1. JJ Enterprises is considering the purchase of a new machine that will produce

Question

1. JJ Enterprises is considering the purchase of a new machine that will produce thumb drives. The new machine will require an initial investment of $100,000 and has an economic life of five years and will be fully depreciated by the straight line method. The machine will produce 12,000 thumb drives per year with each costing $2.00 to make. Each will be sold at $4.50. 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.

2. A company is building a fuel efficient power plant which will generate its first annual cash flow of $18m exactly 4 years from today. As it ages, the volume it produces will remain constant but competing new technologies will drive prices down further. Hence the cash flows it creates will decline by 1% per year. Exactly 45 years from today, this plant will be scrapped, and the Environmental Protection Agency will require $30m expenditures to dismantle and clean it up. The plant’s OCC is 8%. What is the highest price that a buyer should consider paying for it?

3. The returns on QRC stock and an investor’s portfolio over three years are given in the table below. Based on this data, compute the volatility of the portfolio and briefly describe how to interpret it. Based on this data, calculate the correlation between QRC and the portfolio, and briefly describe what it means. Show your work. Suppose the portfolio represents the portfolio of all wealth. What is QRC’s market beta?

Year QRC Portfolio

1 5.0% 19.0%

2 -3.0% 14.0%

3 13.0% 9.0%

Explanation / Answer

1)

Since NPV is negative, JJ Enterprises should not make the purchase.

2)

Highest price that a buyer should consider paying for it = $153718529.16 (Rounded to the nearest cent)

3)

Volatility can be measued using the STDEV function of excel.

Correlation can be measued using the CORREL function of excel.

Beta = Covariance(QRC,Portfolio)/Variance(Portfolio)

Covariance can be measured using the COVAR function of excel.

Variance can be measured using the VAR function of excel.

Volatility of the portfolio is measured by its standard deviation. It measures its dispersion or deviation from the mean. Since the value of the standard deviation is 5%, it means that the returns can deviate 5% from the mean (Mean of portfolio is 14%), that is, it measures the volatility in the returns of the portfolio.

Correlation is a measure of how the two assets (QRC and Portfolio) move together. A correlation coefficien of -0.5 means that the two assets are moderately negatively correlated, that is, generally if one asset gives positive return, the other one generally gives negative return. 0.5 signifies that the negative realtionship between QRC and the portfolio is moderate.

Beta is the systematic risk or sensitivity of the stock with respect to the market and is the movement in the stock with respect to the overall movement in the market. Beta of -0.53 means , the QRC stock will go down by 0.53 times the market risk premium due to the overall movement in the market.

Year Initial Investment Sales (Units) Sales Production Cost Depreciation Cash Flow Discounted Cash Flow 0 100000 0 0 0 0 -100000 -100000.00 1 0 12000 54000 24000 20000 26600 23333.33 2 0 12000 54000 24000 20000 26600 20467.84 3 0 12000 54000 24000 20000 26600 17954.24 4 0 12000 54000 24000 20000 26600 15749.34 5 0 12000 54000 24000 20000 26600 13815.21 NET PRESENT VALUE -$8680.05

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