Question 1a Given: We have a stock that will pay $14 per year with the next dividend paid later today. In 3 years, company can retain all earnings and earn 11% over the following year. Discount rate is 8% What is the present value of the stock if it continues to be a cash cow? PV=14 + 14/.08 =189

Yes, because rate of return is greater than discount rate Question 1b Given: We have a stock that will pay $14 per year with the next dividend paid later today. In 3 years, company can retain all earnings and earn 11% over the following year. Discount rate is 8% Should the company retain its earnings? Yes, because rate of return is greater than discount rate 11% > 8% Also, NPV>0 (see 1c)

Question 1c NPV=-14/1.08^3 + (14*1.11)/1.08^4 = .3087 Given: We have a stock that will pay $14 per year with the next dividend paid later today. In 3 years, company can retain all earnings and earn 11% over the following year. Discount rate is 8% How much does the stock’s PV change if the company retains its earnings ? NPV=-14/1.08^3 + (14*1.11)/1.08^4 = .3087

Question 2 March 8 2016: PV=Face/(1.0263)^30 500=Face/(1.0263)^30 We have a zero coupon bond sold for $500 on March 8 2016. When sold on the date, the YTM was 2.63%. The maturity date is March 8, 2046. If the YTM on June 8 2016 was 2.51%, what did the bond sell for on this date? March 8 2016: PV=Face/(1.0263)^30 500=Face/(1.0263)^30 Face=1089.43 June 8 2016: PV=1089.43 / (1.0251)^29.75 PV=521.08

Question 3 Machine is purchased today for $5000. First maintenance cost is $50 two years from today. That cost is paid annually and grows 4% every year. Last maintenance cost is 9 years from today. What is the EAC if EAR is 10% and machine lasts 12 years? PV of costs= 5000+ 50 .1−.04 1− 1.04 1.1 8 ∗ 1 1.1 =5000+273.9=5273.9 EAC: 5273.9= 𝑋 .1 1− 1 1.1 12 X= 774.02

Question 4 CAPM: Perp: 𝑟= 𝑟 𝑓 +𝛽 𝑟 𝑚 − 𝑟 𝑓 Stock currently sells for $50 and pays X dividend every year starting one year from today. The stock has a beta value of 1.5. Risk free rate is 5% and the risk premium is 6%. What is X? CAPM: 𝑟= 𝑟 𝑓 +𝛽 𝑟 𝑚 − 𝑟 𝑓 𝑟=.05+1.5 .06 =.14 : Use this as the discount rate‼ Perp: X/.14 = 50 X= 7

Question 5 Let X be proportion held by bondholders Company gives stockholders expected rate of return of 20% if company is unlevered. company’s cost of debt is 12%. Stockholders are currently owning 25%. What fraction of the company’s value is held by bondholders? Let X be proportion held by bondholders .2 = .12X + .25 ( 1-X) .13X=.05 X= .3846

Question 5 Company gives stockholders expected rate of return of 20% if company is unlevered. company’s cost of debt is 12%. Stockholders are currently owning 25%. What fraction of the company’s value is held by bondholders? Also use M/M II 𝑟 𝑆 = 𝑟 0 + 𝐵 𝑆 𝑟 0 − 𝑟 𝑏 .25=.2+ 𝐵 𝑆 .2−.12 .05 .08 = 𝐵 𝑆 𝑆= 8 13 , 𝐵= 5 13

Question 6 On July 5, 2013, Lauren borrowed 100,000. She financed the loan with equal monthly payments over 84 months, starting August 5, 2013. The SAR is 15% compounded month. On August 5, 2016, Lauren makes a balloon payment in addition to the regular payment. The loan has a .5% penalty charged on the amount of the balloon payment. What is the balloon payment? 1) Find monthly payment 100,000= 𝑋 .15 12 1− 1 1+ .15 12 84 →→→→ 𝑋=1929.68 2) Find remaining regular balloon payment: 84-37 payments= 47 payments left 𝐵𝑎𝑙𝑙𝑜𝑜𝑛= 1929.68 .15 12 1− 1 1+ .15 12 47 =68,273.28 3) Total Payment = Balloon * 1.005 = 68,614.28

Question 7 A stock is either $80 or $105 two years from today both with 50% probability. A European call option for this stock has an exercise price of $90 two years from today. If EAR is 14%, what is the most someone will be willing to pay for the option? PV= .5∗ 0 1.14 2 + .5∗ 105−90 1.14 2 =5.77 Willing to pay at most 5.77