Question 1: . The real rate of interest is currently 3%. The inflation expectation and risk premiums for a number of securities follow:
|
Security
|
Premium
|
Risk Premium
|
|
A
|
6%
|
3%
|
|
B
|
9
|
2
|
|
C
|
8
|
2
|
|
D
|
5
|
4
|
|
E
|
11
|
1
|
A. Find the risk free rate of interest, Rf, that is applicable to each security
B. Although not noted, what factor must be the cause of the differing risk free rates found in part a?
C. Find the nominal rate of interest for each security
Question 2: . Laura Drake wishes to estimate the value of an asset expected to provide cash inflows of $3000 per year at the end of years 1 through 4 and $15,000 at the end of year 5. Her research indicates that she must earn 10% on low-risk assets, 15% on average risk assets, and 22% on high risk assets.
A. Determine what is the most Laura should pay for the asset if it is classified as 1.) low risk, 2) average risk 3) high risk
B. Suppose that Laura is unable to assess the risk of the asset and wants to be certain she's making a good deal. On the basis of your findings in part a, what is the most she should pay? Why?
C. All else being the same, what effect does increasing risk have on the value of an asset? Explain in light of your findings in part a.
Question 3:
Mark Goldsmith's broker has shown him two bonds. Each has a maturity of 5 years, a par value of $1000 and a yield to maturity of 12%. Bond A has a coupon interest rate of 6% paid annually. Bond B has a coupon interest rate of 14% paid annually.
A. Calculate the selling price for each of the bonds.
B. Mark has $20,000 to invest. Judging on the basis of the price of the bonds, how many of either one could Mark purchase if he were to choose it over the other? (Mark cannot really purchase a fraction of a bond, but for purposes of this question, pretend that he can)
C. Calculate the yearly interest income of each bond on the basis of its coupon rate and the number of bonds that Mark could buy with his $20,000
D. Assume that Mark with reinvest the interest payments as they are paid (at the end of each year) and that his rate of return on the reinvestment is only 10%. For each bond, calculate the value of the principal payment plus the value of Mark's reinvestment account at the end of the 5 years.
E. Why are the two values calculated in part d different? If Mark were worried that he would earn less than the 12% yield to maturity on the reinvested interest payments, which of these two bonds would be a better choice?
Question 4:.
|
Assets
|
|
Liabilities and Stockholders Equity
|
|
|
Cash
|
$40,000
|
Accounts Payable
|
$100,000
|
|
Marketable Securities
|
60,000
|
Notes Payable
|
30,000
|
|
Accounts Receivable
|
120,000
|
Accrued Wages
|
30,000
|
|
Inventories
|
160,000
|
Total Liab.
|
160,000
|
|
Total current assets
|
$380,000
|
Long-term debt
|
180,000
|
|
Land and Buildings (net)
|
150,000
|
Preferred Stock
|
80,000
|
|
Machinery & Equip
|
250,000
|
Common Stock
|
260,000
|
|
Total fixed assets
|
400,000
|
Retained Earnings
|
100,000
|
|
Total Assets
|
780,000
|
Total liab & stockholders equity
|
780,000
|
Additional Information
1. Preferred stock can be liquidated at book value
2. Accounts receivable and inventories can be liquidated at 90% of book value
3. The firm has 10,000 shares of common stock outstanding
4. All interest and dividends are currently paid up
5. Land and buildings can be liquidated at 130% of book value
6. Machinery and equipment can be liquidated at 70% of book value
7. Cash and marketable securities can be liquidated at book value
Given this information, answer the following
A. What is the book value per share?
B. What is the liquidation value per share?
C. Compare, contrast and discuss the values found in parts a and b
Question 5:
Giant Enterprises stock has a required return of 14.8%. The company which plans to pay a dividend of $2.60 per share in the coming year, anticipates that its future dividends will increase at an annual rate consistent with that experienced over the 2009-2015 period, when the following dividends were paid.
Check Figures (Part A = 4.8%)
|
Year
|
Dividend per share
|
|
2015
|
$2.45
|
|
2014
|
2.28
|
|
2013
|
2.10
|
|
2012
|
1.95
|
|
2011
|
1.82
|
|
2010
|
1.80
|
|
2009
|
1.73
|
A. If the risk free rate is 10%, what is the risk premium on Giant's stock?
B. Using the constant growth model, estimate the value f Giant's stock
C. Explain what effect, if any, a decrease in the risk premium would have on the value of Giant's stock.
Question 6:
Melissa is trying to value Generic Utility, Incs stock, which is clearly not growing at all. Generic declared and paid a $5 dividend last year. The required rate of return for utility stocks is 11% but Melissa is unsure about the financial reporting integrity of Generic's finance team. She decides to add an extra 1% credibility risk premium to the required return as part of her valuation analysis.
A. What is the value of Generic's stock, assuming that the financials are trustworthy?
B. What is the value of Generic's stock, assuming that Melissa includes the extra 1% credibility risk premium?
C. What is the difference between the values found in parts a and b, and how might one interpret that difference?