HW3_2023

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Stevens Institute Of Technology *

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321

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Finance

Date

Feb 20, 2024

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Part 1 (5pt for each question): 1) Which of the following formulas is INCORRECT? A) Yield to maturity for an n-period zero-coupon bond = B) Price of an n -period bond = + + ... + + C) Price of an n -period bond = Coupon × + D) Coupon = Suppose the current zero-coupon yield curve for risk-free bonds is as follows: Maturity (years) 1 2 3 4 5 YTM 3.25% 3.50% 3.90% 4.25% 4.40% 2) The price per $100 face value of a three-year, zero-coupon, risk-free bond is closest to: A) $93.80. B) $90.06. C) $89.16. D) $86.39. 3) Suppose a five-year bond with a 7% coupon rate and semiannual compounding is trading for a price of $951.58. This bond's yield to maturity (YTM) is closest to: A) 7.0%. B) 7.5%. C) 7.8%. D) 8.2%. 4) The yield to maturity for the two-year zero-coupon bond with the current price of $89.68 is closest to: A) 6.0%. B) 5.8%. C) 5.6%. D) 5.2%. 5) Von Bora Corporation (VBC) is expected to pay a $2.00 dividend at the end of this year. If you expect VBC's dividend to grow by 5% per year forever and VBC's equity cost of capital is 13%, then the value of a share of VBC stock is closest to: A) $25.00. B) $40.00. C) $15.40.

D) $11.10. 6) Taggart Transcontinental will pay $2 per share as dividend next year. Taggart's equity cost of capital is 10%, and its dividends are expected to grow at a constant rate (7.5%). Based on this information, Taggart's price is closest to: A) $85 B) $80. C) $101 D) $65 7) If you want to value a firm that has consistent earnings growth, but varies how it pays out these earnings to shareholders between dividends and repurchases, the simplest model for you to use is the: A) enterprise value model. B) dividend discount model. C) total payout model. D) discounted free cash flow model. Use the information for the question(s) below. You expect CCM Corporation to generate the following free cash flows over the next five years: Year 1 2 3 4 5 FCF ($ millions) 25 28 32 37 40 Following year five, you estimate that CCM's free cash flows will grow at 5% per year and that CCM's weighted average cost of capital is 13%. 8) The enterprise value of CCM corporation is closest to: A) $396 million. B) $290 million. C) $382 million. D) $350 million. Use the table for the question(s) below. Consider the following probability distribution of returns for Alpha Corporation: Current Stock Price ($) Stock Price in One Year ($) Return R Probabilit y PR $35 40% 25% $25 $25 0% 50%

$20 -20% 25% 9) The expected return for Alpha Corporation is closest to: A) 6.67%. B) 5.00%. C) 10%. D) 0.00%. 10) The variance of the return on Alpha Corporation is closest to: A) 5.00%. B) 4.75%. C) 3.625%. D) 3.75%. 11) Which of the following is NOT a diversifiable risk? A) The risk that oil prices rise, increasing production costs B) The risk of a product liability lawsuit C) The risk that the CEO is killed in a plane crash D) The risk of a key employee being hired away by a competitor Use the following information to answer the question(s) below. Company Ticker Beta Ford Motor Company F 2.77 International Business Machines IBM 0.73 Merck MRK 0.90 12) If the market risk premium is 6% and the risk-free rate is 4%, then the expected return of investing in Ford Motor Company is closest to: A) 10.0%. B) 16.2%. C) 17.1%. D) 20.6%. Part 2 (40pt, 3 questions in total): Use the information for the question(s) below. You expect DM Corporation to generate the following free cash flows over the next five years: Year 1 2 3 4 5 FCF ($ millions) 75 84 96 111 120 Beginning with year six, you estimate that DM's free cash flows will grow at 6% per year and that DM's weighted average cost of capital is 15%. 1) Calculate the enterprise value for DM Corporation. (Make sure you write your detailed steps of calculations to get full credit) ( 20pt ) Future FCF = (FCF of 5*growth rate)/(WACC-growth rate) = (120*1.06)/(0.15-0.06)

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= $1413.33 million Enterprise Value = Future FCF*PV of discounting factor = 75/1.15 + 84/(1.15)^2 + 96/(1.15)^3 + 111/(1.15)^4 + 120/(1.15)^5 + 1413.33/(1.15)^6 = $1017.66 million The Enterprise Value is approximately $1017.66 million dollar

Use the following information to answer the question(s) below. Company Ticker Beta Ford Motor Company F 2.77 International Business Machines IBM 0.73 Merck MRK 0.90 2)If the expected return on the market is 11% and the expected return of investing in Merck is 10.35%, calculate the risk-free rate. (Make sure you write your detailed steps of calculations to get full credit) ( 10pt )  Market Expected Return = 11%  Expected return of MRK = 10.35%  Risk-free = x  Beta of MRK = 0.90 Capital Market Pricing Model Expected return of MRK = R f + Beta(R m – R f ) 10.35% = x + 0.90(11% - x) X = 0.1035 - 0.099 – 0.90x .10X = .1035 – 0.099 = 0.045 = 4.5% The risk-free rate is 4.5% 3) If the risk-free rate is 5% and the expected return of investing in Merck is 11.3%, calculate the expected return on the market. (Make sure you write your detailed steps of calculations to get full credit) ( 10pt ) * Market Expected Return = x Expected return of MRK = R f + Beta(R m – R f ) 0.113 = 0.05 + 0.90(x – 0.05) 0.113 = 0.05 + 0.90x – 0.045 0.113 = 0.005 +.90x 0.108 = 0.90x 0.12 = x X = 0.12 = 12% The expected return on the market is 12%