• You must provide support for your responses to all questions. • For all present value problems, supporting calculations must be rounded to four decimal places and final answers rounded to two decimal places. • Prepare your answers in MS Excel and use formulas for all cells requiring calculations. Below are the financial statements for The Corporation (aka The Firm) followed by other,more general information about the economy, stock market, and The Corporation.
Stock Questions (Questions 1–4; 48 Points) 1. An intern is confused. She is looking at the December 31, 20X10, balance sheet and focusingon the $1,232,000 treasury stock amount. She is trying to provide support that shows how the firm arrived at this amount. Provide this support. (4 points) 2. The firm believes that its stock price at December 31, 20X11, does not accurately reflect its intrinsic value on the same date. Assume that 20X11 dividends were $31,049. a. Calculate the intrinsic value of stock at year-end 20X11. (9 points) b. Explain the pros and cons of purchasing the treasury stock at year-end 20X11. (5 points) c. What is the dividend and capital gains yield for 20X12? (2 points) d. What is the dividend and capital gains yield for 20X14? (2 points) 3. Recalculate 20X11 total assets, 20X11 total liabilities, and 20X11 total stockholders’ equity assuming the firm did not purchase any treasury stock during 20X11. (5 points) 4. Please refer to the background information for some of these problems. During the period20X9–20X11, the firm’s closest competitor had stock price activity that resulted in an average stock return of 25.7 percent with a standard deviation of 19.275 percent. This competitor’s beta is 1.20. a. Based on stand-alone risk and using the Coefficient of Variation, which firm is riskier, our firm or our competitor? Explain your answer. (8 points) b. Calculate the required rates of return for our firm and for our competitor. Show the detail to your work. (4 points) c. If the return on the market were to fall from its current level of 12 percent to 9 percent, what would be the resulting impact on required return for our firm and for our competitor? What explains the difference between the two firms (be specific in your answer)? (6 points) d. If an investor held a portfolio consisting of equal percentages of the market portfolio, thefirm’s stock, and Page 8 of 9 the competitor’s stock, what would the beta of this portfolio be? (3 points) Bond Questions (Questions 5–12; 52 Points) 5. Prepare the journal entry to record the sale of bonds on December 31, 20X1. (5 points) 6. Calculate total interest expense that will be recorded on the books from January 2, 20X2, through December 31, 20X9 (assume zero interest expense during 20X1). (5 points) 7. Assume that the yield-to-maturity at December 31, 20X10, and December 31, 20X11, is still 10percent. Also assume that an investor decides to purchase these bonds in the open market atDecember 31, 20X10, for $736,740, and then sell these bonds one year later (e.g., atDecember 31, 20X11). What is the dollar return (e.g., income/gains) that the investor will earn during 20X11 from this investment? How much of this return is attributed to interest andhow much to change in price of the bond? (5 points) 8. a. Assume that the firm is contemplating purchasing its bonds in the open market on December 31, 20X14, for $748,485. What is the yield-to-maturity for these bonds on this date? (5 points) 9. b. Assume that the change in the yield to maturity is due solely to default risk, and this change in default risk is due to a change in the bond’s ratings. As a result, would this rating have increased (upgrade) or decreased (downgrade). Explain. (4 points) 10.This question is a continuation from Question 9. a. Assume that the firm purchases the bonds on December 31, 20X14, for $748,485. Prepare the journal entry to record this purchase. (6 points) b. Summarize how this purchase impacts total assets, total liabilities, total stockholders’ equity, net income, cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities. (9 points) 11.Assume that on January 1, 20X12, the firm sold another bond issue (20 years, semi-annual interest). The coupon rate was 6 percent, yield-to-maturity is 4 percent, and face Page 9 of 9 – ¼ value is $1,000,000 (1,000 bonds were sold that day). a. Calculate the sales price of these bonds (4 points) b. Prepare the journal entry to record interest expense for the first six months of 20X12 (January 1, 20X12, through June 30, 20X12). (5 points) 12.This problem is a general problem and not specific to The Corporation. The real risk-free rate,r*, is 2.75 percent. Inflation is expected to average 2.9 percent per year for the nextfour years, after which time inflation is expected to average 3.6 percent per year. The maturity risk premium equals 0.1 (t 1) percent, where t the bond’s maturity. A seven-year corporate bond has a yield (r) of 9.2 percent, which includes a liquiditypremium of 0.75 percent. What is this bond’s default risk premium (DRP)? (4 points)