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royal ne...$750.00
ZOE HY$640.00

Question 35  bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

A European company just issued two bonds, a

  • 1 year zero coupon bond at a yield of 8% pa, and a
  • 2 year zero coupon bond at a yield of 10% pa.

What is the company's forward rate over the second year (from t=1 to t=2)? Give your answer as an effective annual rate, which is how the above bond yields are quoted.

Question 113  WACC, CFFA, capital budgeting

The US firm Google operates in the online advertising business. In 2011 Google bought Motorola Mobility which manufactures mobile phones.

Assume the following:

  • Google had a 10% after-tax weighted average cost of capital (WACC) before it bought Motorola.
  • Motorola had a 20% after-tax WACC before it merged with Google.
  • Google and Motorola have the same level of gearing.
  • Both companies operate in a classical tax system.

You are a manager at Motorola. You must value a project for making mobile phones. Which method(s) will give the correct valuation of the mobile phone manufacturing project? Select the most correct answer.

The mobile phone manufacturing project's:

Question 192  NPV, APR

Harvey Norman the large retailer often runs sales advertising 2 years interest free when you purchase its products. This offer can be seen as a free personal loan from Harvey Norman to its customers.

Assume that banks charge an interest rate on personal loans of 12% pa given as an APR compounding per month. This is the interest rate that Harvey Norman deserves on the 2 year loan it extends to its customers. Therefore Harvey Norman must implicitly include the cost of this loan in the advertised sale price of its goods.

If you were a customer buying from Harvey Norman, and you were paying immediately, not in 2 years, what is the minimum percentage discount to the advertised sale price that you would insist on? (Hint: if it makes it easier, assume that you’re buying a product with an advertised price of $100).

Question 204  time calculation, fully amortising loan, APR

You just signed up for a 30 year fully amortising mortgage loan with monthly payments of $1,500 per month. The interest rate is 9% pa which is not expected to change.

To your surprise, you can actually afford to pay $2,000 per month and your mortgage allows early repayments without fees. If you maintain these higher monthly payments, how long will it take to pay off your mortgage?

Question 209  CFFA

Find Piano Bar's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Piano Bar
Income Statement for
year ending 30th June 2013
Sales 310
COGS 185
Operating expense 20
Depreciation 15
Interest expense 10
Income before tax 80
Tax at 30% 24
Net income 56
Piano Bar
Balance Sheet
as at 30th June 2013 2012
  $m $m
Current assets 240 230
    Cost 420 400
    Accumul. depr. 50 35
    Carrying amount 370 365
Total assets 610 595
Current liabilities 180 190
Non-current liabilities 290 265
Owners' equity
Retained earnings 90 90
Contributed equity 50 50
Total L and OE 610 595


Note: all figures are given in millions of dollars ($m).

Question 260  DDM

A share just paid its semi-annual dividend of $5. The dividend is expected to grow at 1% every 6 months forever. This 1% growth rate is an effective 6 month rate.

Therefore the next dividend will be $5.05 in six months. The required return of the stock 8% pa, given as an effective annual rate.

What is the price of the share now?

Question 267  term structure of interest rates

A European company just issued two bonds, a

  • 3 year zero coupon bond at a yield of 6% pa, and a
  • 4 year zero coupon bond at a yield of 6.5% pa.

What is the company's forward rate over the fourth year (from t=3 to t=4)? Give your answer as an effective annual rate, which is how the above bond yields are quoted.

Question 397  financial distress, leverage, capital structure, NPV

A levered firm has a market value of assets of $10m. Its debt is all comprised of zero-coupon bonds which mature in one year and have a combined face value of $9.9m.

Investors are risk-neutral and therefore all debt and equity holders demand the same required return of 10% pa.

Therefore the current market capitalisation of debt ##(D_0)## is $9m and equity ##(E_0)## is $1m.

A new project presents itself which requires an investment of $2m and will provide a:

  • $6.6m cash flow with probability 0.5 in the good state of the world, and a
  • -$4.4m (notice the negative sign) cash flow with probability 0.5 in the bad state of the world.

The project can be funded using the company's excess cash, no debt or equity raisings are required.

What would be the new market capitalisation of equity ##(E_\text{0, with project})## if shareholders vote to proceed with the project, and therefore should shareholders proceed with the project?

Question 549

An Apple iPhone 6 smart phone can be bought now for $999. An Android Samsung Galaxy 5 smart phone can be bought now for $599.

If the Samsung phone lasts for four years, approximately how long must the Apple phone last for to have the same equivalent annual cost?

Assume that both phones have equivalent features besides their lifetimes, that both are worthless once they've outlasted their life, the discount rate is 10% pa given as an effective annual rate, and there are no extra costs or benefits from either phone.

Question 786  fixed for floating interest rate swap, intermediated swap

The below table summarises the borrowing costs confronting two companies A and B.

Bond Market Yields
  Fixed Yield to Maturity (%pa) Floating Yield (%pa)
Firm A 3 L - 0.4
Firm B 5 L + 1


Firm A wishes to borrow at a floating rate and Firm B wishes to borrow at a fixed rate. Design an intermediated swap (which means there will actually be two swaps) that nets a bank 0.1% and shares the remaining swap benefits between Firms A and B equally. Which of the following statements about the swap is NOT correct?

Copyright © 2014 Keith Woodward