FIN2212

TUTORIAL QUESTIONS

Tutorial 1

1. List the THREE (3) main forms of business organizations and describe their
advantages and disadvantages.

2. What is the goal of the firm? Why is maximizing a firm’s accounting profits not an
appropriate goal for the firm? Explain.

3. What is agency problem? How to reduce agency problem? Explain.

4. Suppose you own stock in a company. The current price per share is $25. Another
company has just announced that it wants to buy your company and will pay $35 per
share to acquire all the outstanding stock. Your company management immediately
begins fighting off this hostile bid. Is management acting in the shareholders’ best
interests? Explain.

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 Tutorial 2

1. What is a financial market and why are they important? Provide an example.

2. What is a financial intermediary? List THREE (3) common types of financial

intermediaries in the Malaysian financial markets. Provide an example of each.

3. What do investment banks do in the financial markets? Explain.

4. Describe the differences between the primary market and the secondary market.

5. What are the differences between a debt security and an equity security? Explain.

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 Tutorial 3

1. Calculate the value in five years of $1,000 deposited in a savings account today if the
account pays interest at a rate of:
a. 8% per year, compounded annually
b. 8% per year compounded quarterly

2. For liquidity purposes, a client keeps $10,000 in a bank account. The bank quotes a
stated annual interest rate of 12%. With quarterly compounding, calculate how much
will your client have in his account at the end of the third year, assuming no additions
or withdrawals?

3. You deposit $10,000 at the end of each of the next four years into an account that
pays 12% annually. What is the account balance at the end of 10 years?

4. Strikler Inc. has issued a $10 million, 10-year bond issue. The bonds require Strikler
to establish a sinking fund and make 10 equal, end-of-year deposits into the fund.
These deposits will earn 8% annually, and the sinking fund should have enough
accumulated in it at the end of 10 years to retire the bonds. What are the annual
sinking fund payments?

5. You deposit $4,500 per year at the end of each of the next 25 years into an account
that pays 10% compounded annually. How much could you withdraw at the end of
each of the 20 years following your last deposit?

6. If you receive $1,000 one year from now, calculate the value of that $1,000 if the
opportunity cost (discount rate) is 6%.

7. A business is considering purchasing a machine that is projected to yield cash savings

of $1,000 per year over a 10-year period. Using a 12% discount rate, calculate the
present value of the savings. (Assume that the cash savings occur at the end of each
year.)

8. You own a small business that is for sale. You have been offered $2,000 per year for
five years, with the first receipt at the end of four years. Calculate the present value of
this offer, using a 14% discount rate.

9. Yolanda is 35 years old today and is beginning to plan for her retirement. She wants
to set aside an equal amount at the end of each of the next 25 years so that she can
retire at age 60. She expects to live to an age of 80 and wants to be able to withdraw
$50,000 per year from the account on her 61 st through 80th birthdays. The account is
expected to earn 10% per year for the entire period of time. Compute the size of the
annual deposits that she must make.

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10. Your brother is 30 years old and he plans to retire on his 60th birthday. He wants to
start a retirement plan that will require a series of equal, annual, end of year deposits
into an account that will earn 12% annually. The first deposit will be made on his 31st
birthday and the last payment will be on his 60th birthday. The plan will allow him to
withdraw $120,000 per year for 15 years, beginning on his 61st birthday. At the end of
the 15th year, he wants to withdraw an additional $250,000. Calculate the periodic
payment that must be made into the account if he is to achieve his objectives.

11. Your parents bought a house for $160,000. They paid 20% down payment and agreed
to pay the balance in 20 equal annual installments at the end of each year. Calculate
the equal installments if the annual interest rate is 8%.

12. Your mother is planning to retire this year. Her firm has offered her a lump-sum
retirement payment of $50,000 or a $6,000 lifetime annuity-whichever she chooses.
Your mother is in reasonably good health and expects to live for at least 15 more
years. Which option should she choose, assuming that an 8% interest rate is
appropriate to evaluate the annuity?

13. You are planning to save for retirement over the next 30 years. To do this, you will
invest $700 a month in a stock account and $300 a month in a bond account. The
return of the stock account is expected to be 11%, and the bond account will pay 6%.
When you retire, you will combine your money into an account with a 9% return.
How much can you withdraw each month from your account assuming a 25 year
withdrawal period?

14. The present value of the following cash flow stream is $6,550 when discounted at
10% annually. Calculate the value of the missing cash flow.

Year Cash Flow

1 $1,700
2 ?
3 $2,100
4 $2,800

15. Prepare an amortization schedule for a five-year loan of $42,000. The interest rate is
8% per year, and the loan calls for equal annual payments.
(i) Calculate how much interest is paid in the third year.
(ii) Calculate how much interest is paid over the life of the loan.

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 Tutorial 4

1. What is the current value of a $1000 par value perpetual bond to an investor who
requires a 10% annual rate of return? The perpetual bond pays interest at the rate of
8% per year.

2. Honeywell international zero coupon bonds (par value $1,000) mature on April, 2012.
Calculate the yield to maturity if an investor purchases one of these bonds on April
21, 2006 at a price of $650.

3. Philips Industries has bonds outstanding ($1,000 par value) that mature 10 years from
today and have a coupon interest rate of 9 3/8%. Calculate the maximum price an
investor should be willing to pay if the investor desires a 10% yield to maturity.

4.
(a) Calculate the yield to maturity of a 9-year bond that pays a coupon rate of 20% per
year, has a $1,000 par value, and is currently priced at $1,407? The bond pays annual
coupon.

(b) Calculate the value of a bond that matures in 3 years, has an annual coupon rate of
$110, and a par value of $1,000. The required rate of return is 12%.

(c) What are the differences between bonds and stocks? Explain.

5. Six years ago a firm issued a 15-year bond that pays 10% coupon interest
semiannually on a $1,000 par. If the bond currently sells at $1,100, calculate the
expected rate of return of the bond. Moreover, would you buy the bond if your
required rate of return is 11%?

6. United Bhd 15-year, $1,000 par value bonds pay 8% interest annually. The market
price for the bond is $1,085 and your required rate of return is 10%.

(a) Calculate the bond’s expected rate of return.

(b) Using your required rate of return, what is the value of the bond’s to you?

(c) Should you purchase the bond at the current market price?

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7. (a)
The Power Corporation has two different bonds currently outstanding. Bond X has a
face value of $20,000 and matures in 20 years. The bond makes no payment for the
first six years, then pays $1,100 every six months over the subsequent eight years,
and finally pays $1,400 every six months over the last six years. Bond Y also has a
face value of $20,000 and a maturity of 20 years; it makes no coupon payments over
the life of the bond. If the required return on both these bonds is 7% compounded
semiannually, what is the current price of bond X and bond Y?

(b)
(i) How does a bond issuer decide on the appropriate coupon rate to set on its
bonds?
Explain.

(ii) A company is contemplating a long-term bond issue. It is debating whether to

include a call provision. What is a call provision? What are the benefits and costs
to the company from including a call provision? Explain.

(iii) Companies pay rating agencies such as Moody’s and S&P to rate their
bonds, and the cost can be substantial. However, companies are not required to
have their bonds rated; doing so is strictly voluntary. Why do you think they do it?
Explain.

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 Tutorial 5

1. What is the current value of a share of Edison common stock to an investor who
requires a 12% annual rate of return, if next year’s dividend is expected to be $3 per
share and dividends are expected to grow at an annual rate of 4 % for the foreseeable
future?

2. The Edgar Corporation currently pays a $2 per share dividend. This dividend is
expected to grow at a 20% percent annual rate over the next three years and then to
grow at 6% per year for the foreseeable future. What would you pay for a share of
this stock if you demand a 20% rate of return?

3. P Ltd has historically practiced annual dividend payments. Assuming P Ltd paid a
dividend of $0.75 three years ago has just paid an annual dividend of $1.20 and you
expect dividends to grow at the same annual rate for the next three years. After that
you expect the dividend to grow at an annual rate of 12%. How much are you willing
to pay for a share if you require a 15% rate of return?

4. A stock paid a dividend of $0.68 five years ago, has just paid an annual dividend of
$1 recently, and you expect its dividends to grow at the same annual rate for the next
four years. After that, you expect dividends to grow at an annual rate of 10%. How
much will you be willing to pay for the stock if you require a 16% rate of return?

5. The price of Ellet Corporation stock is expected to be $68 in five years. Dividends are
anticipated to increase at an annual rate of 20% from the most recent dividend of
$2.00. If your required rate of return is 16%, calculate how much you are willing to
pay for Ellet stock?

6.
(a) NTT Company is experiencing a period of rapid growth. Earnings and dividends are
expected to grow at a rate of 20% during the next three years, and at a constant rate of
12 % thereafter. NTT’s current dividend was $0.08, and the required rate of return on
the stock is 15%. Calculate the intrinsic value of the stock today.

(b) The return required by ordinary shareholders should be higher or lower than the
return required by bondholders. Provide TWO (2) reasons to justify your answer.

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7. Tony Krishnan is the CEO of Ekowood Berhad who believes that an average firm in
his company’s industry is expected to grow at a constant rate of 5 percent and has a
beta of 1.25. The average return for the market portfolio is 10% and the 3-month risk-
free rate is 6%. Beta for his company’s stock is 1.25. The company has just
successfully completed some product development activities which lead Tony to
expect that its earnings and dividends will grow at a rate of 50 percent for the next 2
years and after that will follow the industry average rate. The last dividend paid was
$0.20 per share.

(a) Calculate the intrinsic value per share of Ekowood Berhad’s stock today.

(b) Assume that the current market price is $15, should Tony expect the investors to
buy the stock? Why or why not?

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 Tutorial 6

1. A stock’s expected return has the following distribution:

Demand for the Probability of this Rate of return if this

company’s products demand occurring demand occurs
Weak 0.35 -5%
Average 0.40 10%
strong 0.25 22%

Calculate the stock’s return and standard deviation.

2. An investor owns a portfolio consisting of the following stocks:

Stock Percentage of Beta Expected Return

Portfolio
1 35 0.75 9%
2 40 1.35 18%
3 25 1.15 13%

The risk-free rate is 4% and the expected return on the market portfolio is 11%.

(i) Calculate the expected return of the portfolio.

(ii) Calculate the portfolio beta.
(iii) Identify the stocks that appear to be winners and to be losers.

3. “As an investor, it is advisable to hold more stocks in a portfolio in order to reduce

the variability in return.”

(a) What is the difference between systematic and non-systematic risks?

(b) How the numbers of stocks affect the systematic and non systematic risks?
Provide a relevant diagram to support your answer.

(c) How would the relationships between the return of two stocks influence the risks
of the portfolio.

(d) Lists two implications of holding more stocks in a portfolio to investors.

(e) What is beta? How is beta used to calculate an investor’s required rate of return?
Explain.

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4. The J Inc. common stock is expected to pay a dividend of $2 per share at the end of
the year. The stock has a beta equal to 1.05. The risk-free rate is 4% and the expected
return from market portfolio is 7%. The stock currently sells for $28. What does the
market believe will be the stock price at the end of year 5 if the stock’s dividend is
expected to grow at the constant rate g.

5. You own a portfolio equally invested in a risk-free asset and three stocks. If one of the
stocks has a beta of 1.80 and the second stock has the same risk as the market.

(a) Calculate the beta for the third stock in your portfolio if the beta of portfolio is
1.25.

(b) When should you form a portfolio with the beta 1.25? When do you expect the
overall market performance in the coming future is good or poor? Explain.

6. You are given the following the data:

Company Beta
A Ltd 0.864
D Ltd 0.975
G Ltd 1.257

Expected return of the market portfolio is 12.5% and the expected return on the
treasury bills is 5.5%.

(i) Based on the Capital Asset Pricing Model, calculate the expected return for each
company.

(ii) If one of the above companies had an expected return of 12.5%, what would be
the company’s beta?

(iii) Calculate the market risk premium.

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7. (a)
A risky portfolio consists of Stock C and Stock D, and the Capital Asset Pricing
Model (CAPM) is applicable for both stocks.

Stock Expected Return Beta

C 8% 0.72
D 25% 2.75

(i) If you want to construct a portfolio with a 15 percent expected return, calculate
how much of your portfolio should invest in Stock C.

(ii) Calculate the beta of the portfolio.

(iii) The current Treasury bill rate is 3% and the market risk premium 12%. Calculate
the required return of the portfolio. Does the portfolio earn excess return?

(b) Discuss the two components of the total risk of a security. Which component of
the total risk should not be a concern for a well-diversified investor? Why?
Explain.

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 Tutorial 7

1. S Enterprise has a series of 8% coupon bonds outstanding with a $1,000 par value.
The bonds mature in 10 years and currently sell for $946. If new bonds are issued, the
issuance cost is expected to be $11 per bond. S Enterprise’s tax rate is 40%. What is
the after-tax cost of debt for S Enterprises? (Assume annual interest payments.)

2. Clarke Equipment currently pays a common stock dividend of $3.50 per share. The
common stock price is $60. Analysts have forecast that earnings and dividends will
grow at an average annual rate of 6.8% for the foreseeable future.

(a) What is the cost of retained earnings?

(b) What is the cost of new equity if the issuance costs per share are $3?

3. Compute the cost for the following sources of financing:

(a) A $1,000 par value bond with a market price of $970 and a coupon interest rate
of 10%. Flotation costs for a new issue would be approximately 5%. The bonds
mature in 10 years and the corporate tax rate is 34%.

(b) A preferred stock selling for $100 with an annual dividend payment of $8. If the
company sells a new issue, the flotation cost will be $9 per share. The company’s
tax rate is 30%.

4. As a member of the Finance Department of a manufacturing company, your super

visor has asked you to compute the appropriate discount rate of use when evaluating
the purchase of new packaging equipment for the plant. You have determined the
market value of the firm’s capital structure as follows:

Source of Capital Market Value

Bonds $4,000,000
Preferred stock $2,000,000
Common stock $6,000,000

To finance the purchase, the company will sell 10-year bonds par value $1,000 paying
7% per year at the market price of $1,050. Flotation costs for issuing the bonds are
4% of the market price. Preferred stock paying a $2.00 dividend can be sold for $25;
the cost of issuing these shares is $3 per share. Common stock is currently selling for
$55 per share. The firm paid a $3 dividend last year and expects dividends to continue
growing at a rate of 10% per year. Floatation costs for issuing common stock will be
$5 per share and the firm’s tax rate is 30%.

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 Calculate the weighted average cost of capital (WACC) you should use to evaluate
the equipment purchase.
5. (a)
Oracle Corporation, which pays corporation tax at 35 percent, has the following
capital structure:
Ordinary shares: 2 000 000 ordinary shares of nominal value $0.25 per share. The
market value of the shares is $0.59 per share. A dividend of 8 cents per share has just
been paid, and dividends are expected to grow by 8 percent per year for the
foreseeable future.
Preference shares: 500 000 preference shares of nominal value $0.50 per share. The
market value of the share is $0.43 per share and the annual net dividend of 7.5% has
just been made.

Debentures: 2 000 debentures with the face value of $1000 each. The debenture is
currently traded at $960 each and redeemable in 6 years. These debentures have a
coupon rate of 9 percent.

(i) Calculate the market values of the ordinary shares, the preference shares and the
bonds.

(ii) Calculate the weighted average cost of capital (WACC) of Oracle by using the
market values found in part (i) above.

(b) Discuss the internal and external factors that could affect the cost of capital.

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 Tutorial 8

1.
(a) Explain the following: independent project, mutually exclusive project and contingent
project.

(b) Calculate the Net Present Value (NPV) and the Internal Rate of Return (IRR) of the
following project. If the cost of capital is 10%, decide whether the project can be
accepted according to both investment criteria.

Year After-tax cash flows

0 -$5,000
1 $1,650
2 $1,650
3 $1,650
4 $1,650

2. Two mutually exclusive projects have the following expected cash flows:

Year Project G Project H

0 -$10,000 -$10,000
1 $5,000 $0
2 $5,000 $0
3 $5,000 $17,000

(a) Calculate the internal rate of return (IRR) for each project.

(b) Calculate the net present value (NPV) for each project, assuming the firm’s
weighted cost of capital is 12%.

(c) Which project should be adopted? Why?

3. Calculate the net present value of a project with a net investment of $20,000 for
equipment and an additional net working capital investment of $5,000 at time 0. The
project is expected to generate net cash flows of $7,000 per year over a ten year
estimated economic life. In addition, the net working capital will be recovered at the
end of the project. The required return on the project is 11% and the company has a
marginal tax rate of 40%. What is the meaning of the computed net present value
figure?

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4. Calculate the internal rate of return and net present value for a project that is expected
to generate eight years of annual net cash flows of $75,000. The project has a net
investment of $360,000 and the required return on the project is 12%.

5. You are considering a project with an initial cash outlay of $80,000 and expected cash
flows of $20,000 at the end of each year for six years. The discount rate for this
project is 10%. What is the project PI?

6.
(a) How long will it take for the following project to generate enough cash to pay for
itself?

Year Cash Flow ($)

0 500,000
1 150,000
2 150,000
3 150,000
4 150,000
5 150,000
6 150,000
7 150,000
8 150,000

(b) If the management had set a cut-off of 4 years for the project, will the project be
acceptable? Explain.

(c) Calculate the discounted payback using a discount rate of 12%.

7. Steven is a business analyst for Seng Heng IT Company. The board of directors has
asked him to analyse two proposed capital investments, Projects U and V. Each
project has a cost of $10,000, and the cost of capital for each project (k) is 12%. The
projects’ expected net cash flows are as follows:

Expected Net Cash Flows

Year Project U Project V
0 -10,000 -10,000
1 6,500 3,500
2 3,000 3,500
3 3,000 3,500
4 1,000 3,500

(a) Calculate each project’s NPV & IRR.

(b) Which project or projects should be accepted if they are independent?
(c) Which project should be accepted if they are mutually exclusive?
(d) How might a change in the cost of capital produce a conflict between the NPV
and IRR rankings of these two projects?

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