Question one.

If it is managed efficiently, Darly Inc. will have assets with a market value of $50 million, $100 million, or $150 million next year, with each outcome being equally likely. However, managers may engage in wasteful empire building, which will reduce the firm's market value by $5 million in all cases. Managers may also increase the risk of the firm, changing the probability of each outcome to 50%, 10%, and 40%, respectively.

a. What is the expected value of Darly's assets if it is run efficiently?

Suppose managers will engage in empire building unless that behaviour increases the likelihood of bankruptcy. They will choose the risk of the firm to maximize the expected payoff to equity holders.

b. Suppose Darly has debt due in one year as shown below. For each case, indicate whether managers will engage in empire building, and whether they will increase risk. What is the expected value of Darly's assets in each case?

i. $44 million

ii. $49 million

iii. $90 million

iv. $99 million

c. Suppose the tax savings from the debt, after including investor taxes, is equal to 10% of the expected payoff of the debt. The proceeds from the debt, as well as the value of any tax savings, will be paid out to sh?

Question two.

Immunizing a bond portfolio: a. An insurance company must make a payment of $19,487 in seven years. The market interest rate is 10%. You are the portfolio manager for the insurance company and you wish to fund this obligation with a three-year zero coupon bond and perpetuities paying annual coupons. How would you immunize the obligation? Step one: Calculate the duration of this liability. To get you started calculate the PV of the obligation. i.e. what is the PV of $19,487 needed in seven years discounted at 10%? The cash flow of this is identical to a zero-coupon bond. So the duration would be determined exactly the same. Step two: Calculate the duration of the asset portfolio. The portfolio duration is the weighted average of duration of each component asset, with weights proportional to the funds placed in each asset. So calculate the duration of the zero-coupon bond, and also the duration of the perpetuity. (the equation for calculating the duration of a perpetuity is (1+y)/y. Where y = market interest rate. What is the duration for each? The fraction of the portfolio invested in the zero coupon is called "w", and the fraction invested in the perpetuity is (1-w) w=weighted proportion. Hint: Asset Duration of the portfolio = ["w" X (duration of the zero-coupon bond)] + [(1-w) X the duration of the perpetuity.] Step three: Find the asset mix that sets the duration of assets equal to the duration of the liability, i.e. the needed payment (7 years) now solve for "w". This gives you the weights to be invested in the zero-coupon bond and the weight needed to be invested in the perpetuity. What are the weights? That is "w" = ? What are the amounts to be invested in the zero-coupon bond and the amount to be invested in the perpetuity? Step four: Fully fund the obligation. You will need to fund the PV of the liability or $10,000. What amount do you need to invest it the zero-coupon bond today? And what amount do you invest in the perpetuity today? 7. Rebalancing the bond portfolio: Now suppose one year has passed, and the market interest rates remain at 10%. You will need to reexamine your portfolio in #6 above. Is the position still fully funded? Is it still immunized? If not, what actions are required? a. Step one: Examine the funding. What is the PV of the liability now? (remember, one year as gone by, so there are only 6 years left in the required $19,487) b. What is the value now of you asset portfolio? (the zero-coupon bond and the perpetuity? That is, how much is the zero-coupon bond now worth? How much have you earned on the perpetuity? What is the amount still invested in the perpetuity? Is the obligation still fully funded? c. The portfolio weights must now be changed given a year has gone by. (the zero-coupon bond has only 2 years left now, while the perpetuity duration remains at 11 years. The obligation is now due in six years. The weights must now satisfy the equation: W X 2 + (1-w) X 11 = 6 yearswhat does "w" equal? To rebalance the portfolio and maintain the duration match, you must now invest a total of ___________ X "w" which equals ________ in the zero-coupon bond. You have earned _____ in interest from the perpetuity, which can be invested in the zero-coupon bond.Is this enough?If not, how much more will you need?_______

Part ii.

Thus, the net present value (NPV) cost of owning the asset will be: -$22,520 $27,854 $19,787 O -$23,020 Shoe Building Inc. (SBI) has been offered an operating Hase on the same equipment. The four-year lease requires end-of-year payments of $1,400, and the firm will have the option to buy the asset in four years for $7,700. The firm will want to use the equipment longer than four years, so it plans to exercise this option. All maintenance will be provided by the lessor. What is the NPV cost of leasing the asset? (Note: Round your answer to the nearest dollar.) -$9,301 -$2,286 -$32,714 -$11,626 Should SBI lease or buy the equipment? O Buy Lease Grade It Now Save & ContinueA A trial balance is extracted on 31 December 2015 and the total does not agree. There is a shortage of RM180 in debit. As a result, a suspense account is opened. In January 2016, the following errors are found. (1) The sales day book is overstated by RM300. (ii) Wages paid in cash of RM160 is entered correctly in the cash account but in the wages account is entered as RM360. (iii) Office equipment purchased on credit for RM480 from Amin Co is credited to office equipment and debited to Amin Co's account. (iv) Returns inwards of RM80 are only entered in the debtor's account. (v) Insurance paid for by cheque is entered as RM174 when it should be RM156. (vi) A credit sale to Liane for RM152 was debited to sales and credited to the personal account. (vil) Utilities of RM68 paid for in cash was entered in both accounts as RM86. You are required to prepare the following: (a) Journal entries (with no narration) to correct the errors. (b) Suspense account. 5 A bookkeeper failed to balance the trial balance of a firm at the end of the financial year. The credit balance exceeded the debit balance by RM930. The following errors were subsequently identified in the books. (i) The purchase day book was understated by RM100. (ii) Goods bought on credit from Awie-Supplier for RM50 was posted to his account as RM500. (iii) A new equipment costing RM700 was posted in the debit of repairs to Equipment account. (iv) Suguna, a customer, returned goods valued at RM200. This was entered in the sales returns day book and posted in the debit of the customer's account. (v) The sale on credit of various items, i.e. plant and machinery, at their book value of RM3,000 was recorded in the sales day book. (vi) RM600 owed by David, a customer, was overlooked when drawing up a schedule of sundry debtors from the ledger. (vii) A cash discount allowed of RM20 was correctly entered in the cash book, but was not posted in the account of Bahari, the customers. (vili) Business rates amounting RM450 which were treated as paid in advance in the previous accounting period, were not brought down as balance in the business rates account at the start of the accounting period-instead, they were included in the prepayments account. Required : Prepare 112 Financial Accounting 1 a ) Journal entries to correct the errors 6 ) Suspense Account