Zemen postgraduate college

Department of Management studies

MBA program
Advanced Financial Management Assignment out of 40%

Please work out the following questions.

1. To save money for a new house, you want to begin contributing money to a brokerage account.
Your plan is to make 10 contributions to the brokerage account. Each contribution will be for
$1,500. The contributions will come at the beginning of each of the next 10 years. The first
contribution will be made at t = 0 and the final contribution will be made at t = 9. Assume that
the brokerage account pays a 9 percent return with quarterly compounding. How much money
do you expect to have in the brokerage account nine years from now (t = 9)?
2. John and Julie Johnson are interested in saving for their retirement. John and Julie have the
same birthday--both are 50 years old today. They started saving for their retirement on their
25th birthday, when they received a $20,000 gift from Julie’s aunt and deposited the money in
an investment account. Every year thereafter, the couple added another $5,000 to the account.
(The first contribution was made on their 26th birthday and the 25th contribution was made
today on their 50th birthday.) John and Julie estimate that they will need to withdraw $150,000
from the account 3 years from now, to help meet college expenses for their 5 children. The
couple plans to retire on their 58th birthday, 8 years from today. They will make a total of 8
more contributions, one on each of their next 8 birthdays with the last payment made on their
58th birthday. If the couple continues to contribute $5,000 to the account on their birthday,
how much money will be in the account when they retire? Assume that the investment account
earns 12 percent a year.
3. Your father, who is 60, plans to retire in 2 years, and he expects to live independently for 3
years. He wants a retirement income that has, in the first year, the same purchasing power as
$40,000 has today. However, his retirement income will be a fixed amount, so his real income
will decline over time. His retirement income will start the day he retires, 2 years from today,
and he will receive a total of 3 retirement payments.
Inflation is expected to be constant at 5 percent. Your father has $100,000 in savings now, and
he can earn 8 percent on savings now and in the future. How much must he save each year,
starting today, to meet his retirement goals?
4. You are saving for the college education of your two children. One child will enter college in 5 years,
 while the other child will enter college in 7 years. College costs are currently $10,000 per year and
are expected to grow at a rate of 5 percent per year. All college costs are paid at the beginning of the
year. You assume that each child will be in college for four years.
You currently have $50,000 in your educational fund. Your plan is to contribute a fixed amount to the
fund over each of the next 5 years. Your first contribution will come at the end of this year, and your final
contribution will come at the date when you make the first tuition payment for your oldest child. You
expect to invest your contributions into various investments, which are expected to earn 8 percent per
year. How much should you contribute each year in order to meet the expected cost of your children’s
education?
5. Hillary is trying to determine the cost of health care to college students and parents’ ability to cover
those costs. She assumes that the cost of one year of health care for a college student is $1,000 today,
that the average student is 18 when he or she enters college, that inflation in health care cost is rising
at the rate of 10 percent per year, and that parents can save $100 per year to help cover their children’s
costs. All payments occur at the end of the relevant period, and the $100/year savings will stop the
day the child enters college (hence 18 payments will be made). Savings can be invested at a nominal
rate of 6 percent, annual compounding. Hillary wants a health care plan that covers the fully inflated
cost of health care for a student for 4 years, during Years 19 through 22 (with payments made at the
end of Years 19 through 22). How much would the government have to set aside now (when a child
is born), to supplement the average parent’s share of a child’s college health care cost? The lump
sum the government sets aside will also be invested at 6 percent, annual compounding.
6. A 12-year bond has a 9 percent annual coupon, a yield to maturity of 8 percent, and a face
value of $1,000. What is the price of the bond?
7. Yohe Technology’s stock is expected to pay a dividend of $2.00 a share at the end of the year. The
stock currently has a price of $40 a share, and the stock’s dividend is expected to grow at a constant
rate of g percent a year. The stock has a beta of 1.2. The market risk premium, kM – kRF, is 7
percent and the risk-free rate is 5 percent. What is the expected price of Yohe’s stock 5 years from
today?
8. The last dividend paid by Klein Company was $1.00. Klein’s growth rate is expected to be a
constant 5 percent for 2 years, after which dividends are expected to grow at a rate of 10 percent
forever. Klein’s required rate of return on equity (ks) is 12 percent. What is the current price of
Klein’s common stock?
9. Gettysburg Grocers’ stock is expected to pay a year-end dividend, D1, of $2.00 per share. The
dividend is expected to grow at a constant rate of 5 percent, and the stock has a required return of
9 percent. What is the expected price of the stock five years from today?
10. (The following information applies to the next four problems.)
J. Ross and Sons Inc. has a target capital structure that calls for 40 percent debt, 10 percent
preferred stock, and 50 percent common equity. The firm’s current after-tax cost of debt is 6
percent, and it can sell as much debt as it wishes at this rate. The firm’s preferred stock currently
sells for $90 a share and pays a dividend of $10 per share; however, the firm will net only $80 per
share from the sale of new preferred stock. Ross’ common stock currently sells for $40 per share,
but the firm will net only $34 per share from the sale of new common stock. The firm recently
paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow
indefinitely at a constant rate of 10 percent per year. Assume the firm has sufficient retained
earnings to fund the equity portion of its capital budget.
What is the firm’s cost of retained earnings?
What is the firm’s cost of newly issued common stock?
What is the firm’s cost of newly issued preferred stock?
What is the firm’s weighted average cost of capital?
11. Hatch Corporation’s target capital structure is 40 percent debt, 50 percent common stock, and
10 percent preferred stock. Information regarding the company’s cost of capital can be
summarized as follows:
• The company’s bonds have a nominal yield to maturity of 7 percent.
• The company’s preferred stock sells for $42 a share and pays an annual dividend of $4 a share.
• The company’s common stock sells for $28 a share, and is expected to pay a dividend of $2 a
share at the end of the year (i.e., D1 = $2.00). The dividend is expected to grow at a constant rate
of 7 percent a year.
• The firm will be able to use retained earnings to fund the equity portion of its capital budget.
• The company’s tax rate is 40 percent.
What is the company’s weighted average cost of capital (WACC)?
12. Genuine Products Inc. requires a new machine. Two companies have submitted bids, and you
have been assigned the task of choosing one of the machines. Cash flow analysis indicates the
following:
Machine A Machine B
Year Cash Flow Cash Flow
0 -$2,000 -$2,000
1 0 832
2 0 832
3 0 832
4 3,877 832
What is the internal rate of return for each machine?