Chapter 4: The Valuation of Long-Term Securities 1. What is the market value of a $1,000 face-value bond with a 10 percent coupon rate when the market’s rate of return is 9 percent? Answer:More than its face value. 2. If an investor may have to sell a bond prior to maturity and interest rates have risen since the bond was purchased, the investor is exposed to __________. Answer:interest rate risk 3. Beta Budget Brooms will pay a big $2 dividend next year on its common stock, which is currently selling at $50 per share. What is the market’s required return on this investment if the dividend is expected to grow at 5% forever? Answer:9% 4.
If a coupon bond sells at a large discount from par, then which of the following relationships holds true? (P0 > represents the price of a bond and YTM is the bond’s yield to maturity. ) Answer:P0 ; par and YTM ; the coupon rate. 5. Market interest rates and the prices of bonds in the secondary market: Answer:generally move in opposite directions. 6. A $250 face value share of preferred stock pays a $20 annual dividend and investors require a 7% return on this investment. If the security is currently selling for $276, what is the difference (overvaluation) between its intrinsic and market value (rounded to the nearest whole dollar)?
Answer:Approximately $10. 7. Which of the following accurately describes the behavior of bond prices? Answer:If interest rates rise so that the market required rate of return increases, the bond’s price will fall. Chapter 5: Risk and Return 8. The firm of Sun and Moon purchased a share of Acme. com common stock exactly one year ago for $45. During the past year the common stock paid an annual dividend of $2. 40. The firm sold the security today for $85. What is the rate of return the firm has earned? Answer: 94. 2%. Return is over the two-year period and includes both dividends and capital gains. Return = [($2. 0) + ($85 – $45)] / $45 = 94. 2% 9. The ratio of the standard deviation of a distribution to the mean of that distribution is referred to as __________. Answer:coefficient of variation 10. Clive Rodney Megabucks offers friend, Melanie, an interesting gamble involving giving her the choice of the contents in one of two sealed, identical-looking boxes. One box has $20,000 in cash and the second has nothing inside. There is an equal probability that the chosen box contains cash versus nothing. Melanie states that she would not call off the gamble if you offered her a certain $10,999 instead of her choice of box.
The project’s internal rate of return is 12 percent and its WACC is 10 percent. Which of the following statements is most correct? Answer:The project’s MIRR is greater than 10 percent but less than 12 percent. (In actual exam question, you have to solve and get the answer. ) 16. Project S costs $15,000 and is expected to produce cash flows of $4,500 per year for 5 years. Project L costs $37,500 and is expected to produce cash flows of $11,100 per year for 5 years. Calculate the two projects’ NPVs, IRRs and MIRR assuming a cost of capital of 14%. 3 questions. NPV IRR MIRR 17. Answer:Step 1:Determine the PMT: 2% 0 1 10 | | | -1,000 PMT PMT With a financial calculator, input N = 10, I = 12, PV = -1000, and FV = 0 to obtain PMT = $176. 98. Step 2:Calculate the project’s MIRR: 10% 012910 ||| || 1. 10 -1,000176. 98176. 98176. 98176. 98 194. 68 . (1. 10)8 . (1. 10)9 . 379. 37 417. 31 1,00010. 93% = MIRRTV = 2,820. 61 FV of inflows: With a financial calculator, input N = 10, I = 10, PV = 0, and PMT = -176. 98 to obtain FV = $2,820. 61. Then input N = 10, PV = -1000, PMT = 0, and FV = 2820. 61 to obtain I = MIRR = 10. 93%.