David Palmer identified the following bonds for investment:

1. Bond A: A $1 million par, 10% annual coupon bond, which will mature on July 1, 2025.
2. Bond B: A $1 million par, 14% semi-annual coupon bond (interest will be paid on January 1 and July 1 each year), which will mature on July 1, 2031.
3. Bond C: A $1 million par, 10% quarterly coupon bond (interest will be paid on January 1, April 1, July 1, and October 1 each year), which will mature on July 1, 2026.

The three bonds were issued on July 1, 2011.

(Each Part is Independent)

1. If Bond B is issued at face value and both Bond B and Bond A are having the same yield to maturity (EAR), calculate the market price of Bond A on July 1, 2011. [Note: Full mark would only be given to correct answer of which the values of those variables not provided in the question directly are derived.]                                                                       

2. David purchased the Bond C on January 1, 2014 when Bond C was priced to have a yield to maturity (EAR) of 10.3812891%. David subsequently sold Bond C on January 1, 2016 when it was priced to have a yield to maturity (EAR) of 12.550881%. Assume all interests received were reinvested to earn a rate of return of 3% per quarter (from another investment account), calculate the current yield, capital gain yield and the 2-year total rate of return (HPY) on investment for David on January 1, 2016. [Hint: Be careful with how many rounds of coupons has David received during the holding period and thus how much interests (coupons and reinvestment of coupons) he has earned in total during the 2-year holding period.]                                                                                                      

3. David purchased Bond B on a coupon payment day. Bond B is priced to have a yield to maturity (EAR) of 12.36% and its market value is $1,101,058.953 on the date of purchase. Find the remaining life until maturity (in terms of 6-month period or year) of Bond B.       

(Each of the following parts is independent.)

1. According to the Capital Asset Pricing theory, what return would be required by an investor whose portfolio is made up of 40% of the market portfolio (m) and 60% of Treasury bills (i.e. risk-free asset)?  Assume the risk-free rate is 3% and the market risk premium is 7%?

2. You are considering investing in the following two stocks. The risk-free rate is 7 percent and the market risk premium is 8 percent.

1. Compute the expected and required return (using CAPM) on each stock.
2. Which asset is worth investing? Support your answer with calculations.

3. Which pair of stocks used to form a 2-asset portfolio would have the greatest diversification effect for the portfolio? Briefly explain.

(d)   Explain the terms systematic risk and unsystematic risk and their importance in determining investment return.

Please provide stepping for all if possible, much appreciated.

Suppose your firm would like to earn 10% yearly return from the following two investment projects of equal risk.

(a)       If only one project can be accepted, based on the NPV method which one should it be?  Support your answer with calculations.

(b)       Suppose there is another four-year project (Project C) and its cash flows are as follows:

C₀ = –$8,000

             C₁ =   $2,000

               C₂ =   $2,500

               C₃ =   $2,000

               C₄ =   $4,000

(i)      Given the above cash flow patterns, at what required rate of return will Project C have the same NPV as Project B?  Briefly explain your answer.

(ii)     If Project C has the same risk as Project B, without calculations, explain which project will you pick?   

(iii)   If cash flow C₄ of Project C is unknown to you (while C₀ – C₃ are known and as above) and the project’s cost of capital is 10%, what amount of C₄ will make Project C worth accepting?

(iv)    If your firm’s investment policy (based on payback method) is such that it only accepts projects whose initial investment can be recouped within three years, will Project B and/or Project C be accepted?   

(c)       Based on the estimated cash flows of Project A, will you expect its internal rate of return (IRR) to be positive?  Briefly explain your answer WITHOUT calculations.

(d)       What kind of rate of return is the 10% interest stated in the question for Projects A and B?  How can it be used in making investment decisions (i.e. its role in investment decision making)?

Suppose your firm would like to earn 10% yearly return from the following two investment projects of equal risk.

(a)       If only one project can be accepted, based on the NPV method which one should it be?  Support your answer with calculations.                                         

(b)       Suppose there is another four-year project (Project C) and its cash flows are as follows:

C₀ = –$8,000

             C₁ =   $2,000

               C₂ =   $2,500

               C₃ =   $2,000

               C₄ =   $4,000

(i)      Given the above cash flow patterns, at what required rate of return will Project C have the same NPV as Project B?  Briefly explain your answer.                      

(ii)     If Project C has the same risk as Project B, without calculations, explain which project will you pick?                                                                 

(iii)   If cash flow C₄ of Project C is unknown to you (while C₀ – C₃ are known and as above) and the project’s cost of capital is 10%, what amount of C₄ will make Project C worth accepting?                                                                        

(iv)    If your firm’s investment policy (based on payback method) is such that it only accepts projects whose initial investment can be recouped within three years, will Project B and/or Project C be accepted?                                                     

(c)       Based on the estimated cash flows of Project A, will you expect its internal rate of return (IRR) to be positive?  Briefly explain your answer WITHOUT calculations.   

(d)       What kind of rate of return is the 10% interest stated in the question for Projects A and B?  How can it be used in making investment decisions (i.e. its role in investment decision making)?                                                                             

At year-end 2016, total assets for Arrington Inc. were $1.6 million and accounts payable were $440,000. Sales, which in 2016 were $2.7 million, are expected to increase by 30% in 2017. Total assets and accounts payable are proportional to sales, and that relationship will be maintained; that is, they will grow at the same rate as sales. Arrington typically uses no current liabilities other than accounts payable. Common stock amounted to $460,000 in 2016, and retained earnings were $255,000. Arrington plans to sell new common stock in the amount of $55,000. The firm's profit margin on sales is 5%; 60% of earnings will be retained.

1. What were Arrington's total liabilities in 2016? Write out your answer completely. For example, 25 million should be entered as 25,000,000. Round your answer to the nearest cent.
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3. How much new long-term debt financing will be needed in 2017? Write out your answer completely. For example, 25 million should be entered as 25,000,000. Do not round your intermediate calculations. Round your answer to the nearest cent. (Hint: AFN - New stock = New long-term debt.)
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Paladin Furnishings generated $4 million in sales during 2016, and its year-end total assets were $2.2 million. Also, at year-end 2016, current liabilities were $500,000, consisting of $200,000 of notes payable, $200,000 of accounts payable, and $100,000 of accrued liabilities. Looking ahead to 2017, the company estimates that its assets must increase by $0.55 for every $1.00 increase in sales. Paladin's profit margin is 4%, and its retention ratio is 40%. How large of a sales increase can the company achieve without having to raise funds externally? Write out your answer completely. For example, 25 million should be entered as 25,000,000. Do not round intermediate calculations. Round your answer to the nearest cent.

Six-month T-bills have a nominal rate of 2%, while default-free Japanese bonds that mature in 6 months have a nominal rate of 1.40%. In the spot exchange market, 1 yen equals $0.008. If interest rate parity holds, what is the 6-month forward exchange rate? Do not round intermediate calculations. Round your answer to six decimal places.

_________________$

Larissa has decided to expand the company’s operations. She has asked Dan to enlist an underwriter to help sell $50 million in new 20-year bonds to finance new construction. Dan has entered into discussions with Kim McKenzie, an underwriter from the firm of Crowe & Mallard, about which bond features East Coast Yachts should consider and also what coupon rate the issue will likely have. Although Dan is aware of bond features, he is uncertain as to the costs and benefits of some of them, so he isn’t clear on how each feature would affect the coupon rate of the bond issue.

1. You are Kim’s assistant, and she has asked you to prepare a memo to Dan describing the effect of each of the following bond features on the coupon rate of the bond. She would also like you to list any advantages or disadvantages of each feature.

The security of the bond, that is, whether or not the bond has collateral.

The seniority of the bond.

The presence of a sinking fund.

A call provision with specified call dates and call prices.

A deferred call accompanying the above call provision.

A make-whole call provision.

Any positive covenants. Also, discuss several possible positive covenants East Coast Yachts might consider.

Any negative covenants. Also, discuss several possible negative covenants East Coast Yachts might consider.

A conversion feature (note that East Coast Yachts is not a publicly traded company).

A floating rate coupon.

A firm raises capital by selling $20,000 worth of debt with flotation costs equal to 3​% of its par value. If the debt matures in 5 years and has an annual coupon interest rate of 7​%, what is the​ bond's YTM?

The price of a non-dividend paying stock is $15 and the price of a six-month European call option on the stock with a strike price of $23 is $2. The risk-free rate is 4% per annum. What is the price of a six-month European put option with a strike price of $23?

NPV: Your division is considering two projects with the following cash flows (in millions):

                      0   1      2     3

Project A - $16   $7    $9 $10

Project B - $26   $14 $20 $11

a. What are the projects' NPVs assuming the WACC is 5%? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Negative value should be indicated by a minus sign.

Project A $ _______ million

Project B $ _______ million

What are the projects' NPVs assuming the WACC is 10%? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Negative value should be inidcated by a minus sign.

Project A $ _______ million

Project B $ _______million

What are the projects' NPVs assuming the WACC is 15%? Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Negative value should be inidcated by a minus sign.

Project A $ _______ million

Project B $ _______ million

b. What are the projects' IRRs assuming the WACC is 5%? Round your answer to two decimal places.

Project A ________%

Project B ________%

What are the projects' IRRs assuming the WACC is 10%? Round your answer to two decimal places.

Project A _______%

Project B _______%

What are the projects' IRRs assuming the WACC is 15%? Round your answer to two decimal places.

Project A _______%

Project B _______%

c. If the WACC were 5% and A and B were mutually exclusive, which would you choose? (Hint: The crossover rate is 48.57%.) _____________________

If the WACC were 10% and A and B were mutually exclusive, which would you choose? (Hint: The crossover rate is 48.57%.) ________________________

If the WACC were 15% and A and B were mutually exclusive, which would you choose? (Hint: The crossover rate is 48.57%.) ___________________

H. Cochran Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.29 million. The fixed asset qualifies for 100 percent bonus depreciation in the first year. The project is estimated to generate $1,715,000 in annual sales, with costs of $624,000. The project requires an initial investment in net working capital of $260,000, and the fixed asset will have a market value of $195,000 at the end of the project.
  
a.   If the tax rate is 21 percent, what is the project’s Year 0 net cash flow? Year 1? Year 2? Year 3? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to two decimal places, e.g., 32.16.)
b.   If the required return is 9 percent, what is the project's NPV? (Do not round intermediate calculations and round your answer to two decimal places, e.g., 32.16.)

The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $15 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $4.8 million with a 0.2 probability, $1.5 million with a 0.5 probability, and $0.8 million with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. Do not round intermediate calculations. Round your answers to two decimal places at the end of the calculations.

~Debt/Capital ratio is 0.

~Debt/Capital ratio is 10%, interest rate is 9%.

~Debt/Capital ratio is 50%, interest rate is 11%.

~Debt/Capital ratio is 60%, interest rate is 14%.

1.    Valuation of a Stock Through the Gordon Growth Model (8 pts.):  Please use the following information and the Gordon Growth Model of Stock Valuation to calculate the most recent dividend paid by WXZ corporation. (Make sure you convert percentage figures into decimals before using the formula) and please show your work clearly.

Current stock price of a share of WXZ Corporation: $54.25

Expected constant growth rate of dividends: 8.5%

Investor’s required return on investment equity: 12.5%

2.   The Net Asset Value of a Mutual Fund (10 pts.):  Suppose that 12 months ago, an investor purchased a given number of shares of a Mutual fund at the then fund’s Net Asset Value of $4.00. Assume that today (12 months later) this investor sells those shares at today’s NAV and that the yield or rate of return on this individual’s investment is - 4.5%, yes, negative 4.5%.   Suppose, furthermore, that the Fund’s Balance Sheet as of today shows the following information, in no particular order:

Cash…………………………………………………………………………..$24,790

Accrued fees and other liabilities…………………………….. $87,458

Current market value of holdings of stocks……..……$5,749,612

Current market value of holdings of bonds…………. $2,579,536

Please calculate this fund’s NAV today, and the number of this fund’s shares outstanding as of today.  Please show your work clearly.

3.   Hedge Funds (6 pts.):  What key characteristics and regulatory constraints distinguish Hedge Funds from other types of Mutual Funds?