HW 3

P6-3
The following table summarizes prices of variousdefault-free zero-coupon bonds($100
Maturity(years) 1
Price(per $100 facevalue) $96.71
a. Compute the yield to maturity for each bond.
b. Plot thezero-coupon yield curve(for the first fiveyears).
c. Is the yield curve upwardsloping, downwardsloping, orflat?
Note: Assume annual compounding.

Par Value 100

Maturity 1
Price 96.71
YTM 3.40%

YTM
6.00%

5.00%

4.00%

3.00%

2.00%

1.00%

0.00%
1 2 3 4

P6-6
Suppose a 10-year, $1000 bond with a 7% coupon rate and semiannual coupons is tra
a. What is thebond's yield to maturity(expressed as an APR with semiannualcompou
b. If thebond's yield to maturity changes to 9% APR, what will the bond's price be?
a.
Period 10
Par $1,000
Price $937.34
Rate 7%
Compounding 2

YTM 3.96%
YTM Semiannual 7.92%

b.
New Rate 9%
New YTM Semiannual 4.50%

New Price $869.92

P6-13
Consider the followingbonds:
Bond Coupon Rate(annual payments)
A 0%
B 0%
C 4%
D 7%
a. What is the percentage change in the price of each bond if its yield to maturity falls
b. Which of the bonds AD is most sensitive to a 1% drop in interest rates from 6% to
Which bond is least sensitive? Provide an intuitive explanation for your answer.
Note: Assume annual compounding.
Theoretical Price 1000
Change From 6%
Bond Coupon Rate
A 0%
B 0%
C 4%
D 7%

Bond A is most sensitive to a1% drop in interestrates, from 7% to 6% because it has

Bond D is the least sensitive to a1% drop in interestrates, from 7% to 6% because it h

P6-17
Assume thezero-coupon yields ondefault-free securities are as summarized in the foll
Maturity (Years) 1
Zero-Coupon Yields 3.80%
What is the price today of atwo-year, default-free security with a face value of $1,000
Does this bond trade at adiscount, atpar, or at apremium?
Note: Assume annual compounding.

Par $1,000
Coupon Rate 7%
Discount Rate 0
Period 0
C(t) $0.00
PV $1,052.92

If the price is more than $1,000, then the bond sells at a premium. If the price is less t
Since this bond sells for more than $1,000, it trades at a premium.

P6-18
Assume thezero-coupon yields ondefault-free securities are as summarized in the foll
Maturity (Years) 1
Zero-Coupon Yields 4.10%
What is the price today of a five-year, default-free security with a face value of $1,000
Par 1000
Price $768.77

P6-19
Assume thezero-coupon yields ondefault-free securities are as summarized in the foll
Maturity (Years) 1
Zero-Coupon Yields 3.90%
What is the price today of a three-year, default-free security with a face value of $1,00
What is the yield to maturity for thisbond?
Par $1,000
Coupon Rate 5%
Discount Rate 0
Period 0
C(t) $0.00
PV $1,011.56

YTM 4.58%

P6-20
Assume thezero-coupon yields ondefault-free securities are as summarized in the foll
Maturity (Years) 1
Zero-Coupon Yields 6.80%
What is the maturity of a default-free security with annual coupon payments and a yie
One year
It must be one year otherwise there will be an arbitrage opportunity.

P6-21
Maturity (Years) 1
Zero-Coupon Yields 6.30%
Consider a four-year, default-free security with annual coupon payments and a face va

Par Value 1000

PV $757.22
? 0.9407337723
Coupon Value $71.48
Par Coupon Rate 7.15%

P6-22
Consider a five-year, default-free bond with annual coupons of 8% and a face value of
Maturity (Years) 1
Zero-Coupon Yields 7.00%
a. What is the yield to maturity on thisbond?
b. If the yield to maturity on this bond increased to 8.20%, what would the new priceb
a.
Par $1,000
Coupon Rate 8%
Discount Rate 0
Period 0
C(t) $0.00
PV $1,009.98
YTM 7.75%

b.
New YTM 8.20%
New Price $992.06

P6-30
Andrew Industries is contemplating issuing a 30-year bond with a coupon rate of 7.81%
Andrew believes it can get a rating of A from S&P. However, due to recent financial diffi
Yields on A-rated long-term bonds are currently 7.31%, and yields on BBB-rated bonds
a. What is the price of the bond if Andrew maintains the A rating for the bondissue?
b. What will the price of the bond be if it isdowngraded?
Par Value 1000
Period 30
Coupon Rate 7.81%
A Rate 7.31%
BBB Rate 7.71%

a.
A Price $1,060.16
b.
BBB Price $1,011.57

P9-3
Suppose Acap Corporation will pay a dividend of $2.82 per share at the end of this yea
You expect Acap's stock price to be $52.37 in two years. If Acap's equity cost of capita
a. What price would you be willing to pay for a share of Acap stocktoday, if you plann
b. Suppose instead you plan to hold the stock for one year. What price would you expe
c. Given your answer in part b, what price would you be willing to pay for a share of Ac
How does this compare to your answer in part a?
a.
Future Value $52.37
Period 1
Div $2.82
ECC 8.20%
Price $2.61
b.
Price $51.12
c.
Price $49.85
The price you are willing to pay for the stock today is the same whether you plan to ho

P9-8
Canadian-based mining company El Dorado Gold (EGO) suspended its dividend in Mar
Suppose you expect EGO to resume paying annual dividends in two years time, with a
If EGO's equity cost of capital is 9.4%, what is the value of a share of EGO today?
Dividend 0.35
Dividend Growth Rate 2.90%
ECC 9.40%
Future Price $5.38
Current Price $4.92

P9-10
DFB, Inc., expects earnings this year of $4.11 per share, and it plans to pay a $1.73 div
DFB will retain $2.38 per share of its earnings to reinvest in new projects with an expe
Suppose DFB will maintain the same dividend payout rate, retention rate, and return o
a. What growth rate of earnings would you forecast forDFB?
b. IfDFB's equity cost of capital is 12.1%, what price would you estimate for DFBstock
c. Suppose DFB instead paid a dividend of $2.73 per share this year and retained only
Thatis, it chose to pay a higher dividend instead of reinvesting in as many new projec
If DFB maintains this higher payout rate in thefuture, what stock price would you estim
EPS $4.11
Dividend $1.73
Retention $2.38
Expected Rate of Return 14.70%
ECC 12.10%

a.
Earnings Growth Rate 8.51%
b.
Price $48.22
c.
New Dividend $2.73
New Retention $1.38
New EGR 4.94%
New Price $38.11
The company should not raise dividends because projects have positive NPV when the

P9-13
Colgate-Palmolive Company has just paid an annual dividend of $1.41.
Analysts are predicting dividends to grow by $0.19 per year over the next five years.
After then, Colgate's earnings are expected to grow 5.4% per year, and its dividend pa
If Colgate's equity cost of capital is 8.9% per year, what price does the dividend-discou
Dividend $1.41
Dividend Growth Rate $0.19
ECC 8.90%
Earnings Growth Rate 5.40%

Period 1
Dividend $1.60
Div/ECC $1.47

Price = $7.60
Price $54.00

P9-19
Heavy Metal Corporation is expected to generate the following free cash flows over th
Year 1
FCF ($ million) 52.8
After that, the free cash flows are expected to grow at the industry average of 4.4% pe
Using the discounted free cash flow model and a weighted average cost of capital of 1
a. Estimate the enterprise value of Heavy Metal.
b. If Heavy Metal has no excesscash, debt of $319 million, and 41 million shares outst
a.
Cash Flow Growth 4.40%
Weighted ACC 14.40%
Period 1
FCF ($ million) 52.8
Enterprise Value $46.15
Total Enterprise Value $670.13

b.
Debt $319
Cash $0
Shares Outstanding 41

Share Price $8.56

P9-24
You notice that PepsiCo (PEP) has a stock price of $74.59 and EPS of $3.46.
Its competitor, the Coca-Cola Company (KO), has EPS of $2.39.
Estimate the value of a share of Coca-Cola stock using only this data.

PEP Price $74.59

PEP EPS $3.46
PEP P/E $21.56
KO EPS $2.39
KO Price Estimate $51.52

P9-32
Roybus, Inc., a manufacturer of flash memory, just reported that its main production fa
While the plant was fully insured, the loss of production will decrease Roybus's free ca
a. If Roybus has 3030 million shares outstanding and a weighted average cost of capit
(Assume that the value of Roybus' debt is not affected by the event.)
b. Would you expect to be able to sell Roybus's stock on hearing this announcement a
a.
Period 1
Loss $176
Shares 30
ACC 13.70%

PV FVF ($154.79)
Change in Price ($6.76)
b.
If this is public information, in an efficient market the share price will drop immediately
coupon bonds($100 facevalue):
2 3 4 5
$92.39 $87.85 $82.99 $77.93

2 3 4 5
92.39 87.85 82.99 77.93
4.04% 4.41% 4.77% 5.11%

4 5

nual coupons is trading for a price of $937.34

emiannualcompounding)?
bond's price be?

year
 Semiannual

Maturity(years)
16
12
16
12
eld to maturity falls from 6% to 5%?
st rates from 6% to 5% and why?
your answer.

to 5%
Maturity YTM 6% YTM 5% Difference
16 $393.65 $458.11 16.38%
12 $496.97 $556.84 12.05%
16 $797.88 $891.62 11.75%
12 $1,083.84 $1,177.27 8.62%

6% because it has the lowest coupon and longest maturity.

% to 6% because it has the highest coupon and shortest maturity.

mmarized in the followingtable:

2 3 4 5
4.20% 4.50% 4.90% 5.00%
ace value of $1,000 and an annual coupon rate of 7%
 3.80% 4.20%
1 2
$70 $1,070
$67.44 $985.48

If the price is less than $1,000, then it sells at a discount; and if the price is $1,000, then it sel

mmarized in the followingtable:

2 3 4 5
4.50% 4.90% 5.20% 5.40%
ace value of $1,000?

mmarized in the followingtable:

2 3 4 5
4.30% 4.60% 4.90% 5.30%
face value of $1,000 and an annual coupon rate of 5%?

3.90% 4.30% 4.60%

1 2 3
$50 $50 $1,050
$48.12 $45.96 $917.48

mmarized in the followingtable:

 2 3 4 5
7.20% 7.60% 7.90% 8.10%
payments and a yield to maturity of 6.80%? Why?

2 3 4 5
6.60% 6.90% 7.20% 7.50%
ments and a face value of $1,000 that is issued at par. What is the coupon rate of this bond?

0.8800059136 0.81859085 0.75721788

and a face value of $1,000 and assume zero-coupon yields on default-free securities are as sum
2 3 4 5
7.30% 7.50% 7.70% 7.80%

ould the new pricebe?

7.00% 7.30% 7.50% 7.70% 7.80%

1 2 3 4 5
$80 $80 $80 $80 $1,080
$74.77 $69.48 $64.40 $59.46 $741.87

oupon rate of 7.81% (annual coupon payments) and a face value of $1,000.
 recent financial difficulties at the company, S&P is warning that it may downgrade Andrew Ind
on BBB-rated bonds are 7.71%.
r the bondissue?

years

t the end of this year, and $2.94 per share next year.
quity cost of capital is 8.2%:
today, if you planned to hold the stock for twoyears?
rice would you expect to be able to sell a share of Acap stock for in oneyear?
pay for a share of Acap stocktoday, if you planned to hold the stock for oneyear?

2
$2.94

$47.24 $49.85

ether you plan to hold the stock for one year or two years.

its dividend in March 2016 as a result of declining gold prices and delays in obtaining permits
o years time, with a dividend of $0.35 per share, growing by 2.9% per year.
of EGO today?
s to pay a $1.73 dividend to shareholders.
ojects with an expected return of 14.7% per year.
n rate, and return on new investments in the future and will not change its number of outstand

timate for DFBstock?

r and retained only $1.38 per share in earnings.
s many new projects.
rice would you estimatenow? Should DFB follow this newpolicy?

sitive NPV when the return on new investments is higher than the firm's cost of capital.

he next five years.

and its dividend payout rate will remain constant.
the dividend-discount model predict Colgate stock should sell for today?
 per year for next 5 years

per year

2 3 4 5 6+
$1.79 $1.98 $2.17 $2.36 $2.49
$1.51 $1.53 $1.54 $1.54

+ $71.07 * 65.29%

cash flows over the next five years:

2 3 4 5
69.3 78.8 73.9 81.4
average of 4.4% per year.
cost of capital of 14.4%:

million shares outstanding, estimate its share price.

2 3 4 5 5+
69.3 78.8 73.9 81.4 84.9816
$52.95 $52.63 $43.15 $41.54 $433.71

million
million
million
of $3.46.

s main production facility in Taiwan was destroyed in a fire.

se Roybus's free cash flow by $176 million at the end of this year and by $62 million at the end
verage cost of capital of 13.7%, what change in Roybus's stock price would you expect upon th

is announcement and make a profit? Explain.

2
$62
million

($47.96) ($202.75)

ill drop immediately to reflect the news, and no trading profit is possible.
e is $1,000, then it sells at par.
n rate of this bond?

e securities are as summarized in the following table:

owngrade Andrew Industries bonds to BBB.

neyear?

s in obtaining permits for its mines in Greece.

ts number of outstanding shares.

ost of capital.
$62 million at the end of next year.
ld you expect upon this announcement?