Question 99 capital structure, interest tax shield, Miller and Modigliani, trade off theory of capital structure
A firm changes its capital structure by issuing a large amount of debt and using the funds to repurchase shares. Its assets are unchanged.
Assume that:
- The firm and individual investors can borrow at the same rate and have the same tax rates.
- The firm's debt and shares are fairly priced and the shares are repurchased at the market price, not at a premium.
- There are no market frictions relating to debt such as asymmetric information or transaction costs.
- Shareholders wealth is measured in terms of utiliity. Shareholders are wealth-maximising and risk-averse. They have a preferred level of overall leverage. Before the firm's capital restructure all shareholders were optimally levered.
According to Miller and Modigliani's theory, which statement is correct?
The following cash flows are expected:
- 10 yearly payments of $60, with the first payment in 3 years from now (first payment at t=3 and last at t=12).
- 1 payment of $400 in 5 years and 6 months (t=5.5) from now.
What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate?
The following cash flows are expected:
- 10 yearly payments of $80, with the first payment in 3 years from now (first payment at t=3).
- 1 payment of $600 in 5 years and 6 months (t=5.5) from now.
What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate?
A three year bond has a fixed coupon rate of 12% pa, paid semi-annually. The bond's yield is currently 6% pa. The face value is $100. What is its price?
Bonds X and Y are issued by different companies, but they both pay a semi-annual coupon of 10% pa and they have the same face value ($100), maturity (3 years) and yield (10%) as each other.
Which of the following statements is true?
Question 455 income and capital returns, payout policy, DDM, market efficiency
A fairly priced unlevered firm plans to pay a dividend of $1 next year (t=1) which is expected to grow by 3% pa every year after that. The firm's required return on equity is 8% pa.
The firm is thinking about reducing its future dividend payments by 10% so that it can use the extra cash to invest in more projects which are expected to return 8% pa, and have the same risk as the existing projects. Therefore, next year's dividend will be $0.90. No new equity or debt will be issued to fund the new projects, they'll all be funded by the cut in dividends.
What will be the stock's new annual capital return (proportional increase in price per year) if the change in payout policy goes ahead?
Assume that payout policy is irrelevant to firm value (so there's no signalling effects) and that all rates are effective annual rates.
Question 558 portfolio weights, portfolio return, short selling
An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of 16% pa.
- Stock A has an expected return of 8% pa.
- Stock B has an expected return of 12% pa.
What portfolio weights should the investor have in stocks A and B respectively?
The covariance and correlation of two stocks X and Y's annual returns are calculated over a number of years. The units of the returns are in percent per annum ##(\% pa)##.
What are the units of the covariance ##(\sigma_{X,Y})## and correlation ##(\rho_{X,Y})## of returns respectively?
Hint: Visit Wikipedia to understand the difference between percentage points ##(\text{pp})## and percent ##(\%)##.
Question 578 inflation, real and nominal returns and cash flows
Which of the following statements about inflation is NOT correct?
Question 580 price gains and returns over time, time calculation, effective rate
How many years will it take for an asset's price to quadruple (be four times as big, say from $1 to $4) if the price grows by 15% pa?