1. Interest Rate Risk. Both Bond Bill and Bond Ted have 7 percent coupons, make semiannual payments, and are priced at par value. Bond Bill has 3 years to maturity, whereas Bond Ted has 20 years to maturity. If interest rates suddenly rise by 2 percent, what is the percentage change in the price of Bond Bill? Of Bond Ted? If rates were to suddenly fall by 2 percent instead, what would the percentage change in the price of Bond Bill be then? Of Bond Ted? Illustrate your answers by graphing bond prices versus YTM. What does this problem tell you about the interest rate risk of longer-term bonds?
2. Valuing Preferred Stock. E-Eyes.com has a new issue of preferred stock it calls 20/20 preferred. The stock will pay a $20 dividend per year, but the first dividend will not be paid until 20 years from today. If you require a return of 8 percent on this stock, how much should you pay today?
3. Stock Valuation. Alexander Corp. will pay a dividend of $2.72 next year. The company has stated that it will maintain a constant growth rate of 4.5 percent a year forever. If you want a return of 12 percent, how much will you pay for the stock? What if you want a return of 8 percent? What does this tell you about the relationship between the required return and the stock price?
4. Calculating Payback. Global Toys Inc., imposes a payback cutoff of three years for its international investment projects. If the company has the following two projects available, should it accept either of them?
|
Year
|
Cash Flow (A)
|
|
0
|
-$55,000
|
|
1
|
19,000
|
|
2
|
27,000
|
|
3
|
24,000
|
|
4
|
9,000
|
5. Calculating AAR. You're trying to determine whether or not to expand your business by building a new manufacturing plant. The plant has an installation cost of $14 million, which will be depreciated straight-line to zero over its four-year life. If the plant has projected net income of $1,253,000, $1,935,000, $1,738,000, and $1,310,000 over these four years, what is the project's average accounting return (AAR)?
6. Calculating IRR. A firm evaluates all of its projects by applying the IRR rule. If the required return is 11 percent, should the firm accept the following project?
|
Year
|
Cash Flow
|
|
0
|
-$153,000
|
|
1
|
78,000
|
|
2
|
67,000
|
|
3
|
49,000
|
7. Calculating NPV. For the cash flows in the previous problem, suppose the firm uses the NPV decision rule. At a required return of 9 percent, should the firm accept this project? What if the required return was 21 percent?