QCU and Exercises for Part 2 : 20 QCU (only one answer is right) and 1 Exercise. Session 4 : Shares Session 5 : Bonds. Corporate Finance.

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1 QCU and Exercises for Part 2 : 20 QCU (only one answer is right) and 1 Exercise Session 4 : Shares Session 5 : Bonds Corporate Finance Master All campuses 1

2 20 QCU Use the information for the question(s) below. Von Bora Corporation is expected pay a dividend of $1.40 per share at the end of this year and a $1.50 per share at the end of the second year. You expect Von Bora's stock price to be $25.00 at the end of two years. Von Bora's equity cost of capital is 10% 1) The price you would be willing to pay today for a share of Von Bora stock, if you plan to hold the stock for two years is closest to: A) $23.15 B) $20.65 C) $21.95 D) $ ) Suppose you plan to hold Von Bora stock for only one year. Your dividend yield from holding Von Bora stock for the first year is closest to: A) 6.0% B) 4.0% C) 6.5% D) 5.5% 3) Suppose you plan on purchasing Von Bora stock in one year, right after the $1.40 dividend is paid. You then plan on selling your stock at the end of year two, right after the $1.50 dividend is paid. The total return that you will receive on your investment is closest to: A) 9.50% B) 10.75% C) 10.25% D) 10.00% Use the following information to answer the question(s) below. Price Earnings Book Value Company Ticker per Share per Share per Share Abbott Labs ABT Bristol-Myers-Squibb BMY GlaxoSmithKline GSK Johnson & Johnson JNJ Merck MRK Pfizer PFE $18.30 $ ) Assuming that Novartis AG (NVS) has an EPS of $3.35, based upon the average P/E ratio for its competitors, Novartis' stock price is closest to: A) $13.00 B) $31.86 C) $43.47 D) $

3 5) Assuming that Novartis AG (NVS) has an EPS of $3.35, based upon the price-to-book ratios for its competitors, the lowest expected stock price for Novartis is closest to: A) $7.47 B) $13.00 C) $22.95 D) $31.86 Use the information for the question(s) below. Suppose that Texas Trucking (TT) has earnings per share of $3.45 and EBITDA of $45 million. TT also has 5 million shares outstanding and debt o $150 million (net of cash). You believe that Oklahoma Logistics and Transport (OLT) is comparable to TT in terms of its underlying business, but OLT has no debt. OLT has a P/E of 12.5 and an enterprise value to EBITDA multiple of 7. 6) Based upon the price earnings multiple, the value of a share of Texas Trucking is closest to: A) $49.30 B) $43.10 C) $24.15 D) $ ) Based upon the enterprise value to EBITDA ratio, the value of a share of Texas Trucking is closest to: A) $33.00 B) $82.50 C) $43.10 D) $21.25 Use the information for the question(s) below. In November 2009, Perrigo Co. (PRGO) had a share price of $ They had million shares outstanding, a market-to-book ratio of In addition, PRGO had $ million in outstanding debt, $ million in net income, and cash of $ million. 8) Perrigo's market capitalization is closest to: A) $ million B) $3, million C) $4, million D) $4, million 9) Perrigo's book value of equity is closest to: A) $ million B) $3, million C) $4, million D) $4, million 3

4 Use the information for the question(s) below. Omicron Technologies has $50 million in excess cash and no debt. There are 10 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $50 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. 10) Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend. The amount of the special dividend is closest to: A) $5.00 B) $9.00 C) $4.00 D) $ ) Which of the following statements is false? A) The amount of each coupon payment is determined by the coupon rate of the bond. B) Prior to its maturity date, the price of a zero-coupon bond is always greater than its face value. C) The simplest type of bond is a zero-coupon bond. D) Treasury bills are U.S. government bonds with a maturity of up to one year. 12) Which of the following statements is false? A) One advantage of quoting the yield to maturity rather than the price is that the yield is independent of the face value of the bond. B) Unlike the case of bonds that pay coupons, for zero-coupon bonds, there is no simple formula to solve for the yield to maturity directly. C) Because we can convert any bond price into a yield, and vice versa, bond prices and yields are often used interchangeably. D) The IRR of an investment in a bond is given a special name, the yield to maturity (YTM). 13) Which of the following statements is false? A) Zero-coupon bonds are also called pure discount bonds. B) The IRR of an investment opportunity is the discount rate at which the NPV of the investment opportunity is equal to zero. C) The yield to maturity for a zero-coupon bond is the return you will earn as an investor from holding the bond to maturity and receiving the promised face value payment. D) When prices are quoted in the bond market, they are conventionally quoted in increments of $ ) Consider a zero coupon bond with 20 years to maturity. The price will this bond trade if the YTM is 6% is closest to: A) $215 B) $312 C) $335 D) $306 4

5 Use the information for the question(s) below. The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate for this bond is 8% and that the coupon payments are to be made semiannually. 15) How much will each semiannual coupon payment be? A) $60 B) $40 C) $120 D) $80 16) Assuming the appropriate YTM on the Sisyphean bond is 7.5%, then this bond will trade at A) par. B) a discount. C) a premium. D) None of the above 17) Which of the following statements is false? A) If a bond trades at a premium, its yield to maturity will exceed its coupon rate. B) A bond that trades at a premium is said to trade above par. C) When a coupon-paying bond is trading at a premium, an investor's return from the coupons is diminished by receiving a face value less than the price paid for the bond. D) Holding fixed the bond's yield to maturity, for a bond not trading at par, the present value of the bond's remaining cash flows changes as the time to maturity decreases. 18) Which of the following statements is false? A) Investors pay less for bonds with credit risk than they would for an otherwise identical default-free bond. B) Credit spreads fluctuate as perceptions regarding the probability of default change. C) Credit spreads are high for bonds with high ratings. D) We refer to the difference between the yields of the corporate bonds and the Treasury yields as the default spread or credit spread. Use the information for the question(s) below. Luther Industries needs to raise $25 million to fund a new office complex. The company plans on issuing ten-year bonds with a face value of $1000 and a coupon rate of 7.0% (annual payments). The following table summarizes the YTM for similar ten-year corporate bonds of various credit ratings: Rating AAA AA A BBB BB YTM 6.70% 6.80% 7.00% 7.40% 8.00% 19) Assuming that Luther's bonds receive a AAA rating, the price of the bonds will be closest to: A) $1021 B) $1014 C) $1000 D) $937 5

6 20) Assuming that Luther's bonds receive a AAA rating, the number of bonds that Luther must issue to raise the needed $25 million is closest to: A) 24,655 B) 25,000 C) 24,477 D) 26,681 6

7 Exercise Exercice 1 Andrew Industries is contemplating issuing a 30-year bond with a coupon rate of 7% (annual coupon payments) and a face value of $1000. Andrew believes it can get a rating of A from Standard and Poor s. However, due to recent financial difficulties at the company, Standard and Poor s is warning that it may downgrade Andrew Industries bonds to BBB. Yields on A-rated, long-term bonds are currently 6.5%, and yields on BBB-rated bonds are 6.9%. a. What is the price of the bond if Andrew maintains the A rating for the bond issue? b. What will the price of the bond be if it is downgraded? 7

8 20 QCU :Answer 1) Answer: A Div Explanation: A) P0 = 1 1+ re Div + P (1 + re ) = (1 +.10) 2 = $ ) Answer: A Div Explanation: A) P0 = 1 1+ re Div + P (1 + re ) = (1 +.10) 2 = $23.17 Dividend yield = Div1 / P0 = $1.40 / =.0604 or 6.0% 3) Answer: D Div Explanation: D) P1 = 2+ P2 1 (1 + re ) = (1 +.10) = $24.10 So dividend yield = $1.50 / $24.10 =.0622 or 6.22% So capital gain rate = (P2 - P1) / P1 = ($ $24.10) / $24.10 = or 3.73% Total return = capital gains rate + dividend yield = 3.73% % = 9.95% 4) Answer: D Explanation: D) Price Earnings Book Value Price/ Price/ Company Ticker per Share per Share per Share Earnings Book Abbott Labs ABT Bristol-Myers-Squibb BMY GlaxoSmithKline GSK Johnson & Johnson JNJ Merck MRK Pfizer PFE $18.30 $ Average Novartis' stock price = 3.35 x = $ ) Answer: A Explanation: A) Price Earnings Book Value Price/ Price/ Company Ticker per Share per Share per Share Earnings Book Abbott Labs ABT Bristol-Myers-Squibb BMY GlaxoSmithKline GSK Johnson & Johnson JNJ Merck MRK Pfizer PFE $18.30 $ Average Novartis' stock price = 3.35 x 2.23 = $7.47 6) Answer: B 8

9 Explanation: B) Price = Earnings P / E = = ) Answer: A Explanation: A) Enterprise value = EBITDA multiple = $45 7 = $315 - $150 debt = $165 equity value/5 million shares = $33.00 per share 8) Answer: B Explanation: B) Market cap = price x shares outstanding = $39.2 x million = $3, million 9) Answer: A Explanation: A) Market to Book = (MV Equity)/(BV Equity) = = 3.76; B V Equity = $ million. 10) Answer: A Explanation: A) $50 million cash Dividend = =$5 per share 10 million shares 11) Answer: B 12) Answer: B 13) Answer: D 14) Answer: B Explanation: B) FV 1000 PV = = (1+i) N (1+.06) 20 = ) Answer: B Explanation: B) Coupon = (coupon rate x face value)/number of coupons per year = ( ) / 2 = $40 16) Answer: C 17) Answer: A 18) Answer: C 19) Answer: A Answer: A Explanation: A) Repayment = 1000 Coupon = 70 N = 10 years y = 6.7 % Compute Bond price = ) Answer: C Explanation: C) FV = 1000 Total number of bonds = $25,000,000 / = 24,

10 Exercise : Answer Exercise 1 a P = = $ ( ) ( ) b. If the bond is downgraded, its price will fall to P = = $ ( ) ( ) 10

BUSI 370 Business Finance

BUSI 370 Business Finance Review Session 2 February 7 th, 2016 Road Map 1. BONDS 2. COMMON SHARES 3. PREFERRED SHARES 4. TREASURY BILLS (T Bills) ANSWER KEY WITH COMMENTS 1. BONDS // Calculate the price of a ten-year annual pay