Homework Assignment I

1.

Lee plans to retire in 22 years with a nest egg of $8M. He has already saved $500,000 in an investment
account that generates a nominal rate of return of 12%, compounded quarterly. However, he needs to
withdraw $150,000 from this account in 10 years to finance his sons college education.
(a)
Numerically show that whether Lees investment account balance will reach $8M in 22 years,
based on the information provided above.
<$6.12M>
(b)
The correct answer for part (a) indicates that Lees investment account will fall short of his
retirement goal of $8M in 22 years. Thus, he continues his pursuit by making additional fixed
contributions at the end of every quarter to the same investment account until he retires 22 years
later. How big should be his quarterly contribution in order to achieve his goal? <$4,522.18>
(c)
Assume now that Lee retires and has $8M in his investment account. If he wants to leave $10M
to each of his two children upon his death after enjoying 25 years of retirement. What is the
maximum annual withdrawal from the investment account Lee can make at the beginning of
every year during his retirement?
<$818,587.57>

2.

Maryanne, a baby boomer who turns 50 today, begins to save for retirement with $200,000 that she just
receives from a trust fund. She immediately invests this $200,000 in a stock fund. In addition, she
plans to contribute $10,000, $15,000, and $20,000, respectively, at the end of the next 3 years to the
same stock fund. The stock fund generates a nominal rate of return of 10%, compounded annually.
(a)
What will be the value of her stock fund when she retires at the age of 67? <$1,195,452.48>
(b)
Right after her retirement, she transfers her nest egg into a conservative investment that
compounds monthly. If Maryanne wants to withdraw a fixed monthly payment of $7,000 from
this investment indefinitely, what should be the annual rate of return of this conservative
investment?
<7.03%>

3.

Consider the following two mutually exclusive projects, X and Y, and their cash flows information,
Project
Year 0
Year 1
Year 2
Year 3
Year 4
X
($1,400)
$350
$750
$650
$650
Y
($1,000)
$300
$400
$500
$600
(a)
Assume that the discount rate is 12%, compute the payback period, the IRR, NPV and PI of
project X.
<2.46 years; 23.49%; $386.13; 1.276>
(b)
Use the McKinseys approach to compute the Modified IRR (MIRR) for project X. <19.03%>
(c)
Apply the incremental IRR analysis to compute the crossover rate for projects X and Y, and select
between these two mutually exclusive projects. <19.41%>

4.

The following are two popular approaches used by automobile dealers:

(a)
Cash Rebate Versus Low Rate Dealer Financing
You are given two mutually exclusive options from the dealer on a $20,000 car: (i) $1,500 cash
rebate or (ii) 36-month low rate loan at 3% APR. The prevailing APR on 36-month auto loan
from a typical bank is 8%. Which option is a better deal?
<$579.72;
$581.62>
(b)
Buying Versus Leasing
You are interested in a $25,000 car. A simplified leasing contract includes the following: (i) upfront cost of $3,000, (ii) $400 monthly lease payment over a 36-month period, and (iii) purchase
cost of $12,000 at the end of the lease. What are the implied APR and EAR of the lease?
Should you lease the car or buy and finance the car with a loan from the bank in (a)?
<8.45%; 8.79%>

5.

You have been asked by the president of your firm to evaluate the proposed acquisition of new
special-purpose equipment. The equipment's base price is $500,000, and another $50,000 for
its installation costs. The equipment falls into the MACRS 3-year class, and it will be sold at
the end of the projects 2-year life for $250,000. Use of the equipment will require net working
capital investment equivalent to 20% of the following years incremental revenues. The
equipment will increase annual revenues by $100,000, and save the firm $200,000 in annual
operating costs. The annual revenues and operating costs are expected to grow at an annual
rate of 10% during the 2nd-year of the project. This equipment will be placed in an unoccupied
site, which can otherwise be sold for $100,000 today. This site will be sold for the same price at
the termination of the project. The depreciation of this site that your firm owns can be ignored.
The firm's tax rate is 30 percent and the discount rate for the project is 12%.
(a)
(b)
(c)
(d)

6.

Compute the initial outlay of the project.

<-$670,000>
Compute the operating cash flows (OCF) in Years 1 and 2.
<$264,995; $304,326>
Compute the non-operating cash flows (i.e., capital spending and change in NWC) at the end of
Year 2. <$333,679>
What is your recommendation on this project according to the conceptually most correct capital
budgeting method? Why? Be concise! <$73,430>

Use the attached financial statements to compute

(a)
the cash flow from assets and its 3 components,
(b)
the cash flow to creditors/bondholders and its 2 components,
(c)
the cash flow to stockholders and its 2 components
for LEE Corporation for the fiscal year of 2014.

<$317>
<$218>
<$99>

LEE Corporation (Problem #6)

Income Statement

2014

Net Sales
Cost of Goods Sold
Depreciation Expenses
Earnings Before Interest and Taxes
Interest Expenses
Taxable Income
Taxes (34%)
Net Income

$ 1,800
$ 1,080
$ 180
$ 540
$ 120
$ 420
$ 143
$ 277

Dividends Paid

$ 83

Balance Sheet

2013

2014

Total Current Assets

Net Fixed Assets
Total Assets

$ 536
$ 2,164
$ 2,700

$ 540
$ 2,160
$ 2,700

Total Current Liabilities

Long-term Debt
Common Stock & Paid-in Capital
Retained Earnings
Total Liabilities and Equity

$ 980
$ 278
$ 700
$ 742
$ 2,700

$ 900
$ 180
$ 684
$ 936
$ 2,700

NOTES:

This homework assignment is composed of a SAMPLE of past examination problems

that are pertaining to the midterm examination. Since this is just a sample, the actual
midterm examination may include other numerical problems that are not included in
this homework assignment, e.g., numerical problems from Chapter 3 and 6 such as
the use of the Pro Forma statement to estimate EFN, the EAC calculation,
Financial Ratio calculations and interpretations, etc. As such, while you will find
this homework assignment a valuable tool for your preparation for the midterm
examination, it is by no mean inclusive of all topics that are covered in the midterm
examination! Besides, I need to explicitly remind you that it takes much practice to
master the course materials. Students who only work on the homework problem sets
(without investing needed time on learning/studying course materials and practicing
suggested problems) may find themselves underprepared for the examinations.
The answers to the problems are given for your reference. Due to the degree of
similarity between these homework problems and the actual examination problems,
detailed solutions will NOT be posted. Please note that numerical illustrations similar
(but not identical) to these homework, and hence examination, problems can be found
in the online lecture notes (via Modules) for the respective chapters/topics!