Expert Solutions FH18

1) 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?

2) 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%?

3) James River $3.38 preferred is selling for $45.25. The preferred dividend is nongrowing. What is the required return on James River preferred stock?

4) Suppose Toyota has nonmaturing  (perpetual) preferred stock outstanding that pays a $1.00 quarterly dividend and has a required return of 12% APR (3% per quarter). What is the stock worth?–

5) (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 that one issue matures in 1 year, one in 7 years, and the third in 15 years. Assume that a coupon payment was made yesterday
a.     If the yield to maturity for all three bonds is 8%, what is the fair price of each bond? –
b.     Suppose that the yield to maturity for all of these bonds changed instantaneously to 7%. What is the fair price of each bond now?
c.     Suppose that the yield to maturity for all of these bonds changed instantaneously again, this time to 9%. Now what is the fair price of each bond?
d.     Based on the fair prices at the various yields to maturity, is interest-rate risk the same, higher, or lower for longer-versus shorter-maturity bonds?

6) B18. (Default risk) You buy a very risky bond that promises a 9.5% coupon and return of the
$1,000 principal in 10 years. You pay only $500 for the bond.
a. You receive the coupon payments for three years and the bond defaults. After liquidating-
the firm, the bondholders receive a distribution of $150 per bond at the end of 3.5
years. What is the realized return on your investment?
b. The firm does far better than expected and bondholders receive all of the promised
interest and principal payments. What is the realized return on your investment?

7) (Constant growth model) Medtrans is a profitable firm that is not paying a dividend on its common stock. James Weber, an analyst for A.G. Edwards believes that Medtrans will begin paying $1.00 per share dividend in two years and that the dividend will increase 6% annually thereafter. Bret Kimes, one of James colleagues at the same firm is less optimistic. Bret thinks that Medtrans will begin paying a dividend in 4 years, that the dividend will be $1.00 and that it will grow at 4% annually. James and Bret agree that the required return for Medtrans is 13%.
1. What value would James estimate for this firm?
2. What value would Bret assign to the Medtrans stock?

8) The riskless return is currently 6%, and Chicago Gear has estimated the contingent returns given here.
a. Calculate the expected returns on the stock market and on Chicago Gear stock.
b. What is Chicago Gear’s beta?
c. What is Chicago Gear’s required return according to the CAPM?
REALIZED RETURN
State of the Market     Probability that State Occurs     Stock Market     Chicago Gear
Stagnant           0.20     (10%)     (15%)
Slow growth     0.35      10           15
Average growth  0.30   15           25
Rapid growth      0.15   25            35

9) Bixton Company’s new chief financial officer is evaluating Bixton’s capital structure. She is concerned that the firm might be underleveraged, even though the firm has larger-than-average research and development and foreign tax credits when compared to other firms in its industry. Her staff prepared the industry comparison shown here.
1. Bixton’s objective is to achieve a credit standing that falls, in the words of the chief financial officer, “comfortably within the ‘A’ range.” What target range would you recommend for each of the three credit measures?
2. Before settling on these target ranges, what other factors should Bixton’s chief financial officer consider?
3. Before deciding whether the target ranges are really appropriate for Bixton in its current financial situation, what key issues specific to Bixton must the chief financial officer resolve?

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 adjustment model, Equation (18.1), to calculate projected dividends per share for this year and the next four.

11) B2. (Dividend policy) A firm has 20 million common shares outstanding. It currently pays out $1.50 per share per year in cash dividends on its common stock. Historically, its payout ratio has ranged from 30% to 35%. Over the next five years it expects the earnings and discretionary
cash flow shown below in millions.
a. Over the five-year period, what is the maximum overall payout ratio the firm could achieve without triggering a securities issue?
b. Recommend a reasonable dividend policy for paying out discretionary cash flow in years 1 through 5.
1         2            3       4           5         Thereafter
Earnings                                100     125     150     120     140     150+ per year
Discretionary Cash Flow      80       70        60       20      15       50+ per year

12. (Comparing borrowing costs) Stephens Security has two financing alternatives: (1) A publicly placed $50 million bond issue. Issuance costs are $1 million, the bond has a 9% coupon paid semiannually, and the bond has a 20-year life. (2) A $50 million private placement with a large pension fund. Issuance costs are $500,000, the bond has a 9.25% annual coupon, and the bond has a 20-year life. Which alternative has the lower cost (annual percentage
yield)?

13. (Leasing, taxes, and the time value of money) The lessor can claim the tax deductions associated with asset ownership and realize the leased asset’s residual value. In return, the lessor must pay tax on the rental income.
a. Explain why a financial lease represents a secured loan in which the lender’s entire debt service stream is taxable as ordinary income to the lessor/lender.
b. In view of this tax cost, what tax condition must hold in order for a financial lease transaction to generate positive net-present-value tax benefits for both the lessor and lessee?
c. Suppose the lease payments in Table 21-2 must be made in advance, not arrears.-
(Assume that the timing of the lease payment tax deductions/obligations changes accordingly but the timing of the depreciation tax deductions does not change). Show that the net advantage to leasing for NACCO must decrease as a result. Explain why this reduction occurs.
d. Show that if NACCO is nontaxable, the net advantage to leasing is negative and greater in absolute value than the net advantage of the lease to the lessor.
e. Either find a lease rate that will give the financial lease a positive net advantage for both lessor and lessee, or show that no such lease rate exists.
f. Explain what your answer to part e implies about the tax costs and tax benefits of the financial lease when lease payments are made in advance.