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Name: FINC 400 Principles of Financial Management Week 4 Homework Problems Complete the following problems: Problem 9-17 Problem 10-6 Problem 11-7 Problem 9-19 Problem 10-13 Problem 11-15 Problem 9-27 Problem 10-24 Problem 11-19 The Western Sweepstakes has just informed you that you have won $1 million.Th year for the next 20 years. With a discount rate of 12 percent, what is Western Sweepstakes Discount Rate = i 12% Periods = n 20 Annuity 50,000 PVIFA Solution: A * PVIFA = PVA ave won $1 million.The amount is to be paid out at the rate of $50,000 a e of 12 percent, what is the present value of your winnings? Bruce Sutter invests $2,000 in a mint condition Nolan Ryan baseball card. He expec five years. After that, he anticipates a 15 percent annual increase for the next three Bruce Sutter Discount Rate = i 20% Periods = n 5 PV * FVIF = Present Value of Investment -2,000 FVIF Discount Rate = i 15% Periods = n 3 PV * FVIF = Present Value of Investment FVIF aseball card. He expects the card to increase in value by 20 percent a year for the next ase for the next three years. What is the projected value of the card after eight years? FV FV ear for the next er eight years? As stated in the chapter, annuity payments are assumed to come at the end of each exception occurs when the annuity payments come at the beginning of each perio annuity due, subtract 1 from n and add 1 to the tabular value. To find the future valu value. For example, to find the future value of a $100 payment at the beginning of e for n = 6 and i = 10 percent. Look up the value of 7.716 and subtract 1 from it for future value of a 10-year annuity of $2,000 per period where payments come at the Information Discount Rate = i 8% Periods = n 11 Annuity 2,000 FVIFA Solution: A * FVIFA = FVA ome at the end of each payment period (termed an ordinary annuity). However, an eginning of each period (termed an annuity due). To find the present value of an To find the future value of an annuity, add 1 to n and subtract 1 from the tabular at the beginning of each period for five periods at 10 percent, go to Appendix C subtract 1 from it for an answer of 6.716 or $671.60 ($100 × 6.716). What is the payments come at the beginning of each period? The interest rate is 8 percent. The Hartford Telephone Company has a $1,000 par value bond outstanding that pays 11 percent annual interest. The current yield to maturity on such bonds in the market is 14 percent. Compute the price of the bonds for these maturity dates: a . 30 years. b . 15 years. c. 1 year Solution: Hartford Telephone Company a) Par Value $1,000 Interest 14% Time to Maturity=n 30 Yield to Maturity = i 14% Annuity = A PVIFA PVIF b) Par Value $1,000 Interest 14% Time to Maturity=n 15 Yield to Maturity = i 14% Annuity = A PVIFA PVIF c) Par Value $1,000 Interest 14% Time to Maturity=n 1 Yield to Maturity = i 14% Annuity = A PVIFA PVIF any has a $1,000 par value bond outstanding that st. The current yield to maturity on such bonds in the e the price of the bonds for these maturity dates: Hartford Telephone Company Present Value of Interest Payments = A * PVIFA Present Value of Interest Payments = Present Value of Principal Payment at Maturity = FV * PVIF Present Value of Principal Payment at Maturity = Total Present Value or Price of the Bond = Present Value of Interest Payments = A * PVIFA Present Value of Interest Payments = Present Value of Principal Payment at Maturity = FV * PVIF Present Value of Principal Payment at Maturity = Total Present Value or Price of the Bond = Present Value of Interest Payments = A * PVIFA Present Value of Interest Payments = Present Value of Principal Payment at Maturity = FV * PVIF Present Value of Principal Payment at Maturity = Total Present Value or Price of the Bond = Tom Cruise Lines, Inc., issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the annual interest payment was then 12 percent. This return was in line with the required returns by bondholders at that point as described below: Real rate of return ........................ 3% Inflation premium ......................... 5 Risk premium .............................. 4 Total return ............................... 12% Assume that five years later the inflation premium is only 3 percent and is appropriately reflected in bonds have 20 years remaining until maturity. Compute the new price of the bon Tom Cruise Lines, Inc. Par Value $1,000 Real Rate of Return 3% Interest 12% Inflation Rate 5% Time to Maturity=n 20 Risk Premium 4% Yield to Maturity = i Total Return Annuity = A PVIFA Inflation Rate in 5 years 3% PVIF Solution: Compute new required rate of return (yield to maturity) Real Rate of Return Inflation Rate Risk Premium Total Return Present Value of Interest Payments = A * PVIFA Present Value of Interest Payments = Present Value of Principal Payment at Maturity = FV * PVIF Present Value of Principal Payment at Maturity = Total Present Value or Price of the Bond = d is appropriately reflected in the required return (or yield to maturity) of the bonds. The A * PVIFA Value of Interest Payments = Maturity = FV * PVIF ncipal Payment at Maturity = alue or Price of the Bond = Bedford Mattress Company issued preferred stock many years ago. It carries a fixed dividend of $8 per share. With the passage of time, yields have gone down from the original 8 percent to 6 percent (yield is the same as required rate of return). a . What was the original issue price? b . What is the current value of this preferred stock? North Pole Cruise Lines Annual Dividend $8.00 Original Required Rate of Return 8% New Required Rate of Return 6% Solution: a) ORIGINAL PRICE Price of Preferred Stock = CURRENT VALUE b) Price of Preferred Stock = many years ago. It carries a time, yields have gone down same as required rate of The Goodsmith Charitable Foundation, which is tax-exempt, issued debt last year at 8 percent to help finance a new playground facility in Los Angeles. This year the cost of debt is 20 percent higher; that is, firms that paid 10 percent for debt last year will be paying 12 percent this year. a . If the Goodsmith Charitable Foundation borrowed money this year, what would the aftertax cost of debt be, based on its cost last year and the 20 percent increase? b . If the receipts of the foundation were found to be taxable by the IRS (at a rate of 35 percent because of involvement in political activities), what would the aftertax cost of the debt be? Goodsmith Charitable Foundation Debt issued last year at 8% Cost of debt last year 10% Cost of debt this year 20% higher than last year Cost of debt this year 12.0% Corporate Tax Rate (b) 35.0% a) Solution: If the Goodsmith Charitable Foundation borrowed money this year, what would the aftertax cost of debt be, based on their cost last year and the 20 percent increase? b) If the receipts of the foundation were found to be taxable by the IRS (at a rate of 35 percent because of involvement in political activities), what would the aftertax cost of debt be? The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 2 percent less than that for preferred stock. Based on the facts below, is she correct? Debt can be issued at a yield of 10.6 percent, and the corporate tax rate is 35 percent. Preferred stock will be priced at $50 and pay a dividend of $4.40. The flotation cost on the preferred stock is $2. Riley Coal Co. Yield Solution: Corporate Tax Rate = T 35% Dividend = Dp $4.40 Price of Preferred Stock =Pp $50 Floatation Cost = F $2.00 Based on the facts above, is the trea he cost of fixed income culations, she assumes at for preferred stock. rporate tax rate is a dividend of $4.40. Aftertax Cost of Debt Aftertax Cost of Preferred Stock Based on the facts above, is the treasurer correct? The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 2 percent less than that for preferred stock. Based on the facts below, is she correct? Debt can be issued at a yield of 10.6 percent, and the corporate tax rate is 35 percent. Preferred stock will be priced at $50 and pay a dividend of $4.40. The flotation cost on the preferred stock is $2. United Business Forms Capital Structure Debt 35% Aftertax Cost of Debt 7.00% Preferred Stock 15% Cost of Preferred Stock 10% Common Equity 50% Cost of Common Equity 13.00% Solution: Cost (aftertax) Weights Weighted Cost Debt (Kd) Preferred Stock (Kp) Common Equity (Ke) Weighted Average Cost of Capital (Ka)

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posted: | 4/9/2011 |

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