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# Week 2 Problem Sets Noneya Bizness FIN/571 Corporate Finance Monday, July 25, 2011 Professor Terry Loserton

The bond’s coupon rate is 7.Week 2 Problem Sets Chapter 5 A1.42241 PV = 1000 * 0.47% .38 preferred is selling for $45. The preferred dividend is nongrowing.38 / 45.25 Required return = 3.25. What is the required return on James River preferred stock? Required return = Dividend / Market Price Dividend = $3.4176 = 474. (Dividend discount model) Assume RHM is expected to pay a total cash dividend of $5.09 N is the period of maturity = 10 Bond Value is $1000 (Cash flow) PV Factor = 1/(1+I)^N = 0.90 + 422.41 Coupon rate is used to calculate the present value of the bond.4176 PV = $74 * 6. what is the current market value of a share of RHM stock if the required return on RHM common stock is 10%? Current market value = D1/(Required return – growth rate) = 5.25 Required return = 7.42241 = 422. Assuming annual dividend payments.10 – 0.60 next year and its dividends are expected to grow at a rate of 6% per year forever.4%.31 A10.38 Market Price = $45. Cash flow = $1000 * 7. 2 (Bond valuation) A $1.60 / (0. (Required return for a preferred stock) James River $3.06) = 5.04) = $140 A12.60 / (0.000 face value bond has a remaining maturity of 10 years and a required return of 9%. What is the fair value of this bond? PV factor calculation: I is return required (9%) = 0.41 = 897.90 Fair Value of the bond = 474.4/100 = $74 PV factor = (1/I) * (1-1/(1+I)^N = 6.

00 Annual Percentage Rate (APR) = 12% or .25 / 2 = 45. If the yield to maturity for all three bonds is 8%.42 15 yr maturity n = 15 x 2 = 30 r = 8% / 2 = 4% PV = x PMT = 9.00 Annual Dividend = (1.125% x 1000 / 2 PMT = 91.125% x 1000 / 2 = 45. Suppose PhilEl’s bonds have identical coupon rates of 9. Assume that a coupon payment was made yesterday.00 quarterly dividend and has a required return of 12% APR (3% per quarter).12 Preferred Stock Value (P0) = (D / R) P0 = (4. a.00 * 4) = $4.125% x 1000 / 2 = 45. Preferred Dividend (D) = $1. What is the stock worth? Perpetual Qtrly.125% but that one issue matures in 1 year.625 FV = $1000 PV = ($1097. (Interest-rate risk) Philadelphia Electric has many bonds trading on the New York Stock Exchange.625 FV = $1000 PV = $1010.Week 2 Problem Sets A14. and the third in 15 years.27) .00 / 0. one in 7 years.12) P0 = $33.625 FV = $1000 PV = $1059.61 7 yr maturity n = 7 x 2 = 14 r = 8% / 2 = 4% PV = x PMT = 9. 3 (Stock valuation) Suppose Toyota has nonmaturing (perpetual) preferred stock outstanding that pays a $1.33 B16. what is the fair price of each bond? 1 yr maturity n=1x2=2 r = 8% / 2 = 4% PV = x PMT = 9.

625 FV = $1000 PV = $1116. Suppose that the yield to maturity for all of these bonds changed instantaneously to 7%.25 / 2 = 45.17 7 yr maturity n=1x2=2 r = 9% / 2 = 4.5% PV = x PMT = 9.5% PV = x PMT = 9.5% PV = x PMT = 9.125% x 1000 / 2 .Week 2 Problem Sets 4 b.125% x 1000 / 2 PMT = 91.125% x 1000 / 2 PMT = 91. What is the fair price of each bond now? 1 yr maturity n=1x2=2 r = 7% / 2 = 3.5% PV = x PMT = 9.25 / 2 = 45.625 FV = $1000 PV = $1195.5% PV = x PMT = 9.42 c.18 7 yr maturity n = 7 x 2 = 14 r = 7% / 2 = 3.5% PV = x PMT = 9.125% x 1000 / 2 PMT = 91. Suppose that the yield to maturity for all of these bonds changed instantaneously again.03 15 yr maturity n = 15 x 2 = 30 r = 7% / 2 = 3.625 FV = $1000 PV = $1001.25 / 2 = 45.25 / 2 = 45. this time to 9%.625 FV = $1000 PV = $1020.125% x 1000 / 2 PMT = 91.25 / 2 = 45.39 15 yr maturity n=1x2=2 r = 9% / 2 = 4. Now what is the fair price of each bond? 1 yr maturity n=1x2=2 r = 9% / 2 = 4.125% x 1000 / 2 PMT = 91.625 FV = $1000 PV = $1006.

5 years.5% coupon and return of the $1. What is the realized return on your investment? The calculation for realized return on investment rate is: PV of bond = $500 Par Value of bond = -1000 Annual coupon rate = 9.42% .2242 Realized rate of return on investment = 22. The PV also grows a bit as the length of time is increased.625 FV = $1000 PV = $1010. What is the realized return on your investment? Realized return on investment rate is calculated: PV of bond = $500 Par value of bond = $1000 Annual coupon rate = 9.095) = 95 PV of bond = 500 FV or Par value of bond = -1000 Realized rate of return on investment = 0.18 5 d. is interest-rate risk the same. Based on the fair prices at the various yields to maturity.34% b.5 PV = 500 FV = -1000 Realized return on investment (Rate) = 37. the bondholders receive a distribution of $150 per bond at the end of 3. After liquidating the firm. higher.25 / 2 = 45.Week 2 Problem Sets PMT = 91.versus shorter-maturity bonds? It appears from my calculations that the interest-rate risk is lower when the actual interest rater is lower. (Default risk) You buy a very risky bond that promises a 9.000 principal in 10 years. or lower for longer. You pay only $500 for the bond. You receive the coupon payments for three years and the bond defaults. The firm does far better than expected and bondholders receive all of the promised interest and principal payments.50% Num of yrs to mature = 10 Annual coupon payment = (1000 * .50% Num of yrs to mature = 3. a. B18.

Week 2 Problem Sets 6 B20. Bret Kimes. believes that Medtrans will begin paying a $1.15(25%) rM = 9.3(15%) + 0.06 / 0.35(10%) + 0.06) / 0.75% rCG = Prob1 * rCG1 + Prob2 * rCG2 + Prob3 * rCG3 + Prob4 * rCG4 rCG = 0.06 Required rate of return (R) = 13% or .15 Stock Market (10%) 10 15 25 Chicago Gear (15%) 15 25 35 a.04) / 0. one of James’ colleagues at the same firm. Bret thinks that Medtrans will begin paying a dividend in four years.09 P4 = $1.06) P2 = $1.07 Stock value for MedTrans per James Weber: $15.00 ($1. Calculate the expected returns on the stock market and on Chicago Gear stock.13 Stock value (P2) = D3 / (R – g) P2 = D2 ( 1 + g) / (0.13 – 0.04 / 0.04) P4 = $1. is less optimistic.55 Chapter 7 C1.00. REALIZED RETURN State of the Market Stagnant Slow growth Average growth Rapid growth Probability that State Occurs 0. Edwards.35 0.15(35%) rCG = 15% . What value would Bret assign to the Medtrans stock? Stock value (P4) = D5 / (R – g) P4 = D5 (1 + g) / (0.20 0.07 P2 = $1.09 Stock value for MedTrans per Bret Kimes: $11.13 – 0. (Beta and required return) The riskless return is currently 6%. G. and that it will grow at 4% annually.35(15%) + 0.00 (1. that the dividend will be $1.2(-10%) + 0. James Weber. and Chicago Gear has estimated the contingent returns given here.14 b.2(-15%) + . What value would James estimate for this firm? Dividend paid out in 2 years (D2) = $1000 Dividend growth rate (g) = 6% or .3(25%) + 0.30 0. James and Bret agree that the required return for Medtrans is 13%.00 per share dividend in two years and that the dividend will increase 6% annually thereafter. a. (Constant growth model) Medtrans is a profitable firm that is not paying a dividend on its common stock. rM = Prob1 * rM1 + Prob2 * rM2 + Prob3 * rM3 + Prob4 * rM4 rM = 0. an analyst for A.

2(-10-9.80% / 1.75%-6%) rCG = 11.2(-10%-9.75%)(35%-15%) = 1.49(9.35(10%-9.59% .2119% To calculate the beta: CG = 1.15(25%-9. What is Chicago Gear’s required return according to the CAPM? rCG = rf + BCG(rM – rf) rCG = 6% + 1.75%)(15%-15%) + 0.Week 2 Problem Sets 7 b.75)(-15 –15) + 0.75%)(25%15%) + 0.80% VAR(M) = 0.M) = 0. What is Chicago Gear’s beta? COV(CG.15(25%-9.2119 CG = 1.75%)2 + 0.49 c.75%)2 + 0.35(10%-9.75%)2 = 1.3(15%-9.3(15%-9.75%)2 + 0.