Problems

1. Cornerstone Industries plans on issuing $4,000,000 worth of bonds, (note, thats 4,000 bonds, each with a 1,000 face value) with a 12% coupon rate and a market price of $1150. The bonds mature in 12 years, but are callable in 11 years with a 2% premium over face value.

a. What is the yield to maturity? (4)

b. What is the yield to first call? (4)

c. What is the coupon yield? (3)

d. What is the capital gains yield? (2)

2. For your retirement, you want to invest 700 per month before retirement. Interest rates before retirement will be 11% APR compounded monthly. When you retire, you will spend 300,000 for a trip around the world. You plan to live 30 years after retirement, and leave 1.5 million for your kids. You have $2,000 to invest today, and 40 years to save up for this retirement. Interest rates after retirement are 8% APR compounded monthly, how much will you get to live on each month while retired? (10)

3. You need to borrow $35,000 to buy a truck. The current loan rate is 8% compounded monthly and you want to pay the loan off in equal monthly payments over 7 years. Consider your loan after you have made 6 years worth of payments. How much interest have you paid over the first 6 years of the loan? (10)

4. A stock just paid a $3 dividend. Over the next 4 years, the dividend will grow at 100%, 50%, 100%, 20%. After that, it will grow at 6%. If the required return for this stock is 15%, what is todays stock price? (12)

5. Your company has the following information:

Bonds: Value = 60 million: 10 years left at a 7% coupon, a 1050 price

Equity: Value = 75 million: cost of capital = 16%

Preferred: Value = 5 million: Dividend = 4, price of 50.

The Tax rate is 30%. What is the WACC? (12)

Multiple Choice (3 points each)

1. An investor that has the right to terminate a bond early has a

1. Call option
2. Put option
3. Termination option
4. Liquidation option
5. None of the above statements are true.

2. Your company stock price is 125, and it just paid a dividend of $7 in year 0. If that dividend is expected to grow at 8% and the tax rate is 40%, what cost of capital would you use in the WACC calculation (within .1%)?

1. 6.0
2. 8.4
3. 13.6
4. 14.0
5. None of the above

3. Which of the following methods is the best one (most accurate) for computing the cost of equity capital

1. Discounted cash flow model
2. Capital asset pricing model
3. Risk premium model
4. None of them is superior to the others

4. Which bond would most likely possess the highest degree of reinvestment rate risk?

1. 8% coupon rate, 10 years to maturity.
2. 8% coupon rate, 20 years to maturity.
3. 10% coupon rate, 10 years to maturity.
4. 10% coupon rate, 20 years to maturity.
5. 12% coupon rate, 20 years to maturity.

5. A 13-year bond has an annual coupon rate of 9 percent. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 1 percent. Which of the following statements is most correct?

1. The bond is currently selling at a price below its par value.
2. If market interest rates decline today, the price of the bond will also decline today.
3. If market interest rates remain unchanged, the bonds price one year from now will be lower than it is today.
4. both a and ac are correct.
5. All of the statements above are correct.

6. Preferred stock

1. Is invested capital that never need to be repaid to investors
2. pays dividend checks to investors
3. non-payment puts a company into bankruptcy

1. I only
2. II only
3. III only
4. I and II only
5. I and III only

7. Credit card issuers must by law print their Annual Percentage Rate (APR) on their monthly statements. If the APR is stated to be 17% compounded weekly and the tax rate is 40%, what is the EFF% on the card?

1. 14%
2. 17.0%
3. 18.5%
4. 23.3%
5. None of the above

8. Liddy Products, Inc. just issued 10-year, 8% coupon bonds at par ($1,000). Outstanding Limbaugh Corp. bonds, which have a maturity of 10 years, sell at a premium to par and are viewed by investors as having the same risk as the Liddy bonds. Therefore, it must be true that:

1. The Limbaugh bonds pay coupons more often than twice a year.
2. The coupon rate on the Limbaugh bonds is equal to that on the Liddy bonds.
3. The yield on Limbaugh bonds is higher than the yield on Liddy bonds.
4. The coupon rate on the Limbaugh bonds is higher than that on the Liddy bonds.
5. The coupon payment on the Limbaugh bonds is lower than that on the Liddy bonds.

9. You have accumulated 1.2 million dollars for retirement. On this investment, you can earn a 7% return. You need $6,000 to live on each month. How long before your money runs out?

1. 7.9 years
2. 20.3 years
3. 14.6 years
4. Never
5. None of the above

Short Answer (4 points each)

What are the 3 assumptions that allow the discounted dividend model to work?

Should you use the WACC as a measurement for all potential projects? Why or why not?

What is the time value of money equation I asked you to memorize?

Why do investors care whether they receive their returns as a capital gains yield, or a dividend yield?