Mini Cases, FIN 350
COLLEGE FUND REPAYMENT
You have just completed your four-year degree at Southwest Minnesota State University
(SMSU)! Your student loans that you have accumulated while studying at SMSU total $25,000.
Since you have graduated, you must now begin repaying these student loans. The loan’s annual
interest rate is six percent (6%) and it requires four equal end-of-year payments.
1) Set up an amortization schedule that shows the annual payments, interest payments,
principal repayments, and beginning and ending loan balances. (I.e, you may use Table 5-7
on page 217 of our textbook as a guide as you prepare this amortization schedule.)
2) What is the total amount that you will repay over this four-year period
(principal + interest)?
a. What portion or percentage are the total “Interest Payments” of the initial
loan value of $25,000?
Acme Chemical, Inc.
Acme Chemical, Inc. is a major manufacturer of chemical products for the agricultural
industry, including pesticides, herbicides and other compounds. Due to a number of law suits
related to toxic wastes, Acme Chemical has recently experienced a market re-evaluation of its
common stock. The firm also has a bond issue outstanding with 10 years to maturity and an
annual coupon rate of 5 percent, with interest paid semi annually. The required nominal market
annual interest rate on this bond has now risen to 10 percent due to the high risk level associated
with this firm. The bonds have a par or face value of $1,000.
1. Label each of the variables that you would use to determine the value of this bond in the
market today:
N (time periods until maturity) =
PMT (periodic interest payment) =
I per (periodic market interest rate) =
FV (future value to be received when the bond matures) =
2. Based on the variables that you have identified in Question #1, what is the market value
today (the present value or PV) of one of Acme Chemical’s bonds?
3. After five years of judicial appeals, Acme Chemical emerges victorious in the toxic waste
law suits. This provides a positive signal to the market and the market rate of interest (r d )
applicable to Acme Chemical’s bonds declines to 6 percent. Assume that there are now
5 years remaining until maturity.
a. Label each of the variables that you would use to determine the new value of this bond
in the market:
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N (time periods until maturity) =
PMT (periodic interest payment) =
I per (periodic market interest rate) =
FV (future value to be received when the bond’s mature) =
b. Based on the variables that you have identified in Question #3.a., what is the new market
value (the present value or PV) of one of Acme Chemical’s bonds, following their victory
in appeals court?
4. Why do you suppose that the market value of Acme Chemical’s bonds has risen following the
firm’s victory in appeals court?
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UPTON COMPANY
Upton Company is a technology firm engaged in the manufacture and sale of innovative
computer hardware components. Assume the following:
*The risk-free rate of return, R F, is 5%.
*The required rate of return on the market, r m, is 12%.
*The Upton Company's stock has a beta co-efficient of 1.2.
HINT: For each of the problems listed below: First use the Security Market Line (SML)
equation (top of page 353 in the text) to solve for the required rate of return, r s, on Upton
Company's stock. Then, use the Gordon constant growth model (at the center of page 303) to
solve for the expected stock price, P o.
1. If the dividend expected during the coming year, D 1, is $2.00, and if g equals a constant 4%,
at what price should Upton's stock sell?
a. SML variables:
R F = _________%; r m = __________%; b = __________.
Solve the SML equation to find r s.
b. Gordon Model variables: D 1 = $ __________; g = _________%; r s = __________%**
**Note that r s is the solution to the SML equation just solved.
Solve the Gordon Model equation to find P o.
2. Now, suppose the Federal Reserve Board increases the money supply, causing the risk-free
rate, R F, to drop to 3% and r m to fall to 10%. What would this do to the price of Upton
Company's stock?
a. SML variables:
R F = _________%; r m = __________%; b = __________.
Solve the SML equation to find r s.
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b. Gordon Model variables: D 1 = $ __________; g = _________%; r s = __________%**
**Note that r s is the solution to the SML equation just solved.
Solve the Gordon Model equation to find P o.
3. In addition to the change in Question #2, suppose investors' risk aversion declines; this fact,
combined with the previous decline in R F, causes r m to fall to 8%. At what price would
Upton Company's stock now sell?
a. SML variables:
R F = _________%; r m = __________%; b = __________.
Solve the SML equation to find r s.
b. Gordon Model variables: D 1 = $ __________; g = _________%; r s = __________%**
**Note that r s is the solution to the SML equation just solved.
Solve the Gordon Model equation to find P o.
4. Now, suppose Upton has a change in management. The new group institutes policies that
increase the expected growth rate to 6%. Also, the new management stabilizes sales and profits,
and thus causes the beta co-efficient to decline from 1.2 to 1.1. Assume that R F remains at 3%
and r m remains at 8%. After all of these changes, what is Upton's new equilibrium price,
assuming D 1 increases to $2.15?
a. SML variables:
R F = _________%; r m = __________%; b = __________.
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Solve the SML equation to find r s.
b. Gordon Model variables: D 1 = $ __________; g = _________%; r s = __________%**
**Note that r s is the solution to the SML equation just solved.
Solve the Gordon Model equation to find P o.
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