Business Finance Exam 2

If a bond has no chance of default, there is no risk involved in investing in the bond with the goal of selling the bond before maturity. A. True B. False

False

If a bond's yield-to-maturity is greater than its coupon rate, its price will fall as it approaches maturity if the yield remains constant. A. True B. False

False

If a bond's yield-to-maturity is less than its coupon rate, its price will rise as it approaches maturity if the yield stays constant. A. True B. False

False

If the market exhibited weak-form efficiency, trading strategies that were based on past price-patterns would be profitable. A. True B. False

False

Market efficiency implies that no one can beat market in the short or long term. A. True B. False

False

Market efficiency implies that stock prices cannot deviate from true values. A. True B. False

False

Stocks that do not pay a dividend must have a value of $0. A. True B. False

False

Treasury bills (T-bills) have longer maturities than Treasury bonds. A. True B. False

False

P&G has 150 million shares outstanding and expects earnings @ end this year $300 million. It plans to pay out 60% of earnings in total, paying 20% dividend & using 40% to repurchase shares. If P&G earnings expected to grow by 7.0% per year & payout rates constant, what is share price if cost of capital of 12.0%? A.$24.00 B.$4.35 C.$8.69 D.$13.04

A. $24.00 EPS1 = 2$ = 300 m/ 150 m DPS1 = 2$ * (60%) = 1.20$ gDPS = 7% rE=12$ P0 = DPS1/(rE-g) = 1.20/ (.12-.07) = 24$

You purchase 7-year bond with annual 4% coupons today, when YTM is 5%. You sell the bond 3 years later, just after receiving 3rd annual coupon. If YTM is 8% when you sell bond, what is your rate of return? A.1.65% B.-2.04% C.-7.92% D.3.00%

A. 1.65% Buy price: N = 7, I/Y = 5%, FV = 100, PMT = 4, PV0 =? =94.21 Sell price: N = 4, I/Y = 8, FV = 100, PMT = 4, PV3 = ? =86.75 Summary calculation: N = 3, PV = -94.21, FV = 86.75, PMT= 4, I/Y = ? =1.65%

Merk Inc. announces to public that it faces a decline in earnings forcing it to pay $25 million less in dividends for each of the next 5 years than it had previously intended. Merk's shares react immediately to this announcement by decreasing to fully reflect the reduction in dividends. We can deduce from this that market: A. Exhibits weak-form efficiency B. Exhibits semi-strong-form efficiency C. Exhibits strong-form efficiency D. Is not efficient

B.

Suppose you purchase a 30-year, zero-coupon bond with a yield to maturity of 6%. You hold the bond for 30 years before selling it. If the bond has no chance of default, is your investment subject to any risk(s)? A. No Risk B. Interest Rate Risk C. Reinvestment Risk D. Reinvest Rate Risk & Interest Rate Risk

C.

SnapDeal is reinvesting 50% of its earnings to expand operations. Earnings are expected $1 per share & are expected to grow @ 20% per year until end of year 3. At end of year 3, SnapDeal will cut investment & begin paying 80% of earnings as dividends. Its growth will also slow to long-run rate of 5%. If SnapDeal equity cost of capital is 10%, what is value of SnapDeal share today? A. $18.18 B. $19.13 C. $19.67 D. $24.19

C. $19.67

Airbnb just announced it will cut dividend $4 to $2.50 & use funds to expand. Prior to announcement, Airbnb dividends were expected to grow @ 3%, & share price was $50. W/ expansion Airbnb dividends expected to grow @ 5%. What share price would you expect after announcement? New expansion does not change Airbnb risk. Is expansion good investment? A. $ 22.73 B. $ 36.36 C. $ 41.67 D. $ 66.67

C. $41.67 Estimate rE: rE = Div. Yield + g = 4/50 + 3% = 11% New Price: P(0) = 2.50 / (11% - 5%) = $41.67

A 3% coupon bond with annual coupon payments and 10 years to maturity has a par value of $1,000 and market price of $975. New 10-year treasury notes with a coupon rate of 1.5% that are otherwise similar are being issued at par. What is credit spread for your bond expressed in basis points (bps)? A. 150 bps B. 1.50 bps C. 180 bps D. 1.80 bps

C. 180 bps First, calculate yield on Treasury bond: - Traded @ par, so coupon rate = YTM - Coupon rate = 1.5% = YTM Second, calculate yield on corporate bond: - N=10, PV=-975, FV=1000, PMT=30 - I/Y = 3.30% = YTM Third, calculate spread: rBOND - rF = 3.30% - 1.50% = 1.80% 1.80% = 180 BP as 100 BP = 1 %

A 3% coupon bond with semi-annual coupon payments and 10 years to maturity has a par value of $1,000 and market price of $850. What is its yield-to-maturity? A.4.94% B.2.46% C.4.92% D.1.58%

C. YTM = 4.92% = 2.4584 x 2 PMT = 15 FV = 1000 I/Y = ? N = 10 years x 2 = 20 PV = -850

Colgate-Palmolive Company has just paid annual dividend $0.96. Analysts predicting 11% per year growth rate in earnings over next five years. After then, Colgate earnings are expected to grow @ current industry average 5.2% per year. If Colgate cost of capital 8.5% per year & its dividend payout ratio constant, price Colgate?

Colgate's stock today is worth $39.43, which is the sum of $5.14 (the present value of the first five dividends) and $34.29 (the present value of the dividends growing at 5.2% per year from year 6 onward).

Suppose you purchase a 30-year, zero-coupon bond with a yield to maturity of 6%. You hold the bond for five years before selling it. If the bond has no chance of default, is your investment subject to any risk(s)? A. No Risk B. Interest Rate Risk C. Reinvestment Risk D. Reinvest Rate Risk & Interest Rate Risk

D.

Suppose Tanium, has earnings per share (EPS) of $3. If the average P/E of comparable network service stocks is 20, estimate a value for Tanium stock using P/E as a valuation multiple? What are the assumptions underlying this estimate? A. $30 B. $40 C. $50 D. $60

D. P(Tanium)=20 * EPS of $3 = $60.

Cisco pays no dividends but spent $5 billion on share repurchases last year. If Cisco's equity cost of capital is 12%, & if amount spent on repurchases is expected to grow by 8% per year, estimate Cisco's stock price if it has 6 billion shares? A. $6.94 B. $7.50 C. $10.42 D. $22.50

D. $22.50 First, determine next year's quasi-dividends for the entire firm. Then value the entire firm's equity, recognizing that the equity cost of capital is 12% and the growth rate in dividend is 8%. What is the anticipated Quasi-DPS(0)? $500 billion / 600 billion = $0.8333 a share. What is the anticipated Quasi-DPS(1)? It is $0.8333 * 1.08 = $0.90 a share. rE =0.12 G= 0.08 So P(0) =? P(0) = Quasi-DPS1 / (rE - g) = $0.90 / (.12 - 0.08) = $22.5

Mozido has 200 million shares outstanding & expects earnings @ end this year $700 million. Mozido plans to pay out 60% of earnings in total, paying 40% as dividend & using 20% to repurchase shares. If Mozido earnings are expected to grow by 8% per year & these payout rates remain constant, find Mozido share price assuming equity cost of capital 12%. A. $17.50 B. $29.17 C. $35.00 D. $52.50

D. $52.50 EPS(1) = $700 m /200 m shares = 3.50$ DPS(1) = EPS (1) * Total Payout = 3.50$ * 0.60 = 2.10$ P(0) = DPS(1)/(re-g) = 2.10$/(.12-.08) = $52.50

Suppose that Tesla Motors issued a bond with 10 years until maturity and a face value of $1000, and a coupon rate of 5.0% (annual payments). The yield to maturity on this bond when it was issued was 6.0%. Assuming the yield to maturity remains constant, what is the price of bond at end of first year, immediately before it makes its first coupon payment? A. $876.40 B. $926.40 C. $932.98 D. $981.98

D. $981.98 P = $50 + PV1(annuity w/ N=9, PMT=$50, FV=$1000, I/Y=6%) = $50 + $931.98 = $981.98

Gillette Corporation will pay annual dividend of $0.65 one year from now. Analysts expect this dividend to grow @ 12% per year thereafter until the fifth year. After then, growth will level off @ 2% per year. According to dividend-discount model, what is value of share of Gillette stock if cost of capital 8%?

Gillette's stock today is worth $15.07, which is the sum of $3.24 (the present value of the first five dividends) and $11.83 (the present value of the dividends growing at 2% per year from year 6 onward).

A firm can either pay its earnings to its investors, or it can keep them & reinvest them. A. True B. False

True

Cutting a firm's dividend to increase investment will raise the firm's stock price only if the return on the new investments exceeds the firm's equity cost of capital. A. True B. False

True

The ownership in a corporation is divided into shares of stock, which carry rights to a share in the profits of the firm through future dividend payments. A. True B. False

True

Valuation Principle states that the value of a stock is equal to the present value (PV) of both the dividends and future sale price of that stock which the investor will receive. A. True B. False

True

Forecasting dividends requires forecasting the firm's earnings, dividend payout rate, and future share count. A. True B. False

True DPS = EPS * Payout Ratio, therefore we need to know: (1) Net Income a.k.a. as Earnings, (2) # of shares so that we can find EPS = [NI/ # of shares], and (3) need to know Payout ratio, in order to complete the calculation.