Exam 2 Review

Exam 2 Review

Bonds

Stocks

Capital Budgeting 1

Bonds

Know all bond features / terminology Know how to read WSJ quotations for

corporate and treasury bonds Know how to calculate bond value Understand yield, YTM, coupon rate,

current yield and their relation Understand interest rate risk, default risk

Stocks

WSJ quotations Stock valuation models: General DDM,

Constant Growth DDM, Multi-Stage Assumptions behind various DDM models No dividend case Required return based on constant growth

Capital Budgeting

NPV, IRR, PI, Payback, Disc. Payback, AAR Rules

Cross over rate Know how to make decisions using various

rules Know the weaknesses of the rules Understand NPV profile diagrams Understand terms: conventional,

unconventional, mutually exclusive etc.

Treasury Bonds

Semi-annual coupon - _____ Maturity date = ______ Price you can buy 1 bond = _____ Price you can sell 1 bond = _____ YTM based on purchase price = ______

Maturity Ask

Rate Mo/Yr Bid Asked Chg. Yld.

5 7/8 Feb 08n 96:17 96:19 -6 6.46

Bond Example 1

Calculate the value of 10-year, 7% annual coupon bond with a yield of 5.5%

Answer: ______

Bond Example 2

Calculate the value of a 20-year, 8% semi-annual coupon bond yielding 11%

Answer: ________

Stock Example 1

Bozo corp. will pay a constant $7 dividend for the next seven years after which it will stop paying dividends forever. r = 12? What is the current stock price?

Answer: _______

Stock Example 2

T. Amos Corp. is a young start-up company. No dividends will be paid for the next five years. In the 6th year a dividend of $6 per share will be paid which will increase at 5% forever thereafter. r = 23%. What is the stock price?

Answer: _____

Stock Example 3

J Osborne Corp just paid a dividend of $1.50 which will grow at 30% for the next three years. Thereafter the growth will fall back to 7%. r = 23%. What is the current stock price?

Answer: ________

Capital Budgeting

The projects are mutual exclusive. r = 15%

NPV

NPV (A) = _____ NPV (B) = _____

Which project to accept?

If they were not mutually exclusive, which one(s) will you accept?

IRR

IRR (A) = _____ IRR (B) = _____

Which project to accept?

If they were not mutually exclusive, which one(s) will you accept?

Profitability Index

PI (A) = _____ PI (B) = _____

Which project to accept?

If they were not mutually exclusive, which one(s) will you accept?

Crossover rate

Find the crossover rate of the two projects

Crossover rate = ______

Roughly draw the NPV profiles, labelling all points of interest carefully

Unconventional Cash flows

r = 25%, 35%, 400%. What is the NPV?

Year Cash flow

0 -$4,000

1 +25,000

2 -25,000

IRR = ?

Payback

Payback (A) = _____ Payback (B) = _____

Which project to accept?

If they were not mutually exclusive, which one(s) will you accept?

Discounted Payback

Disc. Payback (A) = _____ Disc. Payback (B) = _____

Which project to accept?

If they were not mutually exclusive, which one(s) will you accept?

NPV Profiles

Understand What is being plotted

Axes, IRR, Accept/Reject regions, etc. How to interpret them

Unconventional cash flows Mutually exclusive projects

Year Cash flow

0 – $275 1 100 2 100 3 100 4 100

Net Present Value Profile

Discount rate2% 6% 10% 14% 18%

120

100

80

60

40

20

Net present value

0

– 20

– 40

22%

IRR

NPV>0

NPV < 0

NPV Profile - Multiple IRR Problem

$0.06

$0.04

$0.02

$0.00

($0.02)

NPV

($0.04)

($0.06)

($0.08)

0.2 0.28 0.36 0.44 0.52 0.6 0.68

IRR = 25%

IRR = 33.3% IRR =

42.8%

IRR = 66.6%

Discount rate

IRR, NPV, and Mutually Exclusive Projects

Discount rate %2% 6% 10% 16% 20%

60

40

20

0

– 20

– 40

Net present value $

– 60

– 80

– 100

24%

IRR A < IRR B

0

140

120

100

80

160

NPV B >NPV A

NPV A >NPV B

Project A

Project B

Crossover rate