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%.
- What does the NPV rule say you should do?
- If you take the contract, what will be the change in the value of your firm?
- 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.
|Expected Return||Standard Deviation||Correlation with Your Portfolio’s Returns|
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.
- What is the expected return of Intel stock?
- What is the expected return of Boeing stock?
- What is the beta of a portfolio that consists of 70% Intel stock and 30% Boeing stock? And the expected return in this portfolio?
- 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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