FINA 2330 - Money, Finance, and the Modern Consumer

Homework Assignment 5
(50 points)

Please solve the following problems. Show all relevant timelines and calculations and
make sure to highlight the final answer to the question. Where MS Excel is required,
please either cut and paste the spreadsheet where it belongs or staple the printout directly
from MS Excel. For spreadsheets that are too long to print, just include a sample printout
of the first and last pages. Note that some questions require a written answer, not just
a number.

1) 3M’s preferred stock, which pays an annual dividend of $6 per share, was trading for
$60 per share yesterday. However, news broke early this morning that some of the
materials the company used for one of his most popular home products is a well-
known carcinogenic. Consequently, the required rate of return for the stock went up
to 12%. What will be the new price of the shares?

New Price= Dividend/ rate of Return= 6/0.12=50

2) A preferred share of stock is currently trading for $45.50 on the New York Stock
Exchange. If this instrument pays a dividend of $3.25 a year, what is its annual
yield?

Annual yield= Dividend/ Share price = 3.25/45.5=0.0714= 7.14%

3) Assume that you plan to buy a share of EMA stock today and to hold it for 3 years.
You expect to receive a dividend of $3.00 at the end of Year 1, $3.50 at the end of
Year 2, and a dividend of $4.0 at the end of Year 3. In addition, you expect to sell the
stock for $75 at the end of Year 3. If your expected rate of return is 10%, how much
should you be willing to pay for this stock today?

Price Willing to pay today = 3.00/ (1+0.1) ^ 1 + 3.50/ (1+0.1) ^2 + (4.00+75) / (1+0.1) ^3
= $64.97

4) A share of common stock is expected to pay a dividend of $3.75 at the end of the
year. The expected long-run growth rate for this stock is 8%, and investors require an
11% rate of return.
a) What should the fair price of the stock?
Fair price of the stock = $3.75/ (0.11-0.08) = $125

b) If the stock is currently trading for $110, what is the market’s consensus rate of
growth for the stock’s dividends?
$110 = $3.75/(0.11-g) = .076
The market’s rate assumed is 7.6%, indefinitely
5) A share of common stock has just paid a dividend of $1.50 today. If the expected
long-run growth rate for this stock is 7%, and if investors require a 13% rate of return,
what should the fair price of the stock?

Fair price of the stock = (1+0.07) *$1.50/ (0.13-0.07) = $1.605/0.06 = $26.75

6) You are indecisive about which stock to buy: Microsoft, which is selling for $96 a
share; or Apple, which is selling for $170 a share. Microsoft stock promises to pay
annual dividends of $4.50, $5.00, and $5.50 over the next three years respectively,
and you estimate it can be sold for $110 at the end of the third year. You expect
Apple to pay a dividend of $10.50 the first year, $11.50, and $12.50 over the next two
years, respectively. You also expect Apple’s stock to be trading at $200 in three
years. Which stock would you buy if stocks from computer manufacturers typically
yield 10%?

Microsoft = 4.50/1.1^1 + 5.00/1.1^2 + (5.50+110)/1.1^3 = $95

Apple = 10.50/1.1 + 11.50 / 1.1^2 + (12.50+200) / 1.1^3 = $178.7
I would buy apple since it is selling at a lower price

7) Use excel to build a monthly amortization table for a 30-year 5% fix-rate mortgage on
a $320,000 home, with a $15,000 down payment. [Please be good to the forests and
cut and paste only the first and last few rows of the table, not the whole thing.]

Months Beginning PMT Int Principal Ending Balance

1 $30,500 1,637.31 1270.833 $366.47 $304,633.53
2 $304,633.53 $1,637.31 $1,269.31 $368.00 $304,265.53
3 $304,265.53 $1,637.31 $1,267.77 $369.53 $303,895.99
358 $4,871.27 $1,637.31 $20.30 $1,617.01 $3,254.26
359 $3,254.26 $1,637.31 $13.56 $1,623.75 $1,630.51
360 $1,630.51 $1,637.31 $6.79 $1,630.51 $0.00

8) Using the amortization table, you built for the previous question, answer the
following [Again, just cut and paste the segment of the amortization table that helps
you answer the question.]:
a. How much money will you still owe on the loan after making one full year
of payments?

$300,883.7
12 6 $1,637.31 $1,253.68 $383.62 $300,500.14
Will owe = $300,500.14

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 b. How much money will you still owe on the loan after making 15 full years
of payments?

$207,817.3
180 2 $1,637.31 $865.91 $771.40 $207,045.92
Will owe= $207,045.92

c. If you want to refinance after 8 years of making payments, how much

financing would you need to secure from your bank to do so?

$262,395.3
96 2 $1,637.31 $1,093.31 $543.99 $261,851.33
Will owe= $261,851.33

d. How much money can you expect to pay in interests alone during the full
life of the mortgage?

Int= $284,430.14

9) You plan to purchase a $150,000 house using a 30-year mortgage obtained from local
credit union. The mortgage rate offered to you is 3.25%. You will make a down
payment of 20% of the purchase price.
a. Calculate your monthly payments on this mortgage.
Monthly Payment = $522.25
b. Calculate the amount of interest and, separately, principal paid in the 30th
payment.
Interest = $308.9059
Principal = $213.34

c. Calculate the amount of interest and, separately, principal paid in the

200th payment.
Interest = $ 184.368
Principal = $337.88

d. Calculate the amount of interest paid over the life of this mortgage.
Interest paid over the life of this mortgage = $68009.1

10) You just got a promotion and you are now taking home $80,000 a year before taxes.
You are thinking about upgrading your home and moving to a nicer neighborhood.
You’ve been living for the past ten years in a 1,500 square foot, 3 bed/2 bath home,
currently valued at $175,000. Thanks to the strong capital appreciation of the past few
years, you estimate that after liquidating the mortgage and covering realtor fees,
you’ll be able to walk away with $50,000, which you intend to use as down payment
on your new home. Your debt payments ratio is only 6% and your credit rating is 710,
so qualifying for a loan won’t be a problem. The best bank rate you’ve found is 4.5%
fixed for a 30-year mortgage.

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 a. Ignoring mortgage insurance premiums, homeowner’s insurance
premiums, and property tax obligations, how much of a home could you
afford?
Debt payment ratio is below 20%. Yes, I qualify for a Loan.
Size of the monthly Payment = (80000/12) (0.29) = $1933.33
Size of the Loan = $381,564.25
Assuming down payment of $50,000
Home Price = $381,564.25+ $ 50,000 = $431,564.25

b. Would your mortgage be considered conforming or non-conforming?

My mortgage will be considered conforming.

c. Do you think you’ll be required to obtain private mortgage insurance?

Why?
Down Payment = $50000
20% Value of the house = $86312.85
It will be required.

11) You plan to purchase a house for $190,000 using a 30-year mortgage from your local
bank. You will make a down payment of 10% of the purchase price.
a. Your bank offers you the following two options for payment:
Option 1: Mortgage rate of 5.5%.
Option 2: Mortgage rate of 4.0% with two discount points.
Which option would you choose?
Size of the loan = 190000 * (1-0.1) = $171,000
Monthly payment of Plan A = $970.92
Monthly payment of option B = $816.38
Magnitude of Monthly savings using Plan B= $970.92-$816.38 = $154.54
Present Value of Monthly Savings = $32370.14
Upfront cost of Plan B = $171000 * 0.02= $3,420
Accept option b because present value of savings > cost

b. Your bank offers you the following two options for payment:
Option 1: Mortgage rate of 5% with 1 discount point.
Option 2: Mortgage rate of 3.5% and 2.5 discount points.
Which option would you choose? [Hint: consider only the incremental
costs and benefits of Option 2 with respect to Option 1]
Size of the loan = $171,000
Monthly Payment option A: $917.96
Monthly payment for option B = $767.87
Monthly Savings = (917.96-767.87) = $150.09
Present value of Monthly savings = $33,424.29
Upfront cost of Option a: 171,000 * 0.01 = 1,710
Upfront cost of option b = 171000 * 0.025 = $ 4,275
Option B is much better.

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