Assignment
1. For each of the following pairs of Treasury securities (each with $1,000 par value), identify which will have the higher price:
a. A threeyear zerocoupon bond or a fiveyear zerocoupon bond?
b. A threeyear zerocoupon bond or a threeyear 4% coupon bond?
c. A twoyear 5% coupon bond or a twoyear 6% coupon bond?
a. A threeyear zerocoupon bond or a fiveyear zerocoupon bond?
Which will have the higher price? (Select the best choice below.)
A. A fiveyear zerocoupon bond, because the present value is received sooner and the future value is higher.
B. A threeyear zerocoupon bond, because the present value is received sooner and the future value is higher.
C. A threeyear zerocoupon bond, because the future value is received sooner and the present value is higher.
D. A fiveyear zerocoupon bond, because the future value is received later and the present value is higher.
b. A threeyear zerocoupon bond or a threeyear 4% coupon bond?
Which will have the higher price? (Select the best choice below.)
A. The threeyear zerocoupon bond, because a pure discount bond pays higher interest payments than a 4% coupon bond.
B. The threeyear 4% coupon bond, because the 4% coupon bond pays interest payments; whereas the zerocoupon bond is a pure discount bond.
C. Since they both have a threeyear maturity, they are equal in price.
D. The threeyear zerocoupon bond, because the zerocoupon bond is riskfree.
c. A twoyear 5% coupon bond or a twoyear 6% coupon bond?
Which will have the higher price? (Select the best choice below.)
A. Because they are both twoyear coupon bonds, they are equal in price.
B. The twoyear 6% coupon bond, because the coupon (interest) payments are higher, even though the timing is the same.
C. The twoyear 5% coupon bond, because the future value will be received sooner, therefore the present value must be higher.
D. The twoyear 5% coupon bond, because the coupon (interest) payments are higher, even though the timing is the same.
2. Anle Corporation has a current stock price of $20.00 and is expected to pay a dividend of $1.00 in one year. Its expected stock price right after paying that dividend is $22.00.
a. What is Anle's equity cost of capital?
b. How much of Anle's equity cost of capital is expected to be satisfied by dividend yield and how much by capital gain?
a. What is Anle's equity cost of capital?
Anle's equity cost of capital is %. (Round to two decimal places.)
b. How much of Anle's equity cost of capital is expected to be satisfied by dividend yield and how much by capital gain?
The portion of Anle's equity cost of capital that is expected to be satisfied by the dividend yield is %. (Round to two decimal places.)
The portion of Anle's equity cost of capital that is expected to be satisfied by capital gains is %. (Round to two decimal places.)
3. Suppose Acap Corporation will pay a dividend of $2.80 per share at the end of this year and $3.00 per share next year. You expect Acap's stock price to be $52.00 in two years. Assume that Acap's equity cost of capital is 10.0%.
a. What price would you be willing to pay for a share of Acap stock today, if you planned to hold the stock for two years?
b. Suppose instead you plan to hold the stock for one year. For what price would you expect to be able to sell a share of Acap stock in one year?
c. Given your answer in (b), what price would you be willing to pay for a share of Acap stock today if you planned to hold the stock for one year? How does this compare to your answer in (a)?
a. What price would you be willing to pay for a share of Acap stock today, if you planned to hold the stock for two years?
If you plan to hold the stock for two years, the price you would pay for a share of Acap stock today is $ . (Round to the nearest cent.)
b. Suppose instead you plan to hold the stock for one year. For what price would you expect to be able to sell a share of Acap stock in one year?
The price for which you expect to sell a share of Acap stock in one year is $ . (Round to the nearest cent.)
c. Given your answer in (b), what price would you be willing to pay for a share of Acap stock today if you planned to hold the stock for one year? How does this compare to your answer in (a)?
Given your answer in (b), the price you would be willing to pay for a share of Acap stock today, if you planned to hold the stock for one year is $ . (Round to the nearest cent.)
When you compare your answer in (a) to the answer in (c), (Select the best choice below.)
A. The price in part (a) is the same as the price in part (c).
B. The price in part (a) is lower than the price in part (c).
C. The price in part (a) is higher than the price in part (c).
D. They are not comparable values.
4. Laurel Enterprises expects this year's earnings to be $4.00 per share and has a 40% retention rate, which it plans to keep constant. Its equity cost of capital is 10%, which is also its expected return on new investment. Its earnings are expected to grow forever at a rate of 4.0% per year. If its next dividend is due in one year, what do you estimate the firm's current stock price to be?
The current stock price will be $ . (Round to the nearest cent.)
5. Assume Gillette Corporation will pay an annual dividend of $0.65 one year from now. Analysts expect this dividend to grow at 12.0% per year thereafter until the 5th year. Thereafter, growth will level off at 2.0% per year. According to the dividenddiscount model, what is the value of a share of Gillette stock if the firm's equity cost of capital is 8.0%?
The value of Gillette's stock is $ . (Round to the nearest cent.)
6. You notice that CocaCola has a stock price of $41.09 and EPS of $1.89. Its competitor PepsiCo has EPS of $3.90. But, Jones Soda, a small batch Seattlebased soda producer has a P/E ratio of 35. Based on this information, what is one estimate of the value of a share of PepsiCo stock?
One share of PepsiCo stock is valued at $ . (Round to the nearest cent.)
7. You have an opportunity to invest $100,000 now in return for $80,000 in one year and $30,000 in two years. If your cost of capital is 9.0%, what is the NPV of this investment?
The NPV will be $ . (Round to the nearest cent.)
8. Your factory has been offered a contract to produce a part for a new printer. The contract would last for 3 years and your cash flows from the contract would be $5.00 million per year. Your upfront setup costs to be ready to produce the part would be $8.00 million. Your discount rate for this contract is 8.0%.
a. What does the NPV rule say you should do?
b. If you take the contract, what will be the change in the value of your firm?
a. What does the NPV rule say you should do?
The NPV of the project is $ million. (Round to two decimal places.)
What should you do? (Select the best choice below.)
A. The NPV rule says that you should not accept the contract because the NPV < 0.
B. The NPV rule says that you should accept the contract because the NPV < 0.
C. The NPV rule says that you should accept the contract because the NPV > 0.
D. The NPV rule says that you should not accept the contract because the NPV > 0.
b. If you take the contract, what will be the change in the value of your firm?
If you take the contract, the value added to the firm will be $ million. (Round to two decimal places.)
9. Your factory has been offered a contract to produce a part for a new printer. The contract would last for three years, and your cash flows from the contract would be $5.00 million per year. Your upfront setup costs to be ready to produce the part would be $8.00 million. Your discount rate for this contract is 8.0%.
a. What is the IRR?
b. The NPV is $4.89 million, which is positive so the NPV rule says to accept the project. Does the IRR rule agree with the NPV rule?
a. What is the IRR?
The IRR is %. (Round to two decimal places.)
b. The NPV is $4.89 million, which is positive so the NPV rule says to accept the project. Does the IRR rule agree with the NPV rule? (Select from the dropdown menu.)
The IRR rule (1) with the NPV rule.
(1) agrees doesn't agree
10. You are evaluating a project that will cost $500,000, but is expected to produce cash flows of $125,000 per year for 10 years, with the first cash flow in one year. Your cost of capital is 11% and your company's preferred payback period is three years or less.
a. What is the payback period of this project?
b. Should you take the project if you want to increase the value of the company?
a. What is the payback period of this project?
The payback period is years. (Round to two decimal places.)
b. Should you take the project if you want to increase the value of the company? (Select from the dropdown menus.)
If you want to increase the value of the company you (1) take the project since the NPV is (2) .
(1) will not will
(2) positive negative
11. You are choosing between two projects. The cash flows for the projects are given in the following table ($ million):
|
Project
|
Year 0
|
Year 1
|
Year 2
|
Year 3
|
Year 4
|
|
A
|
- $50
|
$25
|
$20
|
$20
|
$15
|
|
B
|
- $100
|
$20
|
$40
|
$50
|
$60
|
a. What are the IRRs of the two projects?
b. If your discount rate is 5.0%, what are the NPVs of the two projects?
c. Why do IRR and NPV rank the two projects differently?
a. What are the IRRs of the two projects?
The IRR for project A is %. (Round to one decimal place.)
The IRR for project B is %. (Round to one decimal place.)
b. If your discount rate is 5.0%, what are the NPVs of the two projects?
If your discount rate is 5.0%, the NPV for project A is $ million. (Round to two decimal places.)
If your discount rate is 5.0%, the NPV for project B is $ million. (Round to two decimal places.)
c. Why do IRR and NPV rank the two projects differently? (Select from the dropdown menus.)
NPV and IRR rank the two projects differently because they are measuring different things. (1) is measuring value creation, while (2) is measuring return on investment. Because returns do not scale with different levels of investment, the two measures may give different rankings when the initial investments are different.
(1) NPV IRR
(2) NPV IRR