Question I
Omega Company has 100 million shares outstanding. Its current share price $10. The company's secured bonds are trading at 95% of its face value. These bonds pay coupons once per year. The bonds have a total book value of $80 million and the current yield to maturity on the bonds is 10% per annum. The risk-free rate is 6.50% and the market risk premium is 5.00%. Market analysts estimates that Omega has a beta of 1.2. Omega is subject to a corporate tax rate of 35%. What is Omega's weighted average cost of capital (WACC)?
Question II
Gamma Ltd is growing rapidly. Dividends are expected to grow at rates of 25%, 18%, and 12% over the next three years. After that, the company expects to grow at a constant rate of 6%. The share is currently trading at $20. The required rate of return for Gamma is 12%. What is the dividend for the current year?
Question III
You have bought 200 bonds issued by Theta Ltd. These bonds have seven years remaining to maturity. Each bond pays an annual coupon of $50 and has a face value of $1,000. Unfortunately, the company is on the brink of bankruptcy, so you and other creditors have allowed Theta to postpone the payment of the next three coupon interest (otherwise, the next coupon payment would have been due in 1 year). However, these postponed payments will accrue interest at an annual rate of 6.5% and will be paid as a lump sum at maturity in Year 7. The remaining coupon payments, for Years 4 through 7, will be made as scheduled. Because of Theta's financial distress, the required rate of return on its bonds is currently 25%. What is each bond worth today?
Question IV
Your younger brother knows that the beta of his portfolio is equal to one and the expected return on the market is 12%. However, he does not know the risk-free rate or the market risk premium. What is the expected return on his portfolio?
Show your workings and round your final answers to 2 decimal places.
Question V
To finance one of its major projects, Hawken Ltd. plans to raise $1.5 million by selling bonds. The bonds have 10 years to maturity and pay coupon interest twice per year. The bond has a face value of $1,000 and a coupon rate of 4.0%. The current market yield on similar bonds is 6.0%. What is the bond price? How many bonds will Hawken Ltd. have to sell?
Show your workings and round your final answers to 2 decimal places.
Question VI
Beta Ltd. is expected to increase its dividend by 15% in one year, 13% in two years, and 9% in three years. After that, its dividends will increase at a constant rate of 4% per year forever. Its last dividend paid was $3. The required rate of return for Beta Ltd. is 10%. What is the value of its share today?
Question VII
Your parents have given you AUD 20,000 to invest in the share market. After doing some research, you have narrowed down your choices to two stocks: Woolworth and Coles. The expected return on Woolworth stock is 15%, and the expected return on Coles stock is 10%. If you want to create a portfolio of these two stocks that has an expected return of 12%, how much money will you have to invest in Woolworth and Coles?
Question VIII
Zeta Ltd. has a debt-to-equity ratio of 0.35. The company has a WACC of 12% and is subject to a corporate tax rate of 30%.
i. Suppose Zeta's cost of equity is 14%, what is its pre-tax cost of debt?
ii. What is its cost of equity if its after-tax cost of debt is 5.5%?
Question IX
St Lucia Riverbank Ltd. is considering a new project that requires the purchase of a machine to make its timber-based products. The machine costs $300,000 upfront and will be fully depreciated on a straight-line basis to zero over the 4 years. With this machine, sales revenue will be $200,000 next year. After that, it will grow at 10% per year for the remaining years. Operating expenses account for 50% of the sales revenue. The project requires an investment of $10,000 in working capital, which will be fully recovered at the end of the project. The company is in the 35% tax bracket. The cost of capital for St Lucia Riverbank is 10%.
i. Calculate NOPAT
ii. Calculate net cash flows
iii. Calculate NPV. Should you accept or reject the project?
iv. Calculate Payback Period. Should you accept or reject the project if management requires a payback period cutoff of 2 years?