EPPM2114 FINANCIAL MANAGEMENT

TUTORIAL 1 AND 2
SEM 2 2021/2022

1. Thomas Brothers is expected to pay a $1.8 per share dividend at the end of the year (that is, D 1 = $1.8). The
dividend is expected to grow at a constant rate of 8% a year. The required rate of return on the stock, r s, is
10%. What is the stock's current value per share?

2. Fee Founders has perpetual preferred stock outstanding that sells for $30.00 a share and pays a dividend of
$5.00 at the end of each year. What is the required rate of return?

3. Ezzell Corporation issued perpetual preferred stock with a 12% annual dividend. The stock currently yields
10%, and its par value is $100.

(a) What is the stock's value?

(b) Suppose interest rates rise and pull the preferred stock's yield up to 13%. What would be its new market
value?

4. Martell Mining Company's ore reserves are being depleted, so its sales are falling. Also, because its pit is
getting deeper each year, its costs are rising. As a result, the company's earnings and dividends are declining at
the constant rate of 6% per year. If D0 = $3 and rs = 10%, what is the value of Martell Mining's stock?

5. A stock is expected to pay a dividend of $2.75 the end of the year (that is, D 1 = $2.75), and it should continue
to grow at a constant rate of 5% a year. If its required return is 15%, what is the stock's expected price 4 years
from today?

6. Dozier Corporation is a fast-growing supplier of office products. Analysts project the following free cash flows
(FCFs) during the next 3 years, after which FCF is expected to grow at a constant 8% rate. Dozier's WACC is
13%.
Year 0 1 2 3

FCF ($ millions)
NA - 11 17 45

a) What is Dozier's horizon, or continuing, value? (Hint: Find the value of all free cash flows beyond Year 3
discounted back to Year 3.) Round your answer to two decimal places. Enter your answer in millions. For
example, an answer of $13,550,000 should be entered as 13.55.

b) What is the firm's value today? Round your answer to two decimal places. Enter your answer in millions.
For example, an answer of $13,550,000 should be entered as 13.55.

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 c) Suppose Dozier has $129 million of debt and 29 million shares of stock outstanding. What is your estimate
of the price per share? Round your answer to two decimal places. Write out your answer completely. For
example, 0.00025 million should be entered as 250.

7. What is the present value of a security that will pay $29000 in 20 years if securities of equal risk pay 5%
annually?

8. Your parents will retire in 19 years. They currently have $350000, and they think they will need $800000 at
retirement. What annual interest rate must they earn to reach their goal, assuming they don't save any
additional funds?

9. If you deposit money today in an account that pays 15% annual interest, how long will it take to double your
money?

10. You have $33556.25 in a brokerage account, and you plan to deposit an additional $5000 at the end of every
future year until your account totals $220000. You expect to earn 12% annually on the account. How many
years will it take to reach your goal?

11. How long will it take $300 to double if it earns the following rates? Compounding occurs once a year.

a) 6%.

b) 13%.

c) 21%.

d) 100%.

12. Present value of a perpetuity

a) What is the present value of a $600 perpetuity if the interest rate is 5%?

b) If interest rates doubled to 10%, what would its present value be?

13. You borrow $230000; the annual loan payments are $35029.05 for 30 years. What interest rate are you being
charged?

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14. You have saved $4000 for a down payment on a new car. The largest monthly payment you can afford is $500.
The loan will have a 12% APR based on end-of-month payments.

a) What is the most expensive car you could afford if you finance it for 48 months?

b) What is the most expensive car you could afford if you finance it for 60 months?

15. Starting next year, you will need $5000 annually for 4 years to complete your education. (One year from today
you will withdraw the first $5000.) Your uncle deposits an amount today in a bank paying 6% annual interest,
which will provide the needed $5000 payments.

a) How large must the deposit be?

b) How much will be in the account immediately after you make the first withdrawal?

16. You want to buy a house within 3 years, and you are currently saving for the down payment. You plan to save
$9000 at the end of the first year, and you anticipate that your annual savings will increase by 5% annually
thereafter. Your expected annual return is 8%. How much would you have for a down payment at the end of
Year 3?

17. Your father is 50 years old and will retire in 10 years. He expects to live for 25 years after he retires, until he is
85. He wants a fixed retirement income that has the same purchasing power at the time he retires as $50000
has today. (The real value of his retirement income will decline annually after he retires.) His retirement
income will begin the day he retires, 10 years from today, at which time he will receive 24 additional annual
payments. Annual inflation is expected to be 4%. He currently has $90000 saved, and he expects to earn 8%
annually on his savings. How much must he save during each of the next 10 years (end-of-year deposits) to
meet his retirement goal?

18. You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.8%. Your brother-in-law, a
broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:

Inflation premium = 3.25%, Liquidity premium = 0.6%, Maturity risk premium = 1.85%, Default risk
premium = 2.15%. On the basis of these data, what is the real risk-free rate of return?

19. The real risk-free rate is 2.25%. Inflation is expected to be 2.5% this year and 4.25% during the next 2 years.
Assume that the maturity risk premium is zero.

a) What is the yield on 2-year Treasury securities?

b) What is the yield on 3-year Treasury securities?

20. A Treasury bond that matures in 10 years has a yield of 5.75%. A 10-year corporate bond has a yield of 8.75%.
Assume that the liquidity premium on the corporate bond is 0.35%. What is the default risk premium on the
corporate bond?
21. The real risk-free rate is 2.5%, and inflation is expected to be 2.75% for the next 2 years. A 2-year Treasury
security yields 9.75%. What is the maturity risk premium for the 2- year security?

22. One-year Treasury securities yield 4.85%. The market anticipates that 1 year from now, 1-year Treasury
securities will yield 6.9%. If the pure expectations theory is correct, what is the yield today for 2-year Treasury
securities?

23. Interest rates on 4-year Treasury securities are currently 6.7%, while 6-year Treasury securities yield 7.25%. If
the pure expectations theory is correct, what does the market believe that 2-year securities will be yielding 4
years from now?

24. The real risk-free rate is 2.05%. Inflation is expected to be 3.05% this year, 4.75% next year, and then 2.3%
thereafter. The maturity risk premium is estimated to be 0.05(t - 1)%, where t = number of years to maturity.
What is the yield on a 7-year Treasury note?

25. Due to a recession, expected inflation this year is only 3.25%. However, the inflation rate in Year 2 and
thereafter is expected to be constant at some level above 3.25%. Assume that expectations theory holds and the
real risk-free rate is r* = 3.25%. If the yield on 3-year Treasury bonds equals the 1-year yield plus 3.25%, what
inflation rate is expected after Year 1?

26. A company's 5-year bonds are yielding 8.25% per year. Treasury bonds with the same maturity are yielding
5.2% per year, and the real risk-free rate (r*) is 2.75%. The average inflation premium is 2.05%, and the
maturity risk premium is estimated to be 0.1(t - 1)%, where t = number of years to maturity. If the liquidity
premium is 0.7%, what is the default risk premium on the corporate bonds?

27. An investor in Treasury securities expects inflation to be 2.1% in Year 1, 2.7% in Year 2, and 3.65% each year
thereafter. Assume that the real risk-free rate is 1.95%, and that this rate will remain constant. Three-year
Treasury securities yield 6.75%, while 5-year Treasury securities yield 7.85%. What is the difference in the
maturity risk premiums (MRPs) on the two securities; that is, what is MRP 5 - MRP3?

28. An investor purchased the following 5 bonds. Each bond had a par value of $1,000 and an 10% yield to
maturity on the purchase day. Immediately after the investor purchased them, interest rates fell and each then
had a new YTM of 7%. What is the percentage change in price for each bond after the decline in interest rates?
Fill in the following table.

Price @ 10% Price @ 7% Percentage Change

10-year, 10% annual coupon $____________ $____________ ________%
10-year zero $____________ $____________ ________%
5-year zero $____________ $____________ ________%
30-year zero $____________ $____________ ________%
$100 perpetuity $____________ $____________ ________%
29. You are considering a 10-year, $1000 par value bond. Its coupon rate is 8%, and interest is paid semiannually.
If you require an "effective" annual interest rate (not a nominal rate) of 10.7%, how much should you be
willing to pay for the bond? Do not round intermediate steps. Round your answer to the nearest cent.

30. Last year, Joan purchased a $1000 face value corporate bond with an 8% annual coupon rate and a 15-year
maturity. At the time of the purchase, it had an expected yield to maturity of 10.45%. If Joan sold the bond
today for $982.52, what rate of return would she have earned for the past year?

31. The real risk-free rate, r*, is 1.7%. Inflation is expected to average 1.5% a year for the next 4 years, after which
time inflation is expected to average 4.8% a year. Assume that there is no maturity risk premium. An 11-year
corporate bond has a yield of 8.7%, which includes a liquidity premium of 0.3%. What is its default risk
premium?

32. Suppose 2-year Treasury bonds yield 4.1%, while 1-year bonds yield 3.2%. r* is 1%, and the maturity risk
premium is zero.

a) Using the expectations theory, what is the yield on a 1-year bond, one year from now?

b) What is the expected inflation rate in Year 1?

c) What is the expected inflation rate in Year 2?

33. A 5-year Treasury bond has a 4.45% yield. A 10-year Treasury bond yields 6.95%, and a 10-year corporate
bond yields 9.8%. The market expects that inflation will average 1.65% over the next 10 years (IP 10 = 1.65%).
Assume that there is no maturity risk premium (MRP = 0), and that the annual real risk-free rate, r*, will
remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity
premium are zero for Treasury securities: DRP = LP = 0). A 5-year corporate bond has the same default risk
premium and liquidity premium as the 10-year corporate bond described above. What is the yield on this 5-
year corporate bond?

34. Assume that today is December 31, 2014, and that the following information applies to Vermeil Airlines:

 After-tax operating income [EBIT(1 - T)] for 2015 is expected to be $400 million. The depreciation
expense for 2015 is expected to be $140 million.
 The capital expenditures for 2014 are expected to be $225 million. No change is expected in net
operating working capital.
 The free cash flow is expected to grow at a constant rate of 6% per year. The required return on equity
is 14%.
 The WACC is 10%.
 The market value of the company's debt is $5 billion. 200 million shares of stock are outstanding.

Using the corporate valuation model approach, what should be the company's stock price today? Round your
answer to the nearest cent. Write out your answer completely. For example, 0.00013 million should be entered
as 130.
35. If you deposit $2000 in a bank account that pays 6% interest annually, how much would be in your account
after 5 years?

36. Future value: annuity versus annuity due

a) What's the future value of a 5%, 5-year ordinary annuity that pays $800 each year?

b) If this was an annuity due, what would its future value be?

37. You want to buy a car, and a local bank will lend you $40000. The loan will be fully amortized over 5 years
(60 months), and the nominal interest rate will be 8% with interest paid monthly.

a) What will be the monthly loan payment?

b) What will be the loan's EAR?

38. Find the following values using the equations and then a financial calculator. Compounding/discounting occurs
annually.

a) An initial $600 compounded for 1 year at 6%.

b) An initial $600 compounded for 2 years at 6%.

c) The present value of $600 due in 1 year at a discount rate of 6%.

d) The present value of $600 due in 2 years at a discount rate of 6%

39. Callaghan Motors' bonds have 23 years remaining to maturity. Interest is paid annually, they have a $1000 par
value, the coupon interest rate is 9%, and the yield to maturity is 11%. What is the bond's current market price?

40. A bond has a $1000 par value, 12 years to maturity, and a 8% annual coupon and sells for $980.

a) What is its yield to maturity (YTM)?

b) Assume that the yield to maturity remains constant for the next 3 years. What will the price be 3 years from
today?