Module 3 Trainer

Problem 1: Stef Inc.’s currently outstanding 10% coupon bonds have a yield to maturity
of 12%. Stef believes it could issue new bonds at par that would provide a similar yield to
maturity. If the income tax rate is 30%, what is Stef Inc.’s after-tax cost of debt?

Problem 2: Federer Motors’ bonds have 5 years remaining to maturity. Interest is

paid annually. The bonds have a P1,000 face value, and the coupon interest rate is
6 percent. The bonds have a yield to maturity of 7.5 percent.

1. What is the current market price of these bonds?

2. Assuming that the YTM is 5.25%, what is the current market price?

Problem 3: Nadal Company is planning to issue P10 million bonds that will mature
in ten years. The bonds have a face value of P1,000 and a yield to maturity of 8
percent. They pay interest annually and have a 9 percent coupon rate. What is their
current yield?

Problem 4: Novak Company’s 5-year 8% bonds are issued at P1,075 per bond.

1. What is the yield to maturity for these bonds?

2. What is the YTM for these bonds assuming they are issued at P975 before
P50 flotation costs.

Problem 5: Serena Corporation plans to issue some P 90 par preferred stock with a 6%
dividend. A similar stock is selling on the market for P 100. Serena must pay flotation
costs of 3% of the issue price. The income tax rate is 30%. What is the cost of preferred
stock?

Problem 6: The P 100 par value preferred stock for Rafael Corporation pays an annual
dividend of 5%, it has required rate of return of 8%. Compute the price of the preferred
stock.

Problem 7: Moon Electronics wants you to calculate its cost of common stock. At
the end of 12 months the company expects to pay dividends of P1.20 per share,
and the current price of its common stock is P36 per share. The expected annual
dividend growth rate is 4% and the flotation cost is P2.50 per share.
1. Compute the cost of retained earnings.
2. Compute the cost of new common stock.
Problem 8: Forda Corporation just paid a dividend of P 10 per share on its stock. The
dividends are expected to grow at a constant rate of 5% per year, indefinitely.

1. If investors require a 12% return on Forda Corporation stocks, what is the current
price?
2. What will the price be in three years?

Problem 9: Alecks Enterprises recently paid a dividend of P1.20. It expects to have

non-constant growth of 40% for 3 years followed by a constant rate of 5%
thereafter. The firm’s required return is 9%.

1. How far away is the terminal date?

2. What is the firm’s horizon or terminal value?
3. What is the firm’s intrinsic value today, P0?

Problem 10: Janiel Mining Company’s ore reserves are being depleted, so its
sales are falling. Also, because its pit is getting deeper each year, its costs are
rising. As a result, the company’s earnings and dividends are declining at the
constant rate of 5% per year. If D0 = P1.50 and the expected return is 7.5%, what
is the value of Janiel Mining’s stock?

Problem 11: Gayle Corporation has a beta of 0.8. The yield on a 10-year T-bond is 6%.
The market return is 10%. What is the estimated cost of common equity using CAPM?

Problem 12: Use the basic equation for the capital asset pricing model (CAPM) to work
on each of the following:
a. Find the required rate of return for an asset with a beta of 1.0 when the risk-
free rate and market return are 7% and 12%, respectively.
b. Find the required rate of return for an asset with a beta of 0.80 when the risk-
free rate of return is 6% and the market risk premium is 4%.
c. Find the beta for an asset with a required return of 7.4% when the risk-free rate
and market return are 6% and 8%, respectively.

Problem 13: Use the following information:

State Probability Return

Boom 20% 40%

Normal 60% 15%

Recession 20% (20%)

Requirements:

1. Calculate your company’s expected return.

2. Calculate the standard deviation.

3. Calculate the coefficient of variation.

Problem 14: Cortez Corporation is expanding its research and production capability
to introduce a new line of products. Current plans call for the expenditure of P100
million on four projects of equal size (P25 million each), but different returns. Project
A is in blood clotting proteins and has an expected return of 14 percent. Project
B relates to a hepatitis vaccine and carries a potential return of 12.5 percent.
Project C, dealing with a cardiovascular compound, is expected to earn 11.8
percent and Project D, an investment in orthopedic implants, is expected to show
a 10.5 percent return.
The firm has P15 million in retained earnings. After a capital structure with P15 million
in retained earnings is reached (in which retained earnings represent 60 percent of
the financing), all additional equity financing must come in the form of new common
stock. Common stock is selling for P24 per share and underwriting costs are estimated
at P3 if new shares are issued. Dividends for the next year will be P2.00 per share
(D1), and earnings and dividends have grown consistently at 6 percent.

The yield on comparative bonds has been hovering at 9.2 percent. The investment
banker feels that the first P20 million of bonds could be sold to yield 9.2 percent while
additional debt might require a 2 percent premium and be sold to yield 11.2 percent.
The corporate tax rate is 40 percent. Debt represents 40 percent of the capital
structure.

1. Based on the two sources of financing, what is the initial weighted average cost
of capital?
2. At what capital structure size will the firm run out of retained earnings?
3. What will the marginal cost of capital be immediately after that point?
4. At what capital structure size will there be a change in the cost of debt?
5. What will the marginal cost of capital be immediately after that point?
6. Based on the information about potential returns on investments in the first
paragraph and information on marginal cost of capital (in parts 1, 3, and 5),
how large a capital investment budget should the firm use

-END-