Question

 

1. Value Invest inc is considering purchasing a parcel of wilderness land near a popular historic site. Although this land will cost Value Invest $400,000 today, Value Invest expects to make $35,000 at the end of each year indefinitely by renting out wilderness campsites on this land. If the appropriate discount rate is 8%, then the NPV of this new wilderness land project is closest to: A) $50,000 B) -$37,500 C) -$50,000 D) $37,500

2. Consider stocks and corporate bonds of Selfie Inc. Selfie's stock and bond price were equal to €30 and €70 at the start of 2017 and increased in value to €50 (Selfie stock) and €75 (Selfie bond) at the end of 2017. Selfie paid a coupon of €5 over 2017 and a dividend of €10. Which statement is TRUE? A) Selfie's total stock return falls below Selfie's total bond return over 2017. B) The stock's capital gain rate exceeds the bond's capital gain rate over 2017. C) Selfie's dividend yield is equal to 40%. D) The bond's yield to maturity increased over 2017.

Answer 1

1). Initial value of land today = $400,000

Expected value to make at the end of each year indefinately = $35,000

Dsicount rate =8%

Calculating the Present Value of expected value each year :-

Present Value = Cash Flow/Discount rate

=$35,000/8%

=$437,500

NPV = Present Value of expected value - Initial value of land today

= $437,500 - $400,000

=$37,500

Hence, Option D

2). Selfie's stock(P0) = $30

Stock value increased to (P1) = $50

Stock Dividend = $10

Calculating Capital gain Yield and Dividend Yield for Stock:-

- Capital gain Yield = (P1 - P0)/P0

=($50 - $30)/$30

= 66.67%

- Dividend Yield = Dividend/P0

=$10/$30

= 33.33%

Total Stock Return = Capital gain Yield + Dividend Yield

= 66.67% + 33.33%

= 100%

-  Selfie Bond Price (P0) = $70

Bond value increased to (P1) = $75

Bond Coupon = $5

Calculating Capital gain Yield and Dividend Yield for Stock:-

- Capital gain Yield = (P1 - P0)/P0

=($75 - $70)/$70

=7.143%%

- Dividend Yield = Dividend/P0

=$5/$70

= 7.143%

Total Stock Return = Capital gain Yield + Dividend Yield

= 7.143% + 7.143%

= 14.29%

The Statement which is True is Statment B. Because

A- Selfie's total Stock return is 100% while Bond's Stock return is 14.29%. Thus, Stock return is greater than bond's .hence, False.

B - Selfie's Capital Gain rate is 66.67% while Bond's Capital Gain rate is 7.413%. hence, True.

C- Selfie's dividend yield is equal to 33.33%. hence, False

D- Bond's price has increased in 2017 and as per Inverse relationship between Price and YTM, when price increase YTM decreases. hence, fasle.

If you need any clarification, you can ask in comments.