Business Finance (Section E) Assignment Bond Valuation, Stock Valuation and Capital Budgeting Techniques Submission May 19,

9, 2012
Bonds Valuation 1. A bond trader purchased each of the following bonds at a yield to maturity of 8 percent. Immediately after she purchased the bonds interest rates fell to 7 percent. a.
PRICE

What is the percentage change in the price of each bond after the decline in interest rates? Fill in the following table:
@ 8% PRICE
_____________________ _____________________ _____________________ _____________________ _____________________

@ 7% PERCENTAGE
______________________ _____________________ _____________________ _____________________ _____________________

CHANGE
_____________________ _____________________ _____________________ _____________________ ____________________

10-year, 10% annual coupon 10-year zero 5-year zero 30-year zero $100 perpetuity

b. Can you draw a conclusion about interest rate sensitivity of bonds of different maturity
from above calculations? 2. An investor has two bonds in his portfolio. Each bond matures in 4 years, has a face value of $1,000, and has a yield to maturity equal to 9.6 percent. One bond, Bond C, pays an annual coupon of 10 percent; the other bond, Bond Z, is a zero coupon bond. a) Assuming that the yield to maturity of each bond remains at 9.6 percent over the next 4 years, what will be the price of each of the bonds at the following time periods? Fill in the following table:
T PRICE OF BOND C
_____________________ _____________________ _____________________ _____________________ _____________________

PRICE OF BOND Z
_____________________ _____________________ _____________________ _____________________ _____________________

0 1 2 3 4

b) Plot the time path of the prices for each of the two bonds. Can you draw a conclusion?
Stock Valuation

1. Harrison Clothiers stock currently sells for $20 a share. The stock just paid a dividend of $1.00
a share (i.e., D0 _ $1.00). The dividend is expected to grow at a constant rate of 10 percent a year. What stock price is expected 1 year from now? What is the required rate of return on the companys stock?

2. Martell Mining Companys ore reserves are being depleted, so its sales are falling. Also, its pit
is getting deeper each year, so its costs are rising. As a result, the companys earnings and dividends are declining at the constant rate of 5 percent per year. If D0 _ $5 and ks _ 15%, what is the value of Martell Minings stock?

3. Microtech Corporation is expanding rapidly, and it currently needs to retain all of its earnings,
hence it does not pay any dividends. However, investors expect Microtech to begin paying dividends, with the first dividend of $1.00 coming 3 years from today. The dividend should grow rapidlyat a rate of 50 percent per yearduring Years 4 and 5. After Year 5, the company should grow at a constant rate of 8 percent per year. If the required return on the stock is 15 percent, what is the value of the stock today?

4. Investors require a 15 percent rate of return on Levine Companys stock (ks _ 15%). a. What will be Levines stock value if the previous dividend was D0 _ $2 and if investors
b. c. expect dividends to grow at a constant compound annual rate of (1) _5 percent, (2) 0 percent, (3) 5 percent, and (4) 10 percent? Using data from part a, what is the Gordon (constant growth) model value for Levines stock if the required rate of return is 15 percent and the expected growth rate is (1) 15 percent or (2) 20 percent? Is it reasonable to expect that a constant growth stock would have g >k? Explain. Capital Budgeting 1. After discovering a new gold vein in the Colorado mountains, CTC Mining Corporation must decide whether to mine the deposit. The most cost-effective method of mining gold is sulfuric acid extraction, a process that results in environmental damage. To go ahead with the extraction, CTC must spend $900,000 for new mining equipment and pay $165,000 for its installation. The gold mined will net the firm an estimated $350,000 each year over the 5-year life of the vein. CTCs cost of capital is 14 percent. For the purposes of this problem, assume that the cash inflows occur at the end of the year. a. What is the NPV and IRR of this project? b. Should this project be undertaken, ignoring environmental concerns? c. How should environmental effects be considered when evaluating this, or any other, project? How might these effects change your decision in part b? 2. A firm with a required return of 10% is considering following mutually exclusive projects Year 0 1 2 3 4 5 a. According According accepted? c. According d. According Project A (400) 55 55 55 225 225 Project B (600) 300 300 50 50 50

b.

to the payback criterion, which project should be accepted? to the discounted payback criterion, which project should be to the NPV criterion, which project should be accepted? to the IRR criterion, which project should be accepted?

3.

Under what conditions IRR rule breaks down?

4. Justin is evaluating a project that is expected to produce cash flows of 7,500$ each year for the next 10 years and $10,000 each year for the following 10 years. The IRR for this 20 year project is 10.98%. If the required return is 9 percent, what is the projects NPV?