What is the target expected return for the investor

Reference no: EM131280245

Instructions:

1. You will access the quiz during a designated open 24-hour window. The start and finish times will be electronically recorded.

2. There are 2 (TWO) questions on this quiz and 4 (FOUR) pages in total, including this cover page.

3. This is an open-book quiz. You can access any material you want to help you answer the questions.

4. Each question has multiple parts and some are more difficult than others. Attempt each of the parts to achieve full points. If you get stuck on one part, consider moving on to others to maximize your points.

5. All your work and your answers should be furnished within the quiz document. Enough space for the answer is provided.

6. Read the questions carefully.

7. Show all your calculations.

8. Write as clearly as possible so I can understand what you are doing and so I can give you as much credit as possible for the work.

Question 1 - Capital Budgeting Decisions

(a) What is the NPV decision rule in capital budgeting decisions? How is it different from the Internal Rate of Return (IRR) rule and the Payback rule? Outline some of the pitfalls in applying the IRR and Payback rules? What is the Profitability Index (PI)? What are its benefits and potential shortcomings?

b) Tableau is thinking about marketing a new financial software product. Upfront costs to develop and market the product are $3 million. The product is expected to generate profits of $1.25 million per year for 7 years. A second round of marketing costing $1 million is projected for Year 5. The company will also have to provide product support expected to cost $60,000 per year in perpetuity but only starting in Year 3. Assume all profits and expenses occur at the end of the year.

(a) What is the net present value (NPV) of this investment if the cost of capital is 7%? Should the firm undertake the project? Can the IRR rule be used to evaluate this investment? Why or why not?

Question 2 - Time Value of Money

Analysts predict that earnings for Panera Bread Company (Nasdaq symbol: PNRA) will grow at 25% per year for the next four years. After that, as competition increases, earnings growth is expected to slow to 5% per year and continue at that level forever. PNRA's earnings this past year was $161.5 million. What is the present value of all future earnings if the discount rate is 11%? (Assume that all cash flows occur at the end of the year.)

Topics Covered for quiz 1:
Arbitrage and Financial DecisionMaking
The Time Value of Money
Interest Rates: Nominal, Effective Quotes and AdjustmentsReadings
Valuing Bonds
The Yield Curve and Bond Arbitrage
Valuing Projects: Investment Decision Rules
Fundamentals of Capital Budgeting
Valuing Stocks using the Dividend Discount Model
Total Payout and Free Cash Flow Valuation

In addition to quiz1, the following topics will be covered for Quiz 2:

- Capital Markets and the Pricing of Risk
- Optimal Portfolio Choice
- Making the CAPM at work
- Risk and Return
o Capital Assets Pricing Model
o Estimating the cost of capital
o Capital Market Efficiency

Quiz 2 :

Question 1- Stock Valuation Analysis

Caliente Argentinian Grill (CAG) has 31m shares outstanding, $3.8m in debt and $307m in cash. It projects free cash flows for next 4 years based on earnings forecasts below, a marginal tax rate of 38%, capital expenditures increasing from $140m in Year 1 to $155m by Year 4 in $5m increments, and increases in net working capital (NWC) based on a NWC-to-Sales ratio of 5% per year.

Sales	$1,816	$2,138	$2,482	$2,848	$3,234
Growth vs Prior Year		17.7%	16.1%	14.7%	13.5%
Cost of Goods Sold		($1,336)	($1,539)	(S1,766)	(S2,005)
Gross Profit		5802	5943	$1,082	$1,229
Other Operating Expenses		($201)	($222)	($243)	($265)
SG& A		($172)	($197)	($223)	($251)
Depreciation		(S 71)	(S 75)	(5 80)	(5 85)
EBIT		$359	$449	$536	$628

(a) Compute CAG's free cash flow each year.
(b) Suppose CAG's free cash flow is expected to grow at 6% after Year 4. If CMG's after-tax
WACC is 10%, what is the value of CAG's stock?
(c) What is the value of the stock if the long-run growth rate is 5% instead of 6%?
(d) In general, under what circumstances can a firm increase its share price by cutting its dividend and investing more?

Question 2 - Portfolio Analysis

Suppose an investor currently holds the market portfolio with expected return and volatility shown below. The investor is considering investing in a venture capital fund, called "New Ventures Fund," with its respective expected return and volatility also as shown. New Ventures Fund is correlated with the market portfolio at 0.10.

Stock	E(R)	SD(R
Market portfolio	5.50%	16.30%
New Ventures fimd	32.50%	323.50%

(a) What is the target expected return for the investor if she reallocates 15% of her current investment in the market portfolio into the New Ventures fund?

(b) What is the standard deviation of the new portfolio that combines the market portfolio and New Ventures fund as you determined in (a) above?

(c) Answer whether the following statements are true (1) or false (F). Feel free to offer an explanation, if you think it is needed.

i. Diversification eliminates common, market-wide and idiosyncratic risks alike.

ii. If the Capital Asset Pricing Model (CAPM) correctly prices risk, the market portfolio of all risky securities is an efficient portfolio.

iii. Beta indicates the sensitivity of a security's returns to fluctuations in Treasury bill yields.

iv. A portfolio that includes securities sold short has negative portfolio weights for those securities.

v. An efficient portfolio is any portfolio that only contains diversifiable risk; it contains no systematic risk.

Reference no: EM131280245

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