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a) The two rates are not directly comparable, because they are both Stated Annual Rates and

have different compounding periods. In order to compare the loans, we need to calculate

the Effective Annual Rate for the two Loans.

We will choose the lowest of the two rates. So, for the first loan we have that

1 + 1

0.06

= 1+

2

1 + 2

0.05

= 1+

12

12

The Loan will have 240 payments and a monthly interest rate of 5%/12=0.416%. To

calculate the monthly payments we need to solve the following expression for C

$5,000,000 = 240

0.416% <=> = $32,997.79

b) The amount of money you owe on your Loan is the Present Value of the payments still to

be made. Ten years from now, there will be still 120 monthly payments of $32,997,79 to

be made. So, to liquidate the loan, you need to make a payment of

= $32,997.79120

0.416% = $3,111,076

Question 2

a) The first dividend that is relevant is the dividend coming next year. Since 2/3 of the

Earnings are re-invested in the firm and earn a 9% rate of return, the Earnings are

growing at a rate of 9%*2/3=6%.

So, the first relevant Earnings is $3.00*1.06=$3.18. Since only one third is paid as

dividends, the next dividend to be paid is $1.06. The Earnings and, therefore, the

dividends will grow at a rate of 6%.

So, the Price of a share of stock is

=

$1.06

= $10.6

. 16 .06

b) The Present Value of the Growth Opportunities is the Present Value of the investments

made by the firm in re-investing the Earnings. The easiest way to calculate the value is to

compare the current price of the stock with the price it would have if it paid as dividends

all the Earnings

In that case, the Earnings, and Dividends, will be constant and equal to $3.18. It is not

$3.00 (the previous Earnings) because the firm ALREADY retained 2/3 of them by the

time of this analysis. So, compared to the previous Earnings, they will also grow, for this

year only, 6%. Therefore, the price per share would be

=

$3.18

= $19.875

0.16

c) If they reduce the percentage of Earnings re-invested, two things will happen. The

Dividends will be bigger, but will grow at a lower rate. The new rate will be 9%*1/3 = 3%

and the new dividend will be $3.00*1.03*(2/3)=$2.06. The new price per share will be

$2.06

= $15.85

0.16 0.03

The reason for the price increase is that the firm loses money when it re-invest the

earnings, because the internal rate of return (9%) is lower than the rate of return the

investors require (16%). Therefore, a reduction of the amount re-invested will increase

the value of the firm.

=

The advice you should give is to stop re-investing the earnings in the firm, and pay all the

Earnings as dividends.

Question 3

a) The prices of the three bonds are respectively

1 =

$1,000

= $422.41

1.09 10

2 = $10010

9% +

3 = $8015

9% +

$1,000

= $1,064.18

1.09 10

$1,000

= $919.39

1.09 15

b) First, you need to calculate the prices of the Bonds one year from now.

1 =

$1,000

= $460.43

1.09 9

2 = $10099% +

$1,000

= $1,059.95

1.09 9

3 = $8014

9% +

$1,000

= $922.14

1.09 14

For Bond1

= 0%,

=

$460.43 $422.41

= 9%,

$422.41

= 9%

For Bond2

=

=

$100

= 9.4%,

$1,064.18

$1,059.95 $1,064.18

= 0.4%,

$1,064.18

= 9%

For Bond3

=

=

$80

= 8.7%,

$919.39

$922.14 $919.39

= 0.3%,

$919.39

= 9%

c) If the yield to maturity of the Bonds drops to 7%, the prices of the Bonds one year from

now will change.

1 =

$1,000

= $543.93

1.07 9

2 = $10097% +

$1,000

= $1,195.46

1.07 9

3 = $8014

7% +

$1,000

= $1,087.46

1.07 14

For Bond1

= 0%,

=

$543.93 $422.41

= 28.77%,

$422.41

= 28.77%

For Bond2

=

=

$100

= 9.4%,

$1,064.18

$1,195.46 $1,064.18

= 12.34%,

$1,064.18

= 21.74%

For Bond3

=

=

$80

= 7.4%,

$1,087.46

$1087.46 $919.39

= 18.28%,

$919.39

= 25.68%

d) What matters to you is to pay the least taxes while at the same time obtain $2million to

pay the loan you took.

The first thing you need to consider is that you would pay the Current Income tax, even if

you wouldnt sell the Coupon bearing Bonds. This is because you would always receive

the Coupons and therefore, pay the tax.

So, the only tax that is incremental for this analysis is the Capital Gains tax.

If that is the case, the Bonds you should sell to re-pay the Loan is the 10% coupon Bond.

Because the price is dropping, you will actually get a tax break if you sell them. The one

you want the least to sell is the zero coupon Bond. In this Bond, the variation is the

largest, which means you will pay more taxes and therefore need to sell more Bonds to

get the $2million you need.

In the zero coupon Bonds you are making a gain of $38.02 per bond. This means you are

paying in taxes $11.406 for every bond you sell. Therefore, you are only able to use

$449.024 per bond to re-pay the loan. This means, you need to sell 4,454 Bonds and pay

$50,803.52 in taxes.

For the other Bond, you make a gain of $2.75 per Bond. So, you pay $0.825 in taxes per

Bond sold. So, the amount you use per Bond is $921.315. This means selling 2,171

Bonds and pay $1,790.918 in taxes.

Question 4

This is the table with the Cash Flows

Description

Investment

(-) Tax on Gain

(-) Revenues

(-) Variable Costs

(-) Fixed Costs

(-) Depreciation

(=) EBIT

(-) Taxes

(=) Net Income

Add Depreciation

-Var. NWC

(=) Total Cash Flow

PV Cash Flow

NPV

Year 0

-300,000

-9,000

-309,000

-309,000

58,559

Year 1

Year 2

Year 3

Year 4

Year 5

100,000

35,000

400,000

240,000

36,000

99,000

25,000

8,750

16,250

99,000

0

115,250

96,042

500,000

300,000

36,000

132,000

32,000

11,200

20,800

132,000

0

152,800

106,111

500,000

300,000

36,000

45,000

119,000

41,650

77,350

45,000

0

122,350

70,804

400,000

240,000

36,000

24,000

100,000

35,000

65,000

24,000

0

89,000

42,921

300,000

180,000

36,000

0

84,000

29,400

54,600

0

9,000

128,600

51,681

367,559

The Discounted Payback is 3.84 years

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