principal-of-finance-topic2-tute

Principles of Finance Topic 2QuestionsQuestion 1Suppose Homesafe Cab Co is considering an expansion which it will finance through additional debenture sales. Current outstanding Homesafe debentures are selling for $75.25. These have a face value of $100, a coupon of 8% and 15 years to maturity. If interest is paid semi-annually, what must the yield of the new debentures be in order for the issue to sell at par?a. 8.9%b. 13.32%c. 5.2%d. 11.5%Question 2Suppose Growth Unlimited has just paid a $1 dividend. Over the next 3 years, you estimate the dividends will increase 50%, 25% and 20% respectively. After that, dividends should grow at 10% per year. An appropriate discount rate for this firm is 15%. The stock price for Growth Unlimited is:a. $36.75b. $33.98c. $56.55d. $12.73Question 3CBC shares are selling for $10. Supernormal growth of 20% is expected for the next 2 years. The current dividend is $0.5 and the required return is 15%. What constant growth rate is expected beginning in year 3?a. 6.6%b. 7.2%c. 7.8%d. 8.4%Question 4Gogetum Corp. has preferred stock that pays a $14 dividend. The stock sells for $225. If the company wishes to issue new preferred, the underwriting, or floatation, costs are approximately 2%. What is Gogetums cost of preferred stock?a. 6.22%b. 6.4%c. 6.35%d. $14 times number of preferred shares outstanding.Question 5You have just purchased a newly issued $1,000 five-year Troshani Company bond at par. This five-year bond pays $60 in interest semi-annually. You are also considering the purchase of another Troshani Company bond that pays $30 in semi-annual interest payments and has six years remaining before maturity. This bond has a face value of $1,000.(a)What is the yield on the five-year bond (expressed as an effective annual yield)?The market interest rate and the coupon rate are equal because the bond is selling at par. Since the face value of the bond is $1,000 and the semi-annual coupon payment is $60, the semi-annual coupon rate is 6 percent (=$60/$1,000). Thus, the semi-annual interest is also six percent. Calculate the yield, expressed as an effective annual yield, by compounding the semi-annual interest rate over two periods. Yield =0.1236The yield is 0.1236.(b)Assume that the five-year bond and the six-year bond have the same yield. What should you be willing to pay for the six-year bond?You are willing to pay a price equal to the PV of the bonds payments. To find the PV of the 12 coupon payments, apply the annuity formula, discounted at the semi-annual rate of return. Also, discount the $1,000 payment made at maturity back to the present. The discount rate, r, is the same as calculated in part (a).P=$748.49The price of the bond is $748.49. (c)How will your answer to part (b) change if the five-year bond pays $40 in semi-annual interest instead of $60? Assume that the five-year bond paying $40 is purchased at pair.If the five-year bond pays $40 in semi-annual payments and is priced at par, the semi-annual rate of return will be different from that in part (a). Since the face value of the bond is $1,000 and the semi-annual coupon payment is $40, the semi-annual interest rate is four percent (=$40/$1,000). To calculate the price of the bond, apply the annuity formula, discounted at the semi-annual interest rate. In addition, discount the $1,000 payment made at maturity back 12 periods. P=$906.15The price of the bond is $906.15. Question 6A generalized model for the value of any asset is the present value of the expected cash flows:where N = life of the asset, = cash flow in period t and k = appropriate discount rate. Both stock and bond valuation models use a discounted cash flow approach, which includes the estimation of three factors ().Explain why each of these three factors is generally more difficult to estimate for common stocks than for traditional corporate bonds. CFA Level II Exam Question(a)Life of the asset (N). Typically, bonds have a stated maturity. Bond investors will be paid coupons and repaid principal at or before that maturity. The life of the bond is contractually determined and creates an obligation to honor the promised payments. There is no maturity for common stocks because the life of the corporation is commonly assumed to be infinite. (b)Cash flow ().The contractual nature of bond payments creates an obligation, which makes the estimation of these payments a fairly routine task, especially for high quality bonds. Dividend payments on common stocks, on the other hand, are much more difficult to estimate because dividends are discretionary or indeterminate based on factors such as profitability, financial structure, capital expenditures, or management discretion. (c)Appropriate Discount Rate (k).The discount rate, or required rate of return, reflects the risk of the asset. The required rate of return on a bond is observable and typically determined by comparison with other bonds of similar maturity (as indicated by the yield curve) and issuer credit risk (as indicated by the bond rating). The estimation of the required rate of return for a common stock is more subjective, often relying on an estimated risk proxy such as beta or similar measures of riskiness. Question 7GiGi Limited has an issue of preferred stock outstanding that pays a $7 dividend every year, in perpetuity. If this issue currently sells for $90.21 per share, what is the required return?The price a share of preferred stock is the dividend divided by the required return. This is the same equation as the constant growth model, with a dividend growth rate of zero percent. Remember, most preferred stock pays a fixed dividend, so the growth rate is zero. Using this equation, we find the price per share of the preferred stock is:R = D/P0 R = $7.00/$90.21R = .0776 or 7.76%Yes, the investor should acquire the company shares as the investors required rate of return (10%) is less than the expected rate of return for the investment (11.43%). Also, the value of the share to the investor ($4) exceeds the existing market price ($3.50). Question 8Burgan Mining Companys iron ore reserves are being depleted, and its costs of recovering a declining quantity of ore are rising each year. As a result, the companys earnings are declining at a rate of 10 percent each year. If the dividend per s