1MGF611 HOMEWORK No.

3 - FALL 2013
1. A ten-year U.S. Treasury bond with a face value of $10,000 has
a coupon rate of 5%; coupon payments are made semi-annually. If
the interest rate (i.e., bond yield) is 3.4% per year, what is
the price of the bond?
2. A common stock will pay a dividend next year (i.e., at t=1) of
$5.00. For three years after that (i.e., for t=2, t=3, and t=4),
the dividend will grow at 7% per year. After t=4, the dividend
will grow at 3% per year, forever. If the opportunity cost of
capital is 15%, what is the price of the common stock?
3. Consider a common stock with the following expected dividends:
$2 in one year (i.e., at t=1), $3 in two years (at t=2), $0 in
three years (at t=3), $2 in four years (at t=4) and $5 in five
years (at t=5). After t=5, the dividends will grow at 10% per
year for two years (i.e., t=6 and t=7). After t=7, dividends
will grow at 2% per year, forever. The opportunity cost of
capital is 12%.
You plan to purchase the common stock in three years (i.e.,
at t=3). What is your expected purchase price at t=3?
4. Consider the following one year investments:
Investment
1
2
3
4

Cash Flow, t=0

-10,000
- 5,000
- 5,000
- 2,000

Cash Flow, t=1

+18,000
+ 9,000
+ 5,700
+ 4,000

a. Calculate the NPV and rate of return for each of these

investments. The opportunity cost of capital is 20% for all four
investments.
b. Which investment is most valuable?
c. Suppose the firm can only take one of these investments.
Which investment should the firm choose?
5. Consider the following projects and their cash flows:
Project
A
B

t=0
-3,000
-3,000

t=1
2,000
1,000

t=2
1,000
1,000

t=3
0
1,000

t=4
0
1,000

The opportunity cost of capital is 8%.

a. Calculate the payback period for each project.

t=5
0
1,000
Which

project has the shorter payback period?

b. Calculate the net present value for each project.
project has the higher net present value?

Which

6. Consider the following two projects:

Project
A
B

t=0
-2,002
-2,010

t=1
1,200
0

t=2
1,200
0

t=3
0
2,600

a. Calculate the net present value of each project for the

following rates of return: 0%, 5%, 10%, 15%, and 20%. Plot these
numbers on a graph with NPV on the vertical axis and rate of
return on the horizontal axis.
b. What is the internal rate of return of each project?
c. Assume the company can, at most, accept only one of these
projects. For what range of rates of return should the company
accept project A?
7. Calculate the Profitability Index for a project with the
following cash flows; the opportunity cost of capital is 15%. As
judged by the Profitability Index method, is this a good project?
t=0
-4,000

t=1
1,000

t=2
2,000

t=3
2,000

Assigned: Thursday, October 24, 2013

Due:

Thursday, October 31, 2013

t=4
1,000