GEORGE MASON UNIVERSITY
School of Management
TECM 615
Spring, 2001
Mid-term Exam
100 points
NAME ____________________________________________________________
Instructions: Answer each question or problem in the space provided. THIS EXAM
IS INDIVIDUAL WORK. The number of points for each question is indicated
prior to each question/problem.
1. (10 points) As the winner of the Internet cleaners sweepstakes, you are entitled to
one of the following prizes:
a. $950,000 immediately.
b. $125,000 per year forever.
c. $185,000 per year for the next 10 years starting immediately.
d. $400,000 payable every 2 years over 20 years.
e. $ 49,000 next year growing by 12% forever.
Which prize would you choose if you a rational investor and wanted to maximize
your personal value? The interest rate is 14% compounded annually? Why?
2. (15 points) A father is planning a savings program to put his daughter through
college. His daughter is now 11 years old. She plans to enroll at the university in
7 years, and it should take her 4 years to complete her education. Currently, the
cost per year (for everything—food, clothing, tuition, books, transportation, and
so forth) is $12,500, but a 5 percent annual inflation rate in these costs is
forecasted. The daughter recently received $7,500 from her grandfather’s estate.
This money, which is invested in a bank account paying 8 percent interest
compounded annually, will be used to help meet the costs of the daughter’s
education. The rest of the costs will be met by money the father will deposit in
the savings account. He will make 8 equal deposits to the account, one deposit in
each year from now until his daughter starts college. These deposits will begin
today and will also earn 8 percent interest, compounded annually.
a. What will be the present value of the cost of 4 years of education at the time the
daughter turns 18? [HINT: Calculate the future value of the cost (at 5%) for each
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year of her education, then discount 3 of these costs back (at 8%) to the year in
which she turns 18, then sum the 4 costs].
b. What will be the value of the $7,500 that the daughter received from her
grandfather’s estate when she starts college at age 18?
c. If the father is planning to make the first of 8 deposits today, how large must each
deposit be for him to be able to put his daughter through college? [HINT: An
annuity due assumes interest is earned on all deposits; however, the 8th deposit
earns no interest—therefore, treat the deposits as an ordinary annuity.]
3. (15 points) GenTech has been a hot stock the last few years, but is risky. The
expected returns for GenTech are highly dependent on the state of the economy as
follows:
State of the Economy Probability GenTech’s Returns
Depression .025 -30%
Recession .125 -10%
Mild Slowdown .20 5%
Normal .35 12%
Broad Expansion .20 20%
Strong Expansion .10 35%
a. What is GenTech’s expected return?
b. What is GenTech’s standard deviation?
c. What is GenTech’s coefficient of variation?
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d. From the above information, give an interpretation of the riskiness of GenTech’s
stock.
e. Suppose kRF = 7.5%, kM = 13.5%; and = 1.18; what is ki, the required rate of
return, on GenTech’s stock?
f. Now suppose kRF (1) increases to 10.25 percent or (2) decreases to 6 percent.
(HINT: The slope of the SML remains constant.) How would these changes
affect kM and ki?
g. Now assume kRF remains at 7.5 percent but kM (1) increases to 16 percent or (2)
falls to 11 percent. (HINT: The slope of the SML does not remain constant.)
How would these changes affect ki?
4. (15 points) Complete the balance sheet (fill in the blanks) for Sheffield
Technologies using the following financial data:
Credit sales $38,400
Current ratio 2.00X
Days sales outstanding (DSO) 46.88 days
Inventory turnover 19.20X
Total asset turnover 1.28X
Fixed asset turnover 1.92X
Debt ratio 37.50%
Return on total assets 9.60%
Return on equity 15.36%
Profit margin 8.00%
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Sheffield Technologies, Inc.
Balance Sheet
Assets Liabilities:
Cash _______ Accounts payable _______
Accounts Receivable _______ Notes payable 3,000
Inventory _______ Total current liabilities _______
Total current assets _______ Long-term debt (at 8%) _______
Fixed assets _______ Common stock _______
Retained earnings 10,000
Total assets _______ Total liabilities and equity _______
5. (10 points) Recently Jeep automobile dealers have advertised a promotional lease
program for a Jeep Grand Cherokee. This promotional program requires an initial
one-time capital reduction payment of $1,835 at the beginning of the lease. In
addition to this single capital reduction payment, the monthly lease payments are
$289.00 per month for 36 months. At the end of the 36-month lease term, the
lessee (the user of the vehicle) does have the option to purchase the Grand
Cherokee for $15,780.00. Assume that a potential customer has an opportunity
cost of capital for this type of transaction of 9.8%.
a. Determine the present value of the series of lease payments over the 36-
month lease term.
b. Determine the present value of the option to purchase the Grand Cherokee
at the end of the 36-month lease.
c. What would be the total present value of all of the cash flows associated
with leasing this Grand Cherokee under these lease terms and purchasing
it at option to purchase price?
6. (10 points) Lindsey Insurance Company has current sales of $10 million and
predicts next year's sales will grow to $14 million. Current assets are $3 million
and fixed assets are $4 million. The firm's net profit margin is 7 percent after
taxes. Presently, Lindsey has $900,000 in accounts payable, $1.1 million in long-
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term debt, and $5 million (including $2.5 million in retained earnings) in common
equity. Next year, Lindsey projects that current assets will rise in direct
proportion to the forecasted sales and that fixed assets will rise by $500,000.
Lindsey also plans to pay dividends of $400,000 to common shareholders.
a. What are Lindsey's total financing needs for the upcoming year?
b. Given the above information, what are Lindsey's additional funds needed?
7. (25 points) Using PSI Net’s 1998 Annual Report,
(http://www.psinet.com/ir/areport/98/html/fian_review/fin_rev_main.html) (or
just go to http://www.psinet.com and search for the 1998 annual report (the full
html version is available at that site.)
a. Analyze the financial strength of PSI Net in 1998 by calculating each of
the ratios that follow.
b. Conduct a trend analysis for 3 years and indicate if the calculated ratios
were improving or were getting worse.
c. Find one industry average for each of the 5 categories of ratios and
compare these industry average ratios to those of PSI Net in 1998.
d. Finally, indicate the strengths and weaknesses of PSI Net in 1998. Were
there any indications from the financials and your analysis that would
cause you to conclude that in 2001, PSI Net would be in its current
financial state? What were these indications?
1. Liquidity Ratios: 3. Leverage ratios:
Current Debt Ratio
Quick Times Interest Earned
2. Asset Management Ratios: 4. Profitability Ratios:
Inventory turnover Profit Margin
Days Sales Outstanding Basic Earning Power
Fixed assets turnover Return on Assets
Total assets turnover Return on Equity
Operating Capital 5. Market Value Ratios
EPS
P/E
BVPS
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