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You have been asked by management to prepare a report on why the personnel budget has a large negative variance. What information would you include in your report?
a. Explain why we might not expect to find the efficient number of lighthouses along the coast.
b. (Showing all calculations) what is the efficient number of lighthouses? What would be the net benefits to Zach and Jacob if the efficient number were provided?
5.5 million shares of stock outstanding and investors require a return of 13 percent return on the company’s stock. The corporate tax rate is 40 percent.
a. What is your estimate of the current stock price?
b. Suppose instead that you estimate the terminal value of the company using a PE
multiple. The industry PE multiple is 11. What is your new estimate of the company’s
2. A woman arranges to repay $5,000 bank loan in 15 equal payments at a 10% effective annual interest rate. Immediately after her fifth payment, she borrows another $2,500, also at 10% per year. When she borrows the $2,500, she talks the banker into letting her repay the remaining debt of the first loan and the entire amount of the second loan in 12 equal annual payments. The first of these payments would be one year after she receives the $2,500. Compute the amount of each of payments.
a) What profits are the firms likely to earn in the absence of cooperation?
b) If the firms cooperated, what profits would each firm earn?
2. A project has expected risky cash flows of $90, 000 in perpetuity while the certainty equivalent cash flows are $60, 000. The risk free rate is 10%. What is the risk adjusted rate of return on the risky cash flows?
3. Should an investor invest in this project if the initial cost is $650, 000?
4. What would be the internal rate of return if the cost of the project was $600, 000?
PROBABILTY MACHINE A($) MACHINE B($)
0.25 6000 7000
0.50 5000 5000
0.25 4000 3000
The risk free discount rate is 10% while the risk premium applied as follows.
STANDARD DEVIATION($) RISK PREMIUM
0 – 999 0%
1000 – 1999 10%
2000 – 2999 10%
3000 – 3999 20%
Which of the two machines should be installed?