Question

1. Company X’s bonds have 25 years remaining to maturity. They have a $1,000 par value, the coupon interest rate is 7%, and the yield to maturity is 10%. If you know that interest is paid annually, what is the bond’s current market price?
   1. $ 658.32
   2. $ 727.69
   3. $ 872.58
   4. $ 987.78
   5. $ 1,000

2. Najd company decided to issue preferred stock that would pay an annual dividend of $10.00 and that the issue price was $200.00 per share. What would be the preferred stock's expected return?

1. 2%
2. 2.5%
3. 3%
4. 4%
5. 5%

3. Which of the following items is not a capital component when we calculate the WACC?
   1. Preferred stock
   2. Long-term debt
   3. Retained earnings
   4. Common stock
   5. Net capital spending/capital expenditure

4. Assume that you were hired as a financial consultant for SABIC. You have been provided with the following information: D₁ = $1.45; P₀ = $22.50; and g = 6.50% (constant). Based on the DCF approach, what is the cost of equity for SABIC?
   1. 11.10%
   2. 11.68%
   3. 12.30%
   4. 12.94%
   5. 13.59%
5. Al kharj Mall estimates that its WACC = 10.5%. The Mall is considering the following capital budgeting projects :

Project    Size   Rate of Return

       A           $1M              12%

      B           $2M              11.5%

       C           $2M              11.2%

       D           $2M              11%

       E          $1M              10.7%

       F           $1M              10.3%

       G           $1M              10.2%

Which set of projects should be accepted:

1. Projects A and B only.
2. Projects A, B, and C only.
3. Projects A, B, C, and D only.
4. Projects A, B, C, D, and E only.
5. Projects F and G only.

Answer 1

Please note the solution:

1) Bond Market Price Calculation

> Formula

Price = Coupen Amount * PVAF (r, n) + Face Value * PVIF (r, n)

where, PVAF = Present Value annuity factor at "r " rate of interest for "n" period

            PVIF = Present Value interest factor at "r " rate of interest for "n" period

Price = [ 1000 * 7% ] * PVAF (10%, 25) + 1000 * PVIF (10%, 25)

         = 70 * [ 1/1.1 + 1/(1.1)2 + 1/(1.1)3 + 1/(1.1)4 + ..... +1/(1.1)25 ] + 1000 * [1 / (1.1)25]

         = 70 * 9.07704   +   1000 * 0.0923

        = $ 727.69

Option b is correct.

b) Expected return - Preferred stock

> Formula = [ Expected Dividend / Issue Price ]

> Calculation

Cost = 10 / 200

         = 5%

Option (e) is correct

c) While calculating WACC, cost of preferred stock, common stock, retained earnings and debt is considered only. But the Net capital spending/capital expenditure is not considered.

Hence option (e) is the answer.

d) Cost of equity calculation

> Formula = [ D1 / P0 ] + g

> Calculation = [ 1.45 / 22.50 ] + 0.065

                     = 0.1294 or 12.94 %

Option (d) is correct

e) Decision rule : The project whose rate of return is more than the WACC will be selected. Becaused project with lower required return than WACC will lead to Negative NPV and hence not selected.

           

Project	Rate of return	Selected or not
A	12	Selected since return is more than 10.5
B	11.50	Selected since return is more than 10.5
C	11.20	Selected since return is more than 10.5
D	11	Selected since return is more than 10.5
E	10.70	Selected since return is more than 10.5
F	10.30	Not Selected since return is less than 10.5
G	10.20	Not Selected since return is less than 10.5

Thus, Project A B C D E is selected

Option ( D) is correct.