You are a financial analyst with an investment bank and are examining XYZ company. The yield on 10-year government bonds is 3% and the market risk premium is 5%. XYZ company has a beta of 1.2. The company just paid a dividend of $5 per share.

(a) Determine the required return of the companys common equity. (5 marks)

(b) If the companys dividends are expected to grow at a rate of 2% forever, compute how much should the companys stock be valued at? (5 marks)

(c) If the market price is $80, what does this imply about the markets expectation with regard to the return and risk of the stock? Evaluate whether the market is pricing in a higher or lower risk than that suggested by the value in part (b)? (5 marks)

(d) The company is deliberating whether to issue preferred shares or bonds to finance a new project.

(i) Discuss three (3) reasons why a company might prefer issuing preferred shares rather than bonds.

(ii) Explain when you might confidently use IRR (instead of NPV) to determine whether to accept or reject a project. (4 marks)

(e) Suppose the company is thinking of issuing bonds. It collects data on comparable companies to determine how to price its bonds. What criteria determine whether these companies bonds are comparable, and what measure would you use to price the companys bonds? (5 marks)

(f) You are looking at the following 3 companies as candidates for the comparison in part (e). Which company is most likely to be a comparable company? Company A: 4% coupon rate, 10% YTM Company B: 2% coupon rate 11% YTM Company C: 5% coupon rate 7% YTM (5 marks)