want to invest it in the following three assets: 10 -year US Tr easury bond with coupon rate 3.5 %, Blandy and Gourmange stocks, who have the following historical annual returns : Your goal is to have t he expected annual return of 7.2 % with a minimum portfolio risk. How much money should you allocate to these three assets? Year Blandy Gourmange 1 26.0% 47.0% 2 15.0% -54.0% 3 -14.0% 15.0% 4 -15.0% 7.0% 5 2.0% -28.0% 6 -10.0% 40.0% 7 22.0% 17.0% 8 30.0% -23.0% 9 -32.0% -4.0% 10 28.0% 75.0% 11 28.6% 51.7% 12 16.5% -59.4% 13 -15.4% 16.5% 14 -16.5% 7.7% 15 2.2% -30.8% 16 -11.0% 44.0% 17 62.2% 18.7% 18 33.0% -25.3% 19 -35.2% -4.4% 20 50.8% 82.5% 21 23.4% 42.3% 22 13.5% -48.6% 23 -12.6% 13.5% 24 -13.5% 6.3% 25 1.8% -25.2% 26 -9.0% 36.0% 27 18.8% 15.3% 28 27.0% -20.7% 29 -28.8% -3.6% 30 25.2% 67.5% 4 Problem 4 [30 points] A real estate investor has the following information on an apartment building:  Purchase Price is $1,125,0 00 with acquisition costs of $35 ,000  33,600 leasable square feet  Initial rent of $1.5/sq. ft. per month and will increase at the beginning of each year for 5 percent per year . For example, the first year rent from month 1 to month 12 is $1.5/sq. ft., the 2 nd year rent from month 1 to month 12 is $1.575 ($1.5*(1+5%)), and so on.  Vacancy rate of 5% of gross ren t per month.  Operating e xpenses are 25 % of effective gross i ncome  Three financing choices: 1. Mortgage with 75% LTV ratio, 20 years, monthly payments and 5% annual rate; 2. Mortgage with 80% LTV ratio, 20 years, monthly payments and 6% annual rate; 3. Mortgage with 85% LTV ratio, 20 years, monthly payments and 6.5 % annual rate;  Holding period is 3 years (36 months) and the capital improvement e xpenditure is assumed to be $2 0,000 at the end of the first year only ( 12 months) .  Ex pected increase in value is 50% in total when sold in year 3 (36 months) , 5% selling expenses  75 % depreciable with monthly depreciation.  Investor’s tax rate is 3 5%, and capital gain tax rate is 15%. Questions: 1. Compute equity after -tax cash flows from month 1 to month 36 for each financing choice. 2. What is the equity after -tax annual return (internal rate of return) for each financing choice and which choice would you like to make? 5 Problem 5 [15 points] Based on the Capital Asset Pricing Model (CAPM) and the diagram below, what is the return of the stock if its beta is 1.5 or 0.5 ? Problem 6 [ 15 points] Compute the IRR, NPV, PI, and pa yback period for the following two projects. Assume the required return is 12 %. Expected return b 1% 5 . 3  F R %3 % 10 % 12  M R Project A Project B Year Cash flow Cash flow 0 -2500 -2500 1 900 50 2 800 600 3 1600 150 4 100 900 5 50 500 6 300 2500