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# Finance

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Chpt. 4, 10

1. Assume IBM is expected to pay a total cash dividend of \$3.60 next year and dividends are expected to grow indefinitely by 3 percent a year. Assume the required rate of return (i.e. equity holder's opportunity cost of capital) is 9 percent. Assuming this is the best information available regarding the future of this firm, what would be the most economically rational value of the stock today (i.e. today's "price")?
a. 0.60
b. 120.00
c. 60.00
d. 92.70
e. 40.00

2. Someone offers to sell to you a financial contract that will pay \$90 at the end of each of the next five years, plus an additional \$1000 at the end of the fifth year. If they will sell the contract for \$950, what rate of return are they offering on the investment?
a. 10.3%
b. 7.7%
c. 9.6%
d. 52.6% ((90*5+1000)/950 -1)
e. insufficient information to estimate a return rate

3. The semi-annual interest payments that corporate bonds in the U.S. typically pay are conventionally referred to as
a. yield payments
b. coupon payments
c. call payments
e. dividends

4. Assume that the expected future dividends (D) at end of periods 1,2, and 3, as well as the expected future price (P) at end of period 3 for a stock are as follows: D1 = \$1.20, D2 = \$1.40, D3 = \$1.55, and P3 = \$80.00. What should be the stock's expected price today, (i.e. P0 )? I encourage you to draw a time line clearly indicating the situation. Assume the required return is 8.6 percent.
a. 87.15
b. 66.96
c. 79.14
d. 65.96
e. 68.40

5. Assume a corporation's bond has 16 years remaining until maturity. The coupon interest rate is 8.6% and the bond pays interest semi-annually. Assume bond investors' required rate of return on the bond is 7.5%. What would be the expected market price of this bond. (Assume a \$1000 par value.)
a. 1000
b. 1100
c. 1102
d. 2376
e. insufficient information to compute

6. Zero coupon bonds are
a. discount bonds
c. either discount or premium bonds, depending on whether rates have went up or down
d. riskless, because there are no coupon payments

7. Financial markets are generally recognized as being semi-strong form efficient, which means:
a. all available information, both public and private, is reflected in current prices
b. all publicly available information is reflected in current prices
c. only all past price information is reflected in current prices
d. there is no opportunity for consistently earning returns on investments

8. As interest rates increase, bond prices generally
a. increase
b. do not change, because they are fixed by contract
c. do not change, because the prices are offsetting the rate increases
d. decrease

9. Williams Inc. PAID a \$3 dividend YESTERDAY and that dividend is expected to grow at 4% every year thereafter. If the discount rate is 10%, what would be the present value of the expected dividend stream (aka the expected price of the firm's stock)?
a. 52.00
b. 30.00
c. 0.50
d. 75.00
e. 50.00

10. What is the present value (aka price) of a 10-year, pure discount bond (zero coupon bond) that pays \$1000 at maturity if it is priced to yield 7.75% per year (YTM)?
a. 12,903
b. 1,209
c. 129
d. 474
e. 6,786

#### Solution Preview

1. Assume IBM is expected to pay a total cash dividend of \$3.60 next year and dividends are expected to grow indefinitely by 3 percent a year. Assume the required rate of return (i.e. equity holder's opportunity cost of capital) is 9 percent. Assuming this is the best information available regarding the future of this firm, what would be the most economically rational value of the stock today (i.e. today's "price")?
a. 0.60
b. 120.00
c. 60.00
d. 92.70
e. 40.00

P = D1 where D1 is the dividend one year from now
(k - g) k is the required rate of return
g is the growth rate
P is the current price

P = 3.60
(0.09 - 0.03)

P = 60

2. Someone offers to sell to you a financial contract that will pay \$90 at the end of each of the next five years, plus an additional \$1000 at the end of the fifth year. If they will sell the contract for \$950, what rate of return are they offering on the investment?
a. 10.3%
b. 7.7%
c. 9.6%
d. 52.6% ((90*5+1000)/950 -1)
e. insufficient information to estimate a return rate