Problem 1:
Cost of debt using the approximation formula: For each of the following $1000 par-value bonds, assuming annual interest payment and a 40% tax rate, calculate the after tax cost to maturity using the approximation formula
|
Bond
|
Life (years)
|
Underwriting Fee
|
Discount (-) or premium (+)
|
Coupon Interest Rate
|
|
A
|
20
|
25
|
-$20
|
9%
|
|
B
|
16
|
40
|
+10
|
10
|
|
C
|
15
|
30
|
-15
|
12
|
|
D
|
25
|
15
|
Par
|
9
|
|
E
|
22
|
20
|
-60
|
11
|
***Note: After tax cost of debt for Bond A = 5.66%
Problem 2:
WACC: Book weights: Ridge Tool has on its books the amount and specific (after tax) costs shown in the following table for each source of capital
|
Source of Capital
|
Book Value
|
Individual Cost
|
|
Long-term debt
|
$700,000
|
5.3%
|
|
Preferred Stock
|
50,000
|
12.0
|
|
Common Stock Equity
|
650,000
|
16.0
|
a.) Calculate the firm's weighted average cost of capital using book value weights.
b.) Explain how the firm can use this cost in the investment decision-making process.
Problem 3:
You have been given the expected return data shown in the first table on three assets- F, G and H over the period 2016-2019.
|
|
Expected Return
|
|
|
|
Year
|
Asset F
|
Asset G
|
Asset H
|
|
2016
|
16%
|
17%
|
14%
|
|
2017
|
17
|
16
|
15
|
|
2018
|
18
|
15
|
16
|
|
2019
|
19
|
14
|
17
|
Using these assets, you have isolated the three investment alternatives shown in the following table.
|
Alternative
|
Investment
|
|
1
|
100% of asset F
|
|
2
|
50% of asset F and 50% of asset G
|
|
3
|
50% of asset F and 50 of asset H
|
A. Calculate the expected return over the 4 year period of each of the three alternatives
B. Calculate the standard deviation of returns over the 4 year period for each of the three alternatives
C. Use your findings in part A and B to calculate the coefficient of variation for each of the three alternatives
D. On the basis of your findings, which of the three investment alternatives do you recommend? Why?
Problem 4:
You are considering three stocks: A, B and C for possible inclusion in your investment portfolio. Stock A has a beta of .80, stock B has a beta of 1.40 and stock C has a beta of -0.30.
A. Rank these stocks from the most risky to the least risky
B. If the return on the market portfolio increased by 12% what change would you expect in the return for each of the stocks?
C. If the return on the market portfolio decreased by 5%, what change would you expect in return for each of the stocks?
D. If you believed that the stock market was getting ready to experience a significant decline, which stock would you probably add to your portfolio? Why?
E. If you anticipated a major stock market rally, which stock would you add to your portfolio? Why?