QUESTION 1 In order to accurately assess the capital structure of a firm *

| June 5, 2016

Question
QUESTION 1
In order to accurately assess the capital structure of a firm, it is necessary to convert its balance sheet figures from historical book values to market values. KJM Corporation’s balance sheet (book values) as of today is as follows: The bonds have a 7.7% coupon rate, payable semiannually, and a par value of $1,000. They mature exactly 10 years from today. The yield to maturity is 11%, so the bonds now sell below par. What is the current market value of the firm’s debt?
Long-term debt (bonds, at par) $23,500,000
Preferred stock 2,000,000
Common stock ($10 par) 10,000,000
Retained earnings 4,000,000
Total debt and equity $39,500,000
$17,734,265
$23,394,137
$18,866,239
$16,602,290
$19,054,902
5 points

QUESTION 2
Niendorf Corporation’s 5-year bonds yield 6.75%, and 5-year T-bonds yield 4.80%. The real risk-free rate is r* = 2.75%, the inflation premium for 5-year bonds is IP = 1.65%, the default risk premium for Niendorf’s bonds is DRP = 1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) ? 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Niendorf’s bonds?
0.49%
0.55%
0.61%
0.68%
0.75%
5 points

QUESTION 3
Nagel Equipment has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 13.25%. Using the SML, what is the firm’s required rate of return?
10.20%
13.03%
14.50%
12.29%
11.18%
5 points

QUESTION 4
The Isberg Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future. The company’s beta is 1.15, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is the company’s current stock price, P0?
$18.62
$19.08
$19.56
$20.05
$20.55
5 points

QUESTION 5
Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield 8.90%. Also, corporate bonds have a 0.25% liquidity premium versus a zero liquidity premium for T-bonds, and the maturity risk premium on both Treasury and corporate 10-year bonds is 1.15%. What is the default risk premium on corporate bonds?
4.12%
3.35%
3.12%
3.08%
2.95%
5 points

QUESTION 6
Carter’s preferred stock pays a dividend of $1.00 per quarter. If the price of the stock is $57.50, what is its nominal (not effective) annual rate of return?
7.86%
8.14%
7.72%
7.37%
6.96%
5 points

QUESTION 7
Grossnickle Corporation issued 20-year, noncallable, 6.3% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 19 years to maturity?
$1,136.58
$950.79
$1,289.58
$1,049.15
$1,092.86
5 points

QUESTION 8
Moerdyk Corporation’s bonds have a 10-year maturity, a 6.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 4.75%, based on semiannual compounding. What is the bond’s price?
1,063.09
1,090.35
1,118.31
1,146.27
1,174.93
5 points

QUESTION 9
Jill Angel holds a $200,000 portfolio consisting of the following stocks. The portfolio’s beta is 0.875. If Jill replaces Stock A with another stock, E, which has a beta of 1.85, what will the portfolio’s new beta be?
Stock Investment Beta
A $50,000 0.50
B $50,000 0.80
C $50,000 1.00
D $50,000 1.20
Total $200,000
0.92
1.21
1.30
1.14
1.35
5 points

QUESTION 10
Kristina Raattama holds a $200,000 portfolio consisting of the following stocks. The portfolio’s beta is 0.875. If Kristina replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio’s new beta be?
Stock Investment Beta
A $50,000 0.50
B 50,000 0.80
C 50,000 1.00
D 50,000 1.20
Total $200,000
1.07
1.13
1.18
1.24
1.30
5 points

QUESTION 11
Grossnickle Corporation issued 20-year, noncallable, 8.1% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 19 years to maturity?
$1,132.57
$1,223.69
$1,301.80
$1,353.87
$1,314.82
5 points

QUESTION 12
Suppose the yield on a 10-year T-bond is currently 5.05% and that on a 10-year Treasury Inflation Protected Security (TIPS) is 1.30%. Suppose further that the MRP on a 10-year T-bond is 0.90%, that no MRP is required on a TIPS, and that no liquidity premium is required on any T-bond. Given this information, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
3.45%
3.33%
2.85%
2.82%
3.51%
5 points

QUESTION 13
The Isberg Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future. The company’s beta is 1.35, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is the company’s current stock price, P ?
$15.83
$14.02
$11.61
$18.84
$15.07
5 points

QUESTION 14
Kay Corporation’s 5-year bonds yield 6.20% and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the default risk premium for Kay’s bonds is DRP = 1.30% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Kay’s bonds?
0.52%
0.61%
0.38%
0.50%
0.56%
5 points

QUESTION 15
In order to accurately assess the capital structure of a firm, it is necessary to convert its balance sheet figures to a market value basis. KJM Corporation’s balance sheet as of today is as follows: The bonds have a 4.0% coupon rate, payable semiannually, and a par value of $1,000. They mature exactly 10 years from today. The yield to maturity is 12%, so the bonds now sell below par. What is the current market value of the firm’s debt?
Long-term debt (bonds, at par) $10,000,000
Preferred stock 2,000,000
Common stock ($10 par) 10,000,000
Retained earnings 4,000,000
Total debt and equity $26,000,000
$5,276,731
$5,412,032
$5,547,332
$7,706,000
$7,898,650
5 points

QUESTION 16
Crockett Corporation’s 5-year bonds yield 6.35%, and 5-year T-bonds yield 4.75%. The real risk-free rate is r* = 2.20%, the default risk premium for Crockett’s bonds is DRP = 1.00% versus zero for T-bonds, the liquidity premium on Crockett’s bonds is LP = 0.90% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What inflation premium (IP) is built into 5-year bond yields?
2.02%
2.49%
2.43%
2.11%
2.15%
5 points

QUESTION 17
Mulherin’s stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)
10.36%
10.62%
10.88%
11.15%
11.43%
5 points

QUESTION 18
Koy Corporation’s 5-year bonds yield 9.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Koy’s bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Koy’s bonds?
2.36%
3.10%
2.64%
2.70%
3.69%
5 points

QUESTION 19
The Francis Company is expected to pay a dividend of D = $1.25 per share at the end of the year, and that dividend is expected to grow at a constant rate of 6.00% per year in the future. The company’s beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is the company’s current stock price?
$22.83
$27.99
$27.17
$22.01
$24.18
5 points

QUESTION 20
Company A has a beta of 0.70, while Company B’s beta is 1.30. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A’s and B’s required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)
4.74%
4.05%
3.77%
4.94%
4.70%

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