FIN300 Exam 2 Homework Questions

You purchase a bond with an invoice price of $1,080. The bond has a coupon rate of 9.6 percent, and there are 5 months to the next semiannual coupon date. What is the clean price of the bond? Assume a par value of $1,000.

$1,072

Westco Company issued 11-year bonds a year ago at a coupon rate of 8.9 percent. The bonds make semiannual payments and have a par value of $1,000. If the YTM on these bonds is 7.2 percent, what is the current bond price in dollars?

$1,119.72

E-Eyes.com just issued some new preferred stock. The issue will pay an annual dividend of $19 in perpetuity, beginning 9 years from now. If the market requires a 9 percent return on this investment, how much does a share of preferred stock cost today?

$105.95

Synovec Company is growing quickly. Dividends are expected to grow at a rate of 25 percent for the next 3 years, with the growth rate falling off to a constant 5 percent thereafter. If the required return is 12 percent and the company just paid a $1.30 dividend. what is the current share price?

$31.99

Metallica Bearings, Incorporated, is a young start-up company. No dividends will be paid on the stock over the next nine years because the firm needs to plow back its earnings to fuel growth. The company will pay a dividend of $14 per share 10 years from today and will increase the dividend by 8 percent per year thereafter. If the required return on this stock is 14 percent, what is the current share price?

$71.75

Wine and Roses, Incorporated, offers a bond with a coupon of 7.5 percent with semiannual payments and a yield to maturity of 7.95 percent. The bonds mature in 15 years. What is the market price of a $1,000 face value bond?

$960.97

Interest Rate Risk

-Change in price due to changes in interest rates -Long term bonds have more price risk than short term bonds -Low coupon rate bonds have more price risk than high coupon rate bonds

Profitability Index Advantages

-Closely related to NPV, generally leading to identical decisions -Easy to understand and communicate -May be useful when available investment funds are limited

Dividend Characteristics

-Dividends are not a liability of the firm until a dividend has been declared by the board -Consequently, a firm cannot go bankrupt for not declaring dividends -Dividend payments are not considered a business expense; therefore, they are not tax deductible -The taxation of dividends received by individuals depends on the holding period -Dividends received by corporations have a minimum 50% exclusion from taxable income

Advantages of IRR

-Easy to understand and communicate -Closely related to the NPV, often leading to identical decisions

Characteristics of preferred stock

-Hybrid of debt and equity -Pays dividends -Has a stated dividend that must be paid before dividends can be paid to common stockholders -Dividends are not a liability of the firm, and preferred dividends can be deferred indefinitely -Most preferred dividends are cumulative, any missed preferred dividends must be paid before common dividends can be paid -Preferred stock may have a sinking fund -Generally does not carry voting rights

Yield curve

-Is similar to the term structure but graphs the various treasury security yields relative to maturity -Normal upward sloping, long term yields are higher than short term yields -Inverted downward sloping, long term yields are lower than short term yields

Disadvantages of IRR

-May result in multiple answers with unconventional cash flows -May lead to incorrect decisions in comparisons of mutually exclusive investments

Debt

-Not an ownership interest -Creditors do not have voting rights -Interest is considered a cost of doing business and is tax deductible -Creditors have legal recourse if interest or principal payments are missed -Excess debt can lead to financial distress and bankruptcy

Equity

-Ownership interest -Common stockholders vote for the board of directors and other issues -Dividends are not considered a cost of doing business and are not tax deductible -Dividends are not a liability of the firm, and stockholders have no legal recourse if dividends are not paid -An all equity firm can not go bankrupt merely due to debt since it has no debt

Disadvantages of discounted payback period rule

-Requires an arbitrary cutoff point -May reject positive NPV investments -Ignores cash flows beyond the cutoff point -Biased against long term projects, such as research and development, and new projects

Term Structure of Interest Rates

-Term structure is the relationship between time to maturity and yields on pure discount securities, all else equal -It is important to recognize that we pull out the effect of default risk, different coupons, etc

You purchase a bond with an invoice price of $1,026 and a par value of $1,000. The bond has a coupon rate of 7.2 percent, and there are four months to the next semiannual coupon date. Assume a par value of $1,000. What is the clean price of the bond?

$1,014.00

When the present value of the cash inflows exceeds the initial cost of a project, then the project should be: A) rejected because the net present value is positive. B) rejected because the internal rate of return is negative. C) accepted because the profitability index is negative. D) accepted because the payback period is less than the required time period. E) accepted because the profitability index is greater than 1.

E) accepted because the profitability index is greater than 1.

A member who acts as a dealer in a limited number of securities on the floor of the NYSE is called a: A) commission broker. B) floor post. C) floor broker. D) floor trader. E) designated market maker.

E) designated market maker.

Interest rates that include an inflation premium are referred to as: A) annual percentage rates. B) effective annual rates. C) real rates. D) stripped rates. E) nominal rates.

E) nominal rates.

Internal rate of return

IRR is the return that makes the NPV = 0

Mutually exclusive projects

If you choose one, you can not choose the other

Profitability Index Disadvantages

May lead to incorrect decisions in comparisons of mutually exclusive investments

The Dahlia Flower Company has earnings of $1.40 per share. The benchmark PE for the company is 15. a.What stock price would you consider appropriate? b.What if the benchmark PE were 18?

Stock price at a PE of 15 $21.00 Stock price at a PE of 18 $25.20

Z Space, Incorporated, is a new company and currently has negative earnings. The company's sales are $2.1 million and there are 132,000 shares outstanding. a. If the benchmark price-sales ratio is 5.2, what is your estimate of an appropriate stock price? b. What if the price-sales ratio were 4.6?

Stock price at a price-sales of 5.2 $82.73 Stock price at a price-sales of 4.6 $73.18

Features of common stock Voting rights Board of directors Proxy voting Classes of stock Class A and Class B Other rights Share proportionally in declared dividends Share proportionally in remaining assets during liquidation Preemptive right: first shot at new stock issue to maintain proportionate ownership if desired

-Voting rights Board of directors -Proxy voting -Classes of stock Class A and Class B -Other rights Share proportionally in declared dividends Share proportionally in remaining assets during liquidation Preemptive right: first shot at new stock issue to maintain proportionate ownership if desired

A project has the following cash flows: Year 0 Cash Flows −$129,000 Year 1 Cash Flow $54,200 Year 2 Cash Flow $63,800 Year 3 Cash Flow $51,600 Year 4 Cash Flow$ 28,100 The required return is 9.5 percent. What is the profitability index for this project?

1.252

POD has a project with the following cash flows: Year 0 Cash Flow $239,000 Year 1 Cash Flow $147,600 Year 2 Cash Flow $165,100 Year 4 Cash Flow $130,200 The required return is 8.9 percent. What is the profitability index for this project?

1.571

(Chapter 8 Part 2) Caccamise Company is expected to maintain a constant 4.6 percent growth rate in its dividends indefinitely. If the company has a dividend yield of 6.4 percent, what is the required return on the company's stock?

11%

(Chapter 9b Part 2) A project will generate annual cash flows of $237,600 for each of the next three years, and a cash flow of $274,800 during the fourth year. The initial cost of the project is $761,100. What is the internal rate of return of this project?

11.03%

(Chapter 9b) A firm evaluates all of its projects by applying the IRR rule. A project under consideration has the following cash flows: Year 0 Cash Flow −$ 27,600 Year 1 Cash Flow $11,600 Year 2 Cash Flow $14,600 Year 3 Cash Flow $10,600 If the required return is 18 percent, what is the IRR for this project?

16.09%

(Chapter 9a Part 2) A new project has an initial cost of $165,000. The equipment will be depreciated on a straight-line basis to a zero book value over the five-year life of the project. The projected net income each year is $12,400, $16,300, $18,200, $14,300, and $10,200, respectively. What is the average accounting return?

17.31%

The Lo Sun Corporation offers a 6.1 percent bond with a current market price of $781.50. The yield to maturity is 8.43 percent. The face value is $1,000. Interest is paid semiannually. How many years until this bond matures?

18.93 years

(Chapter 9a) You're trying to determine whether to expand your business by building a new manufacturing plant. The plant has an installation cost of $12.8 million, which will be depreciated straight-line to zero over its four-year life. If the plant has projected net income of $1,934,300, $1,987,600, $1,956,000, and $1,409,500 over these four years, respectively, what is the project's average accounting return (AAR)?

28.47%

Fegley, Incorporated, has an issue of preferred stock outstanding that pays a $3.15 dividend every year in perpetuity. If this issue currently sells for $92 per share, what is the required return?

3.42%

A taxable bond has a coupon rate of 5.20 percent and a YTM of 5.47 percent. If an investor has a marginal tax rate of 30 percent, what is the equivalent aftertax yield?

3.83%

The Lo Sun Corporation offers a 5.3 percent bond with a current market price of $858.50. The yield to maturity is 6.29 percent. The face value is $1,000. Interest is paid semiannually. How many years until this bond matures?

37.02 years

(Chapter 7) A Japanese company has a bond outstanding that sells for 88 percent of its ¥100,000 par value. The bond has a coupon rate of 4.7 percent paid annually and matures in 18 years. What is the yield to maturity of this bond?

5.79%

An investment had a nominal return of 11.6 percent last year. The inflation rate was 4.2 percent. What was the real return on the investment?

7.10%

A municipal bond has a coupon rate of 5.20 percent and a YTM of 5.47 percent. If an investor has a marginal tax rate of 30 percent, what is the equivalent pretax yield on a taxable bond?

7.81%

(Chapter 7 Part 2) Uliana Company wants to issue new 16-year bonds for some much-needed expansion projects. The company currently has 9 percent coupon bonds on the market that sell for $1,095, make semiannual payments, and mature in 16 years. What coupon rate should the company set on its new bonds if it wants them to sell at par?

7.94%

Suppose the real rate is 3.6 percent and the inflation rate is 5.2 percent. What rate would you expect to see on a Treasury bill?

8.99%

The next dividend payment by Im, Incorporated, will be $1.88 per share. The dividends are anticipated to maintain a growth rate of 4 percent forever. If the stock currently sells for $37 per share, what is the required return?

9.08%

Which one of the following methods predicts the amount by which the value of a firm will change if a project is accepted? A) Net present value B) Discounted payback C) Profitability index D) Internal rate of return E) Payback

A) Net present value

Which one of the following indicates an accept decision for an independent project with conventional cash flows? A) PI greater than 1.0 B) Discounted payback period less than the payback period C) AAR lower than the required rate D) Required discount rate greater than the IRR E) Payback period that exceeds the requirement

A) PI greater than 1.0

Which one of the following transactions occurs in the primary market? A) Purchase of newly issued stock from the issuer B) IBM's purchase of GE stock from a dealer C) Gift of 200 shares of stock by a mother to her daughter D) Purchase of 500 shares of GE stock from a current shareholder E) Gift of 100 outstanding shares to a charitable organization

A) Purchase of newly issued stock from the issuer

You purchased a 10-year bond at par value when it was originally issued. It has an annual coupon of 5 percent and matures five years from now. Coupons are paid semiannually. Which one of the following statements applies to this bond if the relevant market interest rate is now 4.7 percent? A) You will realize a capital gain on the bond if you sell it today. B) The current yield is 5 percent. C) The bond is currently valued at one-half of its issue price. D) The current yield to maturity is greater than 5 percent. E) The next interest payment will be $50.

A) You will realize a capital gain on the bond if you sell it today.

A project's average net income divided by its average book value is referred to as the project's average: A) accounting return. B) profitability index. C) net present value. D) internal rate of return. E) payback period.

A) accounting return

You are comparing two mutually exclusive projects, Project X and Project Z. The crossover point is 11.4 percent. You have determined that you should accept project X if the required return is 12.7 percent. This implies you should: A) always accept Project X if the required return exceeds the crossover rate B) be indifferent to the projects at any discount rate above 12.7 percent. C) always accept Project X. D) accept Project Z only when the required return is equal to the crossover rate. E) accept Project Z if the required return is less than 12.7 percent.

A) always accept Project X if the required return exceeds the crossover rate

Javangula Foods is considering two mutually exclusive projects and has determined that the crossover rate for these projects is 12.3 percent. Given this information, you know that: A) the project that is acceptable at a discount rate of 12 percent should be rejected at a discount rate of 13 percent. B) both projects have a zero NPV at a discount rate of 12.3 percent C) both projects provide an internal rate of return of 12.3 percent. D) neither project will be accepted if the discount rate is less than 12.3 percent E) both projects have a negative NPV at discount rates greater than 12.3 percent.

A) the project that is acceptable at a discount rate of 12 percent should be rejected at a discount rate of 13 percent

Which bond would you generally expect to have the highest yield? A) Short-term, inflation-adjusted bond B) Long-term, taxable junk bond C) Risk-free Treasury bond D) Long-term, high-quality, tax-free bond E) Nontaxable, highly liquid bond

B) Long-term, taxable junk bond

Answer this question based on the dividend growth model. If you expect the market rate of return to increase across the board on all equity securities, then you should also expect: A) dividend-paying stocks to increase in price while non-dividend paying stocks remain constant in value. B) a decrease in all stock values. C) dividend-paying stocks to maintain a constant price while non-dividend paying stocks decrease in value. D) all stock values to remain constant. E) an increase in all stock values.

B) a decrease in all stock values.

A Treasury yield curve plots Treasury interest rates relative to: A) the risk-free rate. B) time to maturity. C) comparable corporate bond rates. D) inflation rates. E) market rates.

B) time to maturity.

The internal rate of return is defined as the: A) discount rate that causes the profitability index for a project to equal zero. B) rate of return a project will generate if the project is financed solely with internal funds. C) discount rate which causes the net present value of a project to equal zero. D) discount rate that equates the net cash inflows of a project to zero. E) maximum rate of return a firm expects to earn on a project.

C) discount rate which causes the net present value of a project to equal zero.

The owner of a trading license for the NYSE is called a(n): A) dealer B) broker C) member D) agent E) specialist

C) member

Discounted Payback Period

Compute the present value of each cash flow and then determine how long it takes to pay back on a discounted basis

If you sell a bond with a coupon of 6 percent to a dealer when the market rate is 7 percent, which one of the following prices will you receive? A) Par value B) Asked price C) Bid-ask spread D) Bid price E) Call price

D) Bid price

Chavez & Hwang just issued 15-year, 6.4 percent, unsecured bonds at par. These bonds fit the definition of which one of the following terms? A) Zero coupon B) Discounted C) Note D) Debenture E) Callable

D) Debenture

Which one of the following rights is never directly granted to all shareholders of a publicly held corporation? A) Voting either for or against a proposed merger or acquisition B) Electing the board of directors C) Having first chance to purchase any new equity shares that may be offered D) Determining the amount of the dividend to be paid per share E) Receiving a distribution of company profits

D) Determining the amount of the dividend to be paid per share

A decrease in which of the following will increase the current value of a stock according to the dividend growth model? A) Dividend amount B) Dividend growth rate C) Number of future dividends, provided the total number of dividends is less than infinite D) Discount rate E) Both the discount rate and the dividend growth rate

D) Discount rate

A decrease in which of the following will increase the current value of a stock according to the dividend growth model? A) Dividend growth rate B) Both the discount rate and the dividend growth rate C) Number of future dividends, provided the total number of dividends is less than infinite D) Discount rate E) Dividend amount

D) Discount rate

An example of a negative covenant that might be found in a bond indenture is a statement that the company: A) shall maintain a current ratio of 1.1 or higher. B) must maintain the loan collateral in good working order. C) shall provide audited financial statements in a timely manner. D) cannot lease any major assets without bondholder approval. E) shall maintain a cash surplus of $100,000 at all times.

D) cannot lease any major assets without bondholder approval.

The Fisher Effect

Defines the relationship between real rates, nominal rates, and inflation (1 + R) = (1 + r)(1 + h) R = nominal rate r = real rate h = expected inflation rate r = (1+R)/(1+h) - 1

(Chapter 8) The next dividend payment by Im, Incorporated, will be $1.48 per share. The dividends are anticipated to maintain a growth rate of 5 percent forever. The stock currently sells for $27 per share. a. What is the dividend yield? b. What is the expected capital gains yield?

Dividend yield 5.48% Capital gains yield 5%

Real rate of interest

change in purchasing power

Nominal rate of interest

quoted rate of interest, change in actual number of dollars

Boyd Leasing is analyzing a project that requires purchasing $210,000 of new fixed assets. When the project ends, those assets are expected to have an aftertax salvage value of $22,000. How is the $22,000 salvage value handled when computing the net present value of the project? A) Cash inflow for the year following the final year of the project B) Reduction in the cash outflow at Time 0 C) Cash inflow in the final year of the project D) Cash inflow prorated over the life of the project E) Excluded from the net present value calculation

C) Cash inflow in the final year of the project

Chemical Mines has 5,000 shareholders and is preparing to elect two new board members. You do not own enough shares to personally control the elections but are determined to oust the current leadership. Likewise, no other single shareholder owns sufficient shares to personally control the outcome of the election. Which one of the following is the most likely outcome of this situation given that some shareholders are happy with the existing management? A) Arbitrated settlement where the arbitrator determines who will be elected to the board B) Protracted legal battle over control of the board of directors C) Proxy fight for control of the board D) Control of the board decided without your influence E) Negotiated settlement where each side is granted control over one of the open seats

C) Proxy fight for control of the board

Which one of the following transactions occurs in the primary market? Multiple Choice A) Gift of 200 shares of stock by a mother to her daughter B) Purchase of 500 shares of GE stock from a current shareholder C) Purchase of newly issued stock from the issuer D) Gift of 100 outstanding shares to a charitable organization E) IBM's purchase of GE stock from a dealer

C) Purchase of newly issued stock from the issuer

A project has a required payback period of three years. Which one of the following statements is correct concerning the payback analysis of this project? A) The project's cash flow in Year 3 is discounted by a factor of (1 + R)^3. B) The cash flow in Year 3 is ignored. C) The cash flow in Year 2 is valued just as highly as the cash flow in Year 1. D) The cash flows in each of the three years must exceed one-third of the project's initial cost if the project is to be accepted. E) The project is acceptable whenever the payback period exceeds three years.

C) The cash flow in Year 2 is valued just as highly as the cash flow in Year 1.

Answer this question based on the dividend growth model. If you expect the market rate of return to increase across the board on all equity securities, then you should also expect: A) dividend-paying stocks to increase in price while non-dividend paying stocks remain constant in value. B) all stock values to remain constant. C) a decrease in all stock values. D) dividend-paying stocks to maintain a constant price while non-dividend paying stocks decrease in value. E) an increase in all stock values.

C) a decrease in all stock values.

Fisher Effect Approximation

R approximately equal to r + h

The Fisher effect is defined as the relationship between which of the following variables?

Real rates, inflation rates, and nominal rates

Red, Incorporated, Yellow Corporation, and Blue Company each will pay a dividend of $2.45 next year. The growth rate in dividends for all three companies is 5 percent. The required return for each company's stock is 8 percent, 11 percent, and 14 percent, respectively. What is the stock price for each company?

Red, Incorporated $81.67 Yellow Corporation $40.83 Blue Company $27.22

Default Risk

The risk that the bond issuer does not pay the promised payments in the full amount or on time