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Question 28  DDM, income and capital returns

The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation.

### P_{0} = \frac{C_1}{r_{\text{eff}} - g_{\text{eff}}} ###

What would you call the expression ## C_1/P_0 ##?

Question 249  equivalent annual cash flow, effective rate conversion

Details of two different types of desserts or edible treats are given below:

  • High-sugar treats like candy, chocolate and ice cream make a person very happy. High sugar treats are cheap at only $2 per day.
  • Low-sugar treats like nuts, cheese and fruit make a person equally happy if these foods are of high quality. Low sugar treats are more expensive at $4 per day.

The advantage of low-sugar treats is that a person only needs to pay the dentist $2,000 for fillings and root canal therapy once every 15 years. Whereas with high-sugar treats, that treatment needs to be done every 5 years.

The real discount rate is 10%, given as an effective annual rate. Assume that there are 365 days in every year and that all cash flows are real. The inflation rate is 3% given as an effective annual rate.

Find the equivalent annual cash flow (EAC) of the high-sugar treats and low-sugar treats, including dental costs. The below choices are listed in that order.

Ignore the pain of dental therapy, personal preferences and other factors.

Question 429  takeover

In a takeover deal where the offer is 100% scrip (shares), the merged firm's number of shares will be equal to the sum of the acquirer and target firms' original number of shares. or ?

Question 532  mutually exclusive projects, NPV, IRR

An investor owns a whole level of an old office building which is currently worth $1 million. There are three mutually exclusive projects that can be started by the investor. The office building level can be:

  • Rented out to a tenant for one year at $0.1m paid immediately, and then sold for $0.99m in one year.
  • Refurbished into more modern commercial office rooms at a cost of $1m now, and then sold for $2.4m when the refurbishment is finished in one year.
  • Converted into residential apartments at a cost of $2m now, and then sold for $3.4m when the conversion is finished in one year.

All of the development projects have the same risk so the required return of each is 10% pa. The table below shows the estimated cash flows and internal rates of returns (IRR's).

Mutually Exclusive Projects
Project Cash flow
now ($)
Cash flow in
one year ($)
(% pa)
Rent then sell as is -900,000 990,000 10
Refurbishment into modern offices -2,000,000 2,400,000 20
Conversion into residential apartments -3,000,000 3,400,000 13.33

Which project should the investor accept?

Question 551  fully amortising loan, time calculation, APR

You just entered into a fully amortising home loan with a principal of $600,000, a variable interest rate of 4.25% pa and a term of 25 years.

Immediately after settling the loan, the variable interest rate suddenly falls to 4% pa! You can't believe your luck. Despite this, you plan to continue paying the same home loan payments as you did before. How long will it now take to pay off your home loan?

Assume that the lower interest rate was granted immediately and that rates were and are now again expected to remain constant. Round your answer up to the nearest whole month.

Question 658  CFFA, income statement, balance sheet, no explanation

To value a business's assets, the free cash flow of the firm (FCFF, also called CFFA) needs to be calculated. This requires figures from the firm's income statement and balance sheet. For what figures is the income statement needed? Note that the income statement is sometimes also called the profit and loss, P&L, or statement of financial performance.

Question 757  bond pricing, capital raising, no explanation

A firm wishes to raise $50 million now. They will issue 5% pa semi-annual coupon bonds that will mature in 10 years and have a face value of $100 each. Bond yields are 5% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?

Question 807  market efficiency, expected and historical returns, CAPM, beta, systematic risk, no explanation

You work in Asia and just woke up. It looked like a nice day but then you read the news and found out that last night the American share market fell by 10% while you were asleep due to surprisingly poor macro-economic world news. You own a portfolio of liquid stocks listed in Asia with a beta of 1.6. When the Asian equity markets open, what do you expect to happen to your share portfolio? Assume that the capital asset pricing model (CAPM) is correct and that the market portfolio contains all shares in the world, of which American shares are a big part. Your portfolio beta is measured against this world market portfolio.

When the Asian equity market opens for trade, you would expect your portfolio value to:

Question 825  future, hedging, tailing the hedge, speculation, no explanation

An equity index fund manager controls a USD500 million diversified equity portfolio with a beta of 0.9. The equity manager expects a significant rally in equity prices next year. The market does not think that this will happen. If the fund manager wishes to increase his portfolio beta to 1.5, how many S&P500 futures should he buy?

The US market equity index is the S&P500. One year CME futures on the S&P500 currently trade at 2,155 points and the spot price is 2,180 points. Each point is worth $250.

The number of one year S&P500 futures contracts that the fund manager should buy is:

Question 857  Du Pont formula, accounting ratio, no explanation

The Du Pont formula is:

###\dfrac{\text{Net Profit}}{\text{Sales}} \times \dfrac{\text{Sales}}{\text{Total Assets}} \times \dfrac{\text{Total Assets}}{\text{Ordinary Equity}}###

Which of the following statements about the Du Pont formula is NOT correct?

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