Corporate Finance Homework Assignment

Section 1: Short Answer. Please answer five (5) of the following six (6) questions completely, noting that some questions may contain multiple parts. If you answer all 6 questions, then your score on the first 5 questions will be counted toward your final exam score. Each short answer question that you choose to answer is worth 5 points for a total of 25 possible points in Section 1.

1. Why might a corporation call its issued bonds prior to their maturity?

2. What is a Proxy Fight and how might it be used to overthrow a firm’s leadership? Provide two (2) ways that firm management can fight back against proxy fights and takeovers.

3. Our course textbook describes the inventory turnover ratio as sales divided by inventories. Why might cost of goods sold instead be a more useful numerator when calculating this ratio?

4. Portfolio risk typically consists of two (2) different types of risk. Name each type of risk and describe the potential impact on asset portfolios. Can each type of risk be reduced or eliminated? Why or why not?

5. Common stockholders with a Preemptive rights clause may purchase additional shares of stock in the company on a pro rata or proportional basis if the company issues new shares. Why is this an important feature for stockholders?

6. Explain how leveraging up a company’s balance sheet might shift risk from shareholders to creditors. What is the payoff for this strategy?

Section 2: Problem Solving. Please answer the following questions completely by noting that some problem-solving questions contain multiple parts. Please also show your work when relevant. Each problem-solving question is worth 5 points for a total of 50 possible points in Section 2.

1. What is the present value of a security that will pay you $4,200 in 10 years assuming an annual interest rate of 4.5%?

2. On the day your child is born, you open a college savings fund for him/her with an initial deposit of $5,000. You want this account to be able to cover his/her entire tuition for 4 years of college. In 18 years, when your child is beginning to attend college, 4 years of college tuition will cost $360,000. The bank is giving you an interest rate of 2.5% compounded annually. How much will you need to deposit each month in the college savings account in order to have saved enough money for 4 years of his/her college tuition? Assume that you will make 1 payment equal to the entire amount of tuition in 18 years.

3. (a) Calculate the value of a bond with a 6.75% semiannual coupon and a market interest rate of 8% that matures in 15 years.

(b) If the market rate for the bond in Question 1(a) increased to 10.5% after 2 years, what is the percentage change in the bond value over that time?

4. What would you expect to pay for a 12-year bond with a 5.5% semiannual coupon and yield to maturity of 4.0%? If this bond were callable in 10 years at a price of $1,060, what would the yield to call be?

5. The current price of Cyberdyne stock is $42.50 per share. If Cyberdyne’s last dividend was $3.00 per share, and given that stockholders’ required rate of return is 9%, what is the expected growth rate of Cyberdyne dividends based on the Discounted Dividend Model for constant growth?

6. You are currently 25 years old, and while retirement is not the most pressing matter in your mind you have been thinking about it a lot lately. Specifically, you have heard from friends that it is never too early to begin saving for your retirement. You decide to open a retirement account with a balance of $0.00 that gives you an annual interest rate of 1.75% compounded monthly. You want to retire at age 65 with $1 million. How much will you need to deposit in the account each month to achieve that goal?

7. After living with roommates in Boston for many years, you are ready to purchase your first home. And as luck would have it, you found a really nice condominium in Boston for a purchase price of $400,000. After meeting with several banks to determine how you will finance the purchase of the condo, you have discovered the following:
   • The banks will require you to make a down payment at the time of sale equal to 20% of the purchase price of the property (assume you have this amount of cash on hand);
   • Interest will be compounded monthly for the loan at a rate to be determined; and
   • The banks will loan you the purchase price less the down payment (80% of the purchase price) for a period of 30 years.

You can only afford to pay $1,500 per month for a mortgage payment (assume no real estate tax escrowing or fees). What is the maximum annual interest rate that you could have for this loan to prevent you from paying more than $1,500 per month toward your mortgage?

8. Human Systems, a pharmaceutical company, is expected to experience a high rate of earnings and dividend growth in the next 5 years as a result of having developed a cold remedy that reduces the effects of the common cold to an average of 2 days. We expect the rate of growth in years 1 to 3 to be 20% and in years 4 and 5 to be 10%. The rate of growth in each year thereafter is expected to be 5%, and the last dividend Human Systems paid was $4.00. Stockholders’ required rate of return is 8%. Using the Discounted Dividend Model, what is the intrinsic value today of Humans Systems’ stock given the expected growth in dividends?

9. Your friend is planning to borrow $10,000 from a bank to purchase a used motorcycle. She is considering 3 different loans, each with different interest rates but with the same term. The loan from Bank A has an annual interest rate of 7.99% compounded quarterly. The loan from Bank B has an annual interest rate of 6.99% compounded monthly. And the loan from Bank C has an annual interest rate of 7.5% compounded semiannually. Which loan would you recommend to your friend and why?

10. Management for a movie theater corporation is faced with a difficult decision concerning one of their under-performing movie theaters. They need to decide whether to a) build a new snack bar that provides expanded food options as well as alcoholic drinks, or b) purchase 3 new movie projectors that feature the latest projection technology. They cannot choose to do both projects. The new snack bar will cost the company $2.5 million, while the new projectors will cost the company $240,000. The table at the top of page 4 summarizes the projected cash flows (sales) for each project.

1. If the company’s established minimum acceptable rate of return on investments such as these is 5%, what is the Net Present Value of each investment?

1. Based on your cash flow analysis, in which project do you think the company should invest? Please explain your answer.

Section 3: Portfolio Analysis. Please answer the following questions completely by noting that some questions below may contain multiple parts. Please also show your work when relevant. Each question in this section is worth 5 points for a total of 25 possible points in Section 3.

The tables below contain information on the stocks that are included in the Terrier Fund and the Agganis Fund. Please answer each of the questions that follow about these portfolios.

NOTE: the standard deviation for each stock represents an annualized standard deviation.

1. Calculate the standard deviation for both the Terrier Fund and the Agganis Fund. Explain your findings relative to the market for each portfolio.

2. Calculate beta for both the Terrier Fund and the Agganis Fund. Explain your findings relative to the market for each portfolio.

3. Using the Capital Asset Pricing Model (CAPM), calculate the expected return for each portfolio using a risk-free rate of 2% and a market risk rate of 7%.

4. Which fund might you recommend to a more conservative, risk averse investor given the information that is available? Explain your answer.

5. What additional information might you want to obtain in order to provide a more accurate portfolio recommendation for this conservative, risk averse investor?