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For a price of $129, Joanne will sell you a share which is expected to pay a $30 dividend in one year, and a $10 dividend every year after that forever. So the stock's dividends will be $30 at t=1, $10 at t=2, $10 at t=3, and $10 forever onwards.

The required return of the stock is 10% pa.

Question 26 APR, effective rate

A European bond paying annual coupons of 6% offers a yield of 10% pa.

Convert the yield into an effective monthly rate, an effective annual rate and an effective daily rate. Assume that there are 365 days in a year.

All answers are given in the same order:

### r_\text{eff, monthly} , r_\text{eff, yearly} , r_\text{eff, daily} ###

Question 69 interest tax shield, capital structure, leverage, WACC

Which statement about risk, required return and capital structure is the most correct?

(a) The before-tax cost of debt is less than the before-tax cost of equity. Therefore debt is a cheaper form of financing than equity so companies should try to finance their projects with debt only.

(b) Debt makes a firm's equity more risky. Therefore the higher the amount of debt, the higher the cost of equity.

(c) The more debt a firm has, the higher its tax shields. Therefore firms should seek to have as much debt and as little equity as possible.

(d) The more debt, the lower the firm's after tax WACC. The after tax WACC is the discount rate that discounts the firm's cash flows, so the lower it is the more the firm is worth. Therefore firms should try to make their after tax WACC as low as possible by using as much debt as possible.

(e) The less debt, the lower the chance of bankruptcy. Therefore firms should try to pay off all of their debt so that they are financed by equity only.

Question 151 income and capital returns

A share was bought for $30 (at t=0) and paid its annual dividend of $6 one year later (at t=1).

Just after the dividend was paid, the share price fell to $27 (at t=1). What were the total, capital and income returns given as effective annual rates?

The choices are given in the same order:

##r_\text{total}## , ##r_\text{capital}## , ##r_\text{dividend}##.

Question 225 CFFA

A firm has forecast its Cash Flow From Assets (CFFA) for this year and management is worried that it is too low. Which one of the following actions will lead to a higher CFFA for this year (t=0 to 1)? Only consider cash flows this year. Do not consider cash flows after one year, or the change in the NPV of the firm. Consider each action in isolation.

(a) Buy less land, buildings and trucks than what was planned. Assume that this has no impact on revenue.

(b) Pay off more debt than was planned, to reduce the firm’s interest expense.

(c) Change the depreciation method used for tax purposes from diminishing value to straight line, so less depreciation occurs this year and more occurs in later years. Assume that the government’s tax department allow this.

(d) Buying more inventory than was planned, so there is an increase in net working capital. Assume that there is no increase in sales.

(e) Raising new equity through a rights issue. Assume that all of the money raised is spent on new capital assets such as land and trucks, but they will be fitted out and delivered in one year so no new cash will be earned from them.

Question 301 leverage, capital structure, real estate

Your friend just bought a house for $1,000,000. He financed it using a $900,000 mortgage loan and a deposit of $100,000.

In the context of residential housing and mortgages, the 'equity' or 'net wealth' tied up in a house is the value of the house less the value of the mortgage loan. Assuming that your friend's only asset is his house, his net wealth is $100,000.

If house prices suddenly fall by 15%, what would be your friend's percentage change in net wealth?

Assume that:

No income (rent) was received from the house during the short time over which house prices fell.
Your friend will not declare bankruptcy, he will always pay off his debts.

Question 670 fixed for floating interest rate swap

A company can invest funds in a five year project at LIBOR plus 50 basis points pa. The five-year swap rate is 4% pa. What fixed rate of interest can the company earn over the next five years by using the swap?

Question 767 idiom, corporate financial decision theory, no explanation

The sayings "Don't cry over spilt milk", "Don't regret the things that you can't change" and "What's done is done" are most closely related to which financial concept?

Question 903 option, Black-Scholes-Merton option pricing, option on stock index

A six month European-style call option on the S&P500 stock index has a strike price of 2800 points.

The underlying S&P500 stock index currently trades at 2700 points, has a continuously compounded dividend yield of 2% pa and a standard deviation of continuously compounded returns of 25% pa.

The risk-free interest rate is 5% pa continuously compounded.

Use the Black-Scholes-Merton formula to calculate the option price. The call option price now is:

Question 1002 floating coupon bond, bond pricing

Which of the following statements about vanilla floating coupon bonds paying quarterly coupons is NOT correct? A vanilla floating coupon bond's: