Fin 4342 Midterm 2 Practice Questions 1- DD Corporation's 5-year bonds yield 6.20% and 5-year T-bonds yield 4.40%.

The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the default risk premium for DD's bonds is DRP = 1.30% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t 1) 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on DD's bonds?

2- Suppose interest rates on Tresury bonds rose from 5% to 9%, as a result of higher interest rates in Europe. What effect would this have on the price of an average companys stock price? (Chapter end question 6-8) 3- Why is a call provision advantageous to a bond issuer? When would the issuer be likely to initiate a refunding call? (Chapter end question 7-9) 4- Kebt Corporation's Class Semi bonds have a 12-year maturity and an 8.75% coupon paid semiannually (4.375% each 6 months), and those bonds sell at their $1,000 par value. The firm's Class Ann bonds have the same risk, maturity, nominal interest rate, and par value, but these bonds pay interest annually. Neither bond is callable. At what price should the annual payment bond sell? 5- (Chapter end question 8-1) 6- (Chapter end question 8-4) 7- Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. You now receive another $5.00 million, which you invest in stocks with an average beta of 0.65. What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.)

8- A mutual fund manager has a $40 million portfolio with a beta of 1.00. The risk-free rate is 4.25%, and the market risk premium is 6.00%. The manager expects to receive an additional $60 million which she plans to invest in additional stocks. After investing the additional funds, she wants the funds required and expected return to be 13.00%. What must the average beta of the new stocks be to achieve the target required rate of return?

9- Ackert Company's last dividend was $1.55. The dividend growth rate is expected to be constant at 1.5% for 2 years, after which dividends are expected to grow at a rate of 8.0% forever. The firm's required return (rs) is 12.0%. What is the best estimate of the current stock price?

10- Agarwal Technologies was founded 10 years ago. It has been profitable for the last 5 years, but it has needed all of its earnings to support growth and thus has never paid a dividend. Management has indicated that it plans to pay a $0.25 dividend 3 years from today, then to increase it at a relatively rapid rate for 2 years, and then to increase it at a constant rate of 8.00% thereafter. Management's forecast of the future dividend stream, along with the forecasted growth rates, is shown below. Assuming a required return of 11.00%, what is your estimate of the stock's current value? Year Growth rate Dividends 0 NA $0.000 1 NA $0.000 2 NA $0.000 3 NA $0.250 4 50.00% $0.375 5 25.00% $0.469 6 8.00% $0.506

11- (Chapter end question 10-3) 12- (Chapter end question 10-4) 13- Sapp Truckings balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%. This debt currently has a market value of $50 million. The balance sheet also shows that the company has 10 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $65 million. The current stock price is $22.50 per share; stockholders' required return, rs, is 14.00%; and the firm's tax rate is 40%. The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate. What is the difference between these two WACCs?