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Key to Exam I; F5360; Summer, 2001; page 1 of 4
Short answer questions/problems
1. What basic assumption is crucial to the term structure theory known as the Expecations Hypothesis?
Use the following information to answer questions 2 and 3:
As of Thursday, June 7th, the yield to maturity on Treasury-strips varied according to maturity as follows:
1-year = 3.78%, 2-year = 4.12%, 3-year = 4.52%.
2. What does the Expecations Hypothesis predict about the one-year rate a year from today?
3. What does the Inflation Risk Hypothesis predict about the one-year rate a year from today?
4. What typical shape does the Liquidity Preference Theory predict for the yield curve?
5. Why are long-term bonds riskier than short-term bonds according to the Inflation Risk Hypothesis?
6. What does the average collection period reveal about a firm and to what would you compare this ratio?
Use the information from the following pages to answer questions 7 and 8 below.
7. What is Schering-Plough’s average collection period for 2000?
8. What was Schering-Plough’s debt ratio for 2000?
9. Assume you have borrowed some money and invested all of your personal wealth along with the money you have borrowed
into two stocks. Demonstrate on a graph how your optimal investment in the two stocks would change if the risk of one of the
stocks suddenly fell.
10. What annual rate compounded quarterly would be equivalent to 5.5% per year compounded continuously?
Problems/Essays
1. Assume you want to calculate the EVA for Schering-Plough for 2000 using the Harnischfeger approach. What would NOPAT
equal?
2. Your firm is considering investing in an asset that would produce net cash flows of $100,000 five months from today.
Thereafter, net cash flows are expected to occur quarterly and are expected to increase by 2% per quarter. The asset will not
produce any cash flows beyond 4 years from today. The expected return on the asset will depend on the economy as follows:
Economy Probability Return S&P500
Boom 35% 45% 35%
Average 40% 12% 11%
Bust 25% -22% -3%
The risk-free rate is 3.78%.
a. What is the beta of the asset?
b. What is the value of the asset?
Key to Exam I; F5360; Summer, 2001; page 2 of 4
Additional Information on Schering-Plough
Information from Footnotes:
1. Interest income for 2000, 1999 and 1998 was $159, $103 and $59,respectively.
Interest income and interest expense are included in other(income) expense, net.
2. INVENTORIES
Year-end inventories consisted of the following:
2000 1999
Finished products $459 $437
Goods in process 261 267
Raw materials and supplies 231 254
Total inventories $951 $958
Inventories valued on a last-in, first-out basis comprised approximately 29
percent and 31 percent of total inventories at December 31, 2000 and 1999,
respectively. The estimated replacement cost of total inventories at
December 31, 2000 and 1999 was $995 and $972, respectively.
3. Total income tax payments during 2000, 1999 and 1998 were $606, $502 and $458,
respectively.
SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES
SIX-YEAR SELECTED FINANCIAL & STATISTICAL DATA
(Dollars in millions, except per 2000 1999 1998 1997 1996 1995
share figures)
Research and development $1,333 $1,191 $1,007 $847 $723 $657
SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
For the Years Ended December 31,
(Amounts in millions, except per share 2000 1999 1998
figures)
Net sales $9,815 $9,116 $8,027
Costs and Expenses:
Cost of sales 1,902 1,800 1,601
Selling, general and 3,485 3,374 3,091
administrative
Research and development 1,333 1,191 1,007
Other (income) expense, net (93) (44) 2
Total costs and expenses 6,627 6,321 5,701
Income before income taxes 3,188 2,795 2,326
Income taxes 765 685 570
Net income $2,423 $2,110 $1,756
SCHERING-PLOUGH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
At December 31,
(Amounts in millions, except per share 2000 1999
figures)
ASSETS
Current Assets:
Cash and cash equivalents $2,397 $1,876
Accounts receivable, less 1,413 1,022
allowances: 2000, $96;
1999, $92
Inventories 951 958
Prepaid expenses, deferred 959 1,053
income taxes and other
current assets
Total current assets 5,720 4,909
Property, at cost:
Land 56 50
Buildings and improvements 2,072 1,922
Equipment 1,861 1,760
Construction in progress 938 654
Total 4,927 4,386
Less accumulated 1,565 1,447
depreciation
Property, net 3,362 2,939
Intangible assets, net 627 588
Other assets 1,096 939
$10,805 $9,375
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $1,031 $1,063
Short-term borrowings and 994 728
current portion of
long-term debt
U.S., foreign and state 589 502
income taxes
Accrued compensation 312 301
Other accrued liabilities 719 615
Total current liabilities 3,645 3,209
Long-term Liabilities:
Deferred income taxes 214 284
Other long-term 827 717
liabilities
Total long-term 1,041 1,001
liabilities
Shareholders' Equity:
Preferred shares - - -
authorized shares: 50, $1
par value; issued: none
Common shares - 1,015 1,015
authorized shares: 2,400,
$.50 par value; issued:
2,030
Paid-in capital 974 675
Retained earnings 9,817 8,196
Accumulated other (318) (233)
comprehensive income
Total 11,488 9,653
Less treasury shares: 5,369 4,488
2000, 567; 1999, 558; at cost
Total shareholders' 6,119 5,165
equity
$10,805 $9,375
Key to Exam I; F5360; Summer, 2001; page 4 of 4
Solutions:
Short answer questions/problems
1. Can perfectly predict future short-term interest rates
2. .04461
1.04122 1
1.0378
3. < .04461
4. upwards sloping
5. more difficult to predict inflation over a long-horizon than it is to predict inflation over a short-horizon
6. How long on average it takes to collect accounts receivable. Compare to industry averages, historical trends for
the firm, and credit terms.
9815 365
7. RT 8.0616 ; ACP 45.28
1413 1022 2 8.0616
10,805 6119
8. DR .4337
10,805
9. One point should remain unchanged, the other should shift to the left (a horizontal shift). The feasible set after
the change should be to the left of the original feasible set and the line through the point of tangency should
now be steeper (and should be tangent to the new feasible set).
1
10. e.055 - 1 = .05654; r 1.056541 4 1 .01384; APR = .01384 x 4 = .05538
4
Problems/Essays
1. Operating Profit 4428 = 9815 - 1902 - 3485
+ Interest Income 159
+ R&D Expense 0
+ Amortization of Goodwill 0
+ Change in LIFO Provision 30 =(995 - 951) - (972 - 958)
- Cash taxes -606
1191 1007 847 723 657
- Amortization of R&D -885
5
NOPAT 3126
2. E(rA) = .35(45) + .4(12) + .25(-22) = 15.05
E(rS&P) = .35(35) + .4(11) + .25(-3) = 15.90
A,S&P = .35(45-15.05)(35-15.9) + .4(12-15.05)(11-15.9)+.25(-22-15.05)(-3-15.9) = 381.255
S&P .3535 15.92 .411 15.92 .25 3 15.92 226.59
2
381.255
1.68258
226.59
r = 3.78 + 1.68258(15.9-3.78) = 24.1728
r 1.251728
1
4
14
1 .05562
100,000 1.02 1
15 23
V0 1 1,089,765.35
.05562 .02 1.05562 1.05562
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