Finance 300 Exam 2

If the discount rate declines, investment will then be… Appealing (or more money maker). Because more money is being made.
Nominal rate can be determined by…Example: Calculating nominal rate when Treasury bill rate is 2% and inflation premium is equal to 4% Adding return on risk free investments and rate of inflation.K =? K = 2% + 4% K= 6%K* = 2%IP = 4%
#3If market rate is above the coupon rate then bond will be Trading at a discount
#3If the market rate has gone down (below the coupon rate) this bond will Tarde at a premium
Annuity (aka ordinary annuity)Find the future value of an ordinary annuity that requires payment of 100 at the end of the first, second, and third year & annuity offers you 5% PV = 0FV = 0 FV = 315.25 FV = PMT ((1+i)^(n)-1/i)I = 5N = 3PMT = 100
The basic relationship in interest rate theory is that bonds with a longer maturity will have a larger price fluctuation, and bond with a shorter maturity will have a smaller change Longer maturity will have a larger priceShorter maturity will have a smaller change in price.
A bond with longest maturity is a riskier bonda. 7% coupon rate treasury bond matures in 12 yearsb. 10% coupon rate treasury bond matures in 9 yearsc. 6% coupon rate treasury bond matures in 15 yearsd. 7% coupon rate treasury bond matures in 5 years Answer is C. C is more riskier.
You plan to invest in bonds that pay 6% compounded annually. If you invest $10,000 how long will it take to become $30,000. PV= 10,000FV= 30,000 I/y= 18.85 yearsI= 6N= ?
Suppose a state of California bond will pay you $1,000 in ten years. If the going rate of interest on a 10 year security is 5.5%, find the PV. PV= ?FV= 1,000 PV= 585.43N= 10I/y= 5.5Pmt= 0
How much would $20,000 due in 50 years be worth today if the discount rate is 7.5% PV= ?FV= 20,000 PV= 537.78I/y= 7.5N= 50Pmt= 0
Last year ABC Inc’s sales were $525 million. If sales grew at 7.5% per year, how large will ABC sales be in 8 years? PV= 525FV= ? FV= 936.33I/y= 7.5N= 8Pmt= 0
ABC, Inc, issued (i.e. sold) 20 year non callable 7.5 annual coupon bonds (i.e. face value of each is 1,000) one year ago. Today the market rate is 5.5%. Calculate the value of this bond today? PV= ? Payment= (coupon rate)(face value)FV= 1,000 (7.5%) (1,000)I/y= 5.5 0.075 (1,000)N= 20-1= 19 = 75Pmt= 75 PV= 1,232.15
A 25-year $1,000 face value bond with a coupon rate of 8.5% is selling in the market for $925. If yield-to-matuirty remains at the current level, what will the price be for this bond 5 years from today?(there are two parts) PART 1:PV= 925 Pmt= (8.5)(1,000)FV= 1,000 0.085 (1,000)I/y= ? pmt= 85N= 25Pmt= 85 I/y= 9.281%PART 2: PV= ?FV= 1,000I/y= 9,281 Pmt= 85 PV= 930.11
Current YieldA $1,000 face value bond matures in 20 years is selling in the market for $900. Then its current yield will be greater than…. the coupon rate
If a $1,000 face value bond that matures in 20-years and is selling in the market for $1,100 then its current yield will be… smaller/lower than the coupon rate.
Yield-to-maturity (different prob, same #s as question 12)A 25-year, $1,000 face value bond has a 8.5% annual coupon rate. This bond is selling in the market for $925. Find the yield-to-maturity (YTM) PV= 925FV= 1,000 I/y= 9.281%I/y= ?N= 25Pmt= 85
Which of the following will have a higher than average coupon rate Callable or call provision
Pre-emptive right is important for the current stockholders because it protects them from Dilution of ownership
Find the price at which shares of ABC will be trading if the expected rate of return equals 10% and ABC’s last paid dividend was $3 per share. These dividends are to grow at a constant rate of 6% Formula: Po= (D1/Ks-g)Po= Stock Price ?Ks= Expected rate of return (aka required rate of return) 10%g= Growth Rate (constant) 6%D1= Next dividend or year-end-dividend 3.18%Do= Last paid or current dividendD1= Next dividend or year-end-dividendD1= Do(1+g) = 3(1+0.06)= 3.18 3.18/ (0.10-0.06) = 79.5
If stock of a XYZ is trading for $80 per share and XYZ year-end dividend was $2 per share and constant growth rate is 5%. Calculate the required rate of return for XYZ’s stock (please note expected rate of return is the same as the required rate). Ks= (D1/Po) +gPo= 80 (2/80)+0.05 = 0.075 7.5%D1= 2g= 5%Ks= ?
Another method to calculate Ks. If risk-free rate is 4% and market rate premium is 6% with a beta (coefficient) of 1.2, calculate Ks. Ks= Krf + (Km-Krf) (b)(Km-Krf)= Market Risk Premium (MRP)Krf= 4% 4%+6% (1.2)Km-Krf= MRP 6% 0.04+0.72 = .112 11.2%b= 1.2
There is a 25% chance that a stock will earn 30%, and a 50% chance it will earn 12%. Another 25% of the time it will lose 18% Ki Pi Ki(Pi)0.30—0.25 0.0750.12—-0.50 0.060-0.18—0.25 -0.045Ks= the sum of(KiPi) = 0.09 9%
Your company paid a dividend of $2 per share six years ago. Today, this company paid a dividend of $4 per share, calculate the growth rate of dividend. PV= 2FV= 4 I= 12.25% 12%N= 6I= ?Pmt= 0
Stock A has a required rate of 10%, its last paid dividend was $0.07 per share and it is trading for $25 per share. Stock B has a required rate of 12% and its last paid dividend was $0.11 per share. This stock is trading for $40 per share. What can be paid about these twos stocks. Current (dividend) yield = Do/ stock priceStock A= 0.07/25 = 0.0028Stock B= 0.11/40 = 0.0028* The two stocks have the same dividend yield
Preferred StockFor the preferred stock of an ABC, Inc, dividend was $10 per share and the required rate is 10.3%. Find the value of the preferred VP= Dp/rpV= Value of preferred Dp= Preferred dividendRp= Rate of return for preferred rate 10.00/10.3% = $97.09
Present value of any asset can be determined by discounting future cash flows, i.e. PV can be determined by discounting
Your company sold bonds of $1,000 face value that mature in 20 years and have a coupon rate of 10%. Find the cost of debt after-taxes if your company pays taxes at 40%. Kd(1-T) Kd= 10% = 10%(1-40%) = .06 6%T= 40%
Ks =Formula Ks= Cost of Equity1st Formula: Ks= (D1/Po)+gWhere, Ks= Expected rate of return, aka, required rate of return aka (cost of equity or cost of common equity)2nd Formula: Ks= Krf + (Km-Krf)(b)Where, Ks= Required rate of return or expected rate of return or cost of equity.Krf= Risk free rateKm= Market rateKm-Krf= MRPb = beta coefficient
If stock of ABC is selling for $80 per share, the year-end dividend is $2 per share and the constant growth rate is 5% using this information calculate Ks for ABC Po= $80 Ks= (D1/Po)+g = 2/80 +0.05 = 0.75 7.5%g= 5%D1= $2
If risk free rate is 5% and market risk premium is 1% with a beta coefficient of 1.2. Calculate Ks. Krf= 5% ks=krf + (km-krf)bMRP= (km-krf)= 1% 5% + 1%(1.2)b= 1.2 5% + 1.2% = 6.2% Ks= 6.2%Always a percentage
If Ks is equal to 13%, and risk-free rate equals 5%, with MRP equal to 4%. Calculate beta. Ks= 13% ks=krf + (km-krf)bKrf= 5% 13% = 5% + (4%)bMRP=(Km-Krf) 4% b = 2%b= ?
Weighted average cost of capital WACC= WaKd (1-T) + Wskswhere;WACC= Weighted average cost of capitalwd= Debt portion of capital aka (debt component)ws= Equity portion of capital aka (equity component)Kd= Cost of debtT= Tax rateKs= Cost of equity
An ABC, Inc. is trying to find the weighted average cost of capital and for this ABC has collected the following information-ABC has 40% debt and 60% equity i.e. Wd= 40% 0.40 & ws=60% 0.60-ABC has a 20-year bond issue with a coupon rate of 8% and the bond is trading at par.-ABC is in 40% tax bracket-Risk free rate is 5%MRP equals 4% and ABC’s beta is 1.2 using this information calculate WACC. Wd= 0.40Ws= 0.60 WACC=WdKd (1-T) +WsKsT= 40% Step1: (Find Ks)= Krft (km-kmf)bKrf= 5% bc kerf is givenMRP= 4% 5% + 4% (1.2)= .098 9.8% Percentb= 1.2 Ks= 9.8%Kd= 8%Ks= ? Step 2: WACC= WdKd(1-T)+WsKs ?= (0.04)(0.08)(1-.40)+ 0.6(0.098) .1092 + 0.0588 = .078 7.8%
WACC= WdKd(1-T) + WsKs + WpKp Wp = Preferred StockKp= Cost of preferred stock and return of preferred stock.
A company paid a dividend of $1 per share 12 years ago. This year it paid a dividend f $2 per share. Calculate the growth rate of these dividends I= 5.95%
Payback period has some drawbacks such as -It ignores the time value of money-It ignores cash-flow after the recovery.
Your company has invented $5,000 on a project & it generates the following cash flows:Investment= $5,000 Year CF Cumulative CF Payback Period yrs1 1,500 1,500 – 3 years2 1,250 2,7503 2,250 5,000 –> It ignores cash flow 4 2,250 7,250 after the recovery5 2,250 9,500 (A&B or C&D) answer
A project acceptable i.e. should be accepted if its NPV>0 You invested $750 & it generated cash flows.Year CF [email protected]%0 -750 -7501 2450 2,227.272 3175 2,623.963 4400 3,305.78 7,407.01 = NPV1. PV=? 2. PV=? 3.PV=?FV= 2450 FV= 3175 FV= 4400N= 1 N= 2 N= 3I= 10 I= 10 I= 10Pmt= 0 Pmt= 0 Pmt= 0= 2,227.27 =2,623.96 =3,305.78
If IRR>WACC, accept the project also, IRR is similar to… yield-to-maturity
Riskiness of a project is accounted for by adjusting discount rate upward. PV will be… Smaller (increasing discount rate)

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