T2_371_F09_TypeA_Soln

T2_371_F09_TypeA_Soln - Tma A Salwhlm ActSc 371 Midterm...

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Unformatted text preview: Tma A Salwhlm ActSc 371 Midterm Test 2 This examination contains 5 WA questions with 56 points in total (No multiple choice questions this time) Instruction: Aids: non-programmable Calculator The last page is the formula sheet Answer all questions in the space provided. Your rationale is as important as your final answer ID#: Last Name: First Name: 1. [10 pts] Wintendo Co. wants to issue new 20-year bonds for developing a new game system. The company currently has 8% coupon bonds with face amount $1,000 on the market that sell for $1,148.77. These bonds make semiannual coupons and mature in 10 years. a) [4 pts] Show that the YTM is 6% on the existing bonds p/lUUUXGQO/O/ol \[ 114891;} :‘ 40Qm37fi+ Wm) 0‘03)?” A? K Lox) 111 W] a, VM»%/ C M reunitigp . , ll \l/TM “fJY Semiavlhvxékj air/pm 1300513 \ ‘~ 5m Oxnml tile 11w mtg. '3 ”7 l”. . b) [6 pts] What coupon rate should the company set on its new bonds if it wants them to sell 21% Briefly explain why. "P LOU/PG“ Vat—Q : TTM ) flue/m FflC/Q/ [y‘é LOW/i : an/ alibi/”11¢ . (”0W1m 111‘ @517. to 19...; an at 1”“ :> D 2. [12 pts] You are given the following information on Elmira Pizza Inc. Assume the present time is t=0. ° Earnings are currently $5.5 millions There are 1 million outstanding shares It has no growth plan for now The dividend payout ratio is 100%; The dividends will be paid out at t=l,2,3... The required return on its stock is AER 12% a) [4 pts] Determine the current (that is, at t=0) stock price based on the given information 5%» : 56M” M 1%.! 00 1 f Mfg : W5; :E l0 he! Mimi; 0,/2/ 4?.0035 b) [8 pts] Now suppose that the company proposes an expansion project. The project proposes to open two new pizza stores for the next two years (that is, a new store will be opened at F1 and 2, respectively). In order to fund new stores, 60% of the company's earnings will be retained for the next two years. Each store will earn 40% on its initial investment at each year-end f0 years. The company will change its dividend payout ratio back to 100% from time t:3. Compute the new stoc 'price based on this proposal. 3. [14 pts] Consider the following two projects. Use a discount rate of 7% for the unit time interval in both projects. HINT: a§l7% : 4.1002. Time Project A Project B 0 -100 -55 I 40 20 2 40 20 3 40 20 4 40 20 5 40 20 a) [4 pts] Determine which one should you choose based on the NPV. NW<A> f- ._ i559 jm [15.0 X {2%.}7) t": g4} t.) ()f MMB) =2 tr 7‘ W “a 3W2, 2:“ e boo % 5(leth % ave/”B b) [4 pts] Determine which one you should choose based on the payback time period rule based on the linear interpolation. t 39 ”my 4? Ac: ”i D vgg/ t; Q ””20 ’1? t9} +20 +§ c) [6 pts] Let us denote the IRR of Project A to be X%. Show (or prove) that 25% < X < 30%. Note for part (c): * You may use a graph but should clearly explain the graph and your rationale * No points will be given ifthe answer is obtained by your financial calculator's built-in IRR function WWMMW yaw MMBWM aw 4. [8 pts] An asset is in CCA 10% class with a purchase price 0f$1,000. Compute: a)[4 pts] the CCA amount in the Wyear 5365” b)[4 pts] the PV of the CCA tax shield assuming 5% interest rate, a resale price of 500 at the end of year 3, and a corporate tax rate of 40%. RVWW Wee/i" ; [my 7 /b 7 X “77 (Jr 0.52452» mm {§®//m)%/°2X¢°Z I WWW“ m»— ”we X " 57 + /07» [+52 37 +77 7,555 ; DULCUD} )4 ofiaéij? W @3133} xi— hot; ~ 169.723?% ,,. (IX, PM”?! 2149433”! 5. [12 pts] This question concerns the single period binomial option pricing model. The risk-free rate is 10%. Stock price Option payoff 100 / 120 ‘7 / O \ 90 ' \ 20 tZO t=1 tZO Fl 21) [4 pts] Using the risk neutral probability, compute the current price of the put option. E0, Swing/w) Zx/Qo + (/7?) 90 (+0.! lac 2 CO“ L/3m+éfim: ébhoé/ i./ b) [gpts] Compute the delta of the option l4 c)[0 pts] Assume that the actual (physical) probability of stock going up is 30%. Compute the risk premium that the investors demand on this option. E<Q> 0.3¥0+0\¥X>® \ ,7 _ -__,_ M PM; mi brim (MM lief ~ m [4+9 1. in,” th8 D 6 Mil ,‘fiww M) ding/agave J Formula sheet Note: No further explanation will be given for these formulas at the examinations. Student should know what each variable stands for. Sustainable growth rate (Covered in Ch.3) PC1—@U+E—) :T— Ml—d)(1+E) Alternative formulas for sustainable growth rate (Covered in Ch.3) If ROE is defined as the ratio of the current year’s net income to the previous year’s equity 9 : ROE x (1 — d) If ROE is defined as the ratio of the current year’s net income to the current year’s equity ROE x (1 —d) ng—ROExfl—d) Growing annuity (Covered in Ch. 5) 1 —91" n " C(l 1 m(..) =:—— =0 ——1 (1+r))t r—g i=1 Growing Perpetuity with differential growth (Covered in Ch. 5 and 6) Assuming 91 for the first 71 payments and 92 thereafter, n 1— (1_+9_1) 71—1 1 PV—C 1+7‘ + (1+g1) (1—1—92) >< r—m T—gz um” PV CCA Tax Shield (Covered in Ch.8) CdTC 1+0.5k 1nin(O,S)dTC 1 PVC TS~ CA k+dx 1+k k+d Xn+kw Black-Scholes formula for a call option (Covered in Ch. 23) c=SxNMfl—E€”wafl d1=1n(S/E)+(r + ”72)T aVT d2 2 d1 ~ (Ix/T 1O ...
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