Boston University Finance for Business Investments and Equity Worksheet Please type your solutions. You may use Excel if you’d like, but if you don’t want to, you can solve the problems by hand.
1.(5 points) Suppose in a lawsuit settlement, Teva Pharmaceuticals agrees to pay $2 billion in total for patent infringement damages. The payments are to be made over 20 years in equal annual amounts. The first payment is to be made today. If the appropriate investment rate is 6%, what is the settlement actually worth?
2.(10 points) John Petrozzi has been appointed Fiscal Coordinator for the Stanford Narcolepsy Institute. He always stays awake in class, but he wants to help others who are rather heavy-lidded. He has the task of valuing Matthew’s Magnificent Mattresses (3M – a maker of affordable memory foam mattresses). 3M will pay a dividend of $1.25 next quarter. (aside – these numbers are fictional though the firm is real). John estimates that the firm will grow at 5% per quarter for 4 years, at 4% per quarter for 5 years, then at 1% per quarter thereafter. The cost of equity is 14% with annual compounding. Find the correct stock price for 3M.
3.(15 points) Will Padden is doing some financial planning for a family friend. The friend plans to buy a boat 40 years from now, when he retires. Today’s price for the boat is $250,000. The price is expected to rise at 3% per year. The friend also wants to send his child to BC in 10 years. College is expected to cost $105,000 in the child’s first year, growing at 4% per year while in school. College lasts for 4 years and the first payment is due the first day of school. The friend has $50,000 saved now and expects to put a certain fraction of his salary away each year, starting in 1 year with the final payment on the retirement date. His salary will grow by 2% per year. He currently makes $140,000. If Will can earn 6% per year on the friend’s investments, what fraction of the friend’s salary must be saved?
4. (10 points) Caroline’s Chill Chronometers (3C) is considering buying a machine for $600 million. The machine has a useful life of 20 years. Sales are projected to be $120 million per year, with operating expenses of $35 million per year. An initial NWC investment of $10 million would be needed. NWC, however, would decrease by $300,000 per year over the 15 year life of the project due to improved inventory efficiency. The machine can be sold for $175 million at the end of the project. The tax rate is 20% and the required rate of return is 7%. Find the NPV.
5.(10 points) Bridget Fox is doing some financial planning for a client. The client wants to buy a summer home in 35 years. The home would cost $800,000 today. The price goes up 2% per year. The client also wants to have retirement income over 25 years of retirement. The client wants the income to grow at 3% per year. The client has $350,000 saved now and expects to save 7% of his salary, which will be $250,000 next year. He expects 2% raises annually. If Bridget can earn 8% per year on her client’s investments, how much is the first retirement year’s income (which will be drawn on the day he retires)? The client’s last savings contribution is on the day of retirement.
6.(5 points) Find the price of a 7% bond maturing in 22 years yielding 9% with semi-annual compounding for Chang’s Cool Chips (3C). The par value of the bond is $1,000.
7.(10 points) Tallulah’s Tremendous Trihulls (3T) invests its surplus cash in T-bills. If the firm is
short on cash, it raises funds by selling some T-bills. Each transaction (purchase or sale) of T-
bills costs $10. The interest rate is 2%. 3T wants to keep at least $1,000,000 in its cash balance.
The standard deviation of monthly cash flows is $400,000. Under the Miller-Orr model, what’s
the optimal cash policy?
8.(10 points) Keith’s Krazy Kool Keyboards (4K) has 500 million shares of common stock outstanding, currently trading at $90 per share. 4K also has 70 million shares of preferred stock, with each share worth $50. The preferred stock pays an annual dividend of $5. 4K also has 8,000,000 bonds with a par value of $1,000 that currently sell for 105% of book value. The bonds are priced to yield 6%. The firm has a beta of 1.25. Treasurys yield 2% and the market risk premium is 8%. 4K has a 20% tax rate. Find the firm’s WACC.
9.(5 points) Best Buy is concerned about its inventory of Sony Magnolia 85” 4K Ultra HD TVs. It wants to have at least 3,000 TVs available at a given time. It costs the firm $20 to place an order. It sells 50,000 TVs a year and it costs $20 in storage/insurance per TV per year.
(a) (3 points) How many TVs should Best Buy order at a time?
(b)(2 points) How many TVs does Best Buy have on average in stock?