Valuation and Characteristics of Bonds

Apple, AIG. and Vanguard issue a $1,000 par value bond. Your friend is thinking of purchasing these bonds, but is unsure of how to analyze. She comes to you for help with the following.

1) See the information below. Assuming interestis paid on a yearly basis, calculate the values of the bonds when your friend's required rate of return is as follows: Apple 6%, AIG 8%, and Vanguard 10%.

Apple AIG Vanguard

Coupon Interest rate 5.25 4.25 4.75

Years to maturity 30 10 5

2) Assuming the bonds are selling for the following amounts. What are the expected rates of return for each bond?

APPLE - $1,100

AIG - $1,030

Vanguard - $1,015

3) What change occurs in value if (1) therequired rate of return increases by 2% (2) the required rate of return decreases by 2%?

4) Should you recommend your friend to buy the bonds? Why or why not?

HINT: Before you answer, fill out the table below. It will help you hone in on the informationyou needto move forward. You can find how to do this exercise on page 246-248 in our text.

Apple AIG Vanguard

Coupon interest rate:

Interest payment : PMT=

Years to Maturity : Nper=

par value : FV=

Valuation and Characteristics of Stock

5)Why would a preferred stockholder want the stock to have a cumulative dividendfeature and protective provisions?

6) The common stockholders receive two types of returns from their investments, what are they?

7)What is the value of preferred stock when the dividend rate is 13% on a $100 par value? The appropriate discount rate for a stock of this risk level is 12.5%.Look at valuation for preferred stock

8) The preferred stock ofYou Corp pays a $3.75 dividend. What is the value of the stock of your required return is 8.5%?Look at valuation for preferred stock

9) You are looking to invest in a company that has 10.5% return on equity and retains 60% of its earnings for reinvestment purposes. The company recently paid a dividend of $3.75 and the stock is currently selling for $45.Look at valuation for common stock

A) What is the growth rate of the company?

B) What is the expected return on the company's stock?

C) If you REQUIRE a 13 percent return, should you invest in this firm?

10) You own 230 shares of Candy Landstock preferred stock which currently sells for $39.75per share and pays annual dividends of $3.35.

A) What is your expected return?

B) If you require 8 percent return, given the current price, should you buy more stock?

11) The common stock for CardiInc,. is selling for $35.78per share. The stock recently paid dividends of $2.79per share and has a projected constant growth rate of 7percent. If you purchasethe stock at market price, what is your expected rate of return.

The Cost of Capital

12) Define Cost of Capital

13) Why do firms calculate their weighted average cost of capital?

14) How does a firm's tax rate affect its cost of capital?

15) What is the effect of the flotationcosts associated with a new security issue on a firm's weighted average cost of capital?

16) Please use your textbook to computethe following.

A) You Corp issued new stock at a market price of $35.The company paid$1.50in dividends last year which is expected to grow at an annual rate of 5 percent forever. Flotationcosts will consist of 6 percent of the market price. What will You Corp.'s cost of equity be for the new issue?(Look at the Cost of Equity section for guidance particularlyin the dividend growth model )

B)Glendale Farms Co, is issuing a $1,000 par value bond which pays 7 percent annual interest and matures in 15 years. As an investor to the company, you are willing to pay $850 for the bond. Flotation costs will be 3 percent of market value. The company is at a 30 percent marginal tax bracket. What will be the firm's after-tax cost of debt on the bond.(Look at the Cost of Debt section for guidance =Similar to ex 9.1))

17)Look at the information below. This table refers to Candy Enterprises. Currently common stock is being sold at for a price equal to its book value and the firm's bonds are selling at par. Crawford managers estimate that the market requires a 15 percent return on its common stock, the firm's command a yield to maturity of 8 percent, and the firm faces a tax rate at 34 percent.

Cash $54,000

Accounts Receivable 458,000

Inventories 740,000

Long-term Debt $1,259,000

Net Property, Plant & Equipment 1,895,500

Common Equity 1,888,500

Total Assets $3,147,500 $3,147,500

Cost of debt financing 8%

Cost of equity 15%

Tax rate 34%

Market to book ratio 1

Based on the information above.

A) What is Candy Enterprises'weighted average cost of capital?

Component : Proportion After-tax Cost Product Market Value/ Balance Sheet

Long-term Debt:

Common Equity: