FI 3300 Online Take Home Problem Set 4

Spring 2016

Directions: This problem set covers chapters 8, 9 and 10 in the textbook. Determine or compute an answer for each question/problem. After you have computed an answer for every question, enter your answers online via the “quiz” function entitled “THPS-4 ANSWER SUBMISSION FORM.” See the course calendar for when the answer submission form will open and close. I will post a detailed solution key to the problem set right after the Answer Submission Form closes. See the course calendar for the day(s) on which I will answer questions about these problems in the chat room.

This is a take-home, open book, open notes financial statement analysis problem set. Work on this Assignment is to be yours alone – any discussion of either the questions on the assignment or your answers with anyone other than your instructor will be considered as cheating and, thus, as a violation of the GSU honor code. All questions are equally weighted.

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PART I: MULTIPLE CHOICE – Choose the letter of the most correct answer for each question. Record only one answer per question. Each question is worth 4 points. 1. IS THE FOLLOWING STATEMENT TRUE or FALSE? “A financial security is simply a contract

between the provider of funds and the user of these funds that clearly specifies the amount of money that has been provided and the terms and conditions of how the user is going to repay the provider.”

a. True b. False

2. A consol is a bond that:

a. Pays a fixed annual coupon amount, and when originally issued, is set to mature in 30 years. b. Pays a fixed annual coupon amount, and when originally issued, is set to mature in 50 years. c. Does not pay an annual coupon (i.e., the annual coupon payment is $0) but when it matures pays

out the par value of the bond. d. Does not pay an annual coupon (i.e., the annual coupon payment is $0) and never matures. e. Pays a fixed annual coupon amount forever.

3. Convertible bonds:

a. Allow the security holder to convert the bond into cash at any time during the life of the bond. b. Allow the security holder to convert the bond into products or services that the company sells. c. Allow the security holder to convert the bond into another bond with a higher coupon rate if interest

rates on bonds increase before the convertible bond matures. d. Allow the security holder to convert the bond to another security, usually equity, according to some

pre-specified terms. e. None of the above.

4. The required return (using the constant growth dividend model) for a share of stock is equal to:

a. Next year’s dividend divided by the current price. b. The increase in the value of a share of stock over one year. c. The percentage rate at which a stock increases in value. d. The capital gains yield plus the dividend yield. e. The payment by a corporation to shareholders in the form of cash or stock.

5. According to the constant growth in dividends price formula given in the textbook, if the dividend to

be paid one year from today increases and all other factors remain constant, the price of the stock will __________; if the growth rate of all future dividends increases and all other factors remain constant, the price of the stock will __________; and if the required rate of return increases and all other factors remain constant, the price of the stock will __________.

a. Decrease; decrease; decrease b. Increase; increase; decrease c. Decrease; increase; decrease d. Increase; increase; increase e. None of the answers listed above are correct.

6. This morning, Mary bought a ten-year, $1000 par value bond with a 7.0% coupon rate and semi-annual

payments. She paid $994 for the bond. If the market interest rate on this type of bond decreases to 6.5% tonight, how much will Mary receive for her first coupon payment?

a. $32.50 b. $35.00 c. $65.00 d. $69.58 e. $70.00

7. Suppose that interest rates decrease. Assuming all other parameters that impact the price of bonds and

stocks remain constant, what would you expect to happen to bond and stock prices?

a. Bond prices would increase and stock prices would decrease. b. Bond prices would decrease and stock prices would decrease. c. Bond prices would decrease and stock prices would increase. d. Bond prices would increase and stock prices would increase. e. Stock prices would increase. More information would be needed to determine the impact on bond

prices. 8. Which of the following bonds would have the largest change in price (in percentage terms) for a given

change in interest rates (that is, in yield to maturity) – that is, if the yield to maturity on a bond increases from 8% to 10%, all else constant, which of the following bond prices will change the most (in percentage terms)?

a. A $1000 par value bond with a 10% coupon rate (annual payments) that matures in 2 years. b. A $1000 par value bond with a 10% coupon rate (semi-annual payments) that matures in 25 years. c. A $1000 par value bond with a 2% coupon rate (annual payments) that matures in 4 years. d. A $1000 par value bond with a 2% coupon rate (semi-annual payments) that matures in 30 years. e. The bond that changes the most (in price percentage terms) cannot be determined from the

information given.

9. Five years ago, ABC Inc. issued 25-year fixed coupon bonds at par. Since then the bond’s yield-to- maturity (YTM) has increased by 1.5%. Based on this information, which of the following is true regarding the current market price of the bond?

a. The bond is selling at discount. b. The bond is selling at premium. c. The bond is selling at book value. d. The bond is selling at par. e. Insufficient information.

10. Assume that you have the following information on project A: (i) it will yield cash flows of $900 per

year forever; (ii) the IRR is 16%; (iii) the required rate of return (i.e., the cost of capital) for this project is 11.35%.What is the NPV of this project?

a. $8,458.15 b. $2,304.52 c. $2,242.88 d. $2,458.15 e. None of the numbers listed above are within $10 of the correct answer.

11. Which of the following statements is most correct concerning a project with normal cash flows (i.e., a

cash outflow in Year 0 followed by cash inflows in all subsequent years)?

a. If the NPV of a project is positive then the payback period rule will always accept the project. b. If the NPV of a project is negative, then the profitability index of the project will always be greater

than one. c. If the profitability index of a project is greater than one, then the IRR will always be less than the

project’s cost of capital. d. If the NPV of a project is zero, then the IRR of the project will be equal to the discount rate for the

project. e. If the discount rate of a project is zero, then the project will always be accepted.

12. Consider the following projects, for a firm using a discount rate of 10%:

Project NPV IRR PI A $200,001 12.2% 1.04 B $200,000 11% 1.14 C $60,000 20.1% 1.61 D $(235,000) 9% .95

If the projects are independent, which, if any, project(s) should the firm accept?

a. Project A b. Project B c. Project D d. Projects B and D e. Projects A, B and C

13. Consider the following projects, for a firm using a discount rate of 10%:

Project NPV IRR PI A $200,000 10.2% 1.04 B $200,001 11% 1.14 C $60,000 20.1% 1.61 D $(235,000) 9% .95

If the projects are mutually exclusive, which, if any, project(s) should the firm accept?

a. Project A b. Project B c. Project D d. Projects B and D e. Projects A, B and C

PART II: PROBLEMS – Compute a final numerical answer for each of the following problems. You should work out your solutions on loose leaf paper, however, I may or may not collect your worked out solutions. To be safe, however, I suggest that you write out a solution for every problem and be ready to turn it in if asked. Round all dollar answers to 2 decimal places and record all interest rate, coupon rate and growth rate answers as a percent rounded to one decimal place.

14. The historical stock returns for GAF, Inc. are listed below:

What is the standard deviation of returns for GAF, Inc. stock over the 8 year time period? (Compute the standard deviation assuming this is a population of returns, not a sample – that is, use the procedure described in the textbook for calculating the standard deviation of a series of stock returns).

15. If the expected return on the market portfolio (i.e., Rm) is 14%, if the risk-free rate (i.e., Rf) is 5% and if the beta of Homton, Inc. stock is 1.75, what is the equilibrium expected rate of return on Homton’s stock according to the Capital Asset Pricing Model?

16. Compute the price of a $5,000 par value bond with a coupon rate of 7.5% (semi-annual payments) and 20 years remaining to maturity. Assume that the current yield to maturity on the bond is 8.60%.

17. Compute the yield to maturity of a $2,500 par value bond with a coupon rate of 7.5% (quarterly payments – that is, four times per year) that matures in 25 years. The bond is currently selling for $3,265.

18. What is the yield to maturity of a $1,000 par value bond with a coupon rate of 9.5% (semi-annual coupon payments) that matures in 28 years assuming the bond is currently selling for $838.13?

Year Annual Stock Return

2005 12% 2006 18% 2007 38% 2008 -12% 2009 0% 2010 -18% 2011 15% 2012 27%

19. Two years ago, Phutki Corp. issued a $1,000 par value, 11 percent (annual payment) coupon bond. At the time the bond was issued it had 15 years to maturity. Currently this bond is selling for $1,000 in the bond market. Phutki Corp. is now planning to issue a $1,000 par value bond with a coupon rate of 9 percent (semi-annual payments) that will mature 30 years from today. Assuming that the riskiness of the new bond is the same as the previous bond (i.e., the YTM on the new bond is equal to the current YTM on the previous bond), how much will investor’s pay for this new bond?

20. Consider a Zerobond (i.e., a bond that pays no coupon payment, meaning that the coupon rate on the bond is 0%) with a par value of $1,000 that will mature exactly 12 years from today. The current YTM of this Zerobond is 5.2%. Two years ago the YTM of the same Zerobond was 4.6%. Calculate the dollar price increase/decrease (2 decimal places) within the last two years. If the bond falls in price, enter your answer on D2L as a negative value (i.e., put a minus sign before your number with no space between the minus sign and the number). If the bond increases in price, record the dollar amount of the increase.

21. The current price of a 20-year, $1,000 par value bond is $1,158.91. Interest on this bond is paid every six months, and the current yield to maturity on this bond 13.4 percent. Given these facts, what is the annual coupon rate on this bond?

22. Compute the price of a company’s stock that just paid a dividend of $3.25 (that is, D0 = 3.25), assuming that the growth rate in dividends is expected to be 6.5% per year forever and that the required rate of return on this stock is 15.5%.

23. If shares of common stock of the Samson Co. offer an expected total return of 13% and if the growth rate in future dividends of the stock are expected to be 4.5% per year forever, what is the stock’s dividend yield (i.e., D1/P0)?

24. The stock of Cabbor, Incorporated is trading at $70.00 per share. The company just paid a dividend of $5.00 per share (that is, D0 = 5.00). The growth rate in dividends is projected to be 6 percent per year forever. What is Cabbor’s cost of equity capital (that is, compute the required rate of return on the stock)?

25. Phillips, Inc. just paid a dividend of $3.25 per share on its common stock (that is, D0 = 3.25). Investors expect the dividend to grow at 40% in years 1 and 2, they expect the dividend to grow at 20% in year 3 and they expect that all future dividends (that is, dividends in years 4, 5, …, infinity) to grow at a constant rate of 5% per year. If the cost of capital for Phillips, Inc. stock is 15%, what is the current price of the stock?

26. IBIS Corporation has had dividends grow from $2.50 per share to $6.50 per share over the last 10 years (the $6.50 per share dividend was paid yesterday; that is, D0 = $6.50). This compounded annual growth rate in dividends is expected to continue into the future forever. If the current market price of IBIS’s stock is $45.00 per share, what rate of return do investors expect to receive from buying IBIS stock?

27. A firm will pay a dividend of $0 one year from today and $5.00 two years from today (that is, D1 = $0 and D2 = 5.00). Thereafter, the dividend is expected to grow at a constant rate forever. The price of this stock today is $100 and the required rate of return on the stock is 10%. What is the expected constant growth rate of the dividend stream from year 2 to infinity?

28. Malcolm Manufacturing, Inc. just paid a $2.00 annual dividend (that is, D0 = 2.00). There will be no dividend payment for the next two years (i.e., at t = 1 and t = 2). In year three (t = 3), the dividend is expected to be $5.00. The dividend will then grow at 10% annually for the next 3 years (i.e., at t = 4, t = 5 and t = 6) and thereafter (i.e., beginning at t = 7) dividends will grow at a rate of 3% annually forever. Assuming a required return of 14%, what is the current price of the stock?

29. Consider a project with the following cash flows:

Year t = 0 t =1 t = 2 t = 3 t = 4

??? $7,500 $12,500 $15,000 $17,500

The Payback Period of this project is 2.4 years. The appropriate discount rate is 13%. Find the Net Present Value of the project. (Note that the cash flow for t=0 is not provided to you – that is, you must first solve for it).

30. If the cost of capital for the project shown below is 2.5 percentage points less than the project’s IRR (for example, if the project’s IRR is 12%, the cost of capital is 9.5%), what is the NPV of the project?

Year Cash Flow 0 ($210,000) 1 $40,000 2 $50