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AK/ADMS 3530.03 Finance Final Exam Winter 2008 April 10, 2008 Solutions Type A Exam Each question is worth 2 points. 1. (Q. 8 in B) You’re a recent Atkinson graduate and make the following acquisitions this year. New car of \$28,320. New wardrobe of \$3,248. You also have a new job that pays you \$42,000 after taxes this year and \$46,000 after taxes next year. Your annual living expenses are \$34,000. You plan to get a loan to make up for the difference between your current income and current consumption. The bank offers you a loan at a rate of 14% annually and you intend to pay off this loan in one year from today. How much will you have left to spend next year? A) \$19,132.48 B) \$23,568.00 C) \$26,867.52 D) \$65,568.00 Answer A This year you need \$28,320 + \$3,248 + \$34,000 = \$65,568. Therefore you must borrow \$65,568 – \$42,000 = \$23,568 this year. You will repay next year FV = \$23,568 (1+0.14) = \$26,867.52. Therefore you will have \$46,000 – \$26,867.52 = \$19,132.48 left to spend next year. 2. (Q. 9 in B) Joshua Corporation recently issued 10-year bonds at a price of \$1,000, which is equal to the par value of each bond. These bonds pay \$60 in interest every six months. The bond price has remained the same since they were issued. Due to additional financing needs, the firm wishes to issue new bonds that would have a maturity of 10 years, a par value of \$1,000, and pay \$40 in interest every six months. If both bonds have the same yield, how many new bonds must Joshua Corp. issue to raise \$2,000,000 cash? A) 2,400 B) 2,596 C) 3,000 D) 5,000 Answer B 1

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Since the old bond issue sold at its par value, and still sells at par, its yield (and the yield on the new issue) must be 6 percent semiannually. The new bonds will be offered at a discount: V new bond = \$40(PVIFA 6%,20 ) + \$1,000(PVIF 6%,20 ) = \$40((1 - 1/1.06 20 )/0.06) + \$1,000(1/1.06 20 ) = \$40(11.4699) + \$1,000(0.3118) = \$770.60. Number of bonds = \$2,000,000/\$770.60 = 2,595.38, or approximately 2,596. Financial calculator solution: Inputs: N = 20; I = 6; PMT = 40; FV = 1,000. Output: PV = -\$770.60; V B = \$770.60. B Number of bonds: \$2,000,000/\$770.60, or approximately 2,596 bonds. 3. (Q. 10 in B) Julia Corporation's stock recently paid a dividend of \$2.00 per share. The company has a constant growth rate of 5 percent and a beta equal to 1.5. The required rate of return on the market portfolio is 15 percent, and the risk-free rate is 7 percent. Julia Corp. is considering a change in policy which will increase its beta to 1.75. If other things being equal, what new constant growth rate will cause the common stock price of Julia Corp. to remain unchanged? A) 5.88% B) 6.77% C) 8.85% D) 18.53% Answer B Calculate the initial required rate of return: using the CAPM: r e = 0.07 + 1.5(0.15 - 0.07) = 0.19 = 19%. P
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