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For a price of $1040, Camille will sell you a share which just paid a dividend of $100, and is expected to pay dividends every year forever, growing at a rate of 5% pa.

So the next dividend will be ##100(1+0.05)^1=$105.00##, and the year after it will be ##100(1+0.05)^2=110.25## and so on.

The required return of the stock is 15% pa.

Question 76 CAPM, SML

Government bonds currently have a return of 5%. A stock has a beta of 2 and the market return is 7%. What is the expected return of the stock?

Question 131 APR, effective rate

Calculate the effective annual rates of the following three APR's:

A credit card offering an interest rate of 18% pa, compounding monthly.
A bond offering a yield of 6% pa, compounding semi-annually.
An annual dividend-paying stock offering a return of 10% pa compounding annually.

All answers are given in the same order:

##r_\text{credit card, eff yrly}##, ##r_\text{bond, eff yrly}##, ##r_\text{stock, eff yrly}##

Question 202 DDM, payout policy

Currently, a mining company has a share price of $6 and pays constant annual dividends of $0.50. The next dividend will be paid in 1 year. Suddenly and unexpectedly the mining company announces that due to higher than expected profits, all of these windfall profits will be paid as a special dividend of $0.30 in 1 year.

If investors believe that the windfall profits and dividend is a one-off event, what will be the new share price? If investors believe that the additional dividend is actually permanent and will continue to be paid, what will be the new share price? Assume that the required return on equity is unchanged. Choose from the following, where the first share price includes the one-off increase in earnings and dividends for the first year only ##(P_\text{0 one-off})## , and the second assumes that the increase is permanent ##(P_\text{0 permanent})##:

Note: When a firm makes excess profits they sometimes pay them out as special dividends. Special dividends are just like ordinary dividends but they are one-off and investors do not expect them to continue, unlike ordinary dividends which are expected to persist.

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 413 CFFA, interest tax shield, depreciation tax shield

There are many ways to calculate a firm's free cash flow (FFCF), also called cash flow from assets (CFFA).

One method is to use the following formulas to transform net income (NI) into FFCF including interest and depreciation tax shields:

###FFCF=NI + Depr - CapEx -ΔNWC + IntExp###

###NI=(Rev - COGS - Depr - FC - IntExp).(1-t_c )###

Another popular method is to use EBITDA rather than net income. EBITDA is defined as:

###EBITDA=Rev - COGS - FC###

One of the below formulas correctly calculates FFCF from EBITDA, including interest and depreciation tax shields, giving an identical answer to that above. Which formula is correct?

Question 436 option, no explanation

Question 468 PE ratio

A firm has 1 million shares which trade at a price of $30 each. The firm is expected to announce earnings of $3 million at the end of the year and pay an annual dividend of $1.50 per share.

What is the firm's (forward looking) price/earnings (PE) ratio?

Question 705 utility, risk aversion, utility function

Mr Blue, Miss Red and Mrs Green are people with different utility functions.

Which of the following statements is NOT correct?

Question 833 option, delta, theta, standard deviation, no explanation

Which of the following statements about an option (either a call or put) and its underlying stock is NOT correct?

(a) The option’s expected future continuously compounded returns are always more than or equal to the underlying stock’s expected future continuously compounded returns.

(b) The option’s standard deviation of dollar price changes is always less than or equal to the underlying stock’s standard deviation of dollar price changes.

(c) The option’s standard deviation of continuously compounded returns are always less than or equal to the underlying stock’s standard deviation of continuously compounded returns.

(d) As time elapses and the maturity date of an option approaches, its price will fall, all other things remaining equal.

(e) If the underlying stock’s price rises by $0.01, the call option’s price will rise by less than $0.01 and the put option’s price will fall by less than $0.01.