# MBA570 Homework 4

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Instructions: Either type or write your answers directly on this document and submit the completed assignment to your ESO. Show your work for the calculations. If you use additional documents for the calculations, label them with your name and course number (MBA 570) and submit them as well. Each question is worth 10 points.

1.      A 5-year bond with a face value of \$1,000 has a coupon rate of 10.50%, with semi-annual payments.

a.       The coupon payment for this bond is \$__________. (Round to two decimal places.)

b.      Look at the timeline below and fill in the correct cash flows for the timeline (note: periods are in six-month intervals).

Period                     0          1          2                      9        10

Cash flow                         CF1       CF2                       CF9       CF10

Compute the following cash flows. (Round to two decimal places.)

CF1 is \$__________.

CF2 is \$__________.

CF9 is \$__________.

CF10 is \$__________.

2.      The following table summarizes prices of various default free zero coupon bonds (expressed as a percentage of face value):

 Maturity (years) 1 2 3 4 5 Price (per \$100 face value) \$96.22 \$91.69 \$87.15 \$82.46 \$77.33

a.       Compute the yield to maturity for each bond.

Yield on the 1-year bond is __________% (Round to two decimal places.)

Yield on the 2-year bond is __________% (Round to two decimal places.)

Yield on the 3-year bond is __________% (Round to two decimal places.)

Yield on the 4-year bond is __________% (Round to two decimal places.)

Yield on the 5-year bond is __________% (Round to two decimal places.)

b.      Is the following graph showing the zero-coupon yield curve? (Enter yes or no.)

 7

 6.5

 6

 5.5

 5

 4.5

 4

 3.5

 3

 2.5

0            1             2            3            4             5

c.       The above yield curve is:

A.  upward sloping.

B.  downward sloping.

C.  flat.

3.      Suppose a 10-year, \$1,000 bond with a 7% coupon rate and semiannual coupons is trading for a price of \$1,180.46.

a.       The bond’s yield to maturity (expressed as an APR with semiannual compounding is__________%. (Roundto two decimal places.)

b.      If the bond’s yield to maturity changes to 8% APR, the price of the bond would be \$__________.(Round to nearest cent.)

4.      Assume the zero-coupon yields on default-free securities are as summarized in the following table:

 Maturity 1year 2years 3 years 4 years 5 years Zero-coupon yields 5.50% 6.00% 6.60% 6.80% 7.00%

a.       The price of a three-year, default-free security with a face value of \$1,000 and an annual coupon rate of 7% is \$__________. (Round to two decimal places.)

b.      The yield to maturity for this bond is __________%. (Round to two decimal places.)

5.      The following table summarizes yields to maturity on several 1-year, zero-coupon securities:

 Security Yield Treasury 2.94% AAA Corporate 3.42% BBB Corporate 3.69% B Corporate 4.26%

a.       The price (expressed as a percentage of the face value) of a 1-year, zero-coupon corporate bond with a AAA rating and a face value of \$1,000 is \$__________. (Round to the nearest cent.)

b.      The credit spread on AAA-rated corporate bonds is __________%. (Round to two decimal places.)

c.       The credit spread on B-rated corporate bonds is __________%. (Round to two decimal places.)

d.      How does the credit spread change with the bond rating? Why?

A.    The credit spread decreases as the bond rating increases, because lower rated bonds are riskier.

B.     The credit spread increases as the bond rating falls, because lower rated bonds are riskier.

C.     The credit spread decreases as the bond rating falls, because lower rated bonds are riskier.

D.    The credit spread increases as the bond rating increases, because higher rated bonds are riskier.

6.      Anle Corporation has a current price of \$22, is expected to pay a dividend of \$1 in one year, and its expected price right after paying that dividend is \$27.

a.       Anle’s expected dividend yield is __________%. (Round to two decimal places.)

b.      Anle’s expected capital gain rate is __________%. (Round to two decimal places.)

c.       Anle’s cost of capital is __________%. (Round to two decimal places.)

7.      Summit Systems will pay a dividend of \$1.62 this year. If you expect Summit’s dividend to grow by 6.6% per year, and its equity cost of capital is 11.7%, its price per share is \$__________.(Round to the nearest cent.)

8.      Heavy Metal Corporation is expected to generate the following cash flows over the next five years:

 Year 1 2 3 4 5 FCF (\$ million) 51.3 66.5 79.9 73.1 83.3

After that, the free cash flows are expected to grow at the industry average of 4.2% per year. Using the discounted free cash flow model and a weighted average cost of capital of 14.8%:

a.       The enterprise value will be \$__________ million.(Round to two decimal places.)

b.      If Heavy Metal has no excess cash, debt of \$297 million, and 36 shares outstanding, its stock price per share will be \$__________. (Round to two decimal places.)

9.      You read in the paper that Summit Systems will pay a dividend of \$1.00 this year. At that point you expect Summit’s dividend to grow by 5.5% per year. Today you read in the paper that Summit Systems has revised its growth prospects and expects its dividends to grow at a rate of 4.0% per year forever. If the firm’s equity cost of capital is 10.0%:

a.       The value of a share of Summit Systems stock based on the original expected dividend growth of 5.5% per year is \$__________. (Round to the nearest cent.)

b.      If you tried to sell your Summit Systems stock after reading this news, the price you would likely get for a share is \$__________. (Round to the nearest cent.)

Why is this so?

A.    You would receive \$22.22 if you act very quickly because it takes a day or two to incorporate the information about the new growth rate.

B.     You would receive \$16.67 because markets are efficient and would incorporate the information about the new growth rate immediately.

C.     You would receive \$22.22 because when you bought the stock, the dividend growth rate was still 5.5%.

D.    You would receive a price between \$16.67 and \$22.22 because you should get a blend of the old and new dividend growth rates.

10.  In early 2009, Coca-Cola Company had a share price of \$43.24. Its dividend was \$1.24, and you expect Coca-Cola to raise this dividend by approximately 6.7% per year in perpetuity.

Note: For simplicity, assume that all dividends are paid at the end of the year.

a.       If Coca-Cola’s equity cost of capital is 8.2%, based on your estimate of the dividend growth rate, the price per share you would expect would be\$__________. (Round to the nearest cent.)

b.      Given Coca-Cola’s share price, you would conclude that its future dividend growth rate should be __________%. (Round to one decimal place.)

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