10 May IF THE STOCK IS SELLING FOR $35 WHAT SHOULD YOU DO?
INSTRUCTIONS TO STUDENTS 1. This assignment contains question that is set in English. 2. Answer in English only. 3. Your assignment should be typed using 12 point Times New Roman font and 1.5 line spacing. 4. You must submit your hardcopy assignment to your Facilitator according to the due date. 5. Your assignment should be prepared individually. You should not copy another person’s assignment. You should also not plagiarise another person’s work as your own. EVALUATION This assignment accounts for 30% of the total marks for the course. Question 1 a. The yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield what would be its expected capital gains yield? Explain. b. You hold two bonds. One is a 10-year zero coupon bond and the other is a 10-year bond that pays a 6% annual coupon. The same market rate 6% applies to both bonds. If the market rate rises from the current level: (i) What will happen to the prices of each bond? (ii) Which bond would have higher price change? c. A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Suppose the yield to maturity remains constant. What would happen to the price of the bond from one year from now? Explain. d. Which of the following bonds would have the greatest percentage increase in value if all interest rates fall by 1%? i. 20-year 10% coupon bond. ii. 1-year 10% coupon bond. iii. 20-year zero coupon bond. iv. 10-year zero coupon bond. e. The YTMs of three 10-years bonds with $1 000 face value and have the same level of risk. Bond A has an 8% annual coupon Bond B has a 10% annual coupon and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years. Bond A sells at discount or premium? Explain. What is expected about its price next year? [Total 20 marks] Question 2 (a) Noncallable bonds that mature in 10 years were recently issued by Sternglass Inc. They have a par value of $1 000 and an annual coupon of 5.5%. If the current market interest rate is 7.0% at what price should the bonds sell? (b) Curtis Corporation’s noncallable bonds currently sell for $1 165. They have a 15-year maturity an annual coupon of $95 and a par value of $1 000. What is their yield to maturity? [Total 10 marks] Question 3 (a) Discuss the advantages and disadvantages of issuing stock versus long-term debt? (b) A company estimates that the current risk-free rate is 6.25% the market risk premium is 5% and the company’s beta is 1.75. The company estimates that that its dividend will grow at a rate of 25% this year 20% next year and 15% the following year. After three years the dividend is expected to grow at a constant rate of 7% a year. The company’s last dividend was $1.15. What is the value of the stock today? (c) The ship Corp. has paid annual dividends of $0.48 $0.60 and $0.62 a share over the past three years respectively. The company now predicts that it will maintain a constant dividend since its business has leveled off and sales are expected to remain relatively constant. Given the lack of future growth at what price will you only buy this stock if you can earn at least a 14% rate return? (d) The risk free rate is 8%; the expected return on the market is 12%. Stock X has a beta of 1.3 a dividend growth rate of 7% and a current dividend of $2.40. If the stock is selling for $35 what should you do? [4 8 4 4 = 20 marks] Question 4 Two projects’ net cash flows are given as follows (with cost of capital 12% for both projects): Year Project X Project Y 0 ($10 000) ($10 000) 1 6 500 3 500 2 3 000 3 500 3 3 000 3 500 4 1 000 3 500 (a) Calculate each project payback period NPV IRR and PI. (b) Which project or projects should be accepted if they are independent? If they are mutually exclusive? [ 10 marks]
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