1) A 5-year corporate bond with a 6.

8% coupon rate is trading at $ 970 (the face value is $

1000).
a) Assuming semi-annual coupon payments, estimate the yield to maturity on this
bond.
b) Now assume that the rating of the corporation that issued the bond declines from
AA to BBB and that the default spread increases from 0.5% (which is what it is
now) to 0.8%. Estimate the effect on the bond price.
c) Why, if the coupon payments and maturity are unchanged, is there a change in
value as a result of the ratings change?

2) You have borrowed $ 1 million on a 10-year 8% balloon-payment loan (interest only for
10 years and principal at the end of the 10 th year) and bought an apartment building for
$1.5 million. Assume that you expect to earn rental revenues (net of operating expenses)
of $ 140,000 each year for the next 10 years, and that your tax rate is 40%. At the end of
10 years, you estimate that you can sell the building for $ 1.6 million. Assuming no
depreciation, estimate the value of your equity in the building. (Your cost of equity is
10%)

3) General Signal is a firm that manufactures telecommunication equipment. It reported

earnings before interest and taxes of $ 400 million in the most recent financial year, and
faced a 40% tax rate. In addition, the firm reinvests 40% of its after-tax operating income
back into the business and expects to grow 5% in perpetutity.
a) If the cost of capital is 10%, estimate the value of the firm.
b) How would your answer change if both the growth rate and the cost of capital
increase by 1%?

4) You are valuing First Bank, a large commercial bank. The bank reported earnings per
share of $ 4 last year, and paid out dividends of $2.40 per share. The earnings are
expected to grow 4% a year in perpetuity, and the firm is expected to maintain its existing
payout ratio. The firm’s cost of equity is 9%.
a) Estimate the value of equity per share.
b) If the stock is trading at $ 42 per share, estimate the implied growth rate (the
growth rate that the market is assuming for this stock).