Question 1:

AMCOR Limited has a corporate bond outstanding with a 7% coupon, semi-annual interest, 15 years to maturity and a face value of $1,000. Similar bonds currently yield 13%. By prior agreement, the company will skip the coupon payments in years 6, 7, and 8, (6 payments in total; the payments at time 6 through to 8.5). These payments will be repaid, without interest, at maturity. What is the corporate bond’s value?

Question 2:

Storico Co. just paid a dividend of $3.85 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 5 percent dividend growth, after which the company will keep a constant growth rate forever. If the required return on Storico stock is 13 percent, what will a share of stock sell for today?

Question 3:

A utilization of cash flow analysis is setting the bid price on a project. To calculate the bid price, we set the project NPV equal to zero and find the required price. Thus the bid price represents a financial break-even level for the project. Guthrie Enterprises needs someone to supply it with 140,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you’ve decided to bid on the contract. Before you made the decision, you’ve paid a consulting firm $100,000 last year for evaluating this project. It will cost you $1,800,000 to install the equipment necessary to start production; you’ll depreciate this cost straight-line to zero over the project’s life. You estimate that in five years this equipment can be salvaged for $150,000. Your fixed production costs will be $265,000 per year, and your variable production costs should be $8.50 per carton. You also need an initial investment in net working capital of $130,000. If your tax rate is 35 percent and you require a 14 percent return on your investment, what bid price should you submit?

Question 4:

A share has a beta of 1.4 and an expected return of 16%. A risk-free asset currently earns 6.25%.

  1. What is the expected return on a portfolio that is equally invested in the two assets?
  2. If a portfolio of the two assets has a beta of 0.8, what are the portfolio weights?
  3. If a portfolio of the two assets has an expected return of 12%, what is its beta?
  4. If a portfolio of the two assets has a beta of 2.80, what are the portfolio weights? How do you interpret the weights for the two assets in this case? Explain.

 

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