Question 1
You are considering purchasing your first home. The price tag is $1.2 million. broker informs you that you can lock in a 20-year fully amortizing mortgage at an APR of 3.75%, with monthly compounding and monthly payments. The mortgage requires a 30% down payment, which happens to be exactly the amount you have in your money market account. For simplicity, assume that fees and closing costs associated with this mortgage are zero. You may ignore all taxes for the entirety of this problem. Also, assume that today is t = 0 and if you decide to buy the house you will make the first payment one month from now (t = 1).
a) (8 points) Calculate the monthly payment on your dream home.
b) (8 points) How much of your first payment goes toward paying down principal? How much goes toward paying interest? Repeat this calculation for the 60th payment.
c) (8 points) What is the remaining principal balance after you make your 60th payment (at t = 60)?
d) (6 points) Calculate the effective annual rate (EAR) of your mortgage.

Question 2: True, false, or uncertain. Justify your answer.
a) (10 points) If the CAPM holds, then the ratio of a security's expected return, in excess of the riskless return, to the security's standard deviation (the Sharpe ratio) of all securities are equal in value.
b) (10 points) A firm with an asset beta of 1.8 should consider the acquisition of a firm with an asset beta of 0,5 since this would make the acquirer's shareholders better off by diversifying risk.

Question 3
You have the following information about the Reuet Furniture Company (RFC). Annual sales in 2016 are expected to be $250,000. RFC's profit margin is expected to be 50%.
Sales and free cash flows are expected to grow from 2016 onward at 2% a year.
RFC is expected to reinvest 20% of its NOPAT in fixed assets and net working capital in 2016. That is, its investment efficiency = 0.8.
RFC has an equity beta of 2.0.
RFC is financed with 30% debt and 70% equity.
RFC's debt is risk free.
The risk-free rate of return is 2.5%, and the expected market risk premium E (rm 5%.
a) (15 points) Calculate RFC's Enterprise Value (EV) to FCF multiple, EV to NOPAT multiple, and EV to Sales multiple.
b) (10 points) Using the multiples for (a) estimate the current Enterprise Value of RFC for each multiple.

Question 4
Since Kraft Heinz withdrew its offer for Unilever, analysts have been calling for the consumer goods conglomerate to accelerate earnings and to grow internally. You were recently hired by Unilever as a brand manager and are considering whether to invest in a new line of chocolates.
Your team makes the following projections over the next 5 years of the project: Total revenues are expected to be $5 billion per annum starting in one year (at t = 1), and expected to grow at 9% for the four years after that (until t = 5).
Costs of goods sold are expected to be a constant $3 billion per annum. There are no other operating costs for the project.
The project will require an immediate initial capital expenditure of $15 billion (at t=0) which can be depreciated over the next 5 years (from t = 1 through t = 5) using straight line depreciation assuming a salvage value of zero.
The COCO beans needed to produce the chocolate must be purchased a year in advance.
Therefore, the project will require an initial inventory of $1 billion in COCO beans (at t = 0) and this is expected to grow at 10% per year over the lifetime of the project. Inventories are only needed at time t if chocolate production takes place at time t+1.
The project concludes at the end of five years (at t = 5), when the equipment for the project will be sold for $6 billion.
The marginal tax rate for Unilever is 30%.
a) (30 points) Calculate the stream of free-cash flows (FCF) generated by the project.
b) (10 points) What is the IRR of the project? If the hurdle rate is 7%, should Unilever undertake the project?
Unilever has the following financial information:
A market capitalization (value of equity) of 135 billion USD.
Debt of 18 billion USD.
A negligible amount of excess cash and cash equivalent assets.
An equity beta is 0.85.
A debt beta of 0.28 based on Moody's long-term credit rating of A+.
The current yield of a 5-year Treasury bond is 2%.
The current yield of a 30-year Treasury bond is 3%.
The expected market return is 7%.
c) (15 points) What risk premium above the risk-free rate is Unilever required to pay its equity owners (i.e., its shareholders) to invest in this project?
d) (15 points) What return is Unilever required to pay its bond owners (i.e., its creditors) to invest in this project?
e) (15 points) Calculate an appropriate cost of capital for this project and decide whether Unilever should undertake the project.

Question 5
This problem refers to the following assets:
The common stock of Snap, Inc., denoted as SNAP.
The common stock of General Electric, denoted as GE.
The riskless asset, denoted as rf.
The market portfolio, denoted by M.
You know the following information about the assets:
Asset Expected Return Standard Deviation    Beta
SNAP          ?                               80%                1.2
GE                ?                               50%                1.0
Market       10%                            20%                1.0
Risk-free       1%                            0%                0.0

Correlations
            SNAP          GE       Market    Risk-free
SNAP          1.0          0.1          0.3          0.0
GE                               1.0          0.4          0.0
Market                                           1.0          0.0
Risk-free                                                          1.0
Assume that individuals can borrow and lend at rf and that the Capital Asset Pricing Model (CAPM) accurately describes expected returns on assets.
a) (10 points) What is expected return on GE's stock?
b) (10 points) What fraction of the variance of GE stock returns is due to its sensitivity to the return on the market portfolio?
Your friend has $200,000 invested in SNAP, $200,000 invested in GE, and $100,000 invested in the riskless asset.
c) (15 points) What is the total risk (standard deviation) of your friend's portfolio? You own a portfolio with $200,000 invested in GE, $100,000 in the market portfolio M, and $100,000 in the riskless asset rf.
d) (14 points) What is its beta of your current portfolio?
e) (14 points) Find an efficient portfolio (one that has no diversifiable risk) that has the same expected return as your current portfolio, but the lowest standard deviation possible. What is the standard deviation (total risk) of this new portfolio?
f) (14 points) Find an efficient portfolio (one that has no diversifiable risk) that has the same standard deviation as your current portfolio, but the highest expected return possible. What is the expected return of this new portfolio?

Question 6
A space photography firm, OrbitChat, has hired you to evaluate the firm's investment plans.
The firm is planning to invest in rockets and technology to send satellites into orbit equipped with high resolution cameras that can be temporarily aimed by users of its smartphone app. The app allows you to take photographs as if you were on-board one of the company's orbiting satellites, add captions, and then send them to friends in a way that disappears after 30 seconds.
OrbitChat expects 30% of its cash flows to come from advertisements on its app.
The remaining 70% of its cash flows will come from companies paying OrbitChat to carry cargo into space.
OrbitChat is currently financed 60% with equity and 40% with debt.
The expected return on OrbitChat's debt is 4%.
As part of your analysis you have gathered some information about two other firms. The first firm specializes in temporary photography and is called SnapPic The second firm specializes in carrying cargo into orbit and is called SpaceK. Here is some more information about the two firms:
         Debt-Equity Ratio       βE    βD
SnapPic          2                      1.5    0.6
SpaceK             1                      1.2    0.3
You have also analyzed current market conditions and you see that the relevant risk-free return is 2.5% and that the market risk premium is 5%.
a) (14 points) What discount rate would you recommend that OrbitChat use for calculating the NPV of its space-based photography investment?
b) (14 points) What discount rate should people who buy OrbitChat's stock expect to earn?
c) (14 points) OrbitChat is contemplating selling more shares in the firm. The proceeds from the sale of shares will be used to retire some of their debt. As a result, OrbitChat would increase the share of the firm financed by equity to 80% and reduce the portion financed with debt to 20%. This change will have no effect on the return to OrbitChat's debt. If OrbitChat makes this change, what discount rate would you recommend they use for calculating the NPV of its project?
d) (14 points) What discount rate would people who buy OrbitChat's stock expect to earn if the firm makes this change in financial structure (i.e. the change outlined in part c)?

Question 7
You are employed by the Treasurer's office of Northwest Airlines (ticker symbol GOCATS).
Your assignment is to help the Treasurer analyze possible hedging strategies for the firm's exposure to fluctuations in the price of oil.
You have estimated that, without any hedging, the relationship between Northwest's expected next-year's operating cash flow and the price of oil (per barrel) in twelve months is given by the following relation:
Cash Flow = $2,200,000,000 - $50,000,000*(Poil- - $55) where Poil is the price of a barrel of oil.
Thus, they would expect cash flows of $2.2 billion if the price of oil is $55/barrel. For every dollar increase of the price of oil, cash flows decline by $50 million.
Assume that you have the following 1-year price quotes for options on crude oil, quoted per barrel of oil, from a prestigious investment bank, Dewey, Cheatham, & Howe.
Strike price       Call option price    Put option price
$50.00/barrel          $7.47                      $1.97
$55.00/barrel       $4.64                      $4.10
$60.00/barrel       $2.69                      $7.10
$65.00/barrel       $1.46                      $10.82
$70.00/barrel       $0.76                      $15.07
a) (14 points) The firm wishes to guarantee that they have cash flow of at least $1.7 billion, before taking into account the cost of a hedging program. What is the option position they should take (which option, how many options, buy or sell) to guarantee cash flow of at least $1.7 billion, before the cost of the hedging program?
b) (10 points) What is the cost of the hedging program in (a)?
c) (14 points) The treasurer would like you to investigate a totally different hedging strategy that would completely eliminate the cash flow sensitivity to oil prices. What option positions should they take (which options, how many options, buy or sell) to eliminate all oil price risk and secure a cash flow of $1.7 billion, before the cost of the hedging program?
d) (14 points) What is the cost of the hedging program in (c)? Is it higher or lower than the initial hedging program? Why?

Question 1 You are considering purchasing your first home. The pri...