QUESTION 5 - BOND VALUATION
$M = $1,000 CR= 8% = 0.08
i)
n= 7.5 payments annually from June 30, 2021 - December 31, 2028, therefore 7.5 x 2 = 15
payments semi-annually
i= 14% = 0.14 per year, 7% or 0.07 semi-annually
$I = 8% of $1,000 = $80 / 2 = $40
Vb = $I[1 -1/(1 + i)ˆn] / i + $M / (1 + i)ˆn
Vb = $40 [1 - 1/ (1 + 0.07)ˆ15] / 0.07 + $1,000 / (1 + 0.07)ˆ15
Vb =$40 [1 - 1/ (1.07)ˆ15] / 0.07 + $1,000 / (1.07)ˆ15
Vb =$40 [1 - 1 / 2.759] / 0.07 + $1,000 / 2.759
Vb = $40 [1 - 0.3625] / 0.07 + $362.4502
Vb = $40 [0.6376] / 0.07 + $362.4502
Vb = $40 [9.1079] + $362.4502
Vb =364.314 + $362.4502
Vb =$726.7642
ii)
n = payments annually from December 2023 - December 31, 2028, therefore 5 x 2 = 10
payments semi-annually
i= 6% = 0.06 per year, 3% or 0.03 semi-annually
$I = 8% of $1,000 = $80 / 2 = $40
Vb = $I[1 -1/(1 + i)ˆn] / i + $M / (1 + i)ˆn
Vb = $40 [1 - 1/ (1 + 0.03)ˆ10] / 0.03 + $1,000 / (1 + 0.03)ˆ10
Vb = $40 [1 - 1/ (1.03)ˆ10] / 0.03 + $1,000 / (1.03)ˆ10
Vb = $40 [1 - 1/ 1.3439] / 0.03 + $1,000 / 1.3439
Vb = $40 [8.5299] + $1,000 / 1.3439
Vb = $341.1960 + $744.1030
Vb =$1,085.2990
iii)
n= 9.5 payments annually from June 2019 - December 31, 2028, therefore 9.5 x 2 = 19
payments semi-annually
$I= 8% of $1,000 = $80 / 2 = $40
Po = $975
YTM = [$I + ((M - Po) / n)] / [(M + Po) / 2]
YTM = [$40 + (($1,000 - $975 ) / 19)] / [($1,000 + $975) / 2]
YTM = [$40 + (($25 / 19)] / [($1,975) / 2]
YTM = [$40 + 1.3158] / [987.50]
YTM = [$41.3158] / [987.50]
YTM = 0.0418 = 4.18% semi-annually
Annual YTM = 4.18% x 2 = 8.36%
BONUS WORKINGS
Current Yield = $I / P0
CY = $40 / $975
CY = 0.410 = 4.10% semi-annually
Annual CY = 4.10% x 2 = 8.20%
QUESTION 6 - STOCK VALUATION
D0 = $2.6 k= 10% =0.10
Part A
i)
Step 1 Find the future dividends for the years before constant growth rate
D1 = D0 (1 + g) = $2.60 ( 1 + 0.16) = $2.60 (1.16) = $3.02
D2 = D1 (1 + g) = $3.02 ( 1 + 0.14) = $3.02 (1.14) =$3.44
D3 = D2 (1 + g) = $3.44 ( 1 + 0.10) = $3.44 (1.10) =$3.78
D4 = D3 (1 + g) = $3.78 ( 1 + 0.08) = $3.78(1.08) =$4.08
Step 2 Find price of the year before constant growth rate 5% (Terminal Value)
D5 = D4 (1 + g) = $4.08 ( 1 + 0.05) = $4.08(1.05) =$4.28
P4 = D5 / (k - g) = $4.28 (0.10 - 0.05) =$4.28 / 0.05 = $85.60
Step 3 Find Po by finding the PV of the dividends in step 1 and the price in step 2
PV = FV / (1 + k)ˆn
P0= FV / (1 + k)ˆ1 + FV / (1 + k)ˆ2 + FV / (1 + k)ˆ3 + FV / (1 + k)ˆ4 + P4 / (1 + k)ˆ4
P0 = 3.02/1.1ˆ1 + 3.44/1.1ˆ2 + 3.78/1.1ˆ3 + 4.08/1.1ˆ4 + 85.60 /1.1ˆ4
P0 = $2.75 + $2.84 + $2.84 + $2.79 + $58.47
P0 = $69.69
ii)
P2 = 3.78/1.1ˆ1 + 4.08/1.1ˆ2 + 85.60 /1.1ˆ2
P2 = $3.44 + $3.37 + $70.74
P2 = $77.55
iii)
DY for year 3 = D3 / P2
DY for year 3 = $3.78 / $77.55
DY for year 3 = 0.0487 or 4.87%
Part B
g = 6% = 0.06
D0 = $2.40
D1 = D0 (1 + g) = $2.40 ( 1 + 0.06) = $2.40 (1.06) = $2.54
Ks= D1 / P0 + g
Ks = Krf + (Km - Krf) Beta
Ks = 0.05 + (0.08) 0.9
Ks = 0.05+ 0.072
Ks = 0.122
P0 = D1 / (ks - g)
P0 = 2.54 / (0.122 - 0.06)
P0 = 2.54 / 0.062
P0 = $40.97
BONUS WORKINGS
Preferred Price = Dp / Kp
Dp = Dividend rate x Par value
QUESTION 7 - COST OF CAPITAL
Part A
i)
Cost of Preferred shares
Kp = Dp / Net Pp
Net Pp = Pp - Floatation cost
Kp = 8 / (88 - 6) = 8 / 82 = 0.09756 = 9.76%
Cost of Common shares
Ks = (D1 / P0 ) + g
Ks = [D0 ( 1+ g) / P0 ] + g
Ks = $3.5 (1.06) / $70 + 0.06
Ks = $3.71 / $70 + 0.06
Ks = 0.053 + 0.06
Ks = 0.113
Ks = 11.3%
Cost of Debt
Kdat = Kdbt (1 - T)
Kdat = 0.12 (1 - 0.25)
Kdat = 0.09 = 9%
ii)
wd = 30% = 0.30
wp = 20% = 0.20
ws = 50% =0.50
WACC = wdKdat + wpKp + wsKs
WACC = (0.30 x 0.09) + (0.20 x 0.0976) + (0.50 x 0.113)
WACC = 0.027 + 0.01952 + 0.0565
WACC = 0.10302 = 10.3%
Part B
i)
Structure A
WACC = wdKdat + wpKp + wsKs
WACC = (0.40 x 0.10) + 0 + (0.60 x 0.14)
WACC = 0.40 + 0 + 0.084
WACC = 0.124 = 12.4%
Structure B
WACC = wdKdat + wpKp + wsKs
WACC = (0.30 x 0.08) + 0 + (0.70 x 0.11)
WACC = 0.024 + 0 + 0.077
WACC = 0.101 = 10.1%
ii)
Recommend Structure B since it has a lower cost of capital than Structure A.
QUESTION 8 - CAPITAL BUDGETING
i) Payback Periods
Project Mobile:
-$90,000 + 10,000 (yr1) = -$80,000 +$20,000 (yr 2)= -$60,000 + $30,000 (yr 3) = -$30,000
We only need $30,000 out of the $40,000 due in year 4
Payback period = 3 years + $30,000/$40,000 = 3.75 years
Project Energy:
-$90,000 + 20,000 (yr1) = -$70,000 +$20,000 (yr 2)= -$50,000 + $35,000 (yr 3) = -$15,000
We only need $15,000 out of the $35,000 due in year 4
Payback period = 3 years + $15,000/$35,000 = 3.43 years
Project Tech:
-$90,000 + 30,000 (yr1) = -$60,000 +$30,000 (yr 2)= -$30,000 + $30,000 (yr 3) = 0
Payback period = 3 years
Project Internet:
-$90,000 + 0 (yr1) = -$90,000 + 0 (yr 2)= -$90,000 + $50,000 (yr 3) = -$40,000 + $40,000
(yr 4) = 0
Payback period = 4 years
ii) Project Tech should be selected as it takes the least amount of time to recover the initial
outlay.
iii) Projects Net Present Value (NPV)
r = 12% = 0.12
NPV = FV / (1 + r)ˆn
r = 12% = 0.12
Project Mobile:
NPV = 10,000 / 1.12ˆ1 + $20,000/1.12ˆ2 + $30,000 /1.12ˆ3 + $40,000/ 1.12ˆ4 + 0 - $90,000
NPV = $8,928.57 + $15,943.88 + $21,353.41 + $25,420.72 + 0 - $90,000
NPV = $71,646.58 - $90,000 = -$18,353.42
Project Energy:
NPV = 20,000/1.12ˆ1 + $20,000/1.12ˆ2 + $35,000/1.12ˆ3 + $35,000/1.12ˆ4 +
$30,000/1.12ˆ5 - $90,000
NPV = $17,857.14 + $15,943.88 + $24,912.31 + $22,243.13 + $17,022.81 - $90,000
NPV = $97,979.27 -$90,000 = $7,979.27
Project Tech:
NPV = -$30,000/1.12ˆ1 + $30,000/1.12ˆ2 + $30,000/1.12ˆ3 + $30,000/1.12ˆ4 +
$30,000/1.12ˆ5 -$90,000
NPV = $26,785.71 + $23,915.82 + $21,353.41 + $19,065.54 + $17,022.81
- $90,000
NPV = 108,143.29 - $90,000 = $18,143.29
Project Internet:
NPV = 0 + 0 + $50,000/1.12ˆ3 + $40,000 /1.12ˆ4 + $50,000/1.12ˆ5 - $90,000
NPV = 0 + 0 + $35,589.01 + $25,420.72 + $28,371.34 - $90,000
NPV = $89,381.07 - $90,000 = -$618.93
iv) Project Tech should be selected as it has the highest NPV that is greater than 0.
v) Project Tech and Project Energy should be selected as their NPV's are greater than 0.
BONUS WORKINGS
Discounted Payback = - Initial outlay + discounted cash flows
Project Mobile:
NPV = -$18,353.42
Discounted payback is not achieved for Project Mobile since the initial outlay is never
recovered by discounted cash flows.
Project Energy:
-$90,000 + $17,858 (yr 1) = -$72,142 + $15,944 (yr 2) = -$56,198 + $24,913 (yr 3) =
-$31,285 + $22,243 (yr 4) = -$9,043
After year 4 we only need $9,043 out of the $17,022 due in year 5 to achieve payback.
Discounted Payback Period = 4 years + $9,043/$17,022 = 4.53 years
Project Tech:
-$90,000 + $26,787 (yr 1) = -$63,213 + $23,915.82 (yr 2) = -$39,297 + $21,353.41 (yr 3) =
-$17,943
After year 3 we only need $17,943 out of the $19,065 due in year 4 to achieve payback.
Discounted Payback Period = 3 years + $17,943/$19,065 = 3.94 years
Project Internet:
NPV = -$618.93
Discounted payback is not achieved for Project Internet since the initial outlay is never
recovered by discounted cash flows.
NOTE
If NPV is negative, discounted payback is not achieved since the initial outlay is never
recovered by discounted cash flows.
Discounted payback periods are always more than the original payback periods.
