Assignment
1. ( T or F ) An automaker recently acquired a windshield manufacturer. This type of an acquisition is called a vertical merger.
2. ( T or F ) Black Teas recently acquired Green Teas in a transaction that had a net present value of $1.23 million. The $1.23 million is referred to as synergy.
3. ( T or F ) Short-term financing may be riskier than long-term financing since, during periods of tight credit, the firm may not be able to rollover (renew) its debt.
4. ( T or F ) All other things equal, for a given percentage change in the discount rate on a bond, the price of the bond will change by a greater percentage the shorter its maturity.
5. ( T or F ) You own a July $15 call on ABC stock. Assume today is April 20 and the price of the stock is $13. The call option is in-the-money.
6. ( T or F ) A lockbox is a special safe used by a firm that can only be opened at prespecified times of the day.
7. ‘The law of one price' says that the level of exchange rate should adjust such that consumers can pay the same price wherever they buy. Is the theory consistent with the reality? Explain carefully.
8. You want to know the present value of a lump sum, $50,000, to be paid in 2.5 years from now. What is its present value at the rate of 5.7% under continuous compounding?
9. You will deposit $2,000 at the end of each of next 5 years. If the interest rate is 8% (annual compounding), how much will you have accumulated in 25 years?
10. ABC Company recently issued two types of bonds. The first issue consisted of 20 year straight debt with an 8 percent annual coupon. The second issue consisted of 20 year bonds with a 6 percent annual coupon and attached warrants. Both issues sold at their $1,000 par values. What is the implied value of the warrants attached to each bond?
11. A bond with 20 detachable warrants has just been offered for sale at $1,000. The bond matures in 20 years and has an annual coupon of $115. Each warrant gives the owner the right to purchase two shares of stock in the company at $18 per share.
Ordinary bonds (with no warrants) of similar quality are priced to yield 17 percent. What is the value of one warrant?
(The following information applies to the next four questions)
Pappy's Potato has come up with a new product, the Potato Pet (they are freeze-dried to last longer). Pappy's paid $120,000 for a marketing survey to determine the viability of the product. It is felt that Potato Pet will generate sales of $575,000 per year. The fixed costs associated with this will be $179,000 per year, and variable costs will amount to 20 percent of sales. The equipment necessary for production of the Potato Pet will cost $620,000 and will be depreciated in a straight-line manner for the four years of the product life (as with all fads, it is felt the sales will end quickly). This is the only initial cost for the production. Pappy's is in a 40 percent tax bracket and has a required return of 13 percent.
12. What is the initial () cash outflows?
13. What is the operating cash inflows at ?
14. What is the total cash flows (operating cash flows plus terminal cash flows) at ?
15. Compute the NPV and IRR of the project. Should this new project be accepted?
16. Compute the fair price of the following perpetual bond. Its first interest, $120, will be paid 15 years from now and will be adjusted upward by 3% every year to compensate for the risk of inflation. Investors require 8% return on the bond.
17. Jane and Tom are searching for their first house. They have saved $45,000 for down-payment. Their mortgage company, offering a 30-year 7.2% loan, suggests that they spend up to $1,750 for monthly mortgage payment. What is the maximum price of a house they can afford to buy? Ignore all the transaction costs.
18. Three years ago, you bought a 12% bond that had 7 years to maturity and a yield to maturity of 12%. Today (after the sixth interest payment), you sold the bond when it is yielding 15%. What is your annual rate of return for the three year period? All coupon payments are semi-annual, and the par value is $1,000.
(The following information applies to the next four questions)
Given the following information for XYZ Co., you want to find the cost of capital (WACC). The firm's tax rate is 40%. Ignore all the flotation cost.
Debt: 8,000 7% coupon bonds outstanding, $1,000 par value, 15 years to maturity, selling for 98% of par; the bonds make semiannual payments.
Preferred stock: 20,000 shares of 7% preferred stock outstanding, $100 par value, currently selling for $90 per share.
Common Stock: 300,000 shares outstanding, selling for $50 per share; the beta is 1.25. Currently, the market risk premium is 6%, and the risk-free rate is 3%.
19. What is the cost of debt?
20. What is the cost of preferred stock?
21. What is the cost of common stock?
22. Given the above information, what is the cost of capital?
(The following facts apply to the next two questions about a convertible bond making semiannual payments.)
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Conversion price
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$52/share
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Coupon rate
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6.5%
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Par value
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$1,000
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Yield on nonconvertible debentures of same quality
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8.5%
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Maturity
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25 years
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Market price of stock
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$42 /share
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23. If the price of the convertible bond is $900, what is the value of the call option embedded in the convertible bond?
24. If you buy the convertible bond, are you willing to convert it now? Why or why not? Please explain.
25. You just bought a machine on a credit terms: 2/10, net 40. If your cost of capital is 12%, would it be rational for you to take the cash discount? Why or why not? Explain carefully.
26. If investors become more risk averse, what will happen to the price of stocks in general? Why?
27. Suppose that you are a financial manager of a company that exports mainly to England. You expect to receive a huge payment in British pounds from your customer in a couple of months. To avoid the potential adverse move of British pound, you have decided to completely hedge with forward contracts. What is the advantage of using forward contracts? What is the disadvantage?
28. Is it possible for a firm to have too much cash? Why would shareholders care if a firm accumulates large amounts of cash?
29. Suppose that your company's stock has been rising higher on a strong momentum. Will it be a rational decision for your firm to decide to issue stock to finance its projects? Why or why not? Explain carefully.
30. Suppose that you are a financial manager of a manufacturing company. Would you raise or lower the cash balance of your company if interest rates are rising in the financial market? Why?