Question

2. Peppermint Corporation has just paid a cash dividend of $0.8 per share on its common stock. The dividend is expected to grow by 10 percent per year.

Suppose that investors require a 16 percent return from investments similar to that. Find the current value of a share of Peppermint Corporation.

3. ATA Corporation has just issued a 10-years, with a face value of $1,000, 6% semi-annual coupon bond. The yield-to-maturity (YTM) on this bond is 10% compounded semi-annually.

3a. Determine if this bond is currently valued at par, discount or premium. Explain your answers by applying the concept of bond properties.

3b. Find the current price of this bond.

3c. If the YTM of the bond remains same, what will be the bond price in two years.

4. UFO Company has issued a perpetual bond paying $50 coupon interests each year indefinitely. This perpetual bond, with a face value of $1000, is currently trading at a price of 1,500. Calculate the current interest rate of UFO’s perpetual bond.

6. EGGO Corporation is choosing between the following two capital investments projects:

Year	Project A Cast Flow	Project B Cash Flow
0	-$53,000	-$16,000
1	$27,000	$9,100
2	$27,000	$9,100
3	$27,000	$9,100

Suppose the company requires a 10 percent on its capital investments projects.

6a Using the Net Present Value (NPV) criterion, which project(s) should EGGO Corporation choose if Project A and Project B are independent?

6b If Project A and Project B are mutually exclusive, based on the Net Present Value (NPV) criterion, which project should EGGO choose with reference to your calculations in (a).

6c Using the Profitability Index (PI) criterion, which project(s) should EGGO Corporation choose if Project A and Project B are independent?

6d If Project A and Project B are mutually exclusive, based on the Profitability Index (PI) criterion, which project should EGGO choose with reference to your calculations in (c).

6e Briefly discuss the problems of using Profitability Index (PI) as a capital budgeting technique to decide the project choice.

Answer 1

2]	Current value of a share = 0.8*1.10/(0.16-0.10) =	$              14.67
3]
a]	Currently the bond is valued at a discount. This is
	so because, bond prices move inversely with
	YTM. Here, the YTM has gone up since issue at par, taking the
	bond price below the face value.
b]	Current price is the PV of the expected cash flows from
	the bond if, it is held to maturity, the discount rate being
	the YTM.
	Current price of the bond = 1000/1.05^20+30*(1.05^20-1)/(0.05*1.05^20) =	$            750.76
c]	Price of the bond in two years = 1000/1.05^16+30*(1.05^16-1)/(0.05*1.05^16) =	$            783.24
4]	Current interest of the bond = 50/1500 =	3.33%
6]	NPV of Project A = -53000+27000*(1.1^3-1)/(0.1*1.1^3) =	$            14,145
	PI of Project A = 27000*(1.1^3-1)/(0.1*1.1^3)/53000 =	1.27
	NPV of Project A = -16000+9100*(1.1^3-1)/(0.1*1.1^3) =	$              6,630
	PI of Project A = 9100*(1.1^3-1)/(0.1*1.1^3)/16000 =	1.41
6a]	If NPV is used and the projects are independent, both the projects can be chosen as their NPVs are positive.
6b]	If NPV is used and both the projects are mutually exclusive, Project A will be chosen as it has higher NPV.
6c]	If PI is used and the projects are independent, both the projects can be chosen as their PIs are greater than 1.
6b]	If PI is used and both the projects are mutually exclusive, Project B will be chosen as it has higher PI.
6e]	PI is a ratio, given by PV of cash inflows/PV of cash outflows.
	It tells the PV of benefits for every dollar invested. But, it
	does not give the absolute addition to the shareholders'
	wealth. Hence, when applied to ranking of projects, it may
	rank a project with lower NPV higher than a project with
	higher NPV. This will result in suboptimal decisions when
	there is no constraint for funds. However, when there is
	constraint for funds PI would be useful in capital rationing.