1. Having risen from virtually nothing in the early 1980s, stocks and stock opti

Question

1. Having risen from virtually nothing in the early 1980s, stocks and stock options comprised roughly half of the average CEO compensation in public US firms in 1995. [Source: The Economist, May 4, 1996, p. 80] While this increase in pay for performance helps to align the interests of managers and shareholders, it also makes managers more focused on the short-term and more risk averse. (True, False, Uncertain and explain your response)

2. JJ Enterprises is considering the purchase of a new machine that will produce thumb drives. The new machine will require an initial investment of $800,000 and has an economic life of five years and will be fully depreciated by the straight line method. The machine will produce 150,000 thumb drives per year with each costing $0.10 to make. Each will be sold at $2.00. Assume JJ Enterprises uses a discount rate of 14 percent and has a tax rate of 34 percent. What is the NPV of the project and should JJ Enterprises make the purchase?

3. VBN is a microcap stock included in the Wilshire 5000 index. The following lists the actual returns on VBN and the Wilshire 5000 index for 6 recent years.

Year VBN Wilshire

20X1 -18.0% 13.0%

20X2 -10.0% -8.0%

20X3 15.0% 1.0%

20X4 60.0% 32.0%

20X5 15.0% 27.0%

20X6 28.0% 13.0%

i) Calculate the covariance between the returns on VBN and the Wilshire 5000 index.

ii) Does VBN’s returns move with or against the returns on the Wilshire 5000?

iii) Is VBN highly, moderately, or barely sensitive to fluctuations in the Wilshire 5000?

4. Obsolete Computer Systems, Inc. wants to reemerge as a major producer of computer software. The company has two options: Either it can purchase Upstart Software for $25m now whose products are expected to survive 5 years. Or it can develop an ongoing new line of software via research and development expected to cost $5m per year with implementation costs of $25m in 4 years. Using reasonable cash flow estimates from each product line, the Obsolete CFO has estimated that the internal rate of return from purchasing Upstart Software is 15% and the IRR of in-house R&D is 14%. As a member of Obsolete’s board of directors (and an ERAU alum who knows how misleading IRR analysis can be…hint), you should vote against the CFO’s recommendation to purchase Upstart Software. (True, False, Uncertain and explain your response)

Please Help me!!!

Explanation / Answer

1) True; because managers earn large amount of payoff on their options if stock price increase. Thus they make decisions that increase price of stock in short term but may be detrimental in long term for the firm.

2)

3)

2) VBN return's move with wilshire because co variance is positive

3) VBN is barely sensitive to wilshire because correlation is very small

Please ask 4 seperately

Time line 0 1 2 3 4 5 Project cost -800000 +Increase in working capital 0 =Initial Investment outlay -800000 Revenues =sales unit* ( selling price - cost price) 285000 285000 285000 285000 285000 -Depreciation (cost of equipment and plant)/5 -160000 -160000 -160000 -160000 -160000 =Pre tax operating cf 125000 125000 125000 125000 125000 -taxes =(Savings - depreciation)*(1-tax) 82500 82500 82500 82500 82500 +Depreciation 160000 160000 160000 160000 160000 =after tax operating cash flow 242500 242500 242500 242500 242500 Reversal of Increase in working capital 0 = Terminal year after tax non operating CF Total Cash flow -800000 242500 242500 242500 242500 242500 Discount rate= 14.00% Discount factor = (1 + discount rate) ^ corresponding period 1 1.14 1.2996 1.481544 1.68896 1.925415 Discounted cashflow = total cash flow/discount factor -800000 212719.3 186595.9 163680.6 143579.5 125946.9 NPV= Sum of discounted cash flow = 32522.13

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