Question

AF208 question 1

a).A zero-coupon bond has a face value of $1000 and 10 years to maturity. Bondholder’s have a required return of 12% p.a. compounded annually. The net proceeds per bond from the issue

A. $400

B. $322

C. $350

D. $284

b) Which statement is FALSE regarding WACC and its components?

A. The WACC may increase if the firm seeks external financing for a project.

B. For an all-equity firm, the cost of equity equals the WACC

C. The WACC should be used as the discount rate for all projects that the firm considers

D. The cost of debt is usually less than the cost of equity.

c.) Smith Products is considering changing its credit terms from net 30 to 2/10 net 30.

The firm’s financial managers need to evaluate:

A. the increased investment in accounts receivable to increased sales

B. the reduced level of bad debt expense as customers pay sooner

C. the increased level of bad debt expense as customers pay much later

D. the increased contribution margin as customers pay sooner

d) A project has an NPV of $220000 and a PVFA of 1.7355. The equivalent annual annuity for this project is:

A. $134 500

B. $126 764

C. $132 456

D. $381 810

Answer 1

1) B) $ 322

Explanation :

Net proceeds from issuance of zero coupon bond = Maturity value / ( 1+i) ⁿ

Maturity value = $ 1,000

i = 12% & n = 10

Proceeds from issuance of zero coupon bond = $ 1,000 / ( 1+12) ¹⁰ = 1,000 / 3.105848 = $ 321.97 or $ 322

2) C) The WACC should be used as the discount rate for all projects that the firm considers .

Explanation : Actually, WACC is commonly used as the discount rate for future cash flows in DCF analysis.

3) D) The increased contribution margin as customer pay sooner

Explanation : If customer can get discount by paying within 10days. It will encourage them to pay sooner and contribution margin increases.

Bad debt is not related and relevant with this and nor account receivables increased, rather it will decrease because of prompt payment .

4) B) $ 126,764

NPV = Equivalent annual annuity X PVFA

$ 220,000 / 1.7355 = Equivalent annual annuity

Equivalent annual annuity = $ 126,764.62 or $ 126,764