Question 1 (25 marks)

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 (the price for AMCOR’s bond)?

Question 2 (15 marks)

Storico Co. just paid a dividend of $4 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividend growth rate by 5 percentage 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 15 percent per annum, what will a share of Storico’s stock sell for today?

Question 3 (15 marks)

Your factory has been offered a contract to produce a part for a new printer. The contract would last for five years and your cash flows from the contract would be $3 million per year. Your upfront setup costs to be ready to produce the part would be $6.5 million. Your cost of capital for this contract is 10%.

1. What does the NPV rule say you should do?
2. If you take the contract, what will be the change in the value of your firm?
3. What is the payback period?

Question 4 (15 marks)

You have a portfolio with a standard deviation of 30% and an expected return of 18%. You are considering adding one of the two stocks in the following table. If after adding the stock you will have 20% of your money in the new stock and 80% of your money in your existing portfolio, which one should you add? Why? Explain.

Question 5 (15 marks)

Suppose Intel stock has a beta of 1.8, whereas Boeing stock has a beta of 1.2. If the risk free interest rate is 5% and the expected return of the market portfolio is 15%. The market risk premium is 10%. You expect the Intel stock to have a return of 20% and Boeing stock to have a return of 25% over next year.

1. What is the expected return of Intel stock?
2. What is the expected return of Boeing stock?
3. What is the beta of a portfolio that consists of 70% Intel stock and 30% Boeing stock? And the expected return in this portfolio?
4. Based on your answer in part (a) and part (b), which stock should you buy and which stock should you sell? Why?

Question 6 (15 marks)

At the beginning of 2013, Apple’s beta was 1.2 and the risk-free was about 3%. Apple’s price was $75. Apple’s price at the end of 2013 was $80. If you estimate the market risk premium to have been 6%, did Apple’s managers exceed their investors’ required return as given by the CAPM? Why? Explain.

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