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a)**Determine** the required rate of return for each bond based on the information provided above.

b)**Explain** which bond you would buy.

a)**Determine** the expected rate of return, if the stock is held for one year.

b)**Determine** the required rate of return.

c)Based on your answers to parts (a) and (b), **explain** whether or not you would recommend to purchase Walmart’s common stock.

d)**Compute** Walmart’s P/E ratio from the information provided above. **Explain **what the P/E ratio indicates.

BUS 311 Exam 2A
Spring 2020
Name_____________________________________
1. (10 pts) Suppose that you are considering the purchase of either a ten–year Treasury bond or
a ten–year Walmart Inc. corporate bond. Below are current risk premiums.
Maturity risk premium
1.00%
Default risk premium
1.50%
Real risk free rate
.50%
Seniority risk premium
3.00%
Inflation premium
2.00%
Liquidity premium
0.50%
Currency exchange rate premium
3.00%
Required:
a) Determine the required rate of return for each bond based on the information
provided above.
b) Explain which bond you would buy.
2. (10 pts) The two basic choices for raising funds for an organization are debt and equity.
When considering whether to raise either debt or equity, explain the significance of the
following:
a) Why debt can be more attractive than equity.
b) How preferred stock is a hybrid security.
3. (10 pts) Explain what is meant by the weighted average cost of capital. Be sure to include in
your discussion the optimal capital structure, the optimal capital budget, and the hurdle rate.
4. (10 pts) The following information relates to Walmart Inc. (WMT):
Current market price of common stock
1–Year target estimate
10–Year Treasury bond rate
Market risk premium
Dividends per share of common stock
Earnings per share
Beta for Walmart Inc.
$105.00
$130.00
1.00%
5.50%
$2.16
$5.19
.43
Required:
a) Determine the expected rate of return, if the stock is held for one year.
b) Determine the required rate of return.
c) Based on your answers to parts (a) and (b), explain whether or not you would
recommend to purchase Walmart’s common stock.
d) Compute Walmart’s P/E ratio from the information provided above. Explain
what the P/E ratio indicates.
BUS 311 Exam 2B
Spring 2020
Name _________________________________
(8 pts.) 1. Crowder Corporation has an issue of preferred stock, which has a par value of $80
per share with a dividend rate of 9 percent.
Required:
a) If the market rate for this preferred stock were now 12 percent, what
would be the value of the preferred stock?
b) If the market rate for this preferred stock were now 8 percent, what would
be the value of the preferred stock?
c) Explain why the prices are different.
(10 pts) 2. Twenty years-ago Goran Corp. issued 30-year bonds with a face value of $1,000.
The coupon rate on these bonds is 8 percent paid semiannually. A current bondholder is
considering selling the bond today. The market rate is now 12 percent.
Required:
a) Determine the price of the bond today. Show all computations.
b) Explain why the amount you determined in part (a) is different from the
par value of the bond.
(10 pts) 3. Robinson Inc. is a fast growing technology company. Management projects rapid
growth of 20 percent for the next four years. After that, a constant-growth rate of 6 percent is
expected. The firm expects to pay its first dividend of $5.00 three years from now. Dividends
will grow at the same rate as the firm and the required rate of return on stocks with similar risk is
20 percent.
Required:
a) Determine the current price per share.
b) If the price of the stock is currently $ 40.00, would you recommend that
the stock be purchased? Explain.
(10 pts.) 4. On April 1st, you will buy a boat for $500,000. You will pay $200,000 in cash at the
time of purchase and borrow the remaining amount from the bank. This loan will be paid in four
equal annual installments that include both the principal and 10 percent interest on the declining
balance.
Required:
a) Determine the amount of the annual payment.
b) Determine the total dollars of interest that you will pay for this loan.
c) Determine the amount of interest that is included in the first payment. It is
not necessary to complete an amortization schedule.
(10 pts.) 5. Your client is 25 years old and wishes to retire at age 65. At that time, your client
wishes to have saved $2,000,000. You advise the client to set aside money every year for the
next 40 years. This money will be invested in a fund that you believe will average 10% each year
for the next 40 years.
Required:
a) How much will your client need to set aside for each payment into the
fund in order to accumulate the $2,000,000 total?
b) If your client’s life expectancy is age 80, how much can your client
withdraw each year for the 15 years of retirement? The cost of money is
10%.
(12 pts) 6. Bam Corporation is considering the following independent projects for the coming
year. Their target capital structure is 60 percent debt and 40 percent equity. The after-tax cost of
debt is 6 percent and the cost of equity is 15 percent.
Expected
Required
Rate of
Risk
Project
Investment
Return
Level
A
$13 million
17%
High
B
16 million
9
Low
C
25 million
14
Average
D
10 million
8
Low
E
18 million
16
High
Bam adjusts its WACC for risk by adding 2% to the WACC for high-risk projects and
subtracting 1.0% for low-risk projects.
Required:
a) Determine the WACC for Bam Corporation.
b) Determine which projects Bam Corporation should accept and what would
be the dollar size of its capital budget.
BUS 311 Topics for Exam 2
1. Time Value of Money
FV = PV (IF1)
Lump Sum
Future Value
PV = FV (IF2)
Lump Sum
Present Value
FVA = R (IF3)
Annuity
Future Value
PVA = R (IF4)
Annuity
Present Value
2. Risk / Required Rate of Return
a. Layered / Textured Approach
RRR = RRFR + IP + MRP + LP + DRP + SRP+…
b. Capital Asset Pricing Model (CAPM)
RRR= RF + (RM – RF) B
c. If ERR > RRR
ERR =
Invest
(𝑃,𝐸𝑂𝑃−𝑃,𝐵𝑂𝑃)+𝐷𝐼𝑉
𝑃,𝐵𝑂𝑃
3. Bonds and Equity
a. Types of Bonds
b. Preferred stock
c. Common Stock / 3 rights
d. Price of Bond
Po = INT (IF4) + Prin (IF2)
e. Price of Preferred Stock
𝐷𝐼𝑉
Po = 𝑅𝑅𝑅
f. Price of Common Stock
present value of expected dividends + expected price when stock is sold
4. WACC – Weighted Average Cost of Capital
a. WACC = (WD) x (KD) + (WE) x (KE)
WD = Weight / Proportion of Capital Structure Which is Debt
WE = Weight / Proportion of Capital Structure Which is Equity
KD = Cost of Debt
KE = Cost of Equity
b. Optimal Capital Structure
c. Optimal Capital Budget
d. Golden Rule of Profit Maximization (Hurdle Rate)
...

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