FE 323 Midterm Version A C Fall 2006 Student Name Student ID Section X1 Section X2 Chadwick Chadwick Section X3 Osher Section X4 Section X5 Section X6 Section X7 Section X8 Section X9 Osher Griswold Griswold Santini Santini Griner Please circle your section above Show your work Writing out either your calculator keystroke entries or the underlying equations at each step in the process will be sufficient All interest rates should be accurate to at least four decimal places ie 1584 Dollar amounts must be accurate to the penny Capital Budget amounts to the nearest dollar Please write neatly and CIRCLE ANSWERS Points add up to 100 Long answers total 70 points multiple choice totals 30 points 2 Time Value of Money 21 points 1 5 points You just bought a policy that will pay you and your heirs 14 000 a year forever beginning one year from today You paid 325 000 for this policy What rate of return are you earning on this policy PV PMT i i PMT PV 14 000 325 000 4 31 2 5 points As part of the contract with their new CEO Giant Sunflowers Inc agreed that beginning today to put 125 000 per year for five years five payments total into a special account on the anniversary of Ms Smith s hiring today The account will earn 6 5 interest APR compounded quarterly Ms Smith will receive the total proceeds principal and interest on the fifth anniversary of her hiring How much will she receive on her fifth anniversary 6 5 APR Qtr 6 66 EAR BGN n 5 fv 761 536 30 i 6 66 pv 0 fv pmt 125 000 3 5 points A young BU graduate bought a condo in Back Bay five years ago by obtaining a 25 year adjustable rate mortgage for 150 000 The initial interest rate was 4 8 APR compounded monthly Tomorrow the fifth anniversary of the mortgage is the first time the interest rate will be adjusted The new rate will be 6 4 APR compounded monthly What will be the new monthly payment A C Step 1 n 300 pmt 859 50 After 5 years n 60 fv 132 442 18 Step 2 n 240 Pv 979 67 i 0 4 pv 150 000 fv 0 pmt i 0 4 pv 150 000 fv pmt 859 50 i 0 5333 pv 132 442 18 fv 0 pmt 3 4 6 points You recently won a personal injury law suit You have received three settlement options as follows years beginning Option A 12 000 on the first day of each year for 20 today Option B 995 on the first day of each month for 22 years beginning one year from today Option C 130 000 as a lump sum payment today You can earn a 7 5 Effective Annual Rate on your investments You do not care if you personally receive the funds or if they are paid to your heirs should you die within the next 22 years Which option do you prefer and why fv 0 pv Present value of Option A BGN n 20 i 7 5 pv 131 508 94 Present value of Option B 7 5 EAR 7 2539 APR monthly BGN n 264 pv as of Year 1 131 862 36 pv as if Period 0 131 862 36 1 075 122 662 66 Present value of Option C 130 000 Therefore because it has the greatest present value one would prefer Option A pmt 995 i 0 6045 pv fv 0 pmt 12 000 Bonds 16 points 5 5 points Tulip Industries has a semi annual bond outstanding that has a 5 5 coupon rate 1 000 face value and a market price of 967 29 The market required rate of return on a bond with comparable risk is 5 8 APR compounded semi annually How many years will it be until this bond matures n i 2 9 n 35 17 5 Years pv 967 29 fv 1 000 pmt 27 50 6 5 points Portulaccas Inc wants to raise 11 million to expand their business To accomplish this they plan to sell 30 year 1 000 face value zero coupon bonds The bonds will be priced with a yield to maturity of 6 percent Assume semi annual compounding What is the minimum number of bonds they must sell to raise the 11 million they require i 3 n 60 fv 64 807 mill Portulaccas would have to sell a minimum of 64 808 bonds to raise the 11 million they need pv 11 mill pmt 0 fv 4 7 6 points Settum Mums issued 12 5 million of 15 year 7 5 coupon bonds four years ago to finance a high tech hot house they constructed in LaConner Washington You bought 5 bonds for 5 000 The bonds were issued at par and pay interest annually Since being issued the required rate of return on these bonds has increased by 1 percentage point If you sell these bonds today what would your holding period yield be i 8 5 Step 1 The price today n 11 pv 930 31 Step 2 HPY n 4 i 5 90 i Stocks 15 points pv fv 1 000 pmt 75 pv 1 000 fv 930 31 pmt 75 8 5 points Lavender Enterprises just paid an annual dividend of 3 00 a share on their common stock Next year the dividend is expected to be 3 18 a share The company s board of directors recently voted to have a constant rate of growth dividend policy What will a share of Lavender Enterprises common stock be worth five years from now if the applicable discount rate is 14 percent assuming the dividend discount model of stock valuation Two ways to solve this problem First calculate D6 from which P5 might be determined Second calculate P0 and apply the growth rate representing the rate at which the price would rise The constant growth rate for the dividend is 6 D6 D1 1 06 5 3 18 1 3382 4 256 P5 4 256 14 06 4 256 08 53 19 Alternatively P0 3 18 14 06 3 18 08 39 75 P5 P0 1 06 5 39 75 1 3382 53 19 5 9 5 points Good Herbs Corp announced today that they will begin paying annual dividends The first dividend will be paid in one year in the amount of 0 35 per share The following annual dividends per share will be 0 40 0 60 and 1 00 a share respectively After that dividends are projected to increase by 3 5 per year How much are you willing to pay for one share of this stock if your desired rate of return is 13 and you use the dividend discount model for stock valuation The first four dividends do not represent constant growth Once Good Herbs reaches year 5 it will be in a constant growth situation Therefore P4 will reflect D5 and all future dividends D5 1 00 1 035 1 035 P4 1 035 13 035 1 035 095 10 89 The …