Questions about interest rates on bonds, WACC, EBIT, and cash flows.

Final Exam 1. Consider two bonds, a 3-year bond paying an annual coupon of 5% and a 10year bond also with an annual coupon of 5%. Both currently sell at face value. Now suppose interest rate rises to 10%. a) What is the new price of the 3-year bond? b) What is the new price of the 10-year bond? C) Do you conclude that long-term or short-term bonds are more sensitive to a change in interest rates? (10 points) 2. McDonald's 5 year 2.625% coupon bond is trading at 102.7. What is this bond's yield to maturity? McDonald's common stock has a dividend yield of 2.81%. Why is its dividend yield higher than its 5 year bond yield? (10 points) 3. New Tech Inc. has come out with an improved product, and the firm project 20% growth rate on its dividend for 4 years. By then, other firms will have copycat technology, competition will drive down profit margins and the sustainable growth rate will fall to 5%. The most recent dividend was DIV0= $1 per share. If the discount rate is 10%, what would be the company's stock price based on dividend discount model? (10 points) 4. American Water is a regulated public utility, and its expected dividend growth rate is 8% for the indefinite future. Its last dividend was $5 per share; the stock is sold for $60 per share just after the dividend was paid. What is the company's cost of equity? (10 points) 5. Here is some information about XYZ Inc.: Beta of common stock = 1.2 Treasury bill rate = 0.25% Market risk premium = 4% Yield to maturity on long-term debt = 6% Book value of equity = $440 million Market value of equity = $880 million Long-term debt outstanding = $880 million Corporate tax rate = 35% What is the company's WACC? (10 points) 6. Financial analyst often use earnings multiple, book-value multiple, EBITDA multiple and price to evaluate common stocks. Please explain how each multiple is used under different circumstances. (10 points) 7. A corporation has the following data: Recent share price $31.25 Share outstanding $30 million Market value of debt $115 million Cash and Equivalent $47.6 million Other financial investment $247 million Net income $119.4 million Interest expense $5.8 million Depreciation $6.9 million Amortization $2.3 million Taxes $85.9 million What is the corporation's EV/EBITDA? (10 points) 8. On Jan 10th 2000, AOL announced to acquire Time Warner for $182 billion. When the deal was announced, the combined company is worth $350 billion. Now split again, AOL is worth $3 billion while Time Warner is worth about $140 billion 15 years later. Please explain why mega merger often ended up in financial disaster. Why is the promised synergies never realized? (10 points) 9. The ABC Co. earned $10 million before interest and taxes on revenue of $60 million last year. Investment in fixed capital was $12 million, and depreciation was $8 million. Working capital investment was $3 million. The company expects sales, EBIT, investment in fixed and working capital, depreciation to grow at 12% per year for the next five years. After that, the growth will decline to a stable 4% per year, and investments in fixed assets will offset depreciation. The company's WACC is 8%. What is a fair value of the company? [Cash flows (5 points), terminal value in Year 6 (5 points), final value calculation (10 points)]