Assignment
• Demonstrate your understanding of financial concepts by completing the following problems. Where appropriate, show or explain your work. You may use Excel to work on the problems.
Problem 1. Calculating returns: A stock with an initial price of $55 per share paid a dividend of $1.75 per share throughout the year, with an ending price of $59. Calculate the percentage total return of the stock.
Problem 2. Calculating returns: One year ago, you bought an 8.75 percent coupon bond for $1,065. Today the bond sells for $990.
a. Calculate the total real rate of return on the investment with a $1,000 face value.
b. Calculate your total nominal rate of return on the investment this past year.
Problem 3. Holding period return: A stock has had returns of -19.52 percent, 17.82 percent, -11.93 percent, 21.35 percent, and 6.43 percent over the past five years, respectively. Calculate the holding period return for the stock.
Problem 4. Calculating returns: Last year you bought a share of 7.25 percent preferred stock for $63.75. Your stock's market price is now $66.92. Calculate your total return for last year.
Problem 5. Calculating returns: You bought a stock three months ago for $24.87 per share. The stock pays no dividends and is currently priced at $26.35. Calculate the APR of your investment. What is the effective annual rate (EAR)?
Problem 6. Determining portfolio weights: A portfolio contains 65 shares of Stock A selling for $32 per share and 175 shares of Stock B selling for $26 per share. Calculate the portfolio weight for each stock.
Problem 7. Portfolio expected return: You own a portfolio that has $4,600 invested in Stock Y and $5,200 invested in Stock Z. What is the expected return on the portfolio if the expected returns on these stocks are 9.75 percent and 16.50 percent?
Problem 8. Using the capital asset pricing model (CAPM): A stock has a beta of 1.65, and the projected return on the market is 12.25 percent, with a risk-free rate of 4.75 percent. Calculate the projected return on this stock.
Problem 9. Calculating cost of equity: The Denton Corporation's common stock has a beta of 1.45 and a risk-free rate of 5.75 percent. What is Denton's cost of equity if the projected return on the market is 13 percent?
Problem 10. Calculating the weighted average cost of capital (WACC): If Metro Company has the following features, what is its WACC?
o A target capital structure of 65 percent common stock.
o A target of 35 percent debt.
o Cost of equity is 14 percent.
o Cost of debt is 6 percent.
o The tax rate is 35 percent.
• Demonstrate your understanding of financial concepts by completing the following problems. Where appropriate, show or explain your work. You may use Excel to work on the problems.
Problem 1. Dividends and taxes: Midland Incorporated has declared a $6.50 per share dividend and the stock is about to go ex-dividend. Calculate the ex-dividend price based on the following data:
o Capital gains are not taxed.
o There is a 12 percent tax rate on dividends.
o Taxes must be withheld at the time the dividend is paid, according to new IRS regulations.
o Midland sells for $76 per share.
Problem 2. Stock splits and stock dividends: Billings Corporation (BC) currently has 365,000 shares of stock outstanding that sell for $72 per share. Calculate the share price for each of the following scenarios:
e. After BC has a five-for-three stock split.
f. After BC has a 12 percent stock dividend.
g. After BC has a 45 percent stock dividend.
h. After BC has a five-for-seven reverse stock split.
Problem 3. Dividend smoothing: The Deck Company just paid a dividend of $1.55 per share of stock. Its target payout ratio is 45 percent. In one year, the company expects to have earnings per share of $7.10. If the adjustment rate is .4, as defined in the Lintner model, what will the dividend be one year from now?
Problem 4. Stock dividends: The market value balance sheet for Outland Manufacturing is shown in the table below. Outland has declared a 20 percent stock dividend. The stock goes ex-dividend tomorrow. (Chronology for a stock dividend is similar to that for a cash dividend.) There are 45,000 shares of stock outstanding. Calculate the ex-dividend price.
Problem 4. Stock Dividends: Market Value Balance Sheet
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Problem 4. Stock Dividends: Market Value Balance Sheet
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Cash: $165,000
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Debt: $177,000
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Fixed Assets: $658,000
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Equity: $646,000
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Total: $823,000
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Total: $823,000
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• Complete the following problems based on the Megaware case study below. Where appropriate, show or explain your work. You may use Excel to work on the problems.
Megaware Case Study
Megaware Incorporated is a technology firm that was founded eight years ago by John Thompson and Jill Dillman. Megaware manufactures various hardware and software components. Its products are used in personal computers and other peripheral devices. In addition to John and Jill, Nick Jones is also an owner of the firm because he provided capital. Each of the three owns 20 percent of the company. The current employees own the remaining part of the company.
The firm recently developed a new computer hardware component. The component is supposed to be more energy efficient and less costly to produce. After investigating the possibility of manufacturing the new hardware component, Megaware determined that constructing a new plant would be too costly. John, Jill, and Nick do not want to bring in another outside investor, so Megaware has decided to sell the hardware component for an after-tax payment of $42 million.
Case Study Problems
Problem 1. John thinks that the firm should use the excess cash flow to pay a special one-time dividend to the investors. How will implementing this proposal affect the value of the company as well as the stock price?
Problem 2. Jill believes that the firm should use the excess cash flow to pay off debt and expand its manufacturing capability. How would implementing this proposal affect the company?
Problem 3. Nick contends that a share repurchase will increase the company's ROA, ROE, and P/E ratio. Do you agree? How will a share repurchase affect the value of the firm?
Problem 4. John, Jill, and Nick have discussed a proposal to commence a regular dividend payment to stockholders. Evaluate this plan.
Problem 5. The dividend growth model is used by many investors to value stock. Calculate the price of a share of Megaware stock today by using the following dividend growth model equation:
P0 = E1(1 - b) / Rs = ROE × b
The value of the stock equals next year's dividends divided by the sustainable growth rate.
o The dividend-payout ratio is 1 minus b, where b is the retention ratio. The dividend next year (P0) will be the earnings next year (E1) times 1 minus the retention ratio: P0 = E1(1 - b).
o The sustainable growth rate (Rs) is the return on equity (ROE) times the retention ratio: Rs = ROE × b.
Based on your results, should Megaware pay a dividend or expand its manufacturing capability? Explain your decision.
Problem 6. Does the way a company is organized (as a corporation, LLC, or another structure) determine whether the company should pay a dividend?