Question 1

Use the following information to answer the question below.
As an investor, you are considering investing in the Locke Corporation (LC). According to your estimation there is a 75% probability that the return will be 17%, a 15% probability that the return will be 20%, and a 10% probability that the return will be 8%. You have also estimated LC's beta as 1.7.The market required rate of return is 15% and the risk free rate is 9%.
-What is the expected rate of return for LC?

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Question 2

Use the following information to answer the question below.
As an investor, you are considering investing in the Locke Corporation (LC). According to your estimation there is a 75% probability that the return will be 17%, a 15% probability that the return will be 20%, and a 10% probability that the return will be 8%. You have also estimated LC's beta as 1.7.The market required rate of return is 15% and the risk free rate is 9%.
-What is the required rate of return for LC?

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Question 3

Use the following information to answer the question below.
As an investor, you are considering investing in the Locke Corporation (LC). According to your estimation there is a 75% probability that the return will be 17%, a 15% probability that the return will be 20%, and a 10% probability that the return will be 8%. You have also estimated LC's beta as 1.7.The market required rate of return is 15% and the risk free rate is 9%.
-What is the coefficient of variation for LC?

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Question 4

Use the following information to answer the question below.
As an investor, you are considering investing in the Locke Corporation (LC). According to your estimation there is a 75% probability that the return will be 17%, a 15% probability that the return will be 20%, and a 10% probability that the return will be 8%. You have also estimated LC's beta as 1.7.The market required rate of return is 15% and the risk free rate is 9%.
-Based on the calculations in the three questions above, should you buy the stocks of LC? Why?

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Question 5

Use the following information to answer the question below.
As an investor, you are considering investing in the Locke Corporation (LC). According to your estimation there is a 75% probability that the return will be 17%, a 15% probability that the return will be 20%, and a 10% probability that the return will be 8%. You have also estimated LC's beta as 1.7.The market required rate of return is 15% and the risk free rate is 9%.
-Your portfolio has a value of $1,800,000 with a beta of 1. Then, you buy$200,000 of the LC stock without selling any existing stock. What is the new beta of your portfolio?

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Question 6

Distinguish between business risk and financial risk.

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Question 7

What is risk aversion? How does the assumption of risk aversion affect the risk/return tradeoff?

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Question 8

Compare diversifiable and nondiversifiable risk. What are some examples of each type of risk?

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Question 9

You deposit $10,000 in a bank and plan to keep it there for five years. The bank pays 8% annual interest compounded continuously. Calculate the future value at the end of five years.
A) $15,000
B) $14,918
C) $14,500
D) $14,693

Accepted Answer

The future value of an investment compounded continuously is calculated using the formula $A = Pe^{rt}$, where $P$ is the principal amount ($10,000), $r$ is the annual interest rate (0.08), $t$ is the time in years (5), and $e$ is the base of the natural logarithm (approximately 2.71828). Plugging in the values, we get $A = 10000 \times e^{0.08 \times 5} = 10000 \times e^{0.4} \approx \$14,918$.

Question 10

An annuity is best defined as:
A) a series of payments for a specified period of time.
B) a series of equal payments for a specified number of years.
C) a series of equal payments occurring at equal intervals for a specified number of periods.
D) any series of payments.

Accepted Answer

An annuity is specifically defined as a series of equal payments made at equal intervals over a specified number of periods, which matches choice C.

Question 11

As the discount rate increases, the present value of a positive cash flow to be received at a particular time in the future:
A) gets smaller without limit.
B) gets larger without limit.
C) becomes smaller
D) stays unchanged.

Accepted Answer

As the discount rate increases, the present value of a positive cash flow to be received at a particular time in the future becomes smaller. This is because the higher discount rate means that the future cash flow is worth less in today's dollars.

Question 12

As the discount rate decreases , the present value of a positive cash flow to be received at a particular time in the future:
A) gets larger.
B) gets smaller without limit.
C) gets closer to zero.
D) stays unchanged.

Accepted Answer

As the discount rate decreases, the present value of a future cash flow increases because the cash flow is being discounted back to the present value at a lower rate, making it worth more in today's terms.

Question 13

Company XYZ purchased some machinery and gave a five-year note with a maturity value of $20,000. The discount rate is 8% annually and the interest is discounted monthly. How much did the company borrow?
A) $13,612
B) $12,000
C) $19,346
D) $13,424

Accepted Answer

The company borrowed $13,424. This is calculated using the formula for the present value of a single sum, taking into account that the interest is compounded monthly. The formula is: $PV = FV / (1 + r/n)^{nt}$, where PV is the present value (amount borrowed), FV is the future value ($20,000), r is the annual discount rate (0.08), n is the number of compounding periods per year (12 for monthly), and t is the number of years (5). Plugging in the numbers: $PV = 20000 / (1 + 0.08/12)^{12*5}$, which calculates to approximately $13,424.

Question 14

What is the present value of an annual annuity payment of $7,000 made for 12 years with a required return of 5% per year with the first payment starting today?
A) $65,145
B) $ 3,898
C) $62,043
D) $11,200

Accepted Answer

The present value of an annuity due (since the first payment starts today) can be calculated using the formula for the present value of an annuity due: $PV = PMT \times \left(\frac{1 - (1 + r)^{-n}}{r}\right) \times (1 + r)$, where PMT is the annual payment ($7,000), r is the annual interest rate (5% or 0.05), and n is the number of periods (12 years). Plugging in the values, we get $PV = $7,000 \times \left(\frac{1 - (1 + 0.05)^{-12}}{0.05}\right) \times (1 + 0.05)$, which calculates to approximately $65,145, making option A the correct choice.

Question 15

What is the present value of a semi- annual ordinary annuity payment of $7,000 made for 12 years with a required annual return of 5%compounded semi annually?
A) $ 62,043
B) $128,325
C) $ 65,145
D) $125,195

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Question 16

How long will it take $10,000 to grow to $50,000 if it earns 10% interest compounded semiannually?
A) 17 years
B) 8.5 years
C) 33 years
D) 16.5 year

Accepted Answer

The formula for compound interest is $ A = P(1 + \frac{r}{n})^{nt} $. Here, $ A = 50000 $, $ P = 10000 $, $ r = 0.10 $, and $ n = 2 $. Solving for $ t $, we get $ t \approx 16.5 $ years.

Question 17

How long will it take to triple your money at 8% interest compounded quarterly?
A) 13.9 years
B) 30 years
C) 14.3 years
D) 55.5 years

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Question 18

You take out a twenty-year amortized loan of $100,000 with a 5% annual interest rate. What are the annual payments?
A) $ 8,024
B) $ 8,718
C) $ 4,762
D) $37,689

Accepted Answer

The annual payment for a 20-year amortized loan of $100,000 at a 5% interest rate can be calculated using the formula for an amortizing loan. The correct annual payment is approximately $8,024.

Question 19

You take out a 25- year loan of $150,000 with a 8% annual interest rate. What are the annual payments?
A) $13,965
B) $13,427
C) $ 2,052
D) $14,052

Accepted Answer

To calculate the annual payment of a loan, you can use the formula for an annuity, which in this case is a fixed payment made every year for a certain number of years at a certain interest rate. The formula to calculate the annual payment (A) is: A = P * [r(1+r)^n] / [(1+r)^n - 1], where P is the principal amount ($150,000), r is the annual interest rate (8% or 0.08), and n is the number of payments (25 years). Plugging in the values: A = $150,000 * [0.08(1+0.08)^25] / [(1+0.08)^25 - 1], which calculates to approximately $14,052.

Question 20

What is the present value of $100,000 received in fifteen years with an annual discount rate of 5% compounded monthly?
A) $ 48,102
B) $ 47,310
C) $207,893
D) $ 25,000

Accepted Answer

The present value (PV) of a future amount can be calculated using the formula PV = FV / (1 + r/n)^(nt), where FV is the future value, r is the annual interest rate, n is the number of compounding periods per year, and t is the time in years. Here, FV = $100,000, r = 0.05, n = 12 (monthly compounding), and t = 15. Plugging these values into the formula gives PV = $100,000 / (1 + 0.05/12)^(12*15) ≈ $47,310.

Quiz 3: Essential Concepts in Finance: Part B

Distinguish between business risk and financial risk.

What is risk aversion? How does the assumption of risk aversion affect the risk/return tradeoff?

Compare diversifiable and nondiversifiable risk. What are some examples of each type of risk?

You deposit $10,000 in a bank and plan to keep it there for five years. The bank pays 8% annual interest compounded continuously. Calculate the future value at the end of five years.

An annuity is best defined as:

As the discount rate increases, the present value of a positive cash flow to be received at a particular time in the future:

As the discount rate decreases , the present value of a positive cash flow to be received at a particular time in the future:

Company XYZ purchased some machinery and gave a five-year note with a maturity value of $20,000. The discount rate is 8% annually and the interest is discounted monthly. How much did the company borrow?

What is the present value of an annual annuity payment of $7,000 made for 12 years with a required return of 5% per year with the first payment starting today?

What is the present value of a semi- annual ordinary annuity payment of $7,000 made for 12 years with a required annual return of 5%compounded semi annually?

How long will it take $10,000 to grow to $50,000 if it earns 10% interest compounded semiannually?

How long will it take to triple your money at 8% interest compounded quarterly?

You take out a twenty-year amortized loan of $100,000 with a 5% annual interest rate. What are the annual payments?

You take out a 25- year loan of $150,000 with a 8% annual interest rate. What are the annual payments?

What is the present value of $100,000 received in fifteen years with an annual discount rate of 5% compounded monthly?