Test3A Winter2016.docx-Name ...
Test3A_Winter2016.docx-Name_______________________________________ Perm #_______________________________ Econ 134A John
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Test3A Winter2016.docx-Name ...
Test3A_Winter2016.docx-Name_______________________________________ Perm #_______________________________ Econ 134A John
Test3A Winter2016.docx-Name ...
Test3A_Winter2016.docx-Name_______________________________________ Perm #_______________________________ Econ 134A John
Page 6
12. You have been asked to analyze the costs of two different machines. If you buy Machine A, you have to
pay $2,000 today (year 0), and maintenance costs of $300 in each of
years 2, 3, and 4
. If you buy Machine
B, you have to pay $1,500 today and $500 maintenance costs in each of
years 1, 2, 3, 4, and 5
. Machine A
lasts 4 years, and Machine B lasts 5 years. The effective annual discount rate is 10%. (Note: All dollar
amounts in this problem are in real terms.)
(a) (2 points) What is the present value of all of the costs of Machine A?
(b) (2 points) What is the present value of all of the costs of Machine B?


Page 7
(c) (3 points) What is the equivalent annual cost of Machine A?
(d) (3 points) What is the equivalent annual cost of Machine B?
(e) (2 points) If both machines can be easily replaced in the future, which machine will you buy? Explain in
15 words or less.


Page 8
13. (5 points) Suppose you start a bank account one year from now. If you make annual deposits of $50 into
an account that pays an effective annual interest rate of 10%, when will you have an account balance of
$10,000? (Round to the nearest number of years. The deposits will occur on the same date each year starting
one year from today.)


Page 9
14. Answer each of the following:
(a) (3 points) A zero-coupon bond pays its face value of $1,000 in 3 years. Today’s price for the bond is
$700. What is the yield to maturity, expressed as an annual percentage rate, using semiannual compounding?
(b) (3 points) What is the weighted average cost of capital for a company that has two-fifths of its value in
stocks, three-fifths of its value in bonds, the rate of return of stocks is 12%, and the rate of return of bonds is
2%?


Page 10
15. (6 points) Blue Barrel Oil stock is about to pay its annual dividend today (March 16, 2016), $3 per share.
Every subsequent annual dividend payment until March 16, 2019 will be 20% higher than the previous
dividend. On March 19, 2020, the dividend will be 35% higher than the dividend on March 16, 2019. On
March 16 in the years 2021 and beyond the dividend payment will be the same as the dividend payment on
March 16, 2020. These payments will go on forever. The effective annual interest rate for this stock is 18%.
What is the present value of this stock, assuming that you will receive the next dividend later today?


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16. There are 3 states of the world, each with 1/3 probability of occurring: Ash, Laugh, and Zilch. In the Ash
state, Stock X has a rate of return of 24%, and stock Y has a rate of return of 72%. In the Laugh state, Stock
X has a rate of return of 30% and stock Y has a rate of return of –9%. In the Zilch state of the world, Stock X
has a rate of return of 0% and stock Y has a rate of return of 0%.
(a) (2 points) What is the expected return for each stock?
(b) (4 points) What is the covariance of the two stocks’ returns?


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