# 2. According to CAPM the expected return on a risky asset depends on three components. Name and describe each component explaining its role in determining expected return.

1. Define liquidity risk, default risk and taxability risk, and explain how these risks relate to bonds and bond yields.

2. According to CAPM the expected return on a risky asset depends on three components. Name and describe each component explaining its role in determining expected return.

3. Rosie O’Grady spends \$98000 a week to pay bills and maintains a lower cask balance limit of \$95,000. The standard deviation of the disbursements is \$14,600. The applicable interest rate is 4.8% and the fixed cost of transferring funds in \$50. What is this firm’s total cost of holding cash based on the BAT model.

Part B: Answer each of the following questions in one to three sentences, and perform calculations as requested.

1. Dandelion Fields has a Tobin’s Q of 0.96. The replacement cost of the firm’s assets is \$230,000 and the market value of the firm’s debt is \$115,000. The firm has 20,000 shares of stock outstanding and a book value per share of \$1.93. What is the market to book ratio?

2. Your local travel agent is advertising an upscale winter vacation package for travel three years from now to Antarctica. The package requires that you pay \$25,000 today, and a final payment of \$45,000 on the day you depart three years from today. What is the cost of this vacation in today’s dollars if the discount rate is 9.75%

3. KL Airlines paid an annual dividend of \$1.42 a share last month. The company is planning on paying \$1.50, \$1.75, and \$1.80 a share over the next 3 years, respectively. After that, dividend will be constant at \$2 per share per year. What is the market price of this stock if the market rate of return is 10.5%

4. Champion Bakers uses specialized ovens to bake its bread. One oven costs \$689,000 and lasts about 4 years before it needs to be replaced. The annual operating cost per over \$41,000. What is the equivalent annual cost of an oven if the required rate of return is 13%?

5. Tucker’s trucking is considering a project with a discounted payback period just equal to the project with a discounted payback period just equal to the project’s life. The projections include a sales price of \$38, variable cost per unit of \$18.50, and fixed cost of \$32,000 the operating flow is \$19,700. What is the break-even quantity?

6. Over the past 15 years, the common stock of the flower Shoppe, Inc., has produced an arithmetic average return of 12.2% and a geometric average return of 11.5% What is the projected return of this stock for the next 5 years according to Blume’s formula?

7. Suppose your boss comes to you and asks you to reevaluate a capital budgeting project. The first evaluation was in error, he explains, because it ignored flotation costs. To correct for this, he asks you to evaluate the project using a higher cost of capital which incorporates these costs. Is your boss’s approach correct? Why or Why not?

8. Hanover Tech is currently an all equity firm that has 320,000 shares of stock outstanding with a market price of \$19 a share. The current cost of equity is 15.4% and the tax rate is 36%. The firm is considering adding \$1.2 million of debt with a coupon rate of 8% to its capital structure. The debt will be sold at par value. What is the levered value of the equity?

9. Fancy footwear has a line of credit with a local bank in the amount of \$80,000. The loan agreement calls for interest of 7% with a compensating balance of 5%, which is the based on the total amount borrowed. The compensating balance will be deposited into an interest-free account. What is the effective interest rate on the loan if the firm needs to borrow \$75,000 for one year to cover operating expenses?

10. Polly’s home accents currently sells 345 units a month at a price of \$59 a unit. Polly thinks she can increase her sales by an additional 55 units if she switches to a net 30 credit policy. The monthly interest is0.4% and the variable cost per unit is \$32. What is the net present value of the proposed credit policy switch?