10.

An investor has two bonds in his portfolio that have a face value of $1,000 and pay a 12% annual coupon. Bond L matures in 17 years, while Bond S matures in 1 year.

1. What will the value of the Bond L be if the going interest rate is 7%, 8%, and 13%? Assume that only one more interest payment is to be made on Bond S at its maturity and that 17 more payments are to be made on Bond L. Round your answers to the nearest cent.

   	7%	8%	13%
   Bond L	$	$	$
   Bond S	$	$	$

2. Why does the longer-term bond’s price vary more than the price of the shorter-term bond when interest rates change?
   1. Long-term bonds have greater interest rate risk than do short-term bonds.
   2. The change in price due to a change in the required rate of return decreases as a bond's maturity increases.
   3. Long-term bonds have lower interest rate risk than do short-term bonds.
   4. Long-term bonds have lower reinvestment rate risk than do short-term bonds.
   5. The change in price due to a change in the required rate of return increases as a bond's maturity decreases.

Hagar Industrial Systems Company (HISC) is trying to decide between two different conveyor belt systems. System A costs $300,000, has a 4-year life, and requires $101,000 in pretax annual operating costs. System B costs $380,000, has a 6-year life, and requires $95,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have zero salvage value. Whichever project is chosen, it will not be replaced when it wears out. The tax rate is 22 percent and the discount rate is 10 percent.

Calculate the NPV for both conveyor belt systems. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

9.

A firm's bonds have a maturity of 14 years with a $1,000 face value, have an 11% semiannual coupon, are callable in 7 years at $1,230.20, and currently sell at a price of $1,394.19. What are their nominal yield to maturity and their nominal yield to call? Do not round intermediate calculations. Round your answers to two decimal places.

YTM:   %

YTC:   %

What return should investors expect to earn on these bonds?

1. Investors would not expect the bonds to be called and to earn the YTM because the YTM is greater than the YTC.
2. Investors would not expect the bonds to be called and to earn the YTM because the YTM is less than the YTC.
3. Investors would expect the bonds to be called and to earn the YTC because the YTC is less than the YTM.
4. Investors would expect the bonds to be called and to earn the YTC because the YTC is greater than the YTM.

Happy Times, Inc., wants to expand its party stores into the Southeast. In order to establish an immediate presence in the area, the company is considering the purchase of the privately held Joe’s Party Supply. Happy Times currently has debt outstanding with a market value of $120 million and a YTM of 10 percent. The company’s market capitalization is $260 million, and the required return on equity is 15 percent. Joe’s currently has debt outstanding with a market value of $25.5 million. The EBIT for Joe’s next year is projected to be $17 million. EBIT is expected to grow at 10 percent per year for the next five years before slowing to 3 percent in perpetuity. Net working capital, capital spending, and depreciation as a percentage of EBIT are expected to be 9 percent, 15 percent, and 8 percent, respectively. Joe’s has 2.15 million shares outstanding, and the tax rate for both companies is 35 percent.

a. What is the maximum share price that Happy Times should be willing to pay for Joe’s? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Maximum share price $

After examining your analysis, the CFO of Happy Times is uncomfortable using the perpetual growth rate in cash flows. Instead, she feels that the terminal value should be estimated using the EV/EBITDA multiple. The appropriate EV/EBITDA multiple is 8.

b. What is your new estimate of the maximum share price for the purchase? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Maximum share price $

In 1980 and investor bought 12 initial public offering of oil and gas companies, stock he held each of those for approximately one month and then sold them. The investment rule he followed was to submit a purchase order for every firm commitment initial public offering of oil and gas exploration companies. There were 22 of these offerings, and he submitted a purchase order for a approximately $1000 in stock for each of the companies. With 10 of the 22 offerings he was unable to invest as no shares were allocated to him. With 5 of the 12 offerings that were purchased fewer is in that requested number of shares were allocated and he received fewer shares then he wanted.

The year 1980 was very good for oil and gas exploration company owners: On average for the 22 companies that went public, the stocks were selling for 80 percent above the offering price a month after the initial offering date. The investor looked at his performance record and found that the $8400 invested in the 12 companies had grown to $10,000, representing a return of only about 20% (commissions were negligible). Did he have bad luck, Or should he have expected to do worse than the average initial public offering investor? Explain (your discussion should center on the difference between Under and oversubscribed offerings and the implication to the investors return)

An investor has two bonds in his portfolio that have a face value of $1,000 and pay a 12% annual coupon. Bond L matures in 15 years, while Bond S matures in 1 year.

Assume that only one more interest payment is to be made on Bond S at its maturity and that 15 more payments are to be made on Bond L.

1. What will the value of the Bond L be if the going interest rate is 4%? Round your answer to the nearest cent.
   $
   
   What will the value of the Bond S be if the going interest rate is 4%? Round your answer to the nearest cent.
   $
   
   What will the value of the Bond L be if the going interest rate is 10%? Round your answer to the nearest cent.
   $
   
   What will the value of the Bond S be if the going interest rate is 10%? Round your answer to the nearest cent.
   $
   
   What will the value of the Bond L be if the going interest rate is 13%? Round your answer to the nearest cent.
   $
   
   What will the value of the Bond S be if the going interest rate is 13%? Round your answer to the nearest cent.
   $
   
2. Why does the longer-term bond’s price vary more than the price of the shorter-term bond when interest rates change?
   
   1. The change in price due to a change in the required rate of return decreases as a bond's maturity increases.
   2. Long-term bonds have lower interest rate risk than do short-term bonds.
   3. Long-term bonds have lower reinvestment rate risk than do short-term bonds.
   4. The change in price due to a change in the required rate of return increases as a bond's maturity decreases.
   5. Long-term bonds have greater interest rate risk than do short-term bonds.

Problem 10-11 Calculating Project Cash Flow from Assets [LO1]

Consider the following bond: Face value = 1000; coupon rate = 8%; maturity = 5 years; ytm = 7%

A) What is the value of the bond today and in 2 years?

b) what are the current yield and capital gains yield for this bond this year and in two years?

c) Assuming interest rates remain the same over this bond's lifetime, what is going to happen to the value of this bond as time goes by?

1. Consider these three bonds:

1) USTN 10% due 3/31/2025 with a yield to maturity of 3.5%

2) USTN 3% due 3/31/2025 with a yield to maturity of 3.6%

3) USTN 10% due 12/31/18 with a yield to maturity of 3.1%

Which bond has the highest risk and which bond has the lowest risk. Tell me in your own words, what bond risk means to you. If you were investing in bonds and you believe interest rates will rise across the entire yield curve, which of these three bonds would you buy and why.

At the beginning of 1976 a relative migrated to Australia with $10,000 ‘spare cash’. The money could have been used to buy a block of land or invested in an ‘at-call’ savings account that paid interest at 8% p.a. compounded half-yearly. At the end of 2018, the land was valued by a local real estate agent who was keen to list the property on behalf of his agency, at a price of approximately $400,000.

Required:

1. a) Which of the alternative investments had the higher value at the end of 2018? Justify your response with appropriate calculations.

(Students should write no more than 50 words for this part of the question).

b) i) Assuming the half-yearly compounding of interest, what was the rate of growth in the land value over the total period expressed as a nominal annual interest rate?

ii) What was the rate of growth in the land value over the total period expressed as an effective interest rate?

iii) What was the rate of growth in the ‘at-call’ savings account over the total period expressed as an effective interest rate?

1. c) What investment in the savings account would have been necessary at the beginning of 1976, to have the same value as the land was worth at the end of 2018? Briefly explain your response.

(Students should write no more than 50 words for this part of the question).

d) Recognising both your finance skills and ‘common sense’, one of your friends has asked whether your calculations above allow you to determine which of the investments would have been ‘better’ to make at the beginning of 1976, given the outcomes discussed above at the end of 2018. Provide a well-reasoned, complete response to this question taking into consideration various financial and non-financial issues.

(Students should write no more than 100 words for this part of the question).

1. d) i) You have now been provided further information that the investment in the land required the owner to make continuous annual payments of council rates over the total period held. These amounts are determined in accordance with Table 1 below. Assuming the land was sold at the end of 2018 (but ignoring the expected sale value), what is the adjusted present value at the beginning of 1976 of all the cash outflows relating to the acquisition and continued ownership of the land?

Note: For the purposes of this question assume the following:

1. Rates are payable on the anniversary of each year of land ownership.

2. The annual amount of the rates are determined in accordance with the following formula;

Initial Purchase Cost ($) x Factor (times) x Relevant Percentage (%)

3. Rates are still payable for the 2018 year (for the full year).

Table 1

ii) Taking into consideration the calculations from part e) i) of this question, what is the rate of growth in the land value over the total period expressed as an effective interest rate?

(Students should write no more than 50 words for this part of the question).

Question3.

Suppose you are working a financial manager at one of the investment corporations, if there were two investment opportunities require the same size of the investments (250,000 Saudi Riyals), and the level of risk is close, the cash flows for each project is shown in the following table:

year

1. Calculate the net present value for each project?
2. Which project would you select? and why? (assume that the interest rate is 10%).

North Side, Inc. has no debt outstanding and a total market value of $168,000. Earnings before interest and taxes, EBIT, are projected to be $18,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be $21,960 . The company is considering a $50,000 debt issue with an interest rate of 7.4 percent. The proceeds will be used to repurchase shares of stock. There are currently 5,000 shares outstanding and the tax rate is 21 percent. What is the EPS for each capital structure under each scenario? If we ignore taxes, what is the break-even EBIT?

Assume today is March 16, 2016. Natasha Kingery is 30 years old and has a Bachelor of Science degree in computer science. She is currently employed as a Tier 2 field service representative for a telephony corporation located in Seattle, Washington, and earns $38,000 a year that she anticipates will grow at 3% per year. Natasha hopes to retire at age 65 and has just begun to think about the future.

Natasha has $75,000 that she recently inherited from her aunt. She invested this money in 30-year Treasury Bonds. She is considering whether she should further her education and would use her inheritance to pay for it.*

She has investigated a couple of options and is asking for your help as a financial planning intern to determine the financial consequences associated with each option. Natasha has already been accepted to both of these programs, and could start either one soon.

One alternative that Natasha is considering is attaining a certification in network design. This certification would automatically promote her to a Tier 3 field service representative in her company. The base salary for a Tier 3 representative is $10,000 more than what she currently earns and she anticipates that this salary differential will grow at a rate of 3% a year as long as she keeps working. The certification program requires the completion of 20 Web-based courses and a score of 80% or better on an exam at the end of the course work. She has learned that the average amount of time necessary to finish the program is one year. The total cost of the program is $5000, due when she enrolls in the program. Because she will do all the work for the certification on her own time, Natasha does not expect to lose any income during the certification.

Another option is going back to school for an MBA degree. With an MBA degree, Natasha expects to be promoted to a managerial position in her current firm. The managerial position pays $20,000 a year more than her current position. She expects that this salary differential will also grow at a rate of 3% per year for as long as she keeps working. The evening program, which will take three years to complete, costs $25,000 per year, due at the beginning of each of her three years in school. Because she will attend classes in the evening, Natasha doesn’t expect to lose any income while she is earning her MBA if she chooses to undertake the MBA.

1. Determine the interest rate she is currently earning on her inheritance by going to the U.S. Treasury Department Web site (treasury.gov) and selecting “Data” on the main menu. Then select “Daily Treasury Yiled Curve Rates” under the Interest Rate heading and enter the appropriate year, 2016, and then search down the list for March 16 to obtain the closing yield or interest rate that she is earning. Use this interest rate as the discount rate for the remainder of this problem. --> the identified rate for March 16th on a 30 year bond is 2.73
2. Create a timeline in Excel for her current situation, as well as the certification program and MBA degree options, using the following assumptions:
   • Salaries for the year are paid only once, at the end of the year.
   • The salary increase becomes effective immediately upon graduating from the MBA program or being certified. That is, because the increases become effective immediately but salaries are paid at the end of the year, the first salary increase will be paid exactly one year after graduation or certification.
3. Calculate the present value of the salary differential for completing the certification program. Subtract the cost of the program to get the NPV of undertaking the certification program.
4. Calculate the present value of the salary differential for completing the MBA degree. Calculate the present value of the cost of the MBA program. Based on your calculations, determine the NPV of undertaking the MBA.
5. Based on your answers to Questions 3 and 4, what advice would you give to Natasha? What if the two programs are mutually exclusive? That is, if Natasha undertakes one of the programs there is no further benefit to undertaking the other program. Would your advice be different?

* If Natasha lacked the cash to pay for her tuition upfront, she could borrow the money. More intriguingly, she could sell a fraction of her future earnings, an idea that has received attention from researchers and entrepreneurs; see M. Palacios, Investing in Human Capital: A Capital Markets Approach to Student Funding, Cambridge University Press, 2004.