Midterm Exam

Answer Sheet Mid Term Exam Financial Management

1. Robert Arias
Ratio Island Electric Burger Heaven Fink Software Roland Motors
Utility
Current Ratio 1.10 1.30 6.80 4.50
Quick Ratio 0.90 0.82 5.20 3.70
Debt Ratio 0.68 0.46 0.00 0.35
Net Profit 6.2% 14.3% 28.5% 8.4%
Margin
a. What problems might he encounter in comparing the portfolio?
- Those for companies are from different industries
- The different industries make the operating characteristics various and makes the
ratio values also hard to compare
- The older to newer firms comparison must be cautioned, such as utility and
software company
- The financial ratios from software companies are never very reliable
b. Why might the current and quick ratios for electric utility and the fast-food stock be
so much lower than the same ratios for other companis?
- Might be related to poor management performance
- These 2 industries are most lakiley to operate on cash basis
- Their inventory balance is very likely to be close to zero because the utility and
burgers is imposibble to be stocked
- Their accounts receivable is most likely to be lower since they operate mostly on
cash and has a very quick opreation flow
c. Why it might be alright for the electric utility to carry large amount of debt, but not
software company?
- Electric utility is most likely to have steady cash flow needs
- A high level of debt is not a problem for utility because of it steady cash flow, it
could even be maintained if the firm has a large and predictable cash flow
- The software firm is most likely to have an uncertain and changing cashflow
- This changing cash flow is because the software industry has a greater
competitive condition
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d. Why wouldn’t investors invest all of their money in software companies instead of in
less profitable companies?
- By placing all money in one stock, the reduced risk which can be obtained by
investing diversified stocks is not possible
- Software companies tend to carry large amounts of debt
- The average collection period of software companies is very high
- The risk in software companies is big because of its uncertainties.

2. Pelican Paper Inc. and Timberland Forest. Ratio analysis comparing the firms’ financial
leverages and profitability is given:
A. Calculating debt and coverage ratios
1. Debt Ratio
a. Debt Ratio of Pelican Paper
𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
= 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
$1,000,000
= $10,000,000

= 0.1
= 10%
b. Debt Ratio of Timberland Forest
𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
= 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
$5,000,000
= $10,000,000

= 0.5
= 50%
2. Times interest earned ratio
a. Time interest earned ratio (Pelican paper)
𝐸𝐵𝐼𝑇
= 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
$6,250,000
= $100,000

= 62.5
b. Time interest earned ratio (Timberland forest)
𝐸𝐵𝐼𝑇
= 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
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$6,250,000
= $500,000

= 12.5
B. Calculate probability ratios for two companies
1. Operating Net Profit Margin
a. Net profit margin (Pelican Paper)
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠
= 𝑆𝑎𝑙𝑒𝑠
$3,690,000
= $25,000,000

= 0.1476
b. Net Profit margin (Timberland forest)
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠
= 𝑆𝑎𝑙𝑒𝑠
$3,450,000
= $25,000,000

= 0.138
2. Return on Total Assets
a. Return on Total Assets (Pelican Paper)
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠
= 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
$3,690,000
= $10,000,000

= 0.369
b. Return on Total Assets (Timberland Forest)
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠
= 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
$3,450,000
= $10,000,000

= 0.345
3. Return on common equity
a. Return on Common Equity (Pelican Paper)
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠
= 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 (𝐴𝑙𝑙 𝑐𝑜𝑚𝑚𝑜𝑛)
$3,690,000
= $9,000,000

= 0.41
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b. Return on Common Equity (Timberland paper)

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑓𝑜𝑟 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠
= 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 (𝐴𝑙𝑙 𝑐𝑜𝑚𝑚𝑜𝑛)

$3,450,000
= $5,000,000

= 0.69
C. Why the larger of debt of Timberland Forest made it more profitable than Pelican
Paper? What are the risks?
- Timberland forest operates in more efficient way
- Since Timberland has larger debt, the stockholder’s equity is also reduced and
results in higher ROE than Pelican
- The higher ROE brings higher level of financial risk
- The company won’t be able to compensate unseen events

3. DC fragrance purchase equipment

CF = $245,000
After tax inflow of $68,500 for 5 years

Year Cashflow Present Value

0 - $245,000 - $245,000.00
1 $68,500 $59,565.22
2 $68,500 $51,795.84
3 $68,500 $45,039.86
4 $68,500 $39,165.10
5 $68,500 $34,056.61

$68,500 $68,500 $68,500 $68,500 $68,500

a. NPV = -$245,000 + (1+15%)1 + (1+15%)2 + (1+15%)3 + (1+15%)4 + (1+15%)5

= - $245,000 + $229,622.62
= - $15,377.38
NPV < 0, then the project is unacceptable.
b. The highest cost of capital or the closest whole-percentage rate can be found by
finding the IRR.
IRR (r) is the rate when NPV = 0
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$68,500 $68,500 $68,500 $68,500 $68,500

NPV = -$245,000 + (1+𝑟)1
+ (1+𝑟)2
+ (1+𝑟)3
+ (1+𝑟)4
+ (1+𝑟)5
=0

I use excel formula IRR

Year Cash Flow

0 -$245,000
1 $68,500
2 $68,500
3 $68,500
4 $68,500
5 $68,500
IRR 12.317%

When the expected return is 12.317%, the cashflow and present value table would be
Year Cash Flow Present Value
0 -$245,000 -$245,000.00
1 $68,500 $60,988.07
2 $68,500 $54,299.93
3 $68,500 $48,345.22
4 $68,500 $43,043.53
5 $68,500 $38,323.24
Total $245,000.00

The maximum expected return that the firm needs for the project to be acceptable is
12%. On the other hand, the required return of the project (cost of capital) is 15%. Since
the expected return is < the required return, then the project is rejected.
This finding is the same as the part A when we use the NPV method. The results of
both the NPV and IRR methods are to reject the project.
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4. Simes Innovations Inc. is not sure whether to buy a solar-powered toy car in one-time
payment of $1,500,000 or 5 year-end payment $385,000
a. Simes has cost of Capital of 9%, which form of payment is better?
- Calculate Present Value of 5 year-end future Value
Sum of Present Value of 5 year-end future value
$385,000 $385,000 $385,000 $385,000 $385,000
= (1+9%)1 + (1+9%)2 + (1+9%)3 + (1+9%)4 + (1+9%)5

= $1,497,515,736
Rate 9%
Year Future Value Present Value
1 $385,000.00 $353,211.01
2 $385,000.00 $324,046.80
3 $385,000.00 $297,290.64
4 $385,000.00 $272,743.71
5 $385,000.00 $250,223.58
TOTAL $1,497,515.74
The total of 5 year-end payment of $385,000 is lower than one time payment of
$1,500,000
Therefore, Siemens should choose 5 year-end payment of $385,000
b. What yearly payment would make the two offers identical in value at a cost of capital
of 9%?
- Calculate present value factor at 9 percent for 5 years
1−(1+𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒)−𝑦𝑒𝑎𝑟𝑠
PV factor = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒
1−(1+0.09)−5
= 0.09

= 3.890
- Calculate the required amount
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡
Required amount = 𝑃𝑉 𝐹𝑎𝑐𝑡𝑜𝑟 𝑎𝑡 9% 𝑓𝑜𝑟 5 𝑦𝑒𝑎𝑟𝑠
$1,500,000
= 3.890

= $385,639.69
c. If the yearly payments were made at the beginning of the year. What is the
difference&will it affect the decision?
Present value at the beginning = PV of 5 year-end FV x Sum of interest
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= $4,497,515.74 x (1+9%)
= $1,632,292.15
So, the decision will change because the FV yearly is higher than one-time
investment.
d. After tax cash inflow are projected amount to $250,000 per year for 15 years. Will
this factor change the firm’s decision?
- Calculate PV of cash inflows
$250,000 $250,000 $250,000
= (1+9%)1 + (1+9%)2 + …+ (1+9%)15

= $2,015,172.11
Rate 9%
Year Future Value Present Value
1 $250,000.00 $229,357.80
2 $250,000.00 $210,420.00
3 $250,000.00 $193,045.87
4 $250,000.00 $177,106.30
5 $250,000.00 $162,482.85
6 $250,000.00 $149,066.83
7 $250,000.00 $136,758.56
8 $250,000.00 $125,466.57
9 $250,000.00 $115,106.94
10 $250,000.00 $105,602.70
11 $250,000.00 $96,883.21
12 $250,000.00 $88,883.68
13 $250,000.00 $81,544.66
14 $250,000.00 $74,811.62
15 $250,000.00 $68,634.51
TOTAL $2,015,172.11

- NPV for 5 years end payments

PV of cash inflows – PV of cash outflows
= $2,015,172.11 - $1,497,515.74
= $517,656.37
- NPV for one time payment
PV of cash inflows – PV of cash outflows
= $2,015,172.11 - $1,500,000
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= $515,172.11
- Conclusion: NPV of 5 year-end payment is higher than the NPV of one-time payment,
then, the decision is still to have 5 year-end payments.

5. Aluminum Project
a. The range of annual cash inflows of machine A
= optimistic cashflow – pessimistic cashflow
= $1,350 - $550
= $800
The range of annual cash inflows of machine B
= optimistic cashflow – pessimistic cashflow
= $1200 - $850
= $350
b. Construct NPV
- Find the Total Annual Present Value of Machine A

Cost of Capital 10%

Machine A
Year
Pessimistic PV Most Likely PV Optimistic PV
1 $550 $500.00 $950 $863.64 $1,350 $1,227.27
2 $550 $454.55 $950 $785.12 $1,350 $1,115.70
3 $550 $413.22 $950 $713.75 $1,350 $1,014.27
4 $550 $375.66 $950 $648.86 $1,350 $922.07
5 $550 $341.51 $950 $589.88 $1,350 $838.24
6 $550 $310.46 $950 $536.25 $1,350 $762.04
7 $550 $282.24 $950 $487.50 $1,350 $692.76
8 $550 $256.58 $950 $443.18 $1,350 $629.78
9 $550 $233.25 $950 $402.89 $1,350 $572.53
10 $550 $212.05 $950 $366.27 $1,350 $520.48
11 $550 $192.77 $950 $332.97 $1,350 $473.17
12 $550 $175.25 $950 $302.70 $1,350 $430.15
TOTAL PV $3,747.53 TOTAL PV $6,473.01 TOTAL PV $9,198.48
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Cost of
Capital 10%
Machine B
Year
Pessimistic PV Most Likely PV Optimistic PV
1 $850 $772.73 $1,050 $954.55 $1,200 $1,090.91
2 $850 $702.48 $1,050 $867.77 $1,200 $991.74
3 $850 $638.62 $1,050 $788.88 $1,200 $901.58
4 $850 $580.56 $1,050 $717.16 $1,200 $819.62
5 $850 $527.78 $1,050 $651.97 $1,200 $745.11
6 $850 $479.80 $1,050 $592.70 $1,200 $677.37
7 $850 $436.18 $1,050 $538.82 $1,200 $615.79
8 $850 $396.53 $1,050 $489.83 $1,200 $559.81
9 $850 $360.48 $1,050 $445.30 $1,200 $508.92
10 $850 $327.71 $1,050 $404.82 $1,200 $462.65
11 $850 $297.92 $1,050 $368.02 $1,200 $420.59
12 $850 $270.84 $1,050 $334.56 $1,200 $382.36
TOTAL PV $5,791.64 TOTAL PV $7,154.38 TOTAL PV $8,176.43

NPV = - Investment + Total PV

The table below shows the NPV and NPV Range of each scenario
Machine A Machine B
Pessimistic Most Likely Optimistic Pessimistic Most Likely Optimistic
Life of project (years) 12 12 12 12 12 12
Cost of Capital 10% 10% 10% 10% 10% 10%
Annual Cash Flow $550 $950 $1,350 $850 $1,050 $1,200
PV of Cash flows $3,747.53 $6,473.01 $9,198.48 $5,791.64 $7,154.38 $8,176.43
Initial Investment -$5,000 -$5,000 -$5,000 -$5,500 -$5,500 -$5,500
NPV -$1,252.47 $1,473.01 $4,198.48 $291.64 $1,654.38 $2,676.43
NPV Range $5,450.95 $2,384.79
c. Based on NPV and NPV Range calculation, machine A is riskier (the range is higher
than B) but could provide higher return than Machine B. The recommendation would
repend on the risk management. If the investor is a risk seeker, then machine A would
be more recommended.
d. If the comppany if not willing to take risk (a risk averter), then machine B would be
more recommended since the NPV of machine B still give positive return even in
pessimistic scenarios.
 Midterm Exam

6. Ogden Corporation
Known:
1. Cash inflows, normally distributed with a mean of $36,000, std deviation $9,000
Using Data analysis – random number generation on Excel

2. Cash outflows, normally distributed with a mean of $30,000, std deviation $6,000

3. Cost of capital = 11%

4. Probability distributions of cash inflows and outflows are not expected to change in
10 years
Answer:
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a. The data can be used to develop simulation model and finding net present value. The
table is below:
Cost of Capital 11%
PV of cash PV of cash
Year Cash inflow Cash Outflow
inflow outflow
1 $26,453.72 $23,832.18 $44,765.90 $40,329.64
2 $31,732.68 $25,754.95 $24,206.34 $19,646.41
3 $26,870.05 $19,647.15 $21,956.57 $16,054.45
4 $34,314.06 $22,603.74 $24,159.33 $15,914.50
5 $28,431.88 $16,872.94 $28,015.76 $16,625.99
6 $44,019.90 $23,534.84 $21,377.64 $11,429.36
7 $37,780.62 $18,197.35 $32,475.67 $15,642.18
8 $41,315.71 $17,927.98 $27,240.10 $11,820.20
9 $41,074.96 $16,057.22 $19,417.03 $7,590.60
10 $42,089.22 $14,823.17 $28,694.73 $10,105.84
Total PV of cash
Total PV of cash inflow $199,251.52 $165,159.16
outflow
NPV $34,092.36
The data can be used to develop the simulation model and predict the next 10 years
cash inflow and cash outflow. Using this data, we can understand whether the Net
present Value of the cash flow is positive or negative. Using Excel, we can generate
normally distributed data with specific mean and standard deviation, the data generated
might be different for each simulation, but since the mean and standard deviation don’t
change, the result will be the same. In this case, the NPV will always be positive
because the cash inflow is higher than the cash outflow in present value. Therefore, we
can make decision to accept the project.

b. The advantages of using a simulation to evaluate the proposed project

- The investors are confirmed about the feasibility of the project by using NPV
- If NPV is positive, the manager can accept the project. On the other hand, if the
NPV is negative, the manager better reject the project
- The NPV represents the profit or loss of the project

7. Fine Leather Enterprise

- Price = $129
- Fixed cost annually = $473,000
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- Variable cost per unit = $86

𝐹𝐶
a. Breakeven point (unit) = 𝑃−𝑉𝐶
$473,000
= $129 − 86

= 11,000 units
b. X-axis = sales (units)
Y-axis = cost/revenue
Graph:
Volume Of Marginal
FC VC Total Cost Income Net Profit
Production Income
0 $473,000.00 $0.00 $473,000.00 $0.00 $0.00
4000 $473,000.00 $344,000.00 $817,000.00 $516,000.00 $172,000.00 -$301,000.00
8000 $473,000.00 $688,000.00 $1,161,000.00 $1,032,000.00 $344,000.00 -$129,000.00
12000 $473,000.00 $1,032,000.00 $1,505,000.00 $1,548,000.00 $516,000.00 $43,000.00
16000 $473,000.00 $1,376,000.00 $1,849,000.00 $2,064,000.00 $688,000.00 $215,000.00
20000 $473,000.00 $1,720,000.00 $2,193,000.00 $2,580,000.00 $860,000.00 $387,000.00
24000 $473,000.00 $2,064,000.00 $2,537,000.00 $3,096,000.00 $1,032,000.00 $559,000.00

We got the breakeven point is when the unit of sales 11,000.

Loss happens when total expense > sales (revenues), which is located at the area
under the breakeven point.
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Whereas Profit (EBIT) happens when sales (revenues) > total expense, which is
located at the area above the breakeven point.

8. Diane’s Florist
- Price = $63.5
- Fixed cost annually = $380,000
- Variable cost per unit = $16
𝐹𝐶
a. Breakeven point (unit) = 𝑃−𝑉𝐶
$380,000
= $63.5 − 16

= 8,000 units
b. Calculate EBIT
EBIT = Sales – variable cost – fixed cost
Level of sales in units 9000 10000 11000
Sales (Q x P) $571,500 $635,000 $698,500
Variable cost (Q x VC) -$144,000 -$160,000 -$176,000
Fixed cost -$380,000 -$380,000 -$380,000
EBIT $47,500 $95,000 $142,500

c. Percentage changes in units sold and EBIT, if sales change from 10,000 to 9,000 and
10,000 to 11,000

Unit Sales 10000 9000 11000

Change in unit
0 9,000 - 10,000 = -1,000 11,000 - 10,000 = +1,000
sales
9,000−10,000 11,000−10,000
% change in sales 0 x 100% = -10% x 100% = +10%
10,000 10,000
$47,500 - $95,000 = - $142,500 - $95,000 =
Change in EBIT 0
$47,500 +$47,500
142,500−95,000
47,500−95,000 x 100% =
% Change in EBIT 0 x 100% = -50% 95,000
95,000
+50%

Unit Sales 10000 9000 11000

Change in unit sales 0 -1000 + 1000
% change in sales 0 -10% + 10%
Change in EBIT 0 -$47,500 + $47,500
%change in EBIT 0 -50% + 50%
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d. Calculate degree of operating level at 11,000

% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝐵𝐼𝑇
Degree of Operating Level (DOL) = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠
+ 50%
= + 10%

=5

9. The MBA Decision

1. Ben’s Age affect his decision to get an MBA because it is one thing that is important
to make decision to consinue study. Age affects the experience gained and duration of
the job and salary prospect after finishing the study. Let’s assume that Ben has working
experience for about 5 years after he finished his first degree, and he is able to save his
money to pay for his MBA. If he starts the MBA program at 28, and the study will
likely finish in 2 years, he’s start working again when he’s 30 years old. After that, he
will work again for about 40 years after getting an MBA degree with the salary almost
50% higher than the previous salary. With those reasons, Ben’s age affects his decision
to continue his study
2. What other (no quantifable factors) affect Ben’s decision to get an MBA?
- The job experience requirement to enter MBA program
- His career path after getting MBA degree
- Family conditions, like having spouse or children
- His commitment to continuing education
- His exposure of jobs and relations he will get during MBA program
- He isn’t allowed to work while studying in MBA program
- Years left to work before retired
3. The best option for Ben from a strictly financial standpoint?
a. Keep his current work for the next 40 years without continuing to MBA
- Salary = $60,000
- Tax rate = 26%
- Net salary after tax = $44,400
- r (discount rate) = 6.5%
 Midterm Exam

- g (growth rate) = 3%
- t (number of periods working) = 40
Calculate using PV of growing annuity
𝐶 1+𝑔 𝑡
PV = 𝑟−𝑔 [1 − ( 1+𝑟 ) ]

$44,400 1+3% 40
= 6.5%−3% [1 − (1+6.5%) ]

= $935,283.49

b. Getting the MBA at Wilton University, work for the next 38 years
Calculate NPV
= PV of salary for 38 years after finish MBA + PV for signing bonus – PV of
costs for 2 years (tuition, book&supplies, health insurance, rent fee) – PV of 2
years salary when he works at the money management
• PV of salary for 38 years
- Salary = $110,000
- Tax rate = 31%
- Net salary after tax = $75,900
- r (discount rate) = 6.5%
- g (growth rate) = 4%
- t (number of periods working) = 40 – 2 = 38
PV of Growing Annuity
𝐶 1+𝑔 𝑡
PV = 𝑟−𝑔 [1 − ( 1+𝑟 ) ]

$75,900 1+4% 38
= 6.5%−4% [1 − (1+6.5%) ]

= $1,804,927.68
• PV of signing bonus
- Signing bonus = $20,000
- r (discount rate) = 6.5%
- t (number of periods working) = 40 – 2 = 38
 Midterm Exam

$20,000
PV = (1+6.5%)38

= $1,827.03

• PV cost for 2 years

- Total cost = $65,000 (tuition) + $3,000 (book and other supplies) +
$3,000 (health insurance plan) + $2,000 (room&board expenses) =
$73,000
- r (discount rate) = 6.5%
- t =2
PV of annuity
1
1−( )
(1+𝑟)𝑡
PV =Cx 𝑟
1
1−( )
(1+6.5%)2
= $73,000 x 6.5%

= $132,905.73

• PV of 2 years salary when he works at money management

- Salary = $60,000
- Tax rate = 26%
- Net salary after tax = $44,700
- r (discount rate) = 6.5%
- g (growth rate) = 3%
- t (number of periods working) = 2
𝐶 1+𝑔 𝑡
PV = 𝑟−𝑔 [1 − ( 1+𝑟 ) ]

$60,000 1+3% 2
= 6.5%−3% [1 − (1+6.5%) ]

= $82,010.18
TOTAL NPV = $1,804,927.68 + $1,827.03 - $132,905.73 - $82,010.18
= $1,591,838.80
 Midterm Exam

c. Getting the MBA at Mount Perry College, work for the next 39 years
Calculate NPV
= PV of salary for 39 years after finish MBA + PV for signing bonus – PV of
costs for 1 year (tuition, book&supplies, health insurance, rent fee) – PV of 1 year
salary when he works at the money management
• PV of salary for 39 years
- Salary = $92,000
- Tax rate = 29%
- Net salary after tax = $65,320
- r (discount rate) = 6.5%
- g (growth rate) = 3.5%
- t (number of periods working) = 40 – 1 = 39
PV of Growing Annuity
𝐶 1+𝑔 𝑡
PV = 𝑟−𝑔 [1 − ( 1+𝑟 ) ]

$65,320 1+3.5% 39
= 6.5%−3.5% [1 − (1+6.5%) ]

= $1,462,896.49

• PV of signing bonus
- Signing bonus = $18,000
- r (discount rate) = 6.5%
- t (number of periods working) = 40 – 1 = 39
$18,000
PV = (1+6.5%)39

= $1,543.97
• PV cost for 1 year
- Total cost = $80,000 (tuition) + $4,500 (book and other supplies) +
$3,000 (health insurance plan) + $2,000 (room&board expenses) =
$89,500
- r (discount rate) = 6.5%
- t =1
 Midterm Exam

PV of annuity
1
1−( )
(1+𝑟)𝑡
PV =Cx 𝑟
1
1−( )
(1+6.5%)1
= $89,500 x 6.5%

= $84,037.56
• PV of 1 year salary when he works at money management
- Salary = $60,000
- Tax rate = 26%
- Net salary after tax = $44,700
- r (discount rate) = 6.5%
- g (growth rate) = 3%
- t (number of periods working) = 1
𝐶 1+𝑔 𝑡
PV = 𝑟−𝑔 [1 − ( 1+𝑟 ) ]

$60,000 1+3% 1
= 6.5%−3% [1 − (1+6.5%) ]

= $41,690.14
TOTAL NPV = $1,462,896.49 + $1,543.97- $84,037.56 - $41,690.14
= $1,338,712.73

Table of comparison
No MBA MBA at Wilton MBA at Mount Perry
Degree University College
NPV $935,283.49 $1,591,838.80 $1,338,712.73
Conclusion: The best decision is for him to choose an MBA at Wilton University because
he will receive the most money after finishing his study.

4. Calculate the Future value of each option

a. Keep his current work for the next 40 years without continuing to MBA
Calculate Future Value if he worked at his current company, from the preivous
calculation, we obtain the PV
PV = $935,283.49
 Midterm Exam

FV = 𝑃𝑉 𝑥 (1 + 𝑟)𝑡
= $935,283.49 𝑥 (1 + 6.5%)40
= $11,612,549.47

b. Getting the MBA at Wilton University, work for the next 38 years
Calculate Future Value
= FV of salary for 38 years after finish MBA + FV for signing bonus – FV of costs
for 2 years (tuition, book&supplies, health insurance, rent fee) – FV of 2 years salary
when he works at the money management
• FV of salary for 38 years
PV = $1,804,927.68
FV = 𝑃𝑉 𝑥 (1 + 𝑟)𝑡
= $1,804,927.68 𝑥 (1 + 6.5%)38
= $19,758,087.37
• FV of signing bonus
PV = $1,827.03
FV = 𝑃𝑉 𝑥 (1 + 𝑟)𝑡
= $1,827.03𝑥 (1 + 6.5%)38
= $20,000
• FV cost for 2 years
PV = $132,905.73
FV = 𝑃𝑉 𝑥 (1 + 𝑟)𝑡
= $132,905.73(1 + 6.5%)2
= $150,745.00
• FV of 2 years salary when he works at money management
PV = $82,010.18
FV = 𝑃𝑉 𝑥 (1 + 𝑟)𝑡
= $82,010.18(1 + 6.5%)2
= $93,018.00
TOTAL Futue Value = $19,758,087.37 + $20,000 - $150,745.00 - $93,018.00
= $19,534,324.37
 Midterm Exam

c. Getting the MBA at Mount Perry College, work for the next 39 years
Calculate Future Value
= FV of salary for 39 years after finish MBA + FV for signing bonus – FV of costs
for 1 year (tuition, book&supplies, health insurance, rent fee) – FV of 1 year salary
when he works at the money management

• FV of salary for 39 years

PV = $1,462,896.46
FV = 𝑃𝑉 𝑥 (1 + 𝑟)𝑡
= $1,462,896.46𝑥 (1 + 6.5%)39
= $17,054,865.26

• FV of signing bonus
PV = $1,543.97
FV = 𝑃𝑉 𝑥 (1 + 𝑟)𝑡
= $1,543.97 𝑥 (1 + 6.5%)39
= $18,000
• FV cost for 1 year
PV = $84,037.56
FV = 𝑃𝑉 𝑥 (1 + 𝑟)𝑡
= $84,037.56 𝑥 (1 + 6.5%)1
= $89,500
• FV of 1 year salary when he works at money management
PV = $44,690.14
FV = 𝑃𝑉 𝑥 (1 + 𝑟)𝑡
= $44,690.14𝑥 (1 + 6.5%)1
= $44,400
TOTAL Futue Value = $17,054,865.26 + $18,000 - $89,500 - $44,400
= $16,938,965.26
 Midterm Exam

Table of comparison
No MBA Degree MBA at Wilton University MBA at Mount Perry College
FV $11,612,549.47 $19,534,324.37 $16,938,965.26
Conclusion: The best decision is for him to choose MBA at Wilton University because he
will have the highest future value compared to the others.

5. The initial salary would Ben need to receive to make him indefferent between
attending Wilton University and staying in his current position.
• Staying in his current position (PV1) (annual growth)
• Getting the MBA at Wilton university (PV2) = $1,804,927.68
• PV1 = PV 2
𝐶1 1+3% 40
[1 − (1+6.5%) ]= $1,804,927.68
6.5%−3%
𝐶1
𝑥 0.738 = $1,804,927.68
6.5%−3%
$$1,804,927.68
C1 = 𝑥 3.5%
0.738

= $85,599.55

6. Instead of paying cash to take his MBA, he needed to borrow money. The current
borrowing rate is 5.4%. How would this affect his decision?
a. Getting the MBA at Wilton University for 2 years
Assume that he will pay for the borrowed money for 5 years after he graduated:
Wilton University
Amount borrowed $146,000.00
Rate 5.40%
Period 5

Beginning Total Principal Ending

Year Interest Paid
Balance Payment paid balance
1 $146,000.00 $34,096.06 $7,884.00 $26,212.06 $119,787.94
2 $119,787.94 $34,096.06 $6,468.55 $27,627.51 $92,160.43
3 $92,160.43 $34,096.06 $4,976.66 $29,119.39 $63,041.04
4 $63,041.04 $34,096.06 $3,404.22 $30,691.84 $32,349.20
5 $32,349.20 $34,096.06 $1,746.86 $32,349.20 $0.00
TOTAL $170,480.29 $24,480.29 $146,000.00
 Midterm Exam

The Total payments were calculated using Ms Excel with the formula =PMT. This formula is
used to calculate payments of the money in periodic and continuous, and fixed interest rates.

The sum of payments in 5 years is $170,480.29. we need to calculate the present value with the
discount rate 6.5%.
- C = $170,480.29
- r (discount rate) = 6.5%
- t (number of periods) =5
$170,480.29
PV = (1+6.5%)5

= $124,430.30
We replace the present value of the costs calculated previously on 9-2 with the new PV if he
borrows money
TOTAL NPV = $1,804,927.68 + $1,827.03 - $124,430.30- $82,010.18
= $1,600,314.23

b. Getting the MBA at Mount Perry College for 1 year

Mount Perry
Amount borrowed $89,500.00
Rate 5.40%
Period 5

Beginning Total Interest Principal Ending

Year
Balance Payment Paid paid balance
1 $89,500.00 $20,901.35 $4,833.00 $16,068.35 $73,431.65
2 $73,431.65 $20,901.35 $3,965.31 $16,936.04 $56,495.61
3 $56,495.61 $20,901.35 $3,050.76 $17,850.59 $38,645.02
4 $38,645.02 $20,901.35 $2,086.83 $18,814.52 $19,830.50
5 $19,830.50 $20,901.35 $1,070.85 $19,830.50 $0.00
TOTAL $104,506.75 $15,006.75 $89,500.00

The Total payments were calculated using Ms Excel with the formula =PMT. This formula is
used to calculate payments of the money in periodic and continuous, and fixed interest rates.
 Midterm Exam

The sum of payments in 5 years is $104,506.75. we need to calculate the present value with the
discount rate 6.5%.
- C = $104,506.75
- r (discount rate) = 6.5%
- t (number of periods) =5
$104,506.75
PV = (1+6.5%)5

= $76,277.47
We replace the present value of the costs calculated previously on 9-2 with the new PV if he
borrows money
TOTAL NPV = $1,462,896.49 + $1,543.97 - $76,277.47 - $41,690.14
= $1,346,472.82

Table of Comparison
No MBA MBA at Wilton MBA at Mount Perry
Degree University College
NPV $935,283.49 $1,600,314.23 $1,346,472.81

Conclusion: The best decision is for him to choose MBA at Wilton University because he will
still have the highest value among all, although the NPV is less than if he didn’t borrow the money.

10. The Cost of Capital for Goff Computer, Inc. (GCI)

1. Look on the balance sheet to find the book value of debt and the book value of
equity.
“Long-term Debt” or “Long Term Debt and Interest Rate Risk Management”
 Midterm Exam

a. 10 K

Book Value Equity of 10 K (in millions) January 29, 2021

- Total Assets = $123,415
- Total Liabilities = $115,390
Book value of Equity = Total Assets – Total Liabilities
Book Value of Equity = $123,415 - $115,390 = $8,052
Long Term Debt of 10K = $41,622
 Midterm Exam

b. 10Q

Book Value Equity of 10 Q (in millions) October 29, 2021

- Total Assets = $135,677
- Total Liabilities = $121,483
Book value of Equity = Total Assets – Total Liabilities
Book Value of Equity = $135,677- $121,483 = $14,194
Long Term Debt of 10Q = $31,699
 Midterm Exam

2. Estimate the cost of equity for Dell

- The most recent stock price listed for Dell?
The most recent stock price at Friday close market was $59.51

- What is the market value of equity or market capitalization?

Market Capitalization of Dell = $45.459 Billion
- How many shares of stock does Dell have outstanding?

From 10K report by sec.gov, the common stock outstanding was reported
762,667,390 shares as of March 23, 2021
- What is the beta for Dell? 0.95
- Yield on 3-month treasury bills?

0.3380
 Midterm Exam

- Using a 7 percent market risk premium, what is the cost of equity for Dell
using the CAPM?
𝑅𝑓 + (𝐵𝑒𝑡𝑎 𝑥 (𝑀𝑎𝑟𝑘𝑒𝑡 𝑟𝑖𝑠𝑘 𝑝𝑟𝑒𝑚𝑖𝑢𝑚)
= 0.338% + 0.95 x (7%)
= 0.338% + 6.65%
= 6.988%

3. Find the competitors, find the beta, and calculate the average beta
- Using the average beta, what is the cost of equity?
Company TICKER Beta
Asus 2357.TW 0.42
Lenovo LNVGY 1.17
HP HPQ 1.01
Apple Inc AAPL 1.19
IBM IBM 1.09
Cisco CSCO 0.98
Intel Corp INTC 0.54
Average 0.91

Cost of Equity using CAPM

𝑅𝑓 + (𝐵𝑒𝑡𝑎 𝑥 (𝑀𝑎𝑟𝑘𝑒𝑡 𝑟𝑖𝑠𝑘 𝑝𝑟𝑒𝑚𝑖𝑢𝑚)
= 0.338% + 0.91 x (7%)
= 0.338% + 6.37%
= 6.708%
- Does it matter if we use the beta for Dell of the beta for the industry in this
case?
Yes, we better use the beta of the industry as it reflects the market beta and would
give us the future prospect of Dell. Whereas, if we only use the beta of Dell itself,
we only use the historical data of 5 Years of Dell only.
 Midterm Exam

4. Find the YTM for each of Dell’s bonds

- What is the weighted average cost of Debt for Dell using the book value
weights and the market value weights?

Source:
https://finra-
markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C530085&symbol
=DELL.GN
 Midterm Exam

Source:
https://finra-
markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C487073&symbol
=DELL.GH
 Midterm Exam

Source:
https://finra-
markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C72804&symbol=
DELL.GB

Book Value Percent Weighted Weighted

Market
(original Percent of Quoted of total YTM% Book market
Value (in
offering in total BV (a) Price market (c) Value value
thousand)
thousand) value (b) (a*c) (b*c)
DELL.GN $300,000 0.300 $104 $264,389 0.278 5.071 1.521 1.408
DELL.GH $400,000 0.400 $116 $387,815 0.407 5.040 2.016 2.053
DELL.GB $300,000 0.300 $118 $300,000 0.315 3.747 1.124 1.181
Total $1,000,000 $952,204 4.661 4.641

From the calculation, the weighted book value is 4.661%, whereras the weighted
market value is 4.641%.
- Does it make a difference in this case if we use book value weights or market
value weights?
Since there is only slight difference between these 2, it proves that it would generate
more or less the same result in calculating Dell’s cost of debt using book value or
market value.

5. Calculate the WACC for Dell using book value weights and market value
weights, assuming Dell has 35 percent marginal tax rate. Which cost of capital
number is more important?
𝐷 𝐸
𝑊𝐴𝐶𝐶 = (1 − 𝑇𝑐)𝑥 (𝑉 𝑥 𝑅𝑑) + ( 𝑉 𝑥 𝑅𝑒)
 Midterm Exam

WACC of Dell using 10K Report

DELL 10K
BV Debt (D) $1,000,000,000
BV Equity (E) $8,052,000,000
Rd 4.661
Re 6.988
Tc 35%

$1,000,000,000 $8,052,000,000
𝑊𝐴𝐶𝐶 = (1 − 35%)𝑥 ($9,052,000,000 𝑥 4.661) + ( $9,052,000,000 𝑥 6.988)

= 6.551%

WACC of Dell using 10Q Report

DELL 10Q
BV Debt (D) $1,000,000,000
BV Equity (E) $14,197,000,000
Rd 4.661
Re 6.988
Tc 35%
$1,000,000,000 $14,197,000,000
𝑊𝐴𝐶𝐶 = (1 − 35%)𝑥 ($15,197,000,000 𝑥 4.661) + ( $15,197,000,000 𝑥 6.988)

= 6.728%

I Use $1,000,000,000 for the book value of debt of Dell instead of the Long-
term debt from balance sheet because I assume that the debt is only from the
bonds. Using the Long-term debt from the balance sheet means that the debt came
from more various components, and we don’t have the data for the market value of
debt. Therefore, both of our market value and company use the debt from bonds.
 Midterm Exam

WACC of Dell using Market value

Market
D $952,204,000
E $45,459,000,000
Rd 4.641
Re 6.708
Tc 35%
$952,204,000 $45,459,000,000
𝑊𝐴𝐶𝐶 = (1 − 35%)𝑥 ($46,411,204,000 𝑥 4.661) + ( $46,411,204,000 𝑥 6.988) =

6.632%

Book value is the net value of a company’s asset from its balance sheet, and it is
equal to the total amount of all shareloders would get if they liquidated the
company. Whereas market value is the company’s worth based on the total value
of its outstanding shares in the market, which is market capitalization.
Although the WACC calculation result is only slightly different, the most important
among what we calculated is using market value because it provides concrete
method to determine what an asset is worth. To calculate the WACC, market value
is also generally uses because the expected cost of the new capital is more important
than the sale of existing assets, moreover, the market

6. We used Dell as a representative company to estimate the cost of capital for GCI.
- What are some potential problems with this approach in this situation?
• The two companies basically operate differently. Dell operates through
online and has many branches across the world, whereas CGI operates
in store only.
• Dell is already public since it has been listed in the stock market, but
the GCI hasn’t, it means that the scale of company is different, Dell is
much larger than GCI.
• Because of these 2 reasons, we cannot estimate the cost of capital for
GCI by using the cost of capital of Dell. The result won’t represent the
GCI cost of capital since the operating areas and companies’ scale is
very different.
 Midterm Exam

- What improvements might be suggested?

• If GCI wants to raise more capital, GCI might want to consider
publicizing its stock in the stock market.
• GCI also mignt want starting to sell using online commerce to expand
it’s sales reach and attracts investors.