Exercise 1: (20 points) Answer the following questions assuming the discount rate is 5%. Hint: Chapter 7, Problem 1 page 289 in your book is a similar problem. Its solution at the end of the book could be a useful guide. a. What will be the value in 10 years of $1,000 invested at the end of each year for the next 10 years? b. How much will you pay for a 5-year bond with a par value of $1,000 and a 7% coupon rate, assuming the interest coupons are paid annually? c. How much would you pay for a share of preferred stock paying a $4-per-share annual dividend forever? d. What will be the value in 10 years of $15,000 invested today? e. How much would you invest today to receive deferred payments of $4,000 at the end of the year 1, $5,000 at the end of year 3, and $10,000 at the end of year 5? Exercise 2:?(20 points) You are considering buying a new Lexus ES300 priced at $30,000. A local dealer is willing to finance the purchase at the interest rate of 6% per year. The loan has to be paid off in 5 equal annual payments. a. What is the annual payment amount? b. The dealer will give you a discount of $1,200 on the price of the car if you choose to finance it on your own? The lowest interest rate you have found is 9%. The loan has to be paid off in 5 equal annual payments. What is the annual payment amount? c. Should you finance through the dealer or take the discount? d. d. What would the numbers be if the loan had to be paid off in 60 equal monthly payments? [Note: This requires use of a calculator or computer.] Exercise 3:?(20 points) You recently plan to buy your dream house for $1,200,000 (ignore tax, insurance and closing costs). You are prepared to make a down payment of 20% and expect to obtain 30-year mortgage at 9% to finance the balance. (For simplicity we assume mortgage payments are made on annual basis). a. What is the amount of your annual mortgage payments? b. What is the amount of interest to be paid in the first annual payment? c. Approximately how much principal would you repay in the first annual payment? d. How much total interest will you pay over the life of your mortgage loan? Exercise 3: (20points) Textbook, chapter 8, page 343, problem # 4. Your company's weighted average cost of capital is 11%. It is planning to undertake a project with an internal rate of return of 14% but you believe this project is not a wise investment. What logical arguments would you use to convince your boss this is not a wise project despite its high rate of return. Is it possible that making returns higher than the firms cost of capital with destroy value? If so how /why? Exercise 4: (20 points) You have the following information about Burgundy Basins a sink manufacturing company: Equity shares outstanding 20 million Stock price per share. $40.00 Yield to maturity on debt. 7.5% Book value of interest bearing debt. $320 million Coupon interest rate on debt. 4.8% Market value of debt. $290 million Book value of equity. $500 million Cost of equity capital. 14% Tax rate. 35% ------------------------------------------------------------------------------ The company is contemplating what for the company is an average risk investment costing $40 million and promising an annual after tax cash flow of $6.4 million in perpetuity. A) what is the internal rate of return on the investment? B) what is Burgundy's weighted average cost of capital? C) if undertaken would you expect this investment to benefit shareholders? Why or why not?
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