[Solution]Topic: Business finance

Question 1 What are the five basis principles of finance? Briefly explain them (no more than 250 words). (10 marks) Question 2 Little Book LTD…

Question 1

What are the five basis principles of finance? Briefly explain them (no more than 250 words). (10

marks)

Question 2

Little Book LTD has total assets of $860,000. There are 75,000 shares of stock outstanding, total book value of $750,000 with a market value of $12 a share. The firm has a profit margin of 6.5% and a total asset turnover of 1.5. Required:

a) Calculate the company’s EPS? (6 marks)

 b) What is the market –to- book ratio? (4 marks)

Question 3

Fifteen years ago, you deposited $12,500 into an investment fund. Five years ago, you added an

additional $20,000 to that account. You earned 8%, compounded semi-annually, for the first ten years, and 6.5%, compounded annually, for the last five years.

Required:

a) What is the effective annual interest rate (EAR) you would get for your investment in the first 10

years? (2 marks)

b) How much money do you have in your account today? (4 marks)

c) If you wish to have $85,000 now, how much should you have invested 15 years ago? (4 marks)

Question 4

Giant Equipment Ltd. is considering two projects to invest next year. Both projects have the same start-up costs. Project A will produce annual cash flows of $42,000 at the beginning of each year for eight years. Project B will produce cash flows of $48,000 at the end of each year for seven years. The company requires a 12% return.

Required:

a) Which project should the company select and why? (5 marks)

b) Which project should the company select if the interest rate is 14% at the cash flows in Project B is also at the beginning of each year? (5 marks)

Question 5

 Rachel is a financial investor who actively buys and sells in the securities market. Now she has a portfolio of all blue chips, including: $13,500 of Share A, $7,600 of Share B, $14,700 of Share C, and $5,500 of Share D. Required:

a) Compute the weights of the assets in Rachel’s portfolio? (2 marks)

b) If Rachel’s portfolio has provided her with returns of 9.7%, 12.4%, -5.5% and 17.2% over the past four years, respectively. Calculate the geometric average return of the portfolio for this period. (2 marks)

 c) Assume that expected return of the stock A in Rachel’s portfolio is 13.6% this year. The risk premium on the stocks of the same industry are 4.8%, betas of these stocks is 1.5 and the inflation rate was 2.7%. Calculate the risk-free rate of return using Capital Market Asset Pricing Model (CAPM). (2 marks)

d) Following is forecast for economic situation and Rachel’s portfolio returns next year, calculate the expected return, variance and standard deviation of the portfolio. (4 marks)

State of economyProbabilityRate of returnsMild Recession0.35– 5%Growth0.4515%Strong Growth0.2030%
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