Financial Tools problesm set

Complete the following problems from Chapters 6 and 7 in Principles of Managerial Finance:

1. Bond      Valuation: P6-13; P6-17; P6-18; P6-19; P6-22
2. Stock      Valuation: P7-6; P7-8; P7-9; P7-14; P7-15; P7-16

Use the Chapters 6-7 Excel resource (if needed) to complete the problem-set assignment in this topic.

Please show all work for each problem.

  

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P6-13 Valuation of assets Using the information   provided in the following table, find the value of each asset.

  

Asset

Cash flow

Appropriate required return

 

End of year

Amount

 

A

1

$ 5,000

18%

 

2

5,000

 

3

5,000

 

B

1 through oc

$ 300

15%

 

C

1

$ 0

16%

 

2

0

 

3

0

 

4

0

 

5

35,000

 

D

1 through 5

$ 1,500

12%

 

6

8,500

 

F

1

$ 2,000

14%

 

2

3,000

 

3

5,000

 

4

7,000

 

4,000

 

1,000

P6-17 Bond value and changing required returns Midland Utilities has outstanding a bond issue that will mature to its $1,000 par value in 12 years. The bond has a coupon

interest rate of 11% and pays interest annually.

a. Find the value of the bond if the required return is (1) 11%, (2) 15%, and

(3) 8%.

b. Plot your findings in part a on a set of “required return (x axis)—market value of bond (y axis)” axes.

c. Use your findings in parts a and b to discuss the relationship between the coupon interest rate on a bond and the required return and the market value of the bond relative to its par value.

d. What two possible

   

P6-18 Bond value and time: Constant required returns Pecos Manufacturing has just issued a 15-year, 12% coupon interest rate, $1,000-par bond that pays interest annually.

The required return is currently 14%, and the company is certain it will remain at 14% until the bond matures in 15 years.

a. Assuming that the required return does remain at 14% until maturity, find the value of the bond with (1) 15 years, (2) 12 years, (3) 9 years, (4) 6 years, (5) 3 years, and (6) 1 year to maturity.

b. Plot your findings on a set of “time to maturity (x axis)—market value of bond (y axis)” axes constructed similarly to Figure 6.5 on page 252.

c. All else remaining the same, when the required return differs from the coupon interest rate and is assumed to be constant to maturity, what happens to the bond value as time moves toward maturity? Explain in light of the graph in part b.

P6-19 Bond value and time: Changing required returns Lynn Parsons is considering investing

in either of two outstanding bonds. The bonds both have $1,000 par values and 11% coupon interest rates and pay annual interest. Bond A has exactly 5 years to maturity, and bond B has 15 years to maturity.

a. Calculate the value of bond A if the required return is (1) 8%, (2) 11%, and (3) 14%.

b. Calculate the value of bond B if the required return is (1) 8%, (2) 11%, and (3) 14%.

c. From your findings in parts a and b, complete the following table, and discuss the relationship between time to maturity and changing required returns.

   

      

Required return 1).,11(-1 1.)( d I.

   

LG 6 PG-22 Yield to maturity Each of the bonds shown in the following table pays interest annually.

  

Bond

Par value

Coupon interest rate

Years to maturity

Current value

 

A

$1,000

9%

8

$ 820

 

B

1,000

12

16

1,000

 

C

500

12

12

560

 

D

1,000

15

10

1,120

 

E

1,000

5

3

900

a. Calculate the yield to maturity (YTM) for each bond.

b. What relationship exists between the coupon interest rate and yield to maturity and the par value and market value of a bond? Explain.

P7-6 Common stock value: Zero growth Kelsey Drums, Inc., is a well-established supplier of fine percussion instruments to orchestras all over the United States.

The company’s class A common stock has paid a dividend of $5.00 per share per year for the last 15 years. Management expects to continue to pay at that amount for the foreseeable future. Sally Talbot purchased 100 shares of Kelsey class A common 10 years ago at a time when the required rate of return for the stock was 16%. She wants to sell her shares today. The current required rate of return for the stock is 12%. How much capital gain or loss will Sally have on her shares?

   

P7-8 Common stock value: Constant growth Use the constant-growth model (Gordon
growth model) to find the value of each firm shown in the following table.

  

Firm

Dividend expected next year

Dividend growth rate

Required return

 

A

$1.20

8%

13%

 

B

4.00

5

15

 

C

0.65

10

14

 

D

6.00

8

9

 

E

2.25

8

20

P7-9 Common stock value: Constant growth McCracken Roofing, Inc., common stock paid a dividend of $1.20 per share last year. The company expects earnings and divi­dends to grow at a rate of 5% per year for the foreseeable future.

a. What required rate of return for this stock would result in a price per share of $28?

b. If McCracken expects both earnings and dividends to grow at an annual rate of 10%, what required rate of return would result in a price per share of $28?

P7-14 Common stock value: Variable growth Lawrence Industries’ most recent annual dividend was $1.80 per share (Do = $1.80), and the firm’s required return is 11%. Find the market value of Lawrence’s shares when:

a. Dividends are expected to grow at 8% annually for 3 years, followed by a 5% constant annual growth rate in years 4 to infinity.

b. Dividends are expected to grow at 8% annually for 3 years, followed by a 0% constant annual growth rate in years 4 to infinity.

c. Dividends are expected to grow at 8% annually for 3 years, followed by a 10% constant annual growth rate in years 4 to infinity.

Personal Finance Problem

P7-15 Common stock value: All growth models You are evaluating the potential purchase of a small business currently generating $42,500 of after-tax cash flow

(Do = $42,500). On the basis of a review of similar-risk investment opportunities, you must earn an 18% rate of return on the proposed purchase. Because you are rel­atively uncertain about future cash flows, you decide to estimate the firm’s value us­ing several possible assumptions about the growth rate of cash flows.

a. What is the firm’s value if cash flows are expected to grow at an annual rate of 0% from now to infinity?

b. What is the firm’s value if cash flows are expected to grow at a constant annual rate of 7% from now to infinity?

c. What is the firm’s value if cash flows are expected to grow at an annual rate of 12% for the first 2 years, followed by a constant annual rate of ‘7% from year 3 to infinity?

  

P7-16 Free cash flow valuation Nabor Industries is considering going public but is unsure of a fair offering price for the company. Before hiring an investment banker to assist

in making the public offering, managers at Nabor have decided to make their own estimate of the firm’s common stock value. The firm’s CFO has gathered data for performing the valuation using the free cash flow valuation model.

The firm’s weighted average cost of capital is 11%, and it has $1,500,000 of debt

at market value and $400,000 of preferred stock at its assumed market value. The estimated free cash flows over the next 5 years, 2016 through 2020, are given below.

Beyond 2020 to infinity, the firm expects its free cash flow to grow by 3% annually.

  

Year (t)

Free cash flow (F F,)

 

2016

$200,000

 

2017

250,000

 

2018

310,000

 

2019

350,000

 

2020

390,000

a. Estimate the value of Nabor Industries’ entire company by using the free cash flow valuation model,

b. Use your finding in part a, along with the data provided above, to find Nabor In­dustries’ common stock value.

c. If the firm plans to issue 200,000 shares of common stock, what is its estimated value per share?