1. A 10-year Corporate bond is issued with a face value of $100,000, paying interest of $2,500 semi-annually.
If market yields decrease shortly after the T-bond is issued, what happens to the bond’s:
a. price?
b. coupon rate?
c. yield to maturity?
Company ABC's earnings and dividends will grow at 0.4% monthly during the next five years.
Its growth will stop after year 5. In year 6 and afterward, it will pay out all earnings as dividends.
Assume next year’s EPS is $12 and the dividend is $4 and the market capitalization rate is 8 %.
What is ABC’s stock price?
McCoy, Inc. has equity with a market value of $35 million and
debt with a market value of $25 million.
The cost of the debt is 5 percent semi-annually.
Treasury bills that mature in one year yield 4 percent per annum,
and the expected return on the market portfolio over the
next year is 15 percent.
The beta of McCoy’s equity is 0.75 .The firm pays no taxes.
a. What is McCoy's debt-equity ratio?
b. What is the firm’s weighted average cost of capital?
c. What is the cost of capital for an otherwise identical all-equity firm?
Poulsbo Manufacturing, Inc. is currently an all-equity firm that pays no taxes. The market
value of the firm’s equity is $4 million. The cost of this unlevered equity is 15 percent per
annum. Poulsbo plans to issue $750,000 in debt and use the proceeds to repurchase stock.
The cost of debt is 5 percent semi-annually.
a. After Poulsbo repurchases the stock,what will the firm’sweighted average cost of capital be?
b. After the repurchase, what will the cost of equity be? Explain.
c. Using MM-Proposition 2, what will be the weighted average cost of capital after the
repurchase?
O,Meara, Inc. plans to issue $7 million of perpetual bonds.The face value of each bond is $1,000
The semi-annual coupon on the bonds is 4.5%
Market interest rates on one-year bonds are 8%
With equal probability, the long-term market interest rate will be either 10% or 6%
next year. Assume investors are risk-neutral.
a. If the O'Meara bonds are noncallable,what is the price of the bonds?
b. If the bonds are callable one year from today at $1,250, will their price be greater than
or less than the price you computed in (a)? Why?
Leases R Us, Inc. (LRU) has been contracted by Robotics of Beverly Hills (RBH) to provide lease financing for
a machine that would assist in automating a large part of their current assembly line. Annual lease payments will start
at the beginning of each year. The purchase price of this machine is $250,000, and it will be leased by RBH for a period
of 5 years. LRU will utilize straight line depreciation of $50,000 per year with a zero book salvage value. However,
salvage value is estimated to actually be $50,000 at the end of 5 years. LRU is required to earn a 3%, quarterly after-tax rate
of return on the lease. LRU uses a marginal tax rate of 35%. Calculate the annual lease payments. (Remember, these
payments are to be considered at the beginning of each year—annuity due.)
Hints for students:
There are 3 major steps that need to be accomplished in order to calculate the annual lease payment.
Step A: You need to calculate the amount to be amortized. This would be the cost of the machine less the PV of the after
tax salvage value of the machine and less the PV of the depreciation tax shield.
Step B: You need to calculate the quarterly after-tax required lease income. (Remember, in this step, you need to calculate
it as an annuity due—a beginning of the year payment.) Take your answer from Step A as a present value, and using the number
of years and the required rate of return, calculate the payment.
Step C: Calculate the lease payment. You need to adjust for the appropriate tax rate. Therefore, take your answer in Step B and
divide it by (1 - the tax rate). This will give you the required lease payment.
