Interest rates have fallen over the seven years since a $1,000 par

1. Interest rates have fallen over the seven years since a $1,000 par, 10-year bond was issued with a coupon of 7%. What is the present value of this bond if the required rate of return is currently five percent? (For simplicity, assume annual payments.)

2 . Jamaica Corp. pays a constant $6 dividend on its stock. The company will maintain this dividend for the next 15 years and will then cease paying dividends forever. If the required return on this stock is 12 percent, what is the current share price?

3. The Dow Chemical Company just paid a dividend (D0) of $4 per share. It is expected to increase its dividend by 4% per year. If the market requires a return of 18% on assets with this kind of risks, how much should the stock is selling for?

4. A portfolio is invested 25 percent in Stock A, 40 percent in Stock B, and 35 percent in Stock

C. The expected returns on these stocks are 8 percent, 14 percent, and 18 percent, respectively.

What is the portfolio’s expected return? How do you interpret your answer?

16. Consider the following two mutually exclusive projects:

Year Cash Flow Project A Cash Flow Project B

0 – $175,000 – $25,000

1 22,500 12,000

2 32,500 11,000

3 32,500 9,750

4 220,000 7,300

Whichever project you choose, if any, you require a 15 percent return on your investment.

a) If you apply the payback criterion, which investment will you choose? Why?

b) If you apply the discounted payback criterion, which investment will you choose? Why?

c) If you apply the NPV criterion, which investment will you choose? Why?

d) If you apply the IRR criterion, which investment will you choose? Why?

e) If you apply the profitability index criterion, which investment will you choose? Why?

f) Based on your answers in (a) through (e), which project will you finally choose? Why?

Here’s the SOLUTION

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