QUESTION 5 [Total 14 marks]

(a) A company listed on the Australian share market is expected to pay a dividend of $2 next year and it has a constant growth rate for dividends of 5% per year. The expected rate of return for shareholders is 8% per year. Calculate the price of a share in the company. (4 marks)

(b) What is the annual yield on a 4 year bond with a face value of $100,000 and annual coupon interest payments at 14% per annum if the price of the bond is $127,721? (4 marks)

(c) A sole proprietor intends to invest $30,000 in a project that will generate cash flows before tax of $8,000 per year for 5 years. Depreciation is straight line to zero (i.e. 20% per year). The estimated salvage value is $5,000. The before tax required rate of return is 10% and the sole proprietor is taxed at 40%. What is the appropriate discount rate to use in the capital budgeting analysis? (2 marks)

(d) What is the expected return on the market if the expected return on Asset A is 15%, the risk-free rate is 6% and Asset A has a beta of 0.9? (4 marks)