1. a) You?ve probably noticed coverage in the financial press of an initial public offering (IPO) of a company?s securities. Is an IPO a primary market transaction or a secondary market transaction? List the types of securities that are traded in the money market and what differentiates the money market from the capital market.
?b) ?The primary objective of the firm is to maximize earnings per share.? In no more than 150 words comment on this statement
2. a) The following data apply to K-Mart (millions of dollars):
Cash and Marketable Securities
Days sales outstanding
Return on Equity
?(1) accounts receivable
(2) current liabilities
(3) current assets,
?(4) total assets,
?(5) Return on Assets,
?(6) common equity, and
(7) long-term debt
Hint: For Q (1) begin with the equation for Days Sales Outstanding= (Acc. Receivable over Sales/360), then solve for A/R
b) Suppose you were a potential investor, explain why would you be interested in free cash flow more than net income?
3. BDO Limited just hired you and has offered you two different salary arrangements. Arrangement 1: you can have $90,000 per year for the next two years or Arrangement 2: you can have $65,000 per year for the next two years, along with a $45,000 signing bonus today.
The bonus is paid immediately, and the salary is paid at the end of each year. If the interest rate is 10 percent compounded monthly, which do you prefer?
4. You have just won the Play-to-win Lottery, which pays you $1 million today and another 10 annual payments that increase by $400,000 per year. Therefore, in one year, you receive $1.4 million, in two years you get $1.8 million and so on. If the appropriate interest rate is 9 percent, what is the present value of your winnings?
?a. Explain why the yield on a bond that trades at a discount exceeds the bond?s coupon rate.
b. Why are longer-term bonds more sensitive to changes in interest rates than shorter term bonds?
c. Does the bond?s YTM determine its price or does the price determine the YTM?
?Alibaba Company Limited sold an issue of bonds with a 10-year maturity, a $1,000 par value, a 10 percent coupon rate, and semi-annual interest payments.
a. Two years after the bonds were issued, the going rate of interest on bonds such as these fell to 6 percent. At what price, would the bonds sell?
b. Suppose that 2 years after the initial offering, the going interest rate had risen to 12 percent. At what price, would the bonds sell?
c. Suppose the condition in part a existed. Further assume that the interest rate remained at 6 percent for the next 8 years. What would happen to the price of the bonds over time?
7. Massy United Ltd. has been experiencing high levels of growth over the past 5 years and management has decided to retain most of its earnings to finance that intense growth level. In light of this, the company has decided to reduce its annual dividend by 30 percent annually for the next 2 years. After that, it will maintain a constant dividend of $2.50 a share. Last year, the company paid $3.60 as the annual dividend per share. If the required rate of return is 14.5 percent what is the market value of its stock? (4 POINTS)
8. The common shares of Almond Beach Ltd., have a beta of 0.75, offer an expected return of 9%, and have an historical standard deviation of return of 17%, alternatively, the common shares of Palm Beach Inc. have a beta of 1.25, offer an expected return of 10%, and have an historical standard deviation of return of 13%. Both firms have a marginal tax rate of 37%. The risk-free rate of return is 3% and the expected rate of return on the market portfolio is 9?%.
a. Would a well-diversified investor prefer to invest in the shares of Almond Beach or the shares of Palm Beach? Explain why and show all calculations.
b. Would an investor who can invest in the shares of only one firm prefer to invest in the shares of Almond Beach or the shares of Palm Beach? Explain why.
9. XYZ Company is considering two investments, both of which cost $40,000. The firm?s cost of capital is 15 percent. The cash flows are as follows:
(a) What is the payback period for each project? Which project would you accept based on the payback period?
(b) What is the discounted payback for each project? Which project would you accept based on the discounted payback criterion?
(c) Calculate the NPV of each project? Which project would you choose based on the NPV criterion?
(d) Based on the IRR criteria which project would you choose if they were mutually exclusive? Show all workings.
10. The following balance sheet extract relates to the ABC Company.
Bonds Payable $1,600,000
Common Stock $5,000,000
Preferred Shares $2,550,000
i. The bonds are 8%, annual coupon bonds, with 9 years to maturity and are currently selling for 95% of par.
ii. The company?s common shares which have a book value of $25 per share are currently selling at $28 per share. The beta on the company?s stock is 0.7
iii. Preferred shares have a book value of $100 per share. These shares are currently selling at $120 per share and carries a coupon rate of 6%.
iv. Market Risk premium is 7 % and 3% is the risk-free rate.
v. Company?s Tax rate is 30%
Required: Determine the following for the company
(a) Total Market value
(b) After-tax Cost of Debt
(c) Cost of Common Stock
(d) Cost of Preferred Stock
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