1. (TCOs 1, 8, 9) Using the security market line formula rather than the dividend discount formula, determine the expected return on a firm’s common stock when:
(a) beta = 1.0;
(b) the risk-free rate is 4%; and
(c) marketplace interest rates have hovered around 9%.
2. (TCOs 1, 5, 6) Calculate the appropriate selling price of a 30-year 5% coupon, $1,000 corporate bond that was purchased five years ago. Marketplace interest rates are averaging 8%.
3. (TCO 2) Given the data below, calculate the expected return, variance, and standard deviation of the following company.
In a recessionary economy, which is expected to occur with a 30% probability, the expected returns would be -5%.
In an expanding economy with an expected probability of occurrence of 20%, the expected return would be 20%.
In a normal economy expected to occur 50% of the time, the expected return would be 5%.
4. (TCO 9) As percentage of debt on the balance sheet increases, financial leverage increases, which makes EPS increase. If this is the case, why don’t all firms try to end up with very high debt?
5. (TCO 7) What would be the expected change to a 30-year bond’s market price or value if its YTM increases to 10.4%? Its YTM is now 9.4%, it has an 8% annual coupon, $1,000 face value, it is currently priced at $897.26, and its duration is eight years.
6. (TCO 9) M&M Proposition I comes in both tax free and world with taxes formats. Explain what these concepts mean. You must use your own words to earn credit here.
7. (TCO 6) What is the coupon rate needed on a $1,000 face value, 6% coupon corporate bond to make it equivalent in terms of return to one whose interest rate is tax free? Assume the corporate tax rate is 40%.
8. (TCO 6) A $1,000 face value bond was issued at par 20 years ago with a 6% coupon paid semiannually. The bond now has nine years remaining to maturity and similar debt obligations are yielding 12%.
•Compute the current price of the bond.
•Assuming that the bond is sold at its current price, what is the capital gain or loss from the original purchase?
•Now assume that the price of the bond returns to par. What is the percentage capital gain or loss for the new owner?
•Please explain why the percentage gain is different from the percentage loss