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FINA_4320_Class8

# FINA_4320_Class8 - Homework 1(with solutions Chapter 2#6...

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Unformatted text preview: Homework 1 (with solutions) Chapter 2 #6 Find the after tax return to a corporation that buys a share of preferred stock @ \$40, sells it at year end @ \$40, and receives a \$4 year-end dividend. The firm is in the 30% Tx bracket. Solution The total before-tax income is \$4. After the 70% exclusion ( preferred stock ), taxable income is: (0.30 × \$4) = \$1.20. Therefore: Taxes = (0.30 × \$1.20) = \$0.36 After-tax income = (\$4 - \$0.36) = \$3.64 After-tax rate of return = (\$3.64/\$40) = 9.1% #9 Using the data below, calculate the first period rates of return on the following indexes and stocks a. market value-weighted index b. equally weighted index Stock P Q 1 P 1 Q 2 P 2 Q A 90 100 95 100 95 100 B 50 200 45 200 45 200 C 100 200 110 200 55 400 Note: k P and k Q stand for the price and quantity at period t , respectively. Solution a. Total market value at t = 0 is: (9,000 + 10,000 + 20,000) = 39,000 Total market value at t = 1 is: (9,500 + 9,000 + 22,000) = 40,500 Rate of return = (40,500/39,000) – 1 = 3.85% b. The return on each stock is as follows: r A = (95/90) – 1 = 0.0556 r B = (45/50) – 1 = –0.10 r C = (110/100) – 1 = 0.10 The equally-weighted average is: [0.0556 + (-0.10) + 0.10]/3 = 0.0185 = 1.85% #11 Suppose that short term municipal bonds offer yields of 4%, while taxable bonds pay 5%. Which gives the higher after tax yield if the Tx bracket is a. Zero b. 10% c. 20% d. 30% Solution a. The taxable bond. With a zero tax bracket, the after-tax yield for the taxable bond is the same as the before-tax yield (5%), which is greater than the yield on the municipal bond. b. The taxable bond. The after-tax yield for the taxable bond is: [0.05 × (1 – 0.10)] = 4.5% c. You are indifferent. The after-tax yield for the taxable bond is: [0.05 × (1 – 0.20)] = 4.0% The after-tax yield is the same as that of the municipal bond. d. The municipal bond offers the higher after-tax yield for investors in tax brackets above 20%. Chapter 3 #3 D Trader opens brokerage account, purchases 300 shares of S @40 per share. Borrows \$4,000 from broker; interest on loan is 8%. a. what is the margin for the first purchase? b. If price is down to \$30 per share at the end of the year, what is the remaining margin? If the maintenance margin is 30%, will there be a call? c. What is the rate of return on this investment? Solution a. The stock is purchased for (300 × \$40) = \$12,000. The amount borrowed is \$4,000. Therefore, the investor put up equity, or margin, of \$8,000. b. If the share price falls to \$30, then the value of the stock falls to \$9,000. By the end of the year, the amount of the loan owed to the broker grows to: (\$4,000 × 1.08) = \$4,320. Therefore, the remaining margin in the investor’s account is: (\$9,000 − \$4,320) = \$4,680....
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FINA_4320_Class8 - Homework 1(with solutions Chapter 2#6...

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