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1 MGTCB09H3 – Principles of Finance Fall 2010 Additional self ­ study exercisesfor final exam (answers at the end) QUESTION 1: Tatyana Litvak & Bradley Mcllroy Inc. issues a new series of bonds on January 1, 2004. The bonds are sold at par (\$1,000), have a 10% coupon and mature in 20 years. Coupon payments are made semiannually (on June 30 and December 31). a. What is the yield to maturity of the bond on January 1, 2004? b. What is the price of the bond three years later, on January 1, 2007, assuming that level of interest rate has fallen to 8%? c. Find the current yield and capital gains yield on the bond on January 1, 2007, given the price as determined in part b above. d. On July 1, 2015, the bonds sell for \$1058.54. What is the YTM at that date? e. What are the current yield and the capital gains yield on July 1, 2015? f. Now assume that you purchase an outstanding bond on September 1, 2020. The going rate of interest is 11%. How large a cheque you must write to complete the transaction? QUESTION 2: Matthew James Ing & Ateet Kapadia Limited (MAL) currently pays \$3 per share annual dividend on its common stock in a single annual installment. Management plans on raising its dividend by 6% per year indefinitely. a. If the required rate of return on this stock is 12% compounded quarterly, what is the current share price? b. Now suppose MAL actually pays its dividends in quarterly installments. MAL has just paid a \$0.75 per share quarterly dividend, as it has paid in the previous 3 quarters. What is your estimate of current share price now? (Hint: Find the equivalent end of year dividend for each year, and assume 12% required rate of return is compounded quarterly). QUESTION 3: Charlie Qiu & Nan Sun Manufacturing (CNM) is considering alternative uses for a building they have purchased recently for \$2,000,000. CNM could continue to rent the building to the present tenants for at least another 20 years at \$125,000 per year. Alternatively they can modify the building to manufacture one of the following two products. The revenue and cost data for two product alternatives follow. Product A Product B Initial cash outlay for building modifications \$375,000 \$500,000 Initial cash outlay for equipment 1,250,000 1,625,000 Annual pretax cash revenue (generated for 20 years) 1,000,000 1,200,000 Annual pretax cash expenditure (generated for 20 years) 500,000 600,000 The building will be used for only 20 years for either product A or product B. After 20 years CNM plans to rent the building to tenants similar to the present tenants. To rent the building again, CNM will need to restore the building to its present layout. The estimated cash cost of restoring the building will be \$80,000 if product A was manufactured and \$300,000 if product B

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2 was manufactured. These costs can be deducted for tax purposes in the year the expenditure occur.
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