Financial Management (BUSI 640) Professor Faulkender
Midterm Exam: Fall 2012
1) The exam is open book and open notes. You may use Excel and a calculator.
2) Point totals for each question are specified in parentheses. There are 220 total points.
3) Circle your numerical answers. This makes it easier for me to find them. Show all calculations and the inputs of all values solved for using your calculator or Excel. This allows me to determine how your numbers were arrived at. If you get stuck on the math, tell me what the correct answer should be based on your intuition. Incorrect numerical answers based on the correct logic will ...view middle of the document...
Having recently graduated with his MBA at the Smith school and taking a job in investment banking, Rick is considering the purchase of a platinum edition Cadillac Escalade (this version includes four within-headrest monitors connected to the onboard DVD entertainment system, a 6.2L V8 engine, and 22” chrome rims). With tax and license, the vehicle will cost $92,000.
a. Rick will use $20,000 of his signing bonus towards the down payment and finance the rest. Since he lives in New York and rents an apartment, he will borrow the remaining $72,000 from the dealer’s financing partner over a five-year period with monthly payments at a 4.8% simple annual interest rate. Under those terms, what do you estimate to be the monthly payment? (10)
b. One of Rick’s colleagues, Ben, is looking at the same vehicle. However, he lives in New Jersey where he owns a home and will use the equity in his house to finance the purchase. Ben will pay all $92,000 using his home equity line of credit and pay it off over the next seven years making constant monthly payments. The line of credit also carries a 4.8% annual rate but because the loan is considered a mortgage for tax purposes, the interest payments are tax deductible (Ben’s taxable income in a calendar year is lower by the amount paid in mortgage interest that year). If Ben’s marginal tax rate (federal and state) is 32%, what is his effective monthly payment on the vehicle? By “effective”, I am looking for the constant out-of-pocket monthly payment net of the reduction in taxes from the mortgage interest deduction. (15)
c. Rick and Ben’s managing partner, Eric, makes significantly more money than they do and is expected to have a marginal tax rate of 48.6% over the next five years (39.6% federal plus 9% state). If Eric were to purchase the vehicle, paying a $20,000 down payment out of his money market account and financing the rest through his 4.8% interest rate home equity line of credit over 5 years, what is his effective monthly payment? What is your estimate of the present value of the tax subsidy Eric receives for buying this vehicle coming from the fact that he owns a house whereas Rick rents an apartment? (20)
2. In light of the continued risk of a global recession, you are considering the addition of some bonds to your investment portfolio.
a. One option is a 30-year Treasury bond. Treasuries pay coupons semi-annually and the most recent issue pays a $137.50 coupon every six months (on November 15 and May 15 of each year) and has a $10,000 face value due on November 15, 2042. If it currently has an annual yield of 2.73%, at what price could you currently purchase the bond? (10)
b. If one year from now, inflation were to rise significantly and yields on long-term bonds rose to 4.75%, at what price would the bond trade for in the market?...