Assignment : Answers each question with explain
1. Essex Biochemical Co. has a $1,000 par value bond outstanding that pays 10 percent annual interest. The current yield to maturity on such bonds in the market is 7 percent. Compute the price of the bonds if you know that the bond maturity dates 30 years.(1 Point)
2. Tom Cruise Lines, Inc., issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the annual interest payment was then 12 percent. This return was in line with the required returns by bondholders at that point as described below:
Real rate of return............ 3%
Inflation premium............ 5
Risk premium................... 4
Total return................... 12%
Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds.
The bonds have 20 years remaining until maturity. Compute the new price of the bond.(1 Point)
3. A firm pays a $1.50 dividend at the end of year one (D1), has a stock price of $60 (P0), and a constant growth rate (g) of 8 percent.
a. Compute the required rate of return (Ke).
Indicate whether each of the following changes would make the required rate of return (Ke) go up or down. (Each question is separate from the others. That is, assume only one variable changes at a time.) No actual numbers are necessary.
b. The dividend payment increases.
c. The expected growth rate increases.
d. The stock price increases.
4. Speedy Delivery Systems can buy a piece of equipment that is anticipated to provide an 8 percent return and can be financed at 5 percent with debt. Later in the year, the firm turns down an opportunity to buy a new machine that would yield a 15 percent return but would cost 17 percent to finance through common equity. Assume debt and common equity each represent 50 percent of the firm's capital structure.
a. Compute the weighted average cost of capital.
b. Which project(s) should be accepted?
5. Barton Electronics wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of $1.20 per share, and the current price of its common stock is $30 per share. The expected growth rate is 9 percent.
a. Compute the cost of retained earnings (Ke).
b. If a $2 flotation cost is involved, compute the cost of new common stock (Kn).
6. Diaz Camera Company is considering two investments, both of which cost $10,000. The cash flows are as follows:
|
Year
|
Project A
|
Project B
|
|
1.......................
|
$6,000
|
$5,000
|
|
2.......................
|
4,000
|
3,000
|
|
3.......................
|
3,000
|
8,000
|
a. Which of the two projects should be chosen based on the payback method?
b. Which of the two projects should be chosen based on the net present value method? Assume a cost of capital of 10 percent.
c. Should a firm normally have more confidence in answer a or answer b and why ?
7.King's Department Store is contemplating the purchase of a new machine at a cost of $13,869. The machine will provide $3,000 per year in cash flow for six years. King's has a cost of capital of 12 percent. Using the internal rate of return method, evaluate this project and indicate whether it should be undertaken.