The saying "buy low, sell high" suggests that investors should make a:

Total cash flows can be broken into income and capital cash flows. What is the name given to the **income** cash flow from owning shares?

An asset's total expected return over the next year is given by:

###r_\text{total} = \dfrac{c_1+p_1-p_0}{p_0} ###

Where ##p_0## is the current price, ##c_1## is the expected income in one year and ##p_1## is the expected price in one year. The total return can be split into the income return and the capital return.

Which of the following is the expected **capital** return?

A share was bought for $30 (at t=0) and paid its annual dividend of $6 one year later (at t=1).

Just after the dividend was paid, the share price fell to $27 (at t=1). What were the total, capital and income returns given as effective annual rates?

The choices are given in the same order:

##r_\text{total}## , ##r_\text{capital}## , ##r_\text{dividend}##.

One and a half years ago Frank bought a house for $**600,000**. Now it's worth only $**500,000**, based on recent similar sales in the area.

The expected total return on Frank's residential property is **7**% pa.

He rents his house out for $**1,600** per month, paid in advance. Every 12 months he plans to increase the rental payments.

The present value of 12 months of rental payments is $**18,617.27**.

The future value of 12 months of rental payments one year in the future is $**19,920.48**.

What is the expected annual **rental** yield of the property? Ignore the costs of renting such as maintenance, real estate agent fees and so on.

**Question 278** inflation, real and nominal returns and cash flows

Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year.

**Question 353** income and capital returns, inflation, real and nominal returns and cash flows, real estate

A residential investment property has an expected **nominal** total return of **6**% pa and nominal capital return of **3**% pa.

Inflation is expected to be **2**% pa. All rates are given as effective annual rates.

What are the property's expected **real** total, capital and income returns? The answer choices below are given in the same order.

**Question 407** income and capital returns, inflation, real and nominal returns and cash flows

A stock has a **real** expected total return of **7**% pa and a real expected capital return of **2**% pa.

Inflation is expected to be **2**% pa. All rates are given as effective annual rates.

What is the **nominal** expected total return, capital return and dividend yield? The answers below are given in the same order.

**Question 525** income and capital returns, real and nominal returns and cash flows, inflation

Which of the following statements about cash in the form of notes and coins is **NOT** correct? Assume that inflation is positive.

Notes and coins:

**Question 526** real and nominal returns and cash flows, inflation, no explanation

How can a **nominal** cash flow be precisely converted into a **real** cash flow?

You're considering making an investment in a particular company. They have preference shares, ordinary shares, senior debt and junior debt.

Which is the safest investment? Which will give the highest returns?

Which business structure or structures have the advantage of limited liability for equity investors?

**Question 531** bankruptcy or insolvency, capital structure, risk, limited liability

Who is most in danger of being **personally** bankrupt? Assume that all of their businesses' assets are highly liquid and can therefore be sold immediately.

**Question 575** inflation, real and nominal returns and cash flows

You expect a **nominal** payment of $100 in 5 years. The **real** discount rate is 10% pa and the inflation rate is 3% pa. Which of the following statements is **NOT** correct?

**Question 577** inflation, real and nominal returns and cash flows

What is the present value of a **real** payment of $500 in 2 years? The **nominal** discount rate is 7% pa and the inflation rate is 4% pa.

**Question 554** inflation, real and nominal returns and cash flows

On his 20th birthday, a man makes a resolution. He will put $**30** cash under his bed at the **end** of every month starting from today. His birthday today is the first day of the month. So the first addition to his cash stash will be in one month. He will write in his will that when he dies the cash under the bed should be given to charity.

If the man lives for another **60** years, how much money will be under his bed if he dies just after making his last (720th) addition?

Also, what will be the **real** value of that cash in today's prices if inflation is expected to **2.5%** pa? Assume that the inflation rate is an effective annual rate and is not expected to change.

The answers are given in the same order, the amount of money under his bed in 60 years, and the real value of that money in today's prices.

Which of the following statements about book and market equity is **NOT** correct?

The below screenshot of Commonwealth Bank of Australia's (CBA) details were taken from the Google Finance website on 7 Nov 2014. Some information has been deliberately blanked out.

What was CBA's market capitalisation of equity?

**Question 444** investment decision, corporate financial decision theory

The investment decision primarily affects which part of a business?

**Question 445** financing decision, corporate financial decision theory

The financing decision primarily affects which part of a business?

**Question 443** corporate financial decision theory, investment decision, financing decision, working capital decision, payout policy

Business people make lots of important decisions. Which of the following is the **most** important long term decision?

The expression 'you have to spend money to make money' relates to which business decision?

Suppose you had $100 in a savings account and the interest rate was 2% per year.

After 5 years, how much do you think you would have in the account if you left the money to grow?

Katya offers to pay you $10 at the end of every year for the next 5 years (t=1,2,3,4,5) if you pay her $50 now (t=0). You can borrow and lend from the bank at an interest rate of 10% pa, given as an effective annual rate.

Ignore credit risk.

This annuity formula ##\dfrac{C_1}{r}\left(1-\dfrac{1}{(1+r)^3} \right)## is equivalent to which of the following formulas? Note the **3**.

In the below formulas, ##C_t## is a cash flow at time t. All of the cash flows are equal, but paid at different times.

Your friend overheard that you need some cash and asks if you would like to borrow some money. She can lend you $**5,000** now (t=0), and in return she wants you to pay her back $1,000 in two years (t=2) and every year after that for the next 5 years, so there will be **6** payments of $**1,000** from t=**2** to t=**7** inclusive.

What is the net present value (NPV) of borrowing from your friend?

Assume that banks loan funds at interest rates of **10**% pa, given as an effective annual rate.

Some countries' interest rates are so low that they're zero.

If interest rates are **0**% pa and are expected to stay at that level for the foreseeable future, what is the most that you would be prepared to pay a bank now if it offered to pay you $**10** at the end of every year for the next **5** years?

In other words, what is the present value of five $10 payments at time 1, 2, 3, 4 and 5 if interest rates are 0% pa?

Discounted cash flow (DCF) valuation prices assets by finding the present value of the asset's future cash flows. The single cash flow, annuity, and perpetuity equations are very useful for this.

Which of the following equations is the 'perpetuity with growth' equation?

A stock is expected to pay its **next** dividend of $1 in one year. Future annual dividends are expected to grow by 2% pa. So the first dividend of $1 will be in one year, the year after that $1.02 (=1*(1+0.02)^1), and a year later $1.0404 (=1*(1+0.02)^2) and so on forever.

Its required total return is 10% pa. The total required return and growth rate of dividends are given as effective annual rates.

Calculate the current stock price.

A stock **just paid** a dividend of $1. Future annual dividends are expected to grow by 2% pa. The next dividend of $1.02 (=1*(1+0.02)^1) will be in one year, and the year after that the dividend will be $1.0404 (=1*(1+0.02)^2), and so on forever.

Its required total return is 10% pa. The total required return and growth rate of dividends are given as effective annual rates.

Calculate the current stock price.

A stock is **just about to pay** a dividend of $1 **tonight**. Future annual dividends are expected to grow by 2% pa. The next dividend of $1 will be paid tonight, and the year after that the dividend will be $1.02 (=1*(1+0.02)^1), and a year later 1.0404 (=1*(1+0.04)^2) and so on forever.

Its required total return is 10% pa. The total required return and growth rate of dividends are given as effective annual rates.

Calculate the current stock price.

For a price of $13, Carla will sell you a share which will pay a dividend of $1 in one year and every year after that forever. The required return of the stock is 10% pa.

For a price of $1040, Camille will sell you a share which just paid a dividend of $100, and is expected to pay dividends every year forever, growing at a rate of 5% pa.

So the next dividend will be ##100(1+0.05)^1=$105.00##, and the year after it will be ##100(1+0.05)^2=110.25## and so on.

The required return of the stock is 15% pa.

The perpetuity with growth formula, also known as the dividend discount model (DDM) or Gordon growth model, is appropriate for valuing a company's shares. ##P_0## is the current share price, ##C_1## is next year's expected dividend, ##r## is the total required return and ##g## is the expected growth rate of the dividend.

###P_0=\dfrac{C_1}{r-g}###

The below graph shows the expected future price path of the company's shares. Which of the following statements about the graph is **NOT** correct?

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

###P_0=\frac{d_1}{r-g}###

A stock pays dividends annually. It just paid a dividend, but the next dividend (##d_1##) will be paid in one year.

According to the DDM, what is the correct formula for the expected price of the stock in 2.5 years?

The following is the Dividend Discount Model (DDM) used to price stocks:

###P_0=\dfrac{C_1}{r-g}###

If the assumptions of the DDM hold, which one of the following statements is **NOT** correct? The long term expected:

**Question 497** income and capital returns, DDM, ex dividend date

A stock will pay you a dividend of $**10** **tonight** if you buy it **today**. Thereafter the annual dividend is expected to grow by **5**% pa, so the next dividend after the $10 one tonight will be $10.50 in one year, then in two years it will be $11.025 and so on. The stock's required return is **10**% pa.

What is the stock price today and what do you expect the stock price to be tomorrow, approximately?

In the dividend discount model:

###P_0 = \dfrac{C_1}{r-g}###

The return ##r## is supposed to be the:

A stock pays annual dividends which are expected to continue forever. It just paid a dividend of $10. The growth rate in the dividend is 2% pa. You estimate that the stock's required return is 10% pa. Both the discount rate and growth rate are given as effective annual rates. Using the dividend discount model, what will be the share price?

A stock is expected to pay the following dividends:

Cash Flows of a Stock | ||||||

Time (yrs) | 0 | 1 | 2 | 3 | 4 | ... |

Dividend ($) | 0.00 | 1.00 | 1.05 | 1.10 | 1.15 | ... |

After year 4, the annual dividend will grow in perpetuity at 5% pa, so;

- the dividend at t=5 will be $1.15(1+0.05),
- the dividend at t=6 will be $1.15(1+0.05)^2, and so on.

The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates.

What will be the price of the stock in three and a half years (t = 3.5)?

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

### p_0 = \frac{d_1}{r - g} ###

Which expression is **NOT** equal to the expected dividend yield?

A fairly valued share's current price is $**4** and it has a total required return of **30**%. Dividends are paid annually and next year's dividend is expected to be $**1**. After that, dividends are expected to grow by **5**% pa in perpetuity. All rates are effective annual returns.

What is the expected dividend income paid at the end of the second year (t=**2**) and what is the expected capital gain from just after the first dividend (t=**1**) to just after the second dividend (t=**2**)? The answers are given in the same order, the dividend and then the capital gain.

The following cash flows are expected:

- 10 yearly payments of $80, with the first payment in 3 years from now (first payment at t=3).
- 1 payment of $600 in 5 years and 6 months (t=5.5) from now.

What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate?

What is the Internal Rate of Return (IRR) of the project detailed in the table below?

Assume that the cash flows shown in the table are paid all at once at the given point in time. All answers are given as effective annual rates.

Project Cash Flows | |

Time (yrs) | Cash flow ($) |

0 | -100 |

1 | 0 |

2 | 121 |

If a project's net present value (NPV) is zero, then its internal rate of return (IRR) will be:

The phone company Telstra have 2 mobile service plans on offer which both have the same amount of phone call, text message and internet data credit. Both plans have a contract length of 24 months and the monthly cost is payable in advance. The only difference between the two plans is that one is a:

- 'Bring Your Own' (BYO) mobile service plan, costing $50 per month. There is no phone included in this plan. The other plan is a:
- 'Bundled' mobile service plan that comes with the latest smart phone, costing $71 per month. This plan includes the latest smart phone.

Neither plan has any additional payments at the start or end.

The only difference between the plans is the phone, so what is the implied cost of the phone as a present value?

Assume that the discount rate is 2% per month given as an effective monthly rate, the same high interest rate on credit cards.

The boss of WorkingForTheManCorp has a wicked (and unethical) idea. He plans to pay his poor workers one week late so that he can get more interest on his cash in the bank.

Every week he is supposed to pay his 1,000 employees $1,000 each. So $**1** million is paid to employees every week.

The boss was just about to pay his employees today, until he thought of this idea so he will actually pay them one week (**7** days) later for the work they did last week and every week in the future, forever.

Bank interest rates are **10**% pa, given as a real effective annual rate. So ##r_\text{eff annual, real} = 0.1## and the real effective weekly rate is therefore ##r_\text{eff weekly, real} = (1+0.1)^{1/52}-1 = 0.001834569##

All rates and cash flows are real, the inflation rate is **3**% pa and there are **52** weeks per year. The boss will always pay wages one week late. The business will operate forever with constant real wages and the same number of employees.

What is the net present value (**NPV**) of the boss's decision to pay later?

The required return of a project is 10%, given as an effective annual rate.

What is the payback period of the project in years?

Assume that the cash flows shown in the table are received smoothly over the year. So the $121 at time 2 is actually earned smoothly from t=1 to t=2.

Project Cash Flows | |

Time (yrs) | Cash flow ($) |

0 | -100 |

1 | 11 |

2 | 121 |

A project has the following cash flows:

Project Cash Flows | |

Time (yrs) | Cash flow ($) |

0 | -400 |

1 | 0 |

2 | 500 |

What is the payback period of the project in years?

Normally cash flows are assumed to happen at the given time. But here, assume that the cash flows are received smoothly over the year. So the $500 at time 2 is actually earned smoothly from t=1 to t=2.

The below graph shows a project's net present value (NPV) against its annual discount rate.

For what discount rate or range of discount rates would you accept and commence the project?

All answer choices are given as approximations from reading off the graph.

The below graph shows a project's net present value (NPV) against its annual discount rate.

Which of the following statements is **NOT** correct?

A firm is considering a business project which costs $**11**m now and is expected to pay a constant $**1**m at the end of every year forever.

Assume that the initial $**11**m cost is funded using the firm's **existing cash** so no new equity or debt will be raised. The cost of capital is **10**% pa.

Which of the following statements about net present value (NPV), internal rate of return (IRR) and payback period is **NOT** correct?

A firm is considering a business project which costs $**10**m now and is expected to pay a single cash flow of $**12.1**m in two years.

Assume that the initial $**10**m cost is funded using the firm's **existing cash** so no new equity or debt will be raised. The cost of capital is **10**% pa.

Which of the following statements about net present value (NPV), internal rate of return (IRR) and payback period is **NOT** correct?

You have $100,000 in the bank. The bank pays interest at 10% pa, given as an effective annual rate.

You wish to consume an equal amount now (t=0) and in one year (t=1) and have nothing left in the bank at the end (t=1).

How much can you consume at each time?

You have $100,000 in the bank. The bank pays interest at 10% pa, given as an effective annual rate.

You wish to consume an equal amount now (t=0), in one year (t=1) and in two years (t=2), and still have $50,000 in the bank after that (t=2).

How much can you consume at each time?

Your neighbour asks you for a loan of $100 and offers to pay you back $120 in one year.

You don't actually have any money right now, but you can borrow and lend from the bank at a rate of 10% pa. Rates are given as effective annual rates.

Assume that your neighbour will definitely pay you back. Ignore interest tax shields and transaction costs.

The Net Present Value (NPV) of lending to your neighbour is $9.09. Describe what you would do to actually receive a $9.09 cash flow right now with zero net cash flows in the future.

An investor owns an empty block of land that has local government approval to be developed into a petrol station, car wash or car park. The council will only allow a single development so the projects are mutually exclusive.

All of the development projects have the same risk and the required return of each is 10% pa. Each project has an immediate cost and once construction is finished in one year the land and development will be sold. The table below shows the estimated costs payable now, expected sale prices in one year and the internal rates of returns (IRR's).

Mutually Exclusive Projects | |||

Project | Cost now ($) |
Sale price in one year ($) |
IRR (% pa) |

Petrol station | 9,000,000 | 11,000,000 | 22.22 |

Car wash | 800,000 | 1,100,000 | 37.50 |

Car park | 70,000 | 110,000 | 57.14 |

Which project should the investor accept?

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 ($) |
Cash flow in one year ($) |
IRR (% 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?

A low-quality second-hand car can be bought now for $**1,000** and will last for **1** year before it will be scrapped for nothing.

A high-quality second-hand car can be bought now for $**4,900** and it will last for **5** years before it will be scrapped for nothing.

What is the equivalent annual cost of each car? Assume a discount rate of **10**% pa, given as an effective annual rate.

The answer choices are given as the equivalent annual cost of the low-quality car and then the high quality car.

**Question 180** equivalent annual cash flow, inflation, real and nominal returns and cash flows

Details of two different types of light bulbs are given below:

- Low-energy light bulbs cost $3.50, have a life of nine years, and use about $1.60 of electricity a year, paid at the end of each year.
- Conventional light bulbs cost only $0.50, but last only about a year and use about $6.60 of energy a year, paid at the end of each year.

The real discount rate is 5%, given as an effective annual rate. Assume that all cash flows are real. The inflation rate is 3% given as an effective annual rate.

Find the Equivalent Annual Cost (EAC) of the low-energy and conventional light bulbs. The below choices are listed in that order.

Carlos and Edwin are brothers and they both love Holden Commodore cars.

Carlos likes to buy the latest Holden Commodore car for **$40,000** every **4** years as soon as the new model is released. As soon as he buys the new car, he sells the old one on the second hand car market for **$20,000**. Carlos never has to bother with paying for repairs since his cars are brand new.

Edwin also likes Commodores, but prefers to buy 4-year old cars for **$20,000** and keep them for **11** years until the end of their life (new ones last for 15 years in total but the 4-year old ones only last for another 11 years). Then he sells the old car for **$2,000** and buys another 4-year old second hand car, and so on.

Every time Edwin buys a second hand 4 year old car he **immediately** has to spend **$1,000** on repairs, and then $1,000 every year after that for the next 10 years. So there are **11** payments in total from when the second hand car is bought at t=0 to the last payment at t=10. One year later (t=11) the old car is at the end of its total 15 year life and can be scrapped for $2,000.

Assuming that Carlos and Edwin maintain their love of Commodores and keep up their habits of buying new ones and second hand ones respectively, how much **larger** is Carlos' **equivalent annual cost** of car ownership compared with Edwin's?

The real discount rate is **10%** pa. All cash flows are real and are expected to remain constant. Inflation is forecast to be **3**% pa. All rates are effective annual. Ignore capital gains tax and tax savings from depreciation since cars are tax-exempt for individuals.

You own some nice shoes which you use once per week on date nights. You bought them **2** years ago for $**500**. In your experience, shoes used once per week last for **6** years. So you expect yours to last for another **4** years.

Your younger sister said that she wants to borrow your shoes once per week. With the increased use, your shoes will only last for another **2** years rather than 4.

What is the present value of the cost of letting your sister use your current shoes for the next 2 years?

Assume: that bank interest rates are **10**% pa, given as an effective annual rate; you will buy a new pair of shoes when your current pair wears out and your sister will not use the new ones; your sister will only use your current shoes so she will only use it for the next 2 years; and the price of new shoes never changes.

An industrial chicken farmer grows chickens for their meat. Chickens:

- Cost $
**0.50**each to buy as chicks. They are bought on the day they’re born, at t=**0**. - Grow at a rate of $
**0.70**worth of meat per chicken per week for the first 6 weeks (t=**0**to t=**6**). - Grow at a rate of $
**0.40**worth of meat per chicken per week for the next 4 weeks (t=**6**to t=**10**) since they’re older and grow more slowly. - Feed costs are $
**0.30**per chicken per week for their whole life. Chicken feed is bought and fed to the chickens once per week at the beginning of the week. So the first amount of feed bought for a chicken at t=**0**costs $0.30, and so on. - Can be slaughtered (killed for their meat) and sold at no cost at the
**end**of the week. The price received for the chicken is their total value of meat (note that the chicken grows fast then slow, see above).

The required return of the chicken farm is **0.5%** given as an effective **weekly** rate.

Ignore taxes and the fixed costs of the factory. Ignore the chicken’s welfare and other environmental and ethical concerns.

Find the equivalent **weekly** cash flow of slaughtering a chicken at **6** weeks and at **10** weeks so the farmer can figure out the best time to slaughter his chickens. The choices below are given in the same order, 6 and 10 weeks.

A home loan company advertises an interest rate of 6% pa, payable monthly. Which of the following statements about the interest rate is **NOT** correct? All rates are given to four decimal places.

A semi-annual coupon bond has a yield of 3% pa. Which of the following statements about the yield is **NOT** correct? All rates are given to four decimal places.

Which of the below statements about effective rates and annualised percentage rates (APR's) is **NOT** correct?

A credit card offers an interest rate of 18% pa, compounding monthly.

Find the effective monthly rate, effective annual rate and the effective daily rate. Assume that there are 365 days in a year.

All answers are given in the same order:

### r_\text{eff monthly} , r_\text{eff yearly} , r_\text{eff daily} ###

Calculate the effective annual rates of the following three APR's:

- A credit card offering an interest rate of 18% pa, compounding monthly.
- A bond offering a yield of 6% pa, compounding semi-annually.
- An annual dividend-paying stock offering a return of 10% pa compounding annually.

All answers are given in the same order:

##r_\text{credit card, eff yrly}##, ##r_\text{bond, eff yrly}##, ##r_\text{stock, eff yrly}##

On his 20th birthday, a man makes a resolution. He will deposit $**30** into a bank account at the **end** of every month starting from now, which is the start of the month. So the first payment will be in one month. He will write in his will that when he dies the money in the account should be given to charity.

The bank account pays interest at **6**% pa compounding **monthly**, which is not expected to change.

If the man lives for another **60** years, how much money will be in the bank account if he dies just after making his last (720th) payment?

You want to buy an apartment priced at $300,000. You have saved a deposit of $30,000. The bank has agreed to lend you the $270,000 as a **fully amortising** loan with a term of 25 years. The interest rate is 12% pa and is not expected to change.

What will be your monthly payments? Remember that mortgage loan payments are paid in arrears (at the end of the month).

You want to buy an apartment worth $400,000. You have saved a deposit of $80,000. The bank has agreed to lend you the $320,000 as a **fully amortising** mortgage loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?

You just signed up for a 30 year **fully amortising** mortgage loan with monthly payments of $2,000 per month. The interest rate is 9% pa which is not expected to change.

How much did you borrow? After 5 years, how much will be owing on the mortgage? The interest rate is still 9% and is not expected to change.

You just signed up for a 30 year **fully amortising** mortgage loan with monthly payments of $1,500 per month. The interest rate is 9% pa which is not expected to change.

How much did you borrow? After 10 years, how much will be owing on the mortgage? The interest rate is still 9% and is not expected to change.

You just agreed to a 30 year **fully amortising** mortgage loan with monthly payments of $2,500. The interest rate is 9% pa which is not expected to change.

How much did you borrow? After 10 years, how much will be owing on the mortgage? The interest rate is still 9% and is not expected to change. The below choices are given in the same order.

You want to buy an apartment priced at $300,000. You have saved a deposit of $30,000. The bank has agreed to lend you the $270,000 as an **interest only** loan with a term of 25 years. The interest rate is 12% pa and is not expected to change.

What will be your monthly payments? Remember that mortgage payments are paid in arrears (at the end of the month).

You just borrowed $400,000 in the form of a 25 year **interest-only** mortgage with monthly payments of $3,000 per month. The interest rate is 9% pa which is not expected to change.

You actually plan to pay more than the required interest payment. You plan to pay $3,300 in mortgage payments every month, which your mortgage lender allows. These extra payments will reduce the principal and the minimum interest payment required each month.

At the maturity of the mortgage, what will be the principal? That is, after the last (300th) interest payment of $3,300 in 25 years, how much will be owing on the mortgage?

You want to buy an apartment worth $300,000. You have saved a deposit of $60,000.

The bank has agreed to lend you $240,000 as an **interest only** mortgage loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?

**Question 239** income and capital returns, inflation, real and nominal returns and cash flows, interest only loan

A bank grants a borrower an **interest-only** residential mortgage loan with a very large 50% deposit and a **nominal** interest rate of **6%** that is not expected to change. Assume that inflation is expected to be a **constant 2%** pa over the life of the loan. Ignore credit risk.

From the bank's point of view, what is the long term expected **nominal capital** return of the loan asset?

Calculate the price of a newly issued **ten** year bond with a face value of $**100**, a yield of **8**% pa and a fixed coupon rate of **6**% pa, paid **annually**. So there's only one coupon per year, paid in arrears every year.

Calculate the price of a newly issued **ten** year bond with a face value of $**100**, a yield of **8**% pa and a fixed coupon rate of **6**% pa, paid **semi**-annually. So there are two coupons per year, paid in arrears every six months.

Bonds X and Y are issued by the same US company. Both bonds yield **10**% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.

The only difference is that bond X and Y's **coupon rates** are **8** and **12**% pa respectively. Which of the following statements is true?

**Question 48** IRR, NPV, bond pricing, premium par and discount bonds, market efficiency

The theory of fixed interest bond pricing is an application of the theory of Net Present Value (NPV). Also, a 'fairly priced' asset is not over- or under-priced. Buying or selling a fairly priced asset has an NPV of zero.

Considering this, which of the following statements is **NOT** correct?

The theory of fixed interest bond pricing is an application of the theory of Net Present Value (NPV). Also, a 'fairly priced' asset is not over- or under-priced. Buying or selling a fairly priced asset has an NPV of zero.

Considering this, which of the following statements is **NOT** correct?

A three year bond has a fixed coupon rate of 12% pa, paid semi-annually. The bond's yield is currently 6% pa. The face value is $100. What is its price?

A bond maturing in 10 years has a coupon rate of 4% pa, paid semi-annually. The bond's yield is currently 6% pa. The face value of the bond is $100. What is its price?

Which one of the following bonds is trading at a discount?

Which one of the following bonds is trading at a premium?

An investor bought two fixed-coupon bonds issued by the same company, a zero-coupon bond and a 7% pa semi-annual coupon bond. Both bonds have a face value of $1,000, mature in 10 years, and had a yield at the time of purchase of 8% pa.

A few years later, yields fell to 6% pa. Which of the following statements is correct? Note that a capital gain is an increase in price.

In these tough economic times, central banks around the world have cut interest rates so low that they are practically zero. In some countries, government bond yields are also very close to zero.

A three year government bond with a face value of $100 and a coupon rate of 2% pa paid semi-annually was just issued at a yield of 0%. What is the price of the bond?

A 10 year bond has a face value of $100, a yield of 6% pa and a fixed coupon rate of 8% pa, paid semi-annually. What is its price?

Below are some statements about loans and bonds. The first descriptive sentence is correct. But one of the second sentences about the loans' or bonds' prices is not correct. Which statement is **NOT** correct? Assume that interest rates are positive.

Note that coupons or interest payments are the periodic payments made throughout a bond or loan's life. The face or par value of a bond or loan is the amount paid at the end when the debt matures.

**Question 35** bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

A European company just issued two bonds, a

- 1 year zero coupon bond at a yield of 8% pa, and a
- 2 year zero coupon bond at a yield of 10% pa.

What is the company's forward rate over the second year (from t=1 to t=2)? Give your answer as an effective annual rate, which is how the above bond yields are quoted.

**Question 143** bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

An Australian company just issued two bonds:

- A 6-month zero coupon bond at a yield of 6% pa, and
- A 12 month zero coupon bond at a yield of 7% pa.

What is the company's forward rate from 6 to 12 months? Give your answer as an APR compounding every 6 months, which is how the above bond yields are quoted.

**Question 96** bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

An Australian company just issued two bonds:

- A 1 year zero coupon bond at a yield of 8% pa, and
- A 2 year zero coupon bond at a yield of 10% pa.

What is the forward rate on the company's debt from years 1 to 2? Give your answer as an APR compounding every **6** months, which is how the above bond yields are quoted.

You're trying to save enough money to buy your first car which costs $2,500. You can save $100 at the end of each month starting from now. You currently have no money at all. You just opened a bank account with an interest rate of 6% pa payable monthly.

How many months will it take to save enough money to buy the car? Assume that the price of the car will stay the same over time.

Your main expense is fuel for your car which costs $100 per month. You just refueled, so you won't need any more fuel for another month (first payment at t=1 month).

You have $2,500 in a bank account which pays interest at a rate of 6% pa, payable monthly. Interest rates are not expected to change.

Assuming that you have no income, in how many months time will you not have enough money to **fully** refuel your car?

You really want to go on a back packing trip to Europe when you finish university. Currently you have $**1,500** in the bank. Bank interest rates are **8**% pa, given as an APR compounding per month. If the holiday will cost $**2,000**, how long will it take for your bank account to reach that amount?

A young lady is trying to decide if she should attend university. Her friends say that she should go to university because she is more likely to meet a clever young man than if she begins full time work straight away.

What's the correct way to classify this item from a capital budgeting perspective when trying to find the Net Present Value of going to university rather than working?

The opportunity to meet a desirable future spouse should be classified as:

A young lady is trying to decide if she should attend university or not.

The young lady's parents say that she must attend university because otherwise all of her hard work studying and attending school during her childhood was a waste.

What's the correct way to classify this item from a capital budgeting perspective when trying to decide whether to attend university?

The hard work studying at school in her childhood should be classified as:

A man is thinking about taking a day off from his casual painting job to relax.

He just woke up early in the morning and he's about to call his boss to say that he won't be coming in to work.

But he's thinking about the hours that he could work today (in the future) which are:

A man has taken a day off from his casual painting job to relax.

It's the end of the day and he's thinking about the hours that he could have spent working (in the past) which are now:

What is the net present value (NPV) of undertaking a full-time Australian undergraduate business degree as an Australian citizen? Only include the cash flows over the duration of the degree, ignore any benefits or costs of the degree after it's completed.

Assume the following:

- The degree takes
**3**years to complete and all students pass all subjects. - There are
**2**semesters per year and**4**subjects per semester. - University fees per subject per semester are
**$1,277**, paid at the**start**of each semester. Fees are expected to stay constant for the next 3 years. - There are
**52**weeks per year. - The first semester is just about to start (t=0). The first semester lasts for 19 weeks (t=
**0**to**19**). - The second semester starts immediately afterwards (t=19) and lasts for another 19 weeks (t=
**19**to**38**). - The summer holidays begin after the second semester ends and last for
**14**weeks (t=**38**to**52**). Then the first semester begins the next year, and so on. - Working full time at the grocery store instead of studying full-time pays
**$20**/hr and you can work**35**hours per week. Wages are paid at the**end**of each week. - Full-time students can work full-time during the summer holiday at the grocery store for the same rate of $20/hr for 35 hours per week. Wages are paid at the end of each week.
- The discount rate is
**9.8%**pa. All rates and cash flows are real. Inflation is expected to be**3%**pa. All rates are effective annual.

The NPV of costs from undertaking the university degree is:

Find Candys Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Candys Corp | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 200 | |

COGS | 50 | |

Operating expense | 10 | |

Depreciation | 20 | |

Interest expense | 10 | |

Income before tax | 110 | |

Tax at 30% | 33 | |

Net income | 77 | |

Candys Corp | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Assets | ||

Current assets | 220 | 180 |

PPE | ||

Cost | 300 | 340 |

Accumul. depr. | 60 | 40 |

Carrying amount | 240 | 300 |

Total assets | 460 | 480 |

Liabilities | ||

Current liabilities | 175 | 190 |

Non-current liabilities | 135 | 130 |

Owners' equity | ||

Retained earnings | 50 | 60 |

Contributed equity | 100 | 100 |

Total L and OE | 460 | 480 |

Note: all figures are given in millions of dollars ($m).

Find Sidebar Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Sidebar Corp | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 405 | |

COGS | 100 | |

Depreciation | 34 | |

Rent expense | 22 | |

Interest expense | 39 | |

Taxable Income | 210 | |

Taxes at 30% | 63 | |

Net income | 147 | |

Sidebar Corp | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Inventory | 70 | 50 |

Trade debtors | 11 | 16 |

Rent paid in advance | 4 | 3 |

PPE | 700 | 680 |

Total assets | 785 | 749 |

Trade creditors | 11 | 19 |

Bond liabilities | 400 | 390 |

Contributed equity | 220 | 220 |

Retained profits | 154 | 120 |

Total L and OE | 785 | 749 |

Note: All figures are given in millions of dollars ($m).

The cash flow from assets was:

Find Ching-A-Lings Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Ching-A-Lings Corp | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 100 | |

COGS | 20 | |

Depreciation | 20 | |

Rent expense | 11 | |

Interest expense | 19 | |

Taxable Income | 30 | |

Taxes at 30% | 9 | |

Net income | 21 | |

Ching-A-Lings Corp | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Inventory | 49 | 38 |

Trade debtors | 14 | 2 |

Rent paid in advance | 5 | 5 |

PPE | 400 | 400 |

Total assets | 468 | 445 |

Trade creditors | 4 | 10 |

Bond liabilities | 200 | 190 |

Contributed equity | 145 | 145 |

Retained profits | 119 | 100 |

Total L and OE | 468 | 445 |

Note: All figures are given in millions of dollars ($m).

The cash flow from assets was:

Why is Capital Expenditure (CapEx) subtracted in the Cash Flow From Assets (CFFA) formula?

###CFFA=NI+Depr-CapEx - \Delta NWC+IntExp###

A firm has forecast its Cash Flow From Assets (CFFA) for this year and management is worried that it is too low. Which one of the following actions will lead to a higher CFFA for this year (t=0 to 1)? Only consider cash flows this year. Do not consider cash flows after one year, or the change in the NPV of the firm. Consider each action in isolation.

Which one of the following will decrease net income (NI) but increase cash flow from assets (CFFA) in this year for a tax-paying firm, all else remaining constant?

Remember:

###NI = (Rev-COGS-FC-Depr-IntExp).(1-t_c )### ###CFFA=NI+Depr-CapEx - \Delta NWC+IntExp###Over the next year, the management of an unlevered company plans to:

- Achieve firm free cash flow (FFCF or CFFA) of $1m.
- Pay dividends of $1.8m
- Complete a $1.3m share buy-back.
- Spend $0.8m on new buildings without buying or selling any other fixed assets. This capital expenditure is included in the CFFA figure quoted above.

Assume that:

- All amounts are received and paid at the end of the year so you can ignore the time value of money.
- The firm has sufficient retained profits to pay the dividend and complete the buy back.
- The firm plans to run a very tight ship, with no excess cash above operating requirements currently or over the next year.

How much new equity financing will the company need? In other words, what is the value of new shares that will need to be issued?

Which one of the following will have no effect on net income (NI) but decrease cash flow from assets (CFFA or FFCF) in this year for a tax-paying firm, all else remaining constant?

Remember:

###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c )### ###CFFA=NI+Depr-CapEx - ΔNWC+IntExp###Over the next year, the management of an **unlevered** company plans to:

- Make $
**5**m in sales, $**1.9m**in net income and $**2**m in equity free cash flow (EFCF). - Pay dividends of $
**1**m. - Complete a $
**1.3**m share buy-back.

Assume that:

- All amounts are received and paid at the end of the year so you can ignore the time value of money.
- The firm has sufficient retained profits to legally pay the dividend and complete the buy back.
- The firm plans to run a very tight ship, with no excess cash above operating requirements currently or over the next year.

How much new equity financing will the company need? In other words, what is the value of new shares that will need to be issued?

Find the cash flow from assets (CFFA) of the following project.

One Year Mining Project Data | ||

Project life | 1 year | |

Initial investment in building mine and equipment | $9m | |

Depreciation of mine and equipment over the year | $8m | |

Kilograms of gold mined at end of year | 1,000 | |

Sale price per kilogram | $0.05m | |

Variable cost per kilogram | $0.03m | |

Before-tax cost of closing mine at end of year | $4m | |

Tax rate | 30% | |

Note 1: Due to the project, the firm also anticipates finding some rare diamonds which will give before-tax revenues of $1m at the end of the year.

Note 2: The land that will be mined actually has thermal springs and a family of koalas that could be sold to an eco-tourist resort for an after-tax amount of $3m right now. However, if the mine goes ahead then this natural beauty will be destroyed.

Note 3: The mining equipment will have a book value of $1m at the end of the year for tax purposes. However, the equipment is expected to fetch $2.5m when it is sold.

Find the project's CFFA at time zero and one. Answers are given in millions of dollars ($m), with the first cash flow at time zero, and the second at time one.

Find the cash flow from assets (CFFA) of the following project.

Project Data | ||

Project life | 2 years | |

Initial investment in equipment | $6m | |

Depreciation of equipment per year for tax purposes | $1m | |

Unit sales per year | 4m | |

Sale price per unit | $8 | |

Variable cost per unit | $3 | |

Fixed costs per year, paid at the end of each year | $1.5m | |

Tax rate | 30% | |

Note 1: The equipment will have a book value of $4m at the end of the project for tax purposes. However, the equipment is expected to fetch $0.9 million when it is sold at t=2.

Note 2: Due to the project, the firm will have to purchase $0.8m of inventory initially, which it will sell at t=1. The firm will buy another $0.8m at t=1 and sell it all again at t=2 with zero inventory left. The project will have no effect on the firm's current liabilities.

Find the project's CFFA at time zero, one and two. Answers are given in millions of dollars ($m).

Value the following business project to manufacture a new product.

Project Data | ||

Project life | 2 yrs | |

Initial investment in equipment | $6m | |

Depreciation of equipment per year | $3m | |

Expected sale price of equipment at end of project | $0.6m | |

Unit sales per year | 4m | |

Sale price per unit | $8 | |

Variable cost per unit | $5 | |

Fixed costs per year, paid at the end of each year | $1m | |

Interest expense per year | 0 | |

Tax rate | 30% | |

Weighted average cost of capital after tax per annum | 10% | |

**Notes**

- The firm's current assets and current liabilities are $3m and $2m respectively right now. This net working capital will not be used in this project, it will be used in other unrelated projects.

Due to the project, current assets (mostly inventory) will grow by $2m initially (at t = 0), and then by $0.2m at the end of the first year (t=1).

Current liabilities (mostly trade creditors) will increase by $0.1m at the end of the first year (t=1).

At the end of the project, the net working capital accumulated due to the project can be sold for the same price that it was bought. - The project cost $0.5m to research which was incurred one year ago.

**Assumptions**

- All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
- All rates and cash flows are real. The inflation rate is 3% pa.
- All rates are given as effective annual rates.
- The business considering the project is run as a 'sole tradership' (run by an individual without a company) and is therefore eligible for a 50% capital gains tax discount when the equipment is sold, as permitted by the Australian Tax Office.

What is the expected net present value (NPV) of the project?

When using the dividend discount model, care must be taken to avoid using a nominal dividend growth rate that exceeds the country's nominal GDP growth rate. Otherwise the firm is forecast to take over the country since it grows faster than the average business forever.

Suppose a firm's nominal dividend grows at **10**% pa forever, and nominal GDP growth is **5**% pa forever. The firm's total dividends are currently $**1** billion (t=0). The country's GDP is currently $**1,000** billion (t=0).

In approximately how many years will the company's total dividends be as large as the country's GDP?

**Question 580** price gains and returns over time, time calculation, effective rate

How many years will it take for an asset's price to **quadruple** (be four times as big, say from $1 to $4) if the price grows by **15**% pa?

**Question 579** price gains and returns over time, time calculation, effective rate

How many years will it take for an asset's price to **double** if the price grows by **10**% pa?

Estimate Microsoft's (MSFT) share price using a price earnings (PE) multiples approach with the following assumptions and figures only:

- Apple, Google and Microsoft are comparable companies,
- Apple's (AAPL) share price is $526.24 and historical EPS is $40.32.
- Google's (GOOG) share price is $1,215.65 and historical EPS is $36.23.
- Micrsoft's (MSFT) historical earnings per share (EPS) is $2.71.

Source: Google Finance 28 Feb 2014.

Estimate the US bank JP Morgan's share price using a price earnings (PE) multiples approach with the following assumptions and figures only:

- The major US banks JP Morgan Chase (JPM), Citi Group (C) and Wells Fargo (WFC) are comparable companies;
- JP Morgan Chase's historical earnings per share (EPS) is $
**4.37**; - Citi Group's share price is $
**50.05**and historical EPS is $**4.26**; - Wells Fargo's share price is $
**48.98**and historical EPS is $**3.89**.

Note: Figures sourced from Google Finance on 24 March 2014.

A stock is expected to pay a dividend of $15 in one year (t=1), then $25 for 9 years after that (payments at t=2 ,3,...10), and on the 11th year (t=11) the dividend will be 2% less than at t=10, and will continue to shrink at the same rate every year after that forever. The required return of the stock is 10%. All rates are effective annual rates.

What is the price of the stock now?

**Question 488** income and capital returns, payout policy, payout ratio, DDM

Two companies BigDiv and ZeroDiv are exactly the same except for their dividend payouts.

BigDiv pays large dividends and ZeroDiv doesn't pay any dividends.

Currently the two firms have the same earnings, assets, number of shares, share price, expected total return and risk.

Assume a perfect world with no taxes, no transaction costs, no asymmetric information and that all assets including business projects are fairly priced and therefore zero-NPV.

All things remaining equal, which of the following statements is **NOT** correct?

**Question 535** DDM, real and nominal returns and cash flows, stock pricing

You are an equities analyst trying to value the equity of the Australian telecoms company Telstra, with ticker TLS. In Australia, listed companies like Telstra tend to pay dividends every **6** months. The payment around August is called the final dividend and the payment around February is called the interim dividend. Both occur annually.

- Today is mid-
**March 2015**. - TLS's last interim dividend of $
**0.15**was one month ago in mid-**February 2015**. - TLS's last final dividend of $
**0.15**was seven months ago in mid-**August 2014**.

Judging by TLS's dividend history and prospects, you estimate that the nominal dividend growth rate will be **1**% pa. Assume that TLS's total nominal cost of equity is **6**% pa. The dividends are nominal cash flows and the inflation rate is **2.5**% pa. All rates are quoted as nominal effective annual rates. Assume that each month is exactly one twelfth (1/12) of a year, so you can ignore the number of days in each month.

Calculate the current TLS share price.

**Question 50** DDM, stock pricing, inflation, real and nominal returns and cash flows

Most listed Australian companies pay dividends twice per year, the 'interim' and 'final' dividends, which are roughly 6 months apart.

You are an equities analyst trying to value the company BHP. You decide to use the Dividend Discount Model (DDM) as a starting point, so you study BHP's dividend history and you find that BHP tends to pay the same interim and final dividend each year, and that both grow by the same rate.

You expect BHP will pay a $0.55 interim dividend in six months and a $0.55 final dividend in one year. You expect each to grow by 4% next year and forever, so the interim and final dividends next year will be $0.572 each, and so on in perpetuity.

Assume BHP's cost of equity is 8% pa. All rates are quoted as nominal effective rates. The dividends are nominal cash flows and the inflation rate is 2.5% pa.

What is the current price of a BHP share?

The following equation is called the Dividend Discount Model (DDM), Gordon Growth Model or the perpetuity with growth formula: ### P_0 = \frac{ C_1 }{ r - g } ###

What is ##g##? The value ##g## is the long term expected:

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 ##?

Currently, a mining company has a share price of $6 and pays constant annual dividends of $0.50. The next dividend will be paid in 1 year. Suddenly and unexpectedly the mining company announces that due to higher than expected profits, all of these windfall profits will be paid as a special dividend of $0.30 in 1 year.

If investors believe that the windfall profits and dividend is a one-off event, what will be the new share price? If investors believe that the additional dividend is actually permanent and will continue to be paid, what will be the new share price? Assume that the required return on equity is unchanged. Choose from the following, where the first share price includes the one-off increase in earnings and dividends for the first year only ##(P_\text{0 one-off})## , and the second assumes that the increase is permanent ##(P_\text{0 permanent})##:

Note: When a firm makes excess profits they sometimes pay them out as special dividends. Special dividends are just like ordinary dividends but they are one-off and investors do not expect them to continue, unlike ordinary dividends which are expected to persist.

### p_{0} = \frac{c_1}{r_{\text{eff}} - g_{\text{eff}}} ###

What is the discount rate '## r_\text{eff} ##' in this equation?

The following is the Dividend Discount Model (DDM) used to price stocks:

### P_0 = \frac{d_1}{r-g} ###Assume that the assumptions of the DDM hold and that the time period is measured in years.

Which of the following is equal to the expected dividend in 3 years, ## d_3 ##?

When using the dividend discount model to price a stock:

### p_{0} = \frac{d_1}{r - g} ###

The growth rate of dividends (g):

###p_0=\frac{d_1}{r_\text{eff}-g_\text{eff}}###

Which expression is **NOT** equal to the expected capital return?

For certain shares, the forward-looking Price-Earnings Ratio (##P_0/EPS_1##) is equal to the inverse of the share's total expected return (##1/r_\text{total}##).

For what shares is this true?

Assume:

- The general accounting definition of 'payout ratio' which is dividends per share (DPS) divided by earnings per share (EPS).
- All cash flows, earnings and rates are real.

The following is the Dividend Discount Model used to price stocks:

### p_0=\frac{d_1}{r-g} ###

Which of the following statements about the Dividend Discount Model is **NOT** correct?

**Question 210** real estate, inflation, real and nominal returns and cash flows, income and capital returns

Assume that the Gordon Growth Model (same as the dividend discount model or perpetuity with growth formula) is an appropriate method to value real estate.

The rule of thumb in the real estate industry is that properties should yield a **5**% pa rental return. Many investors also regard property to be as risky as the stock market, therefore property is thought to have a required **total** return of **9**% pa which is the average total return on the stock market including dividends.

Assume that all returns are effective annual rates and they are **nominal** (not reduced by inflation). Inflation is expected to be **2**% pa.

You're considering purchasing an investment property which has a rental yield of 5% pa and you expect it to have the same risk as the stock market. Select the most correct statement about this property.

**Question 58** NPV, inflation, real and nominal returns and cash flows, Annuity

A project to build a toll bridge will take two years to complete, costing three payments of $100 million at the start of each year for the next three years, that is at t=0, 1 and 2.

After completion, the toll bridge will yield a constant $50 million at the end of each year for the next 10 years. So the first payment will be at t=3 and the last at t=12. After the last payment at t=12, the bridge will be given to the government.

The required return of the project is 21% pa given as an effective annual **nominal** rate.

All cash flows are **real** and the expected inflation rate is 10% pa given as an effective annual rate. Ignore taxes.

The Net Present Value is:

You own an apartment which you rent out as an investment property.

What is the price of the apartment using discounted cash flow (DCF, same as NPV) valuation?

Assume that:

- You just signed a contract to rent the apartment out to a tenant for the next 12 months at $2,000 per month, payable in advance (at the start of the month, t=0). The tenant is just about to pay you the first $2,000 payment.
- The contract states that monthly rental payments are fixed for 12 months. After the contract ends, you plan to sign another contract but with rental payment increases of 3%. You intend to do this every year.

So rental payments will increase at the start of the 13th month (t=12) to be $2,060 (=2,000(1+0.03)), and then they will be constant for the next 12 months.

Rental payments will increase again at the start of the 25th month (t=24) to be $2,121.80 (=2,000(1+0.03)^{2}), and then they will be constant for the next 12 months until the next year, and so on. - The required return of the apartment is 8.732% pa, given as an effective annual rate.
- Ignore all taxes, maintenance, real estate agent, council and strata fees, periods of vacancy and other costs. Assume that the apartment will last forever and so will the rental payments.

A credit card company advertises an interest rate of 18% pa, payable monthly. Which of the following statements about the interest rate is **NOT** correct? All rates are given to four decimal places.

Estimate the French bank Societe Generale's share price using a backward-looking price earnings (PE) multiples approach with the following assumptions and figures only. Note that EUR is the euro, the European monetary union's currency.

- The 4 major European banks Credit Agricole (ACA), Deutsche Bank AG (DBK), UniCredit (UCG) and Banco Santander (SAN) are comparable companies to Societe Generale (GLE);
- Societe Generale's (GLE's) historical earnings per share (EPS) is EUR 2.92;
- ACA's backward-looking PE ratio is 16.29 and historical EPS is EUR 0.84;
- DBK's backward-looking PE ratio is 25.01 and historical EPS is EUR 1.26;
- SAN's backward-looking PE ratio is 14.71 and historical EPS is EUR 0.47;
- UCG's backward-looking PE ratio is 15.78 and historical EPS is EUR 0.40;

Note: Figures sourced from Google Finance on 27 March 2015.

**Question 578** inflation, real and nominal returns and cash flows

Which of the following statements about inflation is **NOT** correct?

**Question 576** inflation, real and nominal returns and cash flows

What is the present value of a **nominal** payment of $1,000 in 4 years? The **nominal** discount rate is 8% pa and the inflation rate is 2% pa.

**Question 574** inflation, real and nominal returns and cash flows, NPV

What is the present value of a **nominal** payment of $100 in 5 years? The **real** discount rate is 10% pa and the inflation rate is 3% pa.

**Question 573** bond pricing, zero coupon bond, term structure of interest rates, expectations hypothesis, liquidity premium theory, forward interest rate, yield curve

In the below term structure of interest rates equation, all rates are effective annual yields and the numbers in subscript represent the years that the yields are measured over:

###(1+r_{0-3})^3 = (1+r_{0-1})(1+r_{1-2})(1+r_{2-3}) ###

Which of the following statements is **NOT** correct?

**Question 572** bond pricing, zero coupon bond, term structure of interest rates, expectations hypothesis, forward interest rate, yield curve

In the below term structure of interest rates equation, all rates are effective annual yields and the numbers in subscript represent the years that the yields are measured over:

###(1+r_{0-3})^3 = (1+r_{0-1})(1+r_{1-2})(1+r_{2-3}) ###

Which of the following statements is **NOT** correct?

An Indonesian lady wishes to convert 1 million Indonesian rupiah (IDR) to Australian dollars (AUD). Exchange rates are 13,125 IDR per USD and 0.79 USD per AUD. How many AUD is the IDR 1 million worth?

An American wishes to convert **USD 1 million** to Australian dollars (AUD). The exchange rate is **0.8 USD per AUD**. How much is the USD 1 million worth in AUD?

The average weekly earnings of an Australian adult worker before tax was $1,542.40 per week in November 2014 according to the Australian Bureau of Statistics. Therefore average annual earnings before tax were $**80,204.80** assuming 52 weeks per year. Personal income tax rates published by the Australian Tax Office are reproduced for the 2014-2015 financial year in the table below:

Taxable income | Tax on this income |
---|---|

0 – $18,200 | Nil |

$18,201 – $37,000 | 19c for each $1 over $18,200 |

$37,001 – $80,000 | $3,572 plus 32.5c for each $1 over $37,000 |

$80,001 – $180,000 | $17,547 plus 37c for each $1 over $80,000 |

$180,001 and over | $54,547 plus 45c for each $1 over $180,000 |

The above rates do not include the Medicare levy of 2%. Exclude the Medicare levy from your calculations

How much personal income tax would you have to pay per year if you earned $80,204.80 per annum before-tax?

**Question 568** rights issue, capital raising, capital structure

A company conducts a **1** for **5** rights issue at a subscription price of $**7** when the pre-announcement stock price was $**10**. What is the percentage change in the stock price and the number of shares outstanding? The answers are given in the same order. Ignore all taxes, transaction costs and signalling effects.

A company conducts a **4** for **3** stock split. What is the percentage change in the stock price and the number of shares outstanding? The answers are given in the same order.

**Question 566** capital structure, capital raising, rights issue, on market repurchase, dividend, stock split, bonus issue

A company's share price fell by 20% and its number of shares rose by 25%. Assume that there are no taxes, no signalling effects and no transaction costs.

Which one of the following corporate events may have happened?

What is the correlation of a variable X with a constant C?

The corr(X, C) or ##\rho_{X,C}## equals:

What is the covariance of a variable X with a constant C?

The cov(X, C) or ##\sigma_{X,C}## equals:

What is the correlation of a variable X with itself?

The corr(X, X) or ##\rho_{X,X}## equals:

What is the covariance of a variable X with itself?

The cov(X, X) or ##\sigma_{X,X}## equals:

The covariance and correlation of two stocks X and Y's annual returns are calculated over a number of years. The units of the returns are in percent per annum ##(\% pa)##.

What are the units of the covariance ##(\sigma_{X,Y})## and correlation ##(\rho_{X,Y})## of returns respectively?

**Hint**: Visit Wikipedia to understand the difference between percentage points ##(\text{pp})## and percent ##(\%)##.

The standard deviation and variance of a stock's annual returns are calculated over a number of years. The units of the returns are percent per annum ##(\% pa)##.

What are the units of the standard deviation ##(\sigma)## and variance ##(\sigma^2)## of returns respectively?

**Hint**: Visit Wikipedia to understand the difference between percentage points ##(\text{pp})## and percent ##(\%)##.

**Question 559** variance, standard deviation, covariance, correlation

Which of the following statements about standard statistical mathematics notation is **NOT** correct?

**Question 558** portfolio weights, portfolio return, short selling

An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of **16**% pa.

- Stock A has an expected return of
**8**% pa. - Stock B has an expected return of
**12**% pa.

What portfolio weights should the investor have in stocks A and B respectively?

An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of **6**% pa.

- Stock A has an expected return of
**5**% pa. - Stock B has an expected return of
**10**% pa.

What portfolio weights should the investor have in stocks A and B respectively?

**Question 556** portfolio risk, portfolio return, standard deviation

An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of **12**% pa.

- Stock A has an expected return of
**10**% pa and a standard deviation of**20**% pa. - Stock B has an expected return of
**15**% pa and a standard deviation of**30**% pa.

The correlation coefficient between stock A and B's expected returns is **70**%.

What will be the annual standard deviation of the portfolio with this 12% pa target return?

Find the cash flow from assets (CFFA) of the following project.

Project Data | |

Project life | 2 years |

Initial investment in equipment | $8m |

Depreciation of equipment per year for tax purposes | $3m |

Unit sales per year | 10m |

Sale price per unit | $9 |

Variable cost per unit | $4 |

Fixed costs per year, paid at the end of each year | $2m |

Tax rate | 30% |

Note 1: Due to the project, the firm will have to purchase $40m of inventory initially (at t=0). Half of this inventory will be sold at t=1 and the other half at t=2.

Note 2: The equipment will have a book value of $2m at the end of the project for tax purposes. However, the equipment is expected to fetch $1m when it is sold. Assume that the full capital loss is tax-deductible and taxed at the full corporate tax rate.

Note 3: The project will be fully funded by equity which investors will expect to pay dividends totaling $10m at the end of each year.

Find the project's CFFA at time zero, one and two. Answers are given in millions of dollars ($m).

An investor bought a **20** year **5**% pa fixed coupon government bond priced at **par**. The face value is $100. Coupons are paid semi-annually and the next one is in 6 months.

Six months later, just after the coupon at that time was paid, yields suddenly and unexpectedly rose to **5.5**% pa. Note that all yields above are given as APR's compounding semi-annually.

What was the bond investors' historical total return over that first 6 month period, given as an effective semi-annual rate?

An investor bought a **10** year **2.5**% pa fixed coupon government bond priced at **par**. The face value is $**100**. Coupons are paid **semi-annually** and the next one is in 6 months.

**Six months later**, just **after** the coupon at that time was paid, yields suddenly and unexpectedly fell to **2**% pa. Note that all yields above are given as APR's compounding semi-annually.

What was the bond investors' historical total return over that first 6 month period, given as an effective semi-annual rate?

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.

Many Australian home loans that are interest-only actually require payments to be made on a fully amortising basis after a number of years.

You decide to borrow $**600,000** from the bank at an interest rate of **4.25**% pa for 25 years. The payments will be **interest-only** for the first **10** years (t=0 to 10 years), then they will have to be paid on a **fully amortising** basis for the last **15** years (t=10 to 25 years).

Assuming that interest rates will remain constant, what will be your monthly payments over the first 10 years from now, and then the next 15 years after that? The answer options are given in the same order.

An Apple iPhone 6 smart phone can be bought now for $**999**. An Android Samsung Galaxy 5 smart phone can be bought now for $**599**.

If the Samsung phone lasts for **four** years, approximately how long must the Apple phone last for to have the same equivalent annual cost?

Assume that both phones have equivalent features besides their lifetimes, that both are worthless once they've outlasted their life, the discount rate is **10**% pa given as an effective annual rate, and there are no extra costs or benefits from either phone.

**Question 548** equivalent annual cash flow, time calculation, no explanation

An Apple iPhone 6 smart phone can be bought now for $**999**. An Android Kogan Agora 4G+ smart phone can be bought now for $**240**.

If the Kogan phone lasts for **one** year, approximately how long must the Apple phone last for to have the same equivalent annual cost?

Assume that both phones have equivalent features besides their lifetimes, that both are worthless once they've outlasted their life, the discount rate is **10**% pa given as an effective annual rate, and there are no extra costs or benefits from either phone.

**Question 547** PE ratio, Multiples valuation, DDM, income and capital returns, no explanation

A firm pays out all of its earnings as dividends. Because of this, the firm has no real growth in earnings, dividends or stock price since there is no re-investment back into the firm to buy new assets and make higher earnings. The dividend discount model is suitable to value this company.

The firm's revenues and costs are expected to increase by inflation in the foreseeable future. The firm has no debt. It operates in the services industry and has few physical assets so there is negligible depreciation expense and negligible net working capital required.

Which of the following statements about this firm's PE ratio is **NOT** correct? The PE ratio should:

Note: The inverse of x is 1/x.

**Question 546** income and capital returns, interest only loan, no explanation

Which of the following statements about the capital and income returns of an **interest-only** loan is correct?

Assume that the yield curve (which shows total returns over different maturities) is flat and is not expected to change.

An interest-only loan's expected:

**Question 545** income and capital returns, fully amortising loan, no explanation

Which of the following statements about the capital and income returns of a **25 year** **fully amortising** loan asset is correct?

Assume that the yield curve (which shows total returns over different maturities) is flat and is not expected to change.

Over the 25 years from issuance to maturity, a fully amortising loan's expected **annual** effective:

A firm wishes to raise $10 million now. They will issue 6% pa semi-annual coupon bonds that will mature in 3 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 543** price gains and returns over time, IRR, NPV, income and capital returns, effective return

For an asset price to **triple** every **5** years, what must be the expected future capital return, given as an effective annual rate?

**Question 542** price gains and returns over time, IRR, NPV, income and capital returns, effective return

For an asset price to **double** every **10** years, what must be the expected future capital return, given as an effective annual rate?

Which one of the below statements about effective rates and annualised percentage rates (APR's) is **NOT** correct?

**Question 539** debt terminology, fully amortising loan, bond pricing

A 'fully amortising' loan can also be called a:

**Question 538** bond pricing, income and capital returns, no explanation

Risk-free government bonds that have coupon rates greater than their yields:

**Question 536** idiom, bond pricing, capital structure, leverage

The expression 'my word is my bond' is often used in everyday language to make a serious promise.

Why do you think this expression uses the metaphor of a bond rather than a share?

You have $**100,000** in the bank. The bank pays interest at **10**% pa, given as an effective annual rate.

You wish to consume **half** as much now (t=0) as in one year (t=1) and have nothing left in the bank at the end.

How much can you consume at time zero and one? The answer choices are given in the same order.

You have $**100,000** in the bank. The bank pays interest at **10**% pa, given as an effective annual rate.

You wish to consume **twice** as much now (t=0) as in one year (t=1) and have nothing left in the bank at the end.

How much can you consume at time zero and one? The answer choices are given in the same order.

You want to buy an apartment priced at $500,000. You have saved a deposit of $50,000. The bank has agreed to lend you the $450,000 as a **fully amortising** loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?

You want to buy an apartment priced at $500,000. You have saved a deposit of $50,000. The bank has agreed to lend you the $450,000 as an **interest only** loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?

Which of the following statements about effective rates and annualised percentage rates (APR's) is **NOT** correct?

A European bond paying annual coupons of 6% offers a yield of 10% pa.

Convert the yield into an effective monthly rate, an effective annual rate and an effective daily rate. Assume that there are 365 days in a year.

All answers are given in the same order:

### r_\text{eff, monthly} , r_\text{eff, yearly} , r_\text{eff, daily} ###

You just signed up for a 30 year **fully amortising** mortgage loan with monthly payments of $1,500 per month. The interest rate is 9% pa which is not expected to change.

To your surprise, you can actually afford to pay $2,000 per month and your mortgage allows early repayments without fees. If you maintain these higher monthly payments, how long will it take to pay off your mortgage?

A prospective home buyer can afford to pay $2,000 per month in mortgage loan repayments. The central bank recently lowered its policy rate by 0.25%, and residential home lenders cut their mortgage loan rates from 4.74% to 4.49%.

How much more can the prospective home buyer borrow now that interest rates are **4.49%** rather than **4.74%**? Give your answer as a proportional increase over the original amount he could borrow (##V_\text{before}##), so:

Assume that:

- Interest rates are expected to be
**constant**over the life of the loan. - Loans are
**interest-only**and have a life of 30 years. - Mortgage loan payments are made every month in arrears and all interest rates are given as annualised percentage rates compounding per month.

**Question 56** income and capital returns, bond pricing, premium par and discount bonds

Which of the following statements about risk free government bonds is **NOT** correct?

**Hint:** Total return can be broken into income and capital returns as follows:

###\begin{aligned} r_\text{total} &= \frac{c_1}{p_0} + \frac{p_1-p_0}{p_0} \\ &= r_\text{income} + r_\text{capital} \end{aligned} ###

The capital return is the growth rate of the price.

The income return is the periodic cash flow. For a bond this is the coupon payment.

A two year Government bond has a face value of $100, a yield of 0.5% and a fixed coupon rate of 0.5%, paid semi-annually. What is its price?

A firm wishes to raise $10 million now. They will issue 6% pa semi-annual coupon bonds that will mature in 8 years and have a face value of $1,000 each. Bond yields are 10% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?

Bonds X and Y are issued by the same US company. Both bonds yield **6**% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.

The only difference is that bond X pays coupons of **8**% pa and bond Y pays coupons of **12**% pa. Which of the following statements is true?

**Question 108** bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

An Australian company just issued two bonds:

- A 1 year zero coupon bond at a yield of 10% pa, and
- A 2 year zero coupon bond at a yield of 8% pa.

What is the forward rate on the company's debt from years 1 to 2? Give your answer as an APR compounding every 6 months, which is how the above bond yields are quoted.

Bonds A and B are issued by the same company. They have the same face value, maturity, seniority and coupon payment frequency. The only difference is that bond A has a 5% coupon rate, while bond B has a 10% coupon rate. The yield curve is flat, which means that yields are expected to stay the same.

Which bond would have the higher current price?

Bonds A and B are issued by the same Australian company. Both bonds yield 7% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.

The only difference is that bond A pays coupons of 10% pa and bond B pays coupons of 5% pa. Which of the following statements is true about the bonds' prices?

Bonds X and Y are issued by different companies, but they both pay a semi-annual coupon of **10**% pa and they have the same face value ($100) and maturity (3 years).

The only difference is that bond X and Y's **yields** are **8** and **12**% pa respectively. Which of the following statements is true?

Bonds X and Y are issued by different companies, but they both pay a semi-annual coupon of 10% pa and they have the same face value ($100), maturity (3 years) and yield (10%) as each other.

Which of the following statements is true?

Which one of the following bonds is trading at par?

**Question 213** income and capital returns, bond pricing, premium par and discount bonds

The coupon rate of a fixed annual-coupon bond is constant (always the same).

What can you say about the income return (##r_\text{income}##) of a fixed annual coupon bond? Remember that:

###r_\text{total} = r_\text{income} + r_\text{capital}###

###r_\text{total, 0 to 1} = \frac{c_1}{p_0} + \frac{p_1-p_0}{p_0}###

Assume that there is no change in the bond's total annual yield to maturity from when it is issued to when it matures.

Select the most correct statement.

From its date of issue until maturity, the **income return** of a fixed annual coupon:

Bonds X and Y are issued by the same company. Both bonds yield 10% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.

The only difference is that bond X pays coupons of 6% pa and bond Y pays coupons of 8% pa. Which of the following statements is true?

Your friend just bought a house for $400,000. He financed it using a $320,000 mortgage loan and a deposit of $80,000.

In the context of residential housing and mortgages, the 'equity' tied up in the value of a person's house is the value of the house less the value of the mortgage. So the initial equity your friend has in his house is $80,000. Let this amount be E, let the value of the mortgage be D and the value of the house be V. So ##V=D+E##.

If house prices suddenly fall by **10**%, what would be your friend's percentage change in equity (E)? Assume that the value of the mortgage is unchanged and that no income (rent) was received from the house during the short time over which house prices fell.

Remember:

### r_{0\rightarrow1}=\frac{p_1-p_0+c_1}{p_0} ###

where ##r_{0-1}## is the return (percentage change) of an asset with price ##p_0## initially, ##p_1## one period later, and paying a cash flow of ##c_1## at time ##t=1##.

One year ago you bought $**100,000** of shares partly funded using a margin loan. The margin loan size was $**70,000** and the other $**30,000** was your own wealth or 'equity' in the share assets.

The interest rate on the margin loan was **7.84**% pa.

Over the year, the shares produced a dividend yield of **4**% pa and a capital gain of **5**% pa.

What was the **total** return on your **wealth**? Ignore taxes, assume that all cash flows (interest payments and dividends) were paid and received at the end of the year, and all rates above are effective annual rates.

Hint: Remember that wealth in this context is your equity (E) in the house asset (V = D+E) which is funded by the loan (D) and your deposit or equity (E).

Interest expense (IntExp) is an important part of a company's income statement (or 'profit and loss' or 'statement of financial performance').

How does an **accountant** calculate the annual interest expense of a fixed-coupon bond that has a liquid secondary market? Select the most correct answer:

Annual interest expense is equal to:

A firm has a debt-to-equity ratio of 25%. What is its debt-to-assets ratio?

A manufacturing company is considering a new project in the more risky services industry. The cash flows from assets (CFFA) are estimated for the new project, with interest expense excluded from the calculations. To get the levered value of the project, what should these unlevered cash flows be discounted by?

Assume that the manufacturing firm has a target debt-to-assets ratio that it sticks to.

The US firm Google operates in the online advertising business. In 2011 Google bought Motorola Mobility which manufactures mobile phones.

Assume the following:

- Google had a 10% after-tax weighted average cost of capital (WACC) before it bought Motorola.
- Motorola had a 20% after-tax WACC before it merged with Google.
- Google and Motorola have the same level of gearing.
- Both companies operate in a classical tax system.

You are a manager at Motorola. You must value a project for making mobile phones. Which method(s) will give the correct valuation of the mobile phone manufacturing project? Select the most correct answer.

The mobile phone manufacturing project's:

There are many ways to calculate a firm's free cash flow (FFCF), also called cash flow from assets (CFFA). Some include the annual interest tax shield in the cash flow and some do not.

Which of the below FFCF formulas include the interest tax shield in the cash flow?

###(1) \quad FFCF=NI + Depr - CapEx -ΔNWC + IntExp### ###(2) \quad FFCF=NI + Depr - CapEx -ΔNWC + IntExp.(1-t_c)### ###(3) \quad FFCF=EBIT.(1-t_c )+ Depr- CapEx -ΔNWC+IntExp.t_c### ###(4) \quad FFCF=EBIT.(1-t_c) + Depr- CapEx -ΔNWC### ###(5) \quad FFCF=EBITDA.(1-t_c )+Depr.t_c- CapEx -ΔNWC+IntExp.t_c### ###(6) \quad FFCF=EBITDA.(1-t_c )+Depr.t_c- CapEx -ΔNWC### ###(7) \quad FFCF=EBIT-Tax + Depr - CapEx -ΔNWC### ###(8) \quad FFCF=EBIT-Tax + Depr - CapEx -ΔNWC-IntExp.t_c### ###(9) \quad FFCF=EBITDA-Tax - CapEx -ΔNWC### ###(10) \quad FFCF=EBITDA-Tax - CapEx -ΔNWC-IntExp.t_c###The formulas for net income (NI also called earnings), EBIT and EBITDA are given below. Assume that depreciation and amortisation are both represented by 'Depr' and that 'FC' represents fixed costs such as rent.

###NI=(Rev - COGS - Depr - FC - IntExp).(1-t_c )### ###EBIT=Rev - COGS - FC-Depr### ###EBITDA=Rev - COGS - FC### ###Tax =(Rev - COGS - Depr - FC - IntExp).t_c= \dfrac{NI.t_c}{1-t_c}###One formula for calculating a levered firm's free cash flow (FFCF, or CFFA) is to use earnings before interest and tax (EBIT).

###\begin{aligned} FFCF &= (EBIT)(1-t_c) + Depr - CapEx -\Delta NWC + IntExp.t_c \\ &= (Rev - COGS - Depr - FC)(1-t_c) + Depr - CapEx -\Delta NWC + IntExp.t_c \\ \end{aligned} \\###

One formula for calculating a levered firm's free cash flow (FFCF, or CFFA) is to use net operating profit after tax (NOPAT).

###\begin{aligned} FFCF &= NOPAT + Depr - CapEx -\Delta NWC \\ &= (Rev - COGS - Depr - FC)(1-t_c) + Depr - CapEx -\Delta NWC \\ \end{aligned} \\###

**Question 370** capital budgeting, NPV, interest tax shield, WACC, CFFA

Project Data | ||

Project life | 2 yrs | |

Initial investment in equipment | $600k | |

Depreciation of equipment per year | $250k | |

Expected sale price of equipment at end of project | $200k | |

Revenue per job | $12k | |

Variable cost per job | $4k | |

Quantity of jobs per year | 120 | |

Fixed costs per year, paid at the end of each year | $100k | |

Interest expense in first year (at t=1) | $16.091k | |

Interest expense in second year (at t=2) | $9.711k | |

Tax rate | 30% | |

Government treasury bond yield | 5% | |

Bank loan debt yield | 6% | |

Levered cost of equity | 12.5% | |

Market portfolio return | 10% | |

Beta of assets | 1.24 | |

Beta of levered equity | 1.5 | |

Firm's and project's debt-to-equity ratio |
25% | |

**Notes**

- The project will require an immediate purchase of $
**50**k of inventory, which will all be sold at cost when the project ends. Current liabilities are negligible so they can be ignored.

**Assumptions**

- The debt-to-equity ratio will be kept constant throughout the life of the project. The amount of interest expense at the end of each period has been correctly calculated to maintain this constant debt-to-equity ratio. Note that interest expense is different in each year.
- Thousands are represented by 'k' (kilo).
- All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
- All rates and cash flows are nominal. The inflation rate is 2% pa.
- All rates are given as effective annual rates.
- The 50% capital gains tax discount is not available since the project is undertaken by a firm, not an individual.

What is the net present value (NPV) of the project?

A company issues a large amount of bonds to raise money for new projects of similar risk to the company's existing projects. The net present value (NPV) of the new projects is positive but small. Assume a classical tax system. Which statement is **NOT** correct?

A firm has a debt-to-assets ratio of 50%. The firm then issues a large amount of equity to raise money for new projects of similar systematic risk to the company's existing projects. Assume a classical tax system. Which statement is correct?

A firm has a debt-to-assets ratio of 50%. The firm then issues a large amount of debt to raise money for new projects of similar market risk to the company's existing projects. Assume a classical tax system. Which statement is correct?

**Question 337** capital structure, interest tax shield, leverage, real and nominal returns and cash flows, multi stage growth model

A fast-growing firm is suitable for valuation using a multi-stage growth model.

It's **nominal** unlevered cash flow from assets (##CFFA_U##) at the end of this year (**t=1**) is expected to be $**1** million. After that it is expected to grow at a rate of:

**12**% pa for the next two years (from t=1 to 3),**5**% over the fourth year (from t=3 to 4), and**-1**% forever after that (from t=4 onwards). Note that this is a negative one percent growth rate.

Assume that:

- The nominal WACC
**after**tax is**9.5**% pa and is not expected to change. - The nominal WACC
**before**tax is**10**% pa and is not expected to change. - The firm has a target debt-to-
**equity**ratio that it plans to maintain. - The inflation rate is
**3**% pa. - All rates are given as
**nominal**effective annual rates.

What is the levered value of this fast growing firm's assets?