# Business Finance (Section E) Assignment – Bond Valuation, Stock Valuation and Capital Budgeting Techniques Submission – May 19, 2012

Bonds Valuation 1. A bond trader purchased each of the following bonds at a yield to maturity of 8 percent. Immediately after she purchased the bonds interest rates fell to 7 percent. a.

PRICE

What is the percentage change in the price of each bond after the decline in interest rates? Fill in the following table:

@ 8% PRICE

_____________________ _____________________ _____________________ _____________________ _____________________

@ 7% PERCENTAGE

______________________ _____________________ _____________________ _____________________ _____________________

CHANGE

_____________________ _____________________ _____________________ _____________________ ____________________

10-year, 10% annual coupon 10-year zero 5-year zero 30-year zero $100 perpetuity

**b. Can you draw a conclusion about interest rate sensitivity of bonds of different maturity
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from above calculations? 2. An investor has two bonds in his portfolio. Each bond matures in 4 years, has a face value of $1,000, and has a yield to maturity equal to 9.6 percent. One bond, Bond C, pays an annual coupon of 10 percent; the other bond, Bond Z, is a zero coupon bond. a) Assuming that the yield to maturity of each bond remains at 9.6 percent over the next 4 years, what will be the price of each of the bonds at the following time periods? Fill in the following table:

T PRICE OF BOND C

_____________________ _____________________ _____________________ _____________________ _____________________

PRICE OF BOND Z

_____________________ _____________________ _____________________ _____________________ _____________________

0 1 2 3 4

b) Plot the time path of the prices for each of the two bonds. Can you draw a conclusion?

Stock Valuation

**1. Harrison Clothiers’ stock currently sells for $20 a share. The stock just paid a dividend of $1.00
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a share (i.e., D0 _ $1.00). The dividend is expected to grow at a constant rate of 10 percent a year. What stock price is expected 1 year from now? What is the required rate of return on the company’s stock?

2. Martell Mining Company’s ore reserves are being depleted, so its sales are falling. Also, its pit

is getting deeper each year, so its costs are rising. As a result, the company’s earnings and dividends are declining at the constant rate of 5 percent per year. If D0 _ $5 and ks _ 15%, what is the value of Martell Mining’s stock?

the company should grow at a constant rate of 8 percent per year. If the required return is 9 percent. According Project A (400) 55 55 55 225 225 Project B (600) 300 300 50 50 50
b. However. Should this project be undertaken.000 each year over the 5-year life of the vein.
to the payback criterion. and (4) 10 percent? Using data from part a. Microtech Corporation is expanding rapidly. expect dividends to grow at a constant compound annual rate of (1) _5 percent. what is the value of the stock today?
4. investors expect Microtech to begin paying dividends. Capital Budgeting 1. The dividend should grow rapidly—at a rate of 50 percent per year—during Years 4 and 5. and it currently needs to retain all of its earnings. After discovering a new gold vein in the Colorado mountains.000 each year for the following 10 years. The most cost-effective method of mining gold is sulfuric acid extraction. The gold mined will net the firm an estimated $350. How should environmental effects be considered when evaluating this.500$ each year for the next 10 years and $10. or any other. c. (2) 0 percent. For the purposes of this problem.000 for new mining equipment and pay $165. which project should be to the NPV criterion. a. What is the NPV and IRR of this project? b. What will be Levine’s stock value if the previous dividend was D0 _ $2 and if investors
b. (3) 5 percent. project? How might these effects change your decision in part b? 2.
Under what conditions IRR rule breaks down?
4.00 coming 3 years from today. To go ahead with the extraction. with the first dividend of $1. The IRR for this 20 year project is 10. a.98%.3.000 for its installation. A firm with a required return of 10% is considering following mutually exclusive projects Year 0 1 2 3 4 5 a.
hence it does not pay any dividends. CTC must spend $900. a process that results in environmental damage. CTC’s cost of capital is 14 percent. which project should be accepted? to the IRR criterion. assume that the cash inflows occur at the end of the year. what is the project’s NPV?
. Justin is evaluating a project that is expected to produce cash flows of 7. what is the Gordon (constant growth) model value for Levine’s stock if the required rate of return is 15 percent and the expected growth rate is (1) 15 percent or (2) 20 percent? Is it reasonable to expect that a constant growth stock would have g >k? Explain. According d. which project should be accepted? to the discounted payback criterion. According According accepted? c. ignoring environmental concerns? c. Investors require a 15 percent rate of return on Levine Company’s stock (ks _ 15%). After Year 5. which project should be accepted?
3. If the required return on the stock is 15 percent. CTC Mining Corporation must decide whether to mine the deposit.