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Assignment # 01

Submission Deadline:04th July 2016

Topic: Time Value of Money

1) If the effective annual rate of interest is known to be 16.08% on a debt that has quarterly

payments, what is the quoted/simple interest rate?

2) Universal Bank pays 7 percent interest, compounded annually, on time deposits. Regional

Bank pays 6 percent interest, compounded quarterly. Based on effective interest rates, in

which bank would you prefer to deposit your money?

3) Mr A has decided to start saving for his retirement. Beginning on his twenty-first birthday,

Mr. A plans to invest Rs.2,000 each birthday into a savings investment earning a 7 percent

compound annual rate of interest. He will continue this savings program for a total of 10

years and then stop making payments. But his savings will continue to compound at 7

percent for 35 more years, until Mr A retires at age 65. Ms. B also plans to invest Rs.2,000

a year, on each birthday, at 7 percent, and will do so for a total of 35 years. However, she

will not begin her contributions until her thirty-first birthday. How much will Mr. A and

Ms. B savings programs be worth at the retirement age of 65? Who is better off financially

at retirement, and by how much?

4) Mr A is a friend of yours. He has plenty of money but little financial sense. He received a

gift of $12,000 for his recent graduation and is looking for a bank in which to deposits the

funds. Partners saving bank offers an account with an annual interest rate of 3 percent

compounded semi-annually while selwyns bank offers an account with a 2.75 percent

annual interest rate compounded quarterly. Calculate the value of the two accounts at the

end of one year and recommend to Mr A which account he should choose?

5) Your brother has just graduated from high school and is seeking your advice as to whether

he should find a job immediately or go to college for four years and then find a job. He

estimates that if he gets a job immediately, he will earn $15,000 per year for the next 40

years. If he goes to college first, he estimated that he can earn $30,000 for each of the 36

years after he gets out. (Whether he goes to college or not, he plans to retire 40 years from

today.) Assume that his time value of money is 14% and that all cash flows are ordinary

annuities. (If he goes to college first, he can borrow money at 14% too)

a) What will be the present value of his cash flows if he gets a job immediately?

b) What will be the present value of his cash flows if he goes to college first?

c) What should he do?

Topic: Bonds

6) Sun co.s bonds, maturing in 7 years, pay 8% interest on a $1,000 face value. However, interest

is paid semi-annually. If your required rate of return is 10%, what is the value of the bond? How

would your answer change if the interest were paid annually?

7) Sharp Co. bonds are selling in the market for $1,045. These 15 year bonds pay 7% interest

annually on a $1,000 par value. If they are purchased at the market price, what is the expected

rate of return?

8) You own a bond that pays $100 in annual interest, with a $1,000 par value. It matures in 15

years. Your required rate of return is 10 percent.

2. Calculate YTM

Topic: Stocks

9) ABC Ltd paid a dividend of Rs 4 per share at the end of the year. It is expected to grow by 8

percent each year for the next 4 years. The market price of the shares is expected to be Rs 60 at

the end of 4 years. Assuming 12 percent required rate of return of investors, at what price

should the shares of ABC Ltd sell?

10) Blackburn and Smith common stock currently sells for $23 per share. The companys

executives anticipate a constant growth rate of 10.5 percent and an end-of-year dividend of

$2.50.What is your expected rate of return? If you require a 17% return, should you purchase

the stock

11) BMM industries pays a dividend of $ 2 per quarter, the dividend yield on its stock is reported at

4.8%. What price is the stock selling at?

12) Nonconstant Growth. Tattletale News Corp. has been growing at a rate of 20 percent per year,

and you expect this growth rate in earnings and dividends to continue for another 3 years.

a. If the last dividend paid was $2, what will the next dividend be?

b. If the discount rate is 15 percent and the steady growth rate after 3 years is 4 percent, what

should the stock price be today?

13) Mutually Exclusive Investments. Here are the cash flow forecasts for two mutually exclusive

projects:

a. Which project would you choose on NPV and IRR basisif the opportunity cost of capital is 2

percent?

b. Which would you choose if the opportunity cost of capital is 12 percent?

c. Why does your answer change?

14) Ilana Industries, Inc., needs a new lathe. It can buy a new high-speed lathe for $1

million. The lathe will cost $35,000 to run, will save the firm $125,000 in labor costs,

and will be useful for 10 years. Suppose that for tax purposes, the lathe will be

depreciated on a straight-line basis over its 10-year life to a salvage value of $100,000.

The actual market value of the lathe at that time also will be $100,000. The discount rate

is 10 percent and the corporate tax rate is 35 percent. What is the NPV of buying the

new lathe?

15) Blooper Industries must replace its magnoosium purification system. Quick

& Dirty Systems sells a relatively cheap purification system for $10 million.

The system will last 5 years. Do-It-Right sells a sturdier but more expensive

system for $12 million; it will last for 8 years. Both systems entail $1 million

in operating costs; both will be depreciated straight line to a final value of

zero over their useful lives; neither will have any salvage value at the end of

its life. The firms tax rate is 35 percent, and the discount rate is 12 percent.

Which system should Blooper install?

16) PC shopping network may upgrade its modem pool. It last upgraded

life of 5 years and an assumed salvage value of $15mn for tax

purpose. The firm uses straight line depreciation. The old equipment

can be sold today for $80mn. A new modern pool can be installed

today for $150mn. They will have a 3 year life and will be depreciated

to zero using straight line depreciation. The new equipment will

enable the firm to increase sales by $25mn per year and decrease

operating cost by $10mn per year. At the end of the three years, the

new equipment will be worthless. Assume the firms tax rate is 35%

and the discount rate for the project of this sort is 10%. What is the

NPV of the replacement project?

Topic : Cost of Capital

17) The market value of your firms equity is $500 million, which

is also the value of your total debt. Your cost of debt (rd) is 6%

and your cost of equity is (re) is 10%. What is your weighted

average cost of capital (WACC) if your tax rate is 40%?

18) Fuerst Cola has 10,000 bonds and 400,000 shares outstanding. The bonds have a 10%

annual coupon, $1,000 face value, $1,050 market value, and 10-year maturity. The beta

on the stock is 1.30 and its price per share is $40. The risk-less return is 6%, the

expected market return is 14%, and Fuerst Colas tax rate is 40%.

2. What is the after-tax cost of equity financing?

3. What is the WACC

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