Reference no: EM131420141

Assignment: Corporate Finance

Problem 1

1-year call option, S=100, E=87, r_F=2% (annual)
1 step per year

How much should the call option worth?

Problem 2

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?

Problem 3

You currently have $2,500,000. You want to invest it in the following three assets: 10-year US Treasury bond with coupon rate 3.5%, Blandy and Gourmange stocks, who have the following historical annual returns:

Your goal is to have the expected annual return of 7.2% with a minimum portfolio risk. How much money should you allocate to these three assets?

Problem 4

A real estate investor has the following information on an apartment building:

• Purchase Price is $1,125,000 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 2nd year rent from month 1 to month 12 is $1.575 ($1.5*(1+5%)), and so on.

• Vacancy rate of 5% of gross rent per month.

• Operating expenses are 25% of effective gross income

• 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 expenditure is assumed to be $20,000 at the end of the first year only (12 months).

• Expected 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 35%, 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?

Problem 5

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

Compute the IRR, NPV, PI, and payback period for the following two projects. Assume the required return is 12%.