FIN/571: Corporate Finance
Text Problem Sets - Week Two
Chapter Five
Question # 4
Define the following terms: bond indenture, par value, principal, maturity, call provision, and sinking fund. Bond indenture. Bond indenture is a legal contract for a publicly traded bond. The structure of this contract outline incentives explicitly by detailing responsibilities, constraints, penalties, and oversight required. For example, contracts may specify interest and principal payment timing and amounts. Par value. Par value denotes face value or designated value of a bond or stock. Par value of a bond is typically $1,000 and the sum investors pay upon issue. It is also the sum received when they redeem the bond matures. Conversely, stock par value is frequently set at $1. In this case, par value is an accounting tool that shows no connection to the stocks’ market value. Principal. The term “principal” refers to a sum of money one borrows or invests. The face amount of a bond - the value printed on a stock or bond, or a debt balance. Principal does not encompass finance charges. Principal also describes an investor represented by a broker who executes trades on that investor’s behalf or an investor who trades for his or her own benefit. Principal also refers to a party affected by an agent’s decisions in a principal-agent relationship. Maturity. Maturity is the end of a bond’s life. In finance, maturity (or maturity date) designates the date of final payment on a financial instrument. Maturity value is the amount of money the bond issuer must repay at the end of a bond’s life. At that juncture, the principal and remaining interest payment are due. Face value and par value are terms that describe maturity value. Call provision. Call provision is an option giving bond issuers or businesses the right to repay bonds before their maturity date. It is an indenture provision designating a bond as “callable.” That provision authorizes the issuing entity to cash in the bond prior...

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FIN571 Week Two
Individual Assignment: TextProblemSets
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CHAPTER 5
A1. (Bond valuation) A $1,000 face value bond has a remaining maturity of 10 years and a required return of 9%. The bond’s coupon rate is 7.4%. What is the fair value of this bond?
A10. (Dividend discount model) Assume RHM is expected to pay a total cash dividend of $5.60 next year and its dividends are expected to grow at a rate of 6% per year forever. Assuming annual dividend payments, what is the current market value of a share of RHM stock if the required return on RHM common stock is 10%?
A12. (Required return for a preferred stock) James River $3.38 preferred is selling for $45.25. The preferred dividend is non-growing. What is the required return on James River preferred stock?
B16. (Interest-rate risk) Philadelphia Electric has many bonds trading on the New York Stock Exchange. Suppose PhilEl’s bonds have identical coupon rates of 9.125% but...

...ProblemSets
Chapter 5
A1. (Bond valuation) A $1,000 face value bond has a remaining maturity of 10 years and a required return of 9%. The bond’s coupon rate is 7.4%. What is the fair value of this bond?
Calculating PV factor:
i= required return = 9% = 0.09
n= 10 years
Using Cash Flow of $1000 to calculate present value,
Cash flow= $1000
PV factor = 1/(1+i)^n = 0.42241
PV = $1000*0.42241= 422.41
Using Coupon Rate to calculate present value of Annuity
Cash flow= $1000 * 7.4/100 = $74
PV factor = (1/i)*(1- 1/(1+i)^n) = 6.4176
So, PV = $74*6.4176 = 474.90|
So the fair value of bond = 474.90+422.41 = $897.31
A10. (Dividend discount model) Assume RHM is expected to pay a total cash dividend of $5.60 next year and its dividends are expected to grow at a rate of 6% per year forever. Assuming annual dividend payments, what is the current market value of a share of RHM stock if the required return on RHM common stock is 10%?
Current market value = D1/(Required return – growth rate)
= 5.60/(10%-6%) = $140
A12. (Required return for a preferred stock) James River $3.38 preferred is selling for $45.25. The preferred dividends is now growing. What is the required return on James River preferred stock?
Required Return = Dividend/Market Price
Dividend = $3.38
Market Price = $45.25
Required Return = $3.38 / $45.25
Required Return = 7.47%
A14.(Stock Valuation) Suppose Toyota has nonmaturing...

...Week 2 TextProblemSet
Candy Wungnema
FIN/571
February 5, 2013
Kathleen O’Keefe
Week 2 TextProblemSet
Chapter 5
4. Define the following terms: bond indenture, par value, principal, maturity, call provision, and
sinking fund.
• Bond indenture: A contract for a bond defining specified terms for interest and borrowed capital to be repaid to the lender.
• Par value: “Specifies the amount of money that must be repaid at the end of the bond’s life, which is also called face value or maturity value” (Emery, Finnerty, & Stowe, 2007, p. 112).
• Principal: The original amount of debt or balance borrowed, which does not include interest.
• Maturity: The life end of a contractual obligation.
• Call provision: The right for the issuer to payoff bonds prior to the maturity date (Emery, Finnerty, & Stowe, 2007).
• Sinking funds: Bon repayment in multiple installments (Emery, Finnerty, & Stowe, 2007).
11. What is interest-rate risk? How is interest-rate risk related to the maturity of a bond and to
the coupon rate for a bond?
“Interest-rate risk is the sensitivity of a bond’s value to interest-rate change as it depends primarily on the bond’s remaining maturity” (Emery, Finnerty, & Stowe, 2007, p. 132). An issued bond pays a fixed rate of interest called a coupon rate until it matures. The current prevailing...

...
The Cost of Capital
Benedict Amanor, Yolanda Brown-McCutchen, Edith Compean, Angel Longino
and Melissa Shea-Brooks
FIN/571
May 18, 2015
William Stokes
The Cost of Capital
In our fifth week of understanding the practices of Corporate Finance, we reviewed the Cost of Capital video. This video provided information on Pfizer, a researched based pharmaceutical company that makes products to help face health care challenges. Our goal is to highlight the cost of capital as described by Amit Singh regarding Pfizer's funds in terms of debt and equity along with using the Capital Asset Pricing Model (CAPM). The Weight Average Cost of Capital (WACC) and how Pfizer uses this method will be reviewed. Additionally, each phase of developing and creating new value added drugs role financially will be addressed.
According to Parrino, Kidwell and Bates (2012), the capital asset pricing model describes the relationship between an associated risk and the expected return on an asset. Pfizer uses the CAPM to determine its cost of capital or the weighted average of the costs of debt and equity held in a company’s capital base. Singh states “standard models for a company’s capital structure focus mainly on tax benefits related to leverage and distress costs” (Treasury & Risk, 2011). So when seeking the optimal capital structure for its company, Pfizer mainly focuses on the equity side, which observes the risk-free rate on its treasury bonds,...

...FIN571 Final Exam 1)Which of the following statements is true 2)Book value, or net book value, refers to 3)Assume that the par value of a bond is 1,000. Consider a bond where the coupon rate is 9 and the current yield is 10. Which of the following statements is true 4)If the yield to maturity for a bond is less than the bonds coupon rate, the market value of the bond is __________ 5)For investors, the proper measure of a stocks risk is its __________ 6)A companys beta is -1.5. If the overall stock market decreases by 5, what is the expected change in the firms stock price 7)Which of these investments would you expect to have the highest rate of return for the next 20 years 8)Dimensions of risk include __________ 9)One problem with using negative values for the proportion invested in the riskless asset to represent a borrowed amount is that the implied borrowing rate of interest is the same as the __________. 10)If you were willing to bet that the overall stock market was heading up on a sustained basis, it would be logical to invest in 11)Stony Products has an inventory conversion period (ICP) of about 70 days. The receivables collection period (RCP) is 30 days. Fin 370 final exam. The payables deferral period (PDP) is about 40 days. What is Stonys cash conversion cycle (CCC) 12)The main source of short-term operating capital is _________ 13)An investors risky portfolio is made up of individual stocks. Which of the...

...A-3 (Coverage ratio) The firm in the two preceding problems also had $6 million of principal repayments during the latest 12 months. Its marginal tax rate is 40%. Calculate the debt service coverage ratio.
Debt-Service Coverage Ratio = (EBIT + 1/3 Rentals) / (Interest Expense + 1/3 Rentals + Principal Repayments / (1 - T)) = ($30 + $15 / 3) / ($10 + $15 / 3 + $6 / (1 - 0.40)) = 1.40
A-4 (WACC with rebalancing) Nathan’s Catering is a gourmet catering service located in Southampton, New York. It has an unleveraged required return of r = 43%. Nathan’s rebalances its capital structure each year to a target of L = 0.52. T* = 0.20. Nathan’s can borrow currently at a rate of r
of r = 43%. Nathan’s rebalances its capital structure each year to a target of L = 0.52. T* = 0.20. Nathan’s can borrow currently at a rate of rd = 26%. What is Nathan’s WACC?
WACC = r - T* L rd [(1 + r) / (1 + rd)]
WACC = 0.43 - 0.20 x 0.52 x 0.26 [(1 + 0.43) / (1 + 0.26)] = 0.3993 = 39.93%
A-10 (Dividend adjustment model) Regional Software has made a bundle selling spreadsheet software and has begun paying cash dividends. The firm’s chief financial officer would like the firm to distribute 25% of its annual earnings (POR = 0.25) and adjust the dividend rate to changes in earnings per share at the rate ADJ = 0.75. Regional paid $1.00 per share in dividends last year. It will earn at least $8.00 per share this year and each year in the foreseeable future. Use the dividend...

...FIN 350
Prof. Porter
ProblemSet 4
1. Describe what happens to the total risk of a portfolio as the number of securities is increased. Differentiate between systematic risk and unsystematic risk and explain how total risk and systematic risk are measured.
As the number of securities increases, the total risk of the portfolio decreases. This decrease occurs due to the benefits of diversification which is the process of acquiring a portfolio of securities that have dissimilar risk-return characteristics in order to reduce overall portfolio risk. The total risk of a security or a portfolio is measured with the variance or standard deviations of returns (std dev. ^2 = variance). The larger the standard deviation, the greater the total risk and the more likely it is that you will have a large price move.
Unsystematic risk is the unique or security specific risks that tend to partially offset one another in a portfolio. /this could happen when the price of one stock in the portfolio goes down, the price of another tends to go up, which partially offsets the loss. As long as the returns of two securities are not perfectly, positively correlated, one can reduce total risk by combining securities in a portfolio. By adding securities to a portfolio, it is possible to eliminate unsystematic risk.
Systematic risk is also known as market risk or nondiversifiable risk. The risk tends to affect the entire market in a similar...

...Individual TextProblemSets - Week Two
CHAPTER 5
A1. (Bond valuation) A $1,000 face value bond has a remaining maturity of 10 years and a required return of 9%. The bond’s coupon rate is 7.4%. What is the fair value of this bond?
“The value of a bond, its fair price, is the present value of its promised future payments for coupon and principal.” So we are solving for PV
FV= $1,000
N= 10
I= 9%
Pmt = 7.4% of $1,000 = $74
|Future Value |$1,000|
|Years |10 |
|Rate |9% |
|PMT |$74|
|Present Value |($897.32)| INCORRECT Correct answer PV = -$895.94
A10. (Dividend discount model) Assume RHM is expected to pay a total cash dividend of $5.60 next year and its dividends are expected to grow at a rate of 6% per year forever. Assuming annual dividend payments, what is the current market value of a share of RHM stock if the required return on RHM common stock is 10%?
Fair price = starting dividend/ (required return - growth rate)
Fair price = $5.60/(10%-6%) = $5.60/4% = $5.60/0.04 = $140
A12. (Required return for a preferred stock) James River $3.38 preferred is selling for $45.25. The preferred dividend is non-growing. What is the required return on James River preferred stock?
Value of stock = dividend / return rate
Value of stock * return rate = dividend
Return rate = dividend / value of stock = $3.38/$45.25=...

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