Reference no: EM132283151
Problem 1: Risk-free rate and risk premiums
The real rate of interest is currently 3%; the inflation expectation and risk premiums for a number of securities follow.
| Inflation expectation |
| Security |
Premium |
Risk premium |
| A |
6% |
3% |
| B |
9 |
2 |
| C |
8 |
2 |
| D |
5 |
4 |
a. Find the risk-free rate of interest, RF, that is applicable to each security.
b. Although not noted, what factor must be the cause of the differing risk-free rates found in part a?
c. Find the nominal rate of interest for each security.
Problem 2: Bond valuation:
Annual interest Calculate the value of each of the bonds shown in the following table, all of which pay interest annually.
|
Bond
|
Par value |
Coupon interest rate
|
Years to maturity
|
Required return
|
|
A
|
$1,000 |
14% |
20 |
12%
|
|
B
|
1,000 |
8 |
16 |
8
|
|
C
|
100 |
10 |
8 |
13
|
|
D
|
500 |
16 |
13 |
18
|
|
E
|
1,000 |
12 |
10 |
10
|
Problem 3: Yield to maturity
The Salem Company bond currently sells for $955, has a 12% coupon interest rate and a $1,000 par value, pays interest annually, and has 15 years to maturity.
a. Calculate the yield to maturity (YTM) on this bond.
b. Explain the relationship that exists between the coupon interest rate and yield to maturity and the par value and market value of a bond.
Problem 4: Common stock value:
Constant growth Use the constant-growth model (Gordon growth model) to find the value of each firm shown in the following table.
|
Firm
|
Dividend expected next year
|
Dividend growth rate
|
Required return
|
|
A
|
$1.20
|
8%
|
13% |
|
B
|
4.00
|
5
|
15 |
|
C
|
0.65
|
10 |
14 |
|
D
|
6.00
|
8
|
9 |
|
E
|
2.25
|
8
|
20 |
Problem 5: Management action and stock value REH
Corporation's most recent dividend was $3 per share, its expected annual rate of dividend growth is 5%, and the required re-turn is now 15%. A variety of proposals are being considered by management to re-direct the firm's activities. Determine the impact on share price for each of the following proposed actions, and indicate the best alternative.
a. Do nothing, which will leave the key financial variables unchanged.
b. Invest in a new machine that will increase the dividend growth rate to 6% and lower the required return to 14%.
c. Eliminate an unprofitable product line, which will increase the dividend growth rate to 7% and raise the required return to 17%.
d. Merge with another firm, which will reduce the growth rate to 4% and raise the required return to 16%.
e. Acquire a subsidiary operation from another manufacturer. The acquisition should increase the dividend growth rate to 8% and increase the required return to 17%.
Problem 6: Coefficient of variation
Metal Manufacturing has isolated four alternatives for meeting its need for increased production capacity. The following table summarizes data gathered relative to each of these alternatives.
|
Alternative
|
Expected return
|
Standard deviation of return |
| A |
20%
|
7.0 %
|
| B |
22
|
9.5
|
| C |
19
|
6.0
|
| D |
16
|
5.5
|
a. Calculate the coefficient of variation for each alternative.
b. If the firm wishes to minimize risk, which alternative do you recommend? Why?
Problem 7: Capital asset pricing model (CAPM)
For each of the cases shown in the following table, use the capital asset pricing model to find the required return.
| Case |
Risk-free
rate, RF
|
Market
return,rm.
|
Beta, β
|
| A |
5% |
8% |
1.30
|
| B |
8
|
13 |
0.90
|
| C |
9 |
12 |
-0.20
|
| D |
10 |
15 |
1.00
|
| E |
6 |
10 |
0.60
|
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