Problem1. Presently, Warren Industries can sell 15-year, $1,000-par-value bonds paying annual interest at a 12% coupon rate. As the result of current interest rates, the bonds can be sold for $1,010 each; flotation costs of $30 per bond will be acquired in this process. The firm is in the 40% tax bracket.
a. Find the net proceeds from sale of the bond, Nd.
b. Demonstrate the cash flows from the firm’s point of view over the maturity of the bond.
c. Compute the before-tax and after-tax costs of debt.
d. Use the approximation formula to estimate the before-tax and after-tax costs of debt.
e. Contrast the costs of debt find outd in parts c and d. Which approach do you prefer? Why?
Portfolio betas Rose Berry is attempting to measure two possible portfolios, which comprise the same five assets held in different proportions. She is particularly interested in using beta to compare out the risks of the portfolios, so she has collected the data which is shown in the following table.
Asset Asset Beta Portfolio A Portfolio B
1 1.3 10 30
2 0.7 30 10
3 1.25 10 20
4 1.1 10 20
5 0.9 40 20
a. Compute the betas for portfolios A and B.
b. Compare out the risks of these portfolios to the market as well as to each other. Which portfolio is more risky?
Problem2. Rate of return Douglas Keel, a financial analyst for Orange Industries, wishes to estimation the rate of return for two similar-risk investments, X and Y. Douglas’s research points out that the immediate past returns will serve as reasonable estimates of prospect returns. A year earlier, investment X had a market value of $20,000; investment Y had a market value of $55,000. Throughout the year, investment X generated cash flow of $1,500 and investment Y generated cash flow of $6,800. The current market values of investments X and Y are $21,000 and $55,000, correspondingly.
a. Compute the expected rate of the return on investments X and Y using the most recent year’s data.
b. Supposing that the two investments are equally risky, which one should Douglas suggested? Why?