Question 1. Suppose that an investor with a 5-year investment horizon is considering purchasing a 7-year 9% coupon bond selling at par value of $1,000. The investor expects that she can reinvest the semi-annual coupon payments at an annual interest rate of 8.4%. Furthermore, she expects that at the end of the investment horizon, the then 2-year bonds will be selling to offer a yield to maturity of 11.2%. What is the total return for this bond?
Question 2. Answer the following two questions:
(a) Three years ago, you purchase a corporate bond with 9-years remaining to maturity for 93.15. The market price of this debt obligation today is $95.00. What are some reasons why the price of the bond could have increased since you purchased it 3-years ago?
b) Suppose that you are reviewing a price sheet for bonds and see the following prices reported. You observe what seem to be several errors. Without calculating the price of each bond, indicate which bonds are reported incorrectly and explain why.
Bond Price Coupon (%) Required Yield (%)
U 90 6 9
V 96 9 8
W 110 8 6
X 105 0
Question 3. The following is a fictitious quote on a T-Bill:
Days Ask
Maturity to Maturity Bid Asked Chg. Yield
Dec 27 '05 176 1.79 1.78 +0.01 ?
(a) Calculate the asked price of this security, assuming a face value of $10,000.
(b) What is the yield based on the asked price? What does this mean?
Question 4. Today is September 28, 2005. You obtain the following bond quote from the Wall Street Journal.
Last Last
Company Coupon Maturity Price Yield
WIT 7.5% Sept 28, 2018 115 ??
Assume that the bond makes semiannual coupon payments in answering the following two questions.
(a) What is the yield to maturity of this bond?
(b) If this bond was bought exactly 3 months after the last coupon payment, what is the dirty (or full) price of this bond?
Question 5. Answer the following two questions:
(a) Logos Corporation is planning on issuing bonds that pay no interest but can be converted into $1,000 at maturity, 7-years from their purchase. To price these bonds competitively with other bonds of equal risk, it is determined that they should yield 9%, compounded semi-annually. At what price should Logos Corporation sell these bonds?
(b) Ceteris paribus, which of the following three bonds has the highest amount of reinvestment risk? Why?
• Bond A: A zero-coupon bond with 5 years to maturity
• Bond B: A 9% coupon bond with 5 years to maturity
• Bond C: A 6% coupon with 5 years to maturity
Question 6. The common stock of TNT paid $1.32 in dividends last year. Dividends are expected to grow at an 8% annual rate for an indefinite number of years.
(a) If TNT’s current market price is $23.50 per share, what is the stock’s expected rate of return?
(b) If your required rate of return is 10.50%, should you invest in TNT?
Question 7. High-Tech Company currently pays no dividend on its common stock. Dividends are expected to remain at zero for the next 3 years, after which they will pay dividends of $2.00 increasing at a constant rate of 10% per year. As an investor, you require 13% rate of return on this equity investment. What is the maximum price you are willing to pay for a share of High-Tech based on discounted cash flow valuation?
Question 8. Machines A and B are mutually exclusive investments. Assume each machine will be replaced as it wears out and will be depreciated to zero using straight-line depreciation. The required return on your investment is 10%. Ignore taxes.
Machine A Machine B
Initial cost $80,000 $125,000
Operating Cost/year 7,000 10,000
Life 8 yrs 10 yrs
Use the equivalent cost method (EAC) to determine which machine you should buy?
Question 9. A project costs $390,000, will be depreciated straight-line to zero over its 5-year life, and will require a net working capital investment of $28,000 up-front. The project will save $120,000 per year in pretax operating costs. The fixed assets will be sold for $60,000 at the end of the project. If the firm has a tax rate of 34% and a required return of 10%, what is the project NPV?
Question 10. Answer the following two multiple-choice questions. Circle or highlight your choice
(a) Your company purchased a piece of land five years ago for $150,000 and subsequently added $175,000 in improvements. The current book value of the property is $225,000. There are two options for future use of the land: 1) the land can be sold today for $375,000 on an aftertax basis; 2) your company can destroy the past improvements and build a factory on the land. In consideration of the factory project, what amount (if any) should the land be valued at?
i. The present book value of $225,000.
ii. The aftertax salvage value of $375,000.
iii. The sales price of $375,000 less the book value of the improvements.
iv. The original $150,000 purchase price of the land itself.
v. The property should be valued at zero since it is a sunk cost
(b) Which of the following would likely have erosion consequences?
I. A gas station owner expands floor space to make room for a convenience store.
II. You begin selling coffee in new, small-sized pouches alongside your regular-sized coffee cans.
III. You build a Taco Bell just down the street from your McDonalds franchise.
i. I only
ii. I and II only
iii. III only
iv. I and III only
v. II and III only