Posted: May 7th, 2022

Finance Discussion question Assignment

1. Formulas using symbols

2. “Draw” timelines and graphs to illustrate your answers. You can construct them in Excel and then copy them into this file.

3. You must write a short VERBAL conclusion at the end of each problem summarizing your answer in words. Verbal answers are not a substitute for the quantitative solution.

Question 1

Mark Mezos is deciding on one of two career choices, before retiring in 20-year time.

Choice 1

Mark can go to a prestigious graduate school for two years and obtain a degree. Including tuition and living expenses, he expects to pay $65,000 at the end of each year for two years while at school. After graduating, he expects to land a demanding job that pays $150,000 at the end of the third year. He expects his earnings to grow at a constant rate of 5% each year (so at the end of the fourth year he expects to earn 150,000×1.05=$157,500, etc.). He will retire in 18 years after finishing graduate school.

Choice 2

Mark can continue in his present job. He expects to be paid $78,000 at the end of the current year, and expects his salary to increase by 10% every year, paid at the end of each year (i.e. at the end of the second year her salary will be $78,0001.1, and so on). He expects to work 20 years before retiring.

Suppose that Mark’s discount rate is 12%. Which career should he choose?

Question 2

Consider the following risk-free T-bill and coupon bonds available for sale in the bond market (assume annual coupons):

Maturity (in years)

Price

Coupon rate

1

999

T-bill (zero coupon bond)

2

1003

2%

3

1008

3.5%

a. Construct the term structure of interest rates for these three years.

b. Your company plans to issue three-year maturity bonds. You plan to issue bonds priced at $1005. At what level should you plan to set the coupon on your bond to justify this price?

Question 3

Tresla Corporation is experiencing rapid growth. Dividends are expected to double in each of the next two years, grow at 20% per year over three years after that, and then 5% percent per year indefinitely. The required return on this stock is 15%, and the stock currently sells for $730 per share.

a. Tresla just paid the dividend. What was it?

b. “Draw” the time line table) showing dividends paid by Tresla over the next 7 years.

c. What would be the price of Tresla be if it did not grow and continued to pay the same dividends as it had just paid.

d. What is the present value of Tresla’s growth opportunities (PVGO)?

Question 4

Suppose that you want to buy a 2-year 5% coupon bond, which pays semi-annual coupons and costs $997.

a. Find the yield to maturity on this bond (YTM)

b. Find the effective annual rate of return that you earn on this bond (EAR).

Question 5

Consider the following mutually exclusive projects:

T=0

1

2

3

Project X:

-100

20

30

90

Project Y:

-100

80

30

20

a. Find IRRs for both projects.

b. Find the cross-over rate.

c. Construct a graph, where you will show the NPV of each project as a function of its discount rate (i.e NPV on the vertical axis and r on the horizontal axis). Both NPVs should be on the same graph. This graph is the NPV schedule.

d. Please describe as fully as possible which project is the best and under which circumstances.

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