3.a) What is the price of each of the following bonds ($1,000 principal) if the current interest rate is 8 percent? (4 points) Firm A: coupon 4.5%, Maturity 5 years Firm B: coupon 4.5%, Maturity 10 years Firm C: coupon 12%, Maturity 5 years Firm D: coupon 12%, Maturity 10 years Firm E: coupon 0%, Maturity 5 years Firm F: coupon 0%, Maturity 10 years b) What is the duration of each bond? (8 points) c) Rank the bonds in terms of price fluctuations with the least volatile bond first and the most volatile bond last as judged by each bond’s duration (2 points) d) Confirm your volatility ranking by determining the percentage change in the price of each bond if interest rates rise up to 14%. (4 points) e) What generalizations can be made from the above exercise (2 Points)

3. Here are some sample demand elasticity estimates for various goods:

1

st

class plane ticket = -.3

Regular plane ticket = -1.5

Soda = -.8

Coca-Cola = -3.8

A) Provide some rationale for why the two types of plane tickets have different elasticities.

B) Provide some rationale for why the elasticity of soda is lower than Coca-Cola.

C) If the price of all plane tickets rises, indicate what would happen to the revenue generated from

first class tickets versus regular tickets.

D) Would you expect the cross price elasticity between soda and water to be positive or negative?

Explain.

E) Would you expect the income elasticity on 1

st

class plane tickets to be positive or negative?

Explain.

F) If the price of Coca Cola rises from $1 to $1.5, how much would you expect quantity to change?

Your answer should be in %.

1. George needs to paint his living room walls. He could do it all himself, but would prefer to have some help. He is willing to pay someone up to $50 for the first hour of help, $45 for the second hour, $35 for the third hour, $20 for the fourth hour and $5 for the fifth hour. Assume the current price for painting services is $34 per hour:

   1. How many hours of painting services will George purchase?

   2. How much consumer surplus (if any) will George have as a result?

   3. How many hours will he purchase if the price drops to $25? What will be the change (if any) in consumer surplus relative to your answer to part (ii)? (Note: indicate the sign as well as the magnitude of the change.)

   4. Suppose, instead, that the price drops to $19? How many hours will he purchase? What will be the change (if any) in consumer surplus relative to your answer to part (ii)? (Note: indicate the sign as well as the magnitude of the change.)

All products have different price demand elasticities. For example, many food items have elastic demand due to the substitutes available. Select a good or service (NOTE: Do not pick a class of goods but a specific good) that has not already been selected by another student and describe in three separate short paragraphs:

First paragraph: The good's or services' price demand elasticity and income elasticity. Discuss which of the elasticity rules you used to determine your answer. Note - do not use actual numbers - just use logic by applying the Determinants of Price Elasticity of Demand on pages 128/9.

Second paragraph: How much control might an organization have over pricing based on a product’s elasticity? Discuss which of the elasticity rules you used to determine your answer.

Third paragraph: What is the supply elasticity of the product? Discuss which of the elasticity rules you used to determine your answer.

Bar?? is a portfolio manager. He is analyzing three stocks, Stock 1, Stock 2 and Stock 3, in order to decide whether he should invest in these stocks on behalf of his clients. All three stocks have different characteristics.

Stock 1: The first stock is not paying any dividends for now. The analysts estimate that the stock will start paying dividends of $2 every quarter indefinitely after 5 years. The first dividend payment will be in exactly 5 years from today. The required rate of return on the stock is 10%.

Stock 2: The second stock will distribute $1.5 in exactly 6 months from today. Stock 2 distributes dividends semi-annually and the analysts think that the dividends will grow at a rate of 2% in every 6 months forever. The stock sells for $42.86 today.

Stock 3: The third stock has just paid $1.25 as dividends per share. This company pays annual dividends. It just introduced a new product line and sales are very high so analysts expect that the dividends will grow by 25% per year for the next three years and the growth rate of dividends will decrease to 15% per year after three years and stay at that level for additional two years. After which the growth rate of dividends will decrease to more a manageable level of 5% and stay at that level indefinitely. The required rate of return for the corporation is 15% for the first 4 years. After that it will decrease to 10% and stays at that level forever.

Calculate the price of Stock 1 today.

Bar?? learns from the dealer that Stock 1 sells for $52 in the market today. Based on its price and your valuation of this company stock, decide if Bar?? should include Stock 1 in his client’s portfolio or not, and briefly explain why.

Calculate the annual required rate of return for Stock 2.

Calculate the dividend yield of Stock 2.

Assume a year has passed and the required rate of return on Stock 2 increased to 12% per year forever. Calculate the price of Stock 2 a year from today.

Suppose an investor purchased stock 2 at a price of $42.86 today (assume a year has not passed yet) and sold it a year later at the price you calculated in part (e) of this question. Calculate the capital gains yield and the total return the investor had earned during that 1 year period. Briefly discuss whether the total return you calculated is less or more than the required rate of return the investor had at the time of buying this stock and briefly explain why this is the case.

Draw a time line indicating periods with different dividend growth rates and required rates of return on Stock 3.

Calculate the price of Stock 3 today.

Calculate the price of Stock 3 next year if the required rate of returns are the same.

Suppose an investor purchased Stock 3 at the price you calculated in part (h) today and sold it a year later at the price you calculated in part (i) of this question. Calculate the dividend yield, capital gains yield and the total return the investor had earned during that 1 year period. Briefly discuss whether the total return you calculated is less or more than the required rate of return the investor had at the time of buying this stock and briefly explain why this is the case.

Read the following scenario and answer the questions.

Dr. Henry Duck was working his regular shift as the only doctor working in a small town Emergency Room at around 5:00 pm one day in May when a large tornado struck Dr. Duck’s county directly, causing catastrophic damage and multiple life threatening injuries. Dr. Duck knew that it would make for a long, busy evening treating patients in the Emergency Room, and was ready for the challenge, but did not fully appreciate the Ethical and Moral decisions he would have to make during the evening.

Almost immediately after the tornado passed, the small town’s emergency responders were overwhelmed and neighboring counties’ ambulance and first responder teams helped transport victims of the tornado to Dr. Duck’s emergency room. People were coming in at a rate never seen by Dr. Duck before, with all sorts of varying injuries caused by the tornado. The tornado patients who were coming in were all from different socioeconomic backgrounds, had ages varying from infant to 89 years of age, and included two pregnant women. Dr. Duck was unable to keep up with the heavy flow of incoming patients, which seemed to be never-ending, and began to have to make difficult decisions about who should receive priority in treatment for equally devastating injuries.

At around midnight, Dr. Duck finally felt he was getting the overcrowded emergency room in order and stabilized most of his patients, when the doors of the emergency room flung open. A gunshot victim with life threatening injuries, who was the suspect of a bank robbery in the affluent part of town was being hurried in by police. Almost simultaneously, a woman who underwent complications during a scheduled home delivery of baby twins was rushed through the doors by her concerned and frantic husband who was screaming, “we need help, my wife is going to die! My babies are going to die! Help! Please!” At the same time, Dr. Duck’s beloved 16 year old niece, Daphne, arrived by ambulance with significant, but non- life threatening injuries sustained as a result of a motor vehicle crash.

During the hectic time at the Emergency Room that occurred as a result of the tornado, how would ethical theories and moral judgments impact Dr. Duck’s decisions regarding who to treat first? Would Dr. Duck’s personal values play a role in his decisions?

When the three patients are hurried into the ER at around midnight, who should Dr. Duck treat first and why? What ethical theories apply to this scenario? Does situational ethics, justice and/or bias come into play with the three injured patients who enter the ER around midnight?

1. John’s younger brother calls in just before lunch. He is really excited about a new smartphone that he wants to buy and show it off to his friends at the University. He has been saving for some time and has accumulated $300. His grandfather has also contributed $550 in the kitty. He is asking John for some help as the new phone costs $900. But you know our friend John – He is skeptical as usual and tells his brother, “You know that the value of smartphones falls with time. Trust me, by the same time next year, the phone will be 5% cheaper. You would have seen its customer reviews as well.” By the way, the name of John’s brother is Shaun and he boasts a special combination, which is that of vigorous youth combined with a calm head on his shoulders. He takes his big brother’s advice seriously and decides to deposit his savings along with what his grandfather’s contribution in a 1-year deposit account which offers a real interest rate of 0.15% p.a. The expected inflation rate is 0.8% p.a. He hopes to be able to afford the phone when the deposit matures. Thanking John for his sensible advice, he disconnects the call, leaving John to proceed for lunch.

Will Shaun be able to buy his desired smartphone next year? Support your answer with relevant computations

2. After lunch, Nancy Williams calls up her personal banker to ask about two things. One, she wants a 1-year education loan of $20,000 for her son, Phil and two, she is looking to take out a mortgage loan of $200,000. The banker offers the following choices: 1. Education loan of $20,000: A simple loan to be repaid after a year along with an interest of 10% p.a. or an amortized loan at an interest rate of 10% p.a. to be repaid through 12 equal monthly instalments. 2. Mortgage loan of $200,000: A 9% p.a. loan for 25 years without any discount points or an 8.5% p.a. loan for 25 years with 1 discount point. Nancy decides to go for a simple loan because, well, it is simple instead of being complex. She also decides to avail the discount point facility, assuming that she is unlikely to repay the loan before time. Having done that, she asks for Adam to be ushered into her office.

Assuming yourself to be first Nancy’s husband and then Nancy, prepare an amortization schedule for the first nine months in the first year of the mortgage loan and show the merit / demerit of paying off the loan after 2 years. Who do you think is the eventual winner of the argument? Why?

Consider the following cash flow of an investment and compute the ROR using a trial and error method.

Year 0 1 2 3 4 5 6 7 8 9 10

Cash Flow -$5,000 $100 $100 $100 $100 $100 $100 $100 $100 $100 $7100

What will be your decision on this investment if the MARR is 5%?

Case 6-29 Variable and Absorption Costing Unit Product Costs and Income Statements [LO6-1, LO6-2]

[The following information applies to the questions displayed below.]

O’Brien Company manufactures and sells one product. The following information pertains to each of the company’s first three years of operations:

During its first year of operations, O’Brien produced 91,000 units and sold 79,000 units. During its second year of operations, it produced 84,000 units and sold 91,000 units. In its third year, O’Brien produced 83,000 units and sold 78,000 units. The selling price of the company’s product is $78 per unit.

Case 6-29 Part-3

3. Assume the company uses absorption costing and a FIFO inventory flow assumption (FIFO means first-in first-out. In other words, it assumes that the oldest units in inventory are sold first):

a. Compute the unit product cost for Year 1, Year 2, and Year 3.

b. Prepare an income statement for Year 1, Year 2, and Year 3.