Exam 3 Name:
Which of the following statements is correct?
companies have fewer good investment opportunities, interest rates are likely
individuals increase their savings rate, interest rates are likely to increase.
expected inflation increases, interest rates are likely to increase.
rates on all debt securities tend to rise during recessions because recessions
increase the possibility of bankruptcy, hence the riskiness of all debt
2. If 10 â year T-bonds have a yield of
6.3%, 10 â year corporate bonds yield 7.7%, and corporate bonds have a 0.2%
liquidity premium versus a zero liquidity premium for t-bonds, what is the
default risk premium on the corporate bond?
3. The McCurry Company’s bonds mature in
12 years have a par value of $1,000 and an annual coupon payment of $90. The market interest rate for the bonds is
12%. What is the price of these bonds?
4. John Jacob Inc’s bonds currently sell
for $1,250 and have a par value of $1,000.
They pay an $80 annual coupon and have a 25-year maturity, but they can
be called in 10 years at $1,100. What is
their yield to maturity (YTM)?
Stickle Inc’s bonds currently sell for $1,275 and have a par value of
$1,000. They pay an $80 annual coupon
and have a 20-year maturity, but they can be called in 5 years at $1,080. What is their yield to call (YTC)?
6. A stock just
paid a dividend of $1.25. The
required rate of return is rs = 14%, and the constant growth rate is
7%. What is the current stock price?
7. Johnny Walker
Inc plans to issue preferred stock with a perpetual annual dividend of $1.10
per share and a par value of $15. If the
required return on this stock is currently 10%, what should be the stockâs
8. If D1
= $2.00, g (which is constant) = 6%, and P0 = $70, what is the
stockâs expected total return for the coming year?
9. The Parker Alan
Company’s last dividend was $1.20. Its
dividend growth rate is expected to be constant at 20% for 3 years, after which
dividends are expected to grow at a rate of 8% forever. Connorsâ required return (rs) is
12%. What is Connorsâ current stock
10. If a stockâs
expected return exceeds its required return, this suggests that
The stock should be sold.
The company is probably not trying to maximize price per
The stock is probably a good buy.
Dividends are not being declared.
recommend using an excel spreadsheet and first calculate your cash flows over
the life time of the Death Star. In
addition, you donât need the CAPM, but simply calculation the return for the
stock based upon the information. Each
section is worth five points. I will be here early next week for
questions and can work together to finish this question, just attempt to finish
as much as possible, or at least have the problem mapped out. In addition, I can entertain some email
questions if necessary. Good luck!
The Empire is planning
to create the first ever Death Star. Darth Vader, the Emperorâs right hand man
and the manager of the project, has asked you to evaluate the project. Here is
some of the information that you will need to evaluate the project. The
equipment would cost around IC 100,000 (where IC is the imperial credit) plus
IC 60,000 more for installation. In order to operate the Death Star, working
capital has to increase by IC 40,000 which will be recovered at the end of the
project. As the Emperor has foreseen it, the project is expected to last 4
years after which the equipment will be destroyed by the Rebellion. However,
some parts of the project will be salvaged and sold for IC 20,000 to the Ewoks.
Depreciation will be based on straight-line method with zero salvaged value.
Each planet that Darth Vader destroys will cost the empire IC 10,000 but at the
same time it will bring in IC 25,000 per planet destroyed from other fearing
planets. Each year the empire plans to destroy 10 planets. The Death Star is a
big-machine and therefore will incur a fixed cost of IC 75,000 to operate each
year. In order to set an example, the Empire Department of Tax will charge a
40% tax rate on the Death Star; however they will give tax shield for borrowing
To finance this
project, the Empire will borrow 40% of the initial outlay from the Banking Clan
at a pre-tax rate of 12.50%. The other 60% will come by selling equity to the
Separatist Group. The selling price per share of the Empire is IC 100 and is
expected to grow at the constant rate of 11.67% forever. The next dividend will
be of IC 5. The lenders of the capital require high rate of return because this
is a risky project and has never been done before.
What is your
recommendation of the Death Star project to Darth Vader? Show your work. If you
believe that you cannot do this analysis, Darth Vader has given you the following
warning: âI find your lack of faith disturbing.â
11. What is the initial
outlay for the project? (Hint: Add
increase in working capital.)
12. What is the per
year depreciation expense? (Hint: Do not
count the NOWC.)
13. What is the
after-tax salvage value of the equipment? (Hint:
Remember that the book value of the equipment at the end of the project is
14. What are the cash
flows for all 4 years? (Hint: Cash flows
for year 1, 2, and 3 will be same. For the fourth year, add the NOWC and
after-tax salvage value of the equipment.)
15. What is the after
tax cost of debt?
16. What is the cost of
equity? (Hint: See directions for hint.)
17. Given the financing
need of the Empire, what is WACC?
18. Based on WACC, what
is the NPV of the project?
19. What is the IRR of
20. What is your
recommendation to Darth Vader? (Remember Darth Vader doesnât like simple
answer, you need to provide proper explanation)
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