Finance Practice Problems

Question 1.

• Sate whether these statements below are an example of primary market transaction or secondary market transaction.

1. Apple Computer decides to issue additional stock with the assistance of its investment banker. An investor purchases some of the newly issued shares.
2. IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker
3. IBM issues 2,000,000 shares of existing stock to raise capital

• Briefly explain how ratios can be helpful as a manager, business owner and a shareholder?

Question 2.

• Suppose 1 year T-Bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk of return?
• Suppose the real risk-free rate is 2.50% and the future rate of inflation is expected to be constant at 4.10%. What rate of return would you expect on a 5 year treasury security, assuming the pure expectations theory is valid?

Question 3.

The real risk-free rate of interest, r*, is 3% and it is expected to remain constant over time. Inflation is expected to be 2% per year for the next 3 years and 4% per year for the next 5 years. The maturity risk premium is equal to 0.1 x t -1 %, where t = the bond’s maturity. The default risk premium for a BBB-rated bond is 1.3%

1. What is the average expected inflation rate over the next 4 years?
2. What is the yield on a 4-year treasury bond?
3. What is the yield on a 4-year BBB rated corporate bond with a liquidity premium of 0.5%?
4. What is the yield on an 8-year Treasury bond?
5. What is the yield on an 8-year BBB rated corporate bond with a liquidity premium of 0.5%?
6. If the yield on a 9-year Treasury bond is 7.3%, what does that imply about expected inflation in 9 years?

Question 4.

For 2015, Everyday Electronics reported $22.5 million of sales and $18 million of operating costs (including depreciation). The company has $15 million of total invested capital. Its after-tax cost of capital is 9%, and its federal-plus-state income tax rate was 35%. What was the firm’s economic value added (EVA), That is, how much value did management add to stockholders wealth during 2015?

Question 5.

• Dyl Inc.’s bonds currently sell for $1,040 and have a par value of $1,000. They pay a $65 annual coupon and have a 15-year maturity. What is their yield to maturity (YTM)?
• Radoski Corporation’s bonds make an annual coupon interest payment of 7.35%. The bonds have a par value of $1,000, a current price of $1,130 , and mature in 12 years. What is the yield to maturity on these bonds?

Question 6.

• Windsor Corporation just paid a dividend of $1.25 a share (that is D?= $1.25). The dividend is expected to grow 8% a year for the next three years and then at 4% a year thereafter. What is the expected dividend per share for each of the next five years?
• What will be the nominal rate of return on a perpetual preferred stock with a $100 par value, a stated dividend of 7% of par, and a current market price of $140?