I need some guidance in understaning how to complete the following
finance problems. I have a extensive exam quickly approaching and I am
uncertain how to complete the following problems. Could you please
notify me first as to how much it would cost for Google Answers to
anwer all 5 of the following questions? I have never used Google
Answers before, so I just bid $30.00, since these are not intensive
research questions; just math problems.
1. Acetate, Inc., has common stock with a market value of $20 million
and debt with a market
value of $10 million. The cost of the debt is 14 percent. The current
Treasury-bill rate is 8
percent, and the expected market premium is 10 percent. The beta on
Acetate?s equity is 0.9.
a. What is Acetate?s debt-equity ratio?
b. What is the firm?s overall required return?
2. Rayburn Manufacturing is currently an all-equity firm. The firm?s
equity is worth $2
million. The cost of that equity is 18 percent. Rayburn pays no taxes.
Rayburn plans to issue $400,000 in debt and to use the proceeds to
repurchase stock.
The cost of debt is 10 percent.
a. After Rayburn repurchases the stock, what will the firm?s overall
cost of capital be?
b. After the repurchase, what will the cost of equity be?
c. Explain your result in (b).
3. Andahl Corporation stock, of which you own 500 shares, will pay a
$2-per-share dividend
one year from today. Two years from now Andahl will close its doors;
stockholders will
receive liquidating dividends of $17.5375 per share. The required rate
of return on Andahl
stock is 15 percent.
a. What is the current price of Andahl stock?
b. You prefer to receive equal amounts of money in each of the next
two years. How will
you accomplish this?
How to Value Bonds
4. What is the present value of a 10-year, pure discount bond that
pays $1,000 at maturity and
is priced to yield the following rates?
a. 5 percent
5. Consider the stock of Davidson Company that will pay an annual
dividend of $2 in the
coming year. The dividend is expected to grow at a constant rate of 5
percent permanently.
The market requires a 12-percent return on the company.
a. What is the current price of a share of the stock?
b. What will the stock price be 10 years from today?
Bond Refunding
6. KIC, Inc., plans to issue $5 million of perpetual bonds. The face
value of each bond is
$1,000. The annual coupon on the bonds is 12 percent. Market interest
rates on one-year
bonds are 11 percent. With equal probability, the long-term market
interest rate will be
either 14 percent or 7 percent next year. Assume investors are risk-neutral.
a. If the KIC bonds are noncallable, what is the price of the bonds?
b. If the bonds are callable one year from today at $1,450, will their
price be greater than
or less than the price you computed in part (a)? Why?
1
a) debt Equity ratio = debt/equity = 10 / 20 = 0.50
b) Overall required return =
Using CAPM return on equity = 8% + (10%)*0.90 = 17%
Cost of debt = 14%
Value of firm = 10 + 20 = 30
Overall return = Return Equity * Equity/Value + Debt/Value *
(1-tax)*(cost of debt)
= 17% * (20/30) + 10/30 * (1-0) * (14%)
= 16%
Assuming that the tax rate is zero. If tax rate is 35% then return = 14.37%
2)
a) In the absence of any debt tax shield the overall cost of capital
will remain the same at 18%
b) 18% = Cost Equity * ( 1.6/2.0) + 10% *(0.4/2)
Cost of Equity = 20%
c) The equity cost increased from 18% to 20% because they are now
second to bond holders in case of a liquidation. Since their risk has
increased their required rate of return increased.
3)
a)
Present value of dividend 1 year from now = 2 / 1.15 = 1.74
Present value of final payout 2 years from now = 17.5375 / (1.15*1.15) = 13.26
Current price of share = 1.74 + 13.26 = $15 per share
b)
In order to generate equal amount of money in each of the 2 years we
sell part of the shares at the end of year 1 and the other part at end
of year 2
Value of shares at the end of year 1 (after dividends are paid out) =
17.5375/1.15 = 15.25
Cash inflow end of year 1 assuming x shares sold = 500 * 2 + (x * 15.25)
This should equal the cash received at end of year 2 = (500 ? x ) * 17.5375
Equating the 2 equations : -
500 * 2 + (x * 15.25) = (500 ? x ) * 17.5375
1000 + 15.25x = 8,768.75 ? 17.5375x
x = 236.94 shares
Sell end of year one 236.94 shares for 15.25 + 500 * 2 dividend = 4,613.37
Sell end of year two 500 ? 236.94 = 263.06 shares * 17.5375 = 4,613.37
4)
1000 / (1.05^10) = 613.91
5)
a) 2 * 1.05/(.12-.07) = $30
b) Same that is $ 30 |
