(a) XYZ Company earns an annual net income of $168,000 perpetually. XYZ is an all-equity firm with 20,000 shares outstanding and a cost of capital of 10%.

Herman currently owns 1,000 shares of XYZ common stock. Assume no taxes.

1. Calculate the stock price of XYZ. (Show your calculations). (2 marks)

2. XYZ plans to distribute $80,000 of its current net income as cash dividends. How much will Herman receive from this dividend policy? (Show your calculations). (2 marks)

3. Herman prefers a zero-dividend policy. What will be Hermans homemade dividend strategy to achieve the zero-dividend policy? (Show your calculations). Explain briefly whether the dividend policy of XYZ is relevant or not. (8 marks)

(b) AppleBankisplanningtoissue5%annualcouponbondswithamaturityoftwoyearsand a par value of $10,000. The bonds are callable at $11,750. One year interest rate is 9%.

There is a 0.6 probability that long-term interest rates will increase next year to 10% and a 0.4 probability that they will fall to 8%. The bonds will be called if interest rates fall.

1. Calculate the bond value today. (Show your calculations). (8 marks)

2. Briefly explain the assumptions that the bonds will be called only if interest rates fall.

today. (Show your calculations). (8 marks) ii. Briefly explain the assumptions that the bonds will be called only if interest rates fall.