Question

1. Tech Temps’ financial statements show the following information:

Average cost of funds 10.0%

EBIT $ 500,000

Total capital $ 1,250,000

EPS 30.0%  

(1) Compute the company’s economic value added (EVA)
(2) Interpret the value you computed in part l(1).
Suppose that normally Tech Temps’ P/E ratio is 20x. Using the information given previously, estimate the market price per share for Tech Temps’ common stock.
What are the key features of a bond?
How do you determine the value of a bond?
What is the value of a 1-year, $1,000 par value bond with a 10% annual coupon if its required rate of

return is 10%? What is the value of a similar 10-year bond?
What is interest rate price risk? Which bond has more interest rate price risk, a one-year bond or a 10-

year bond? Why is this?
What is interest reinvestment rate risk? Which bond has more interest rate reinvestment rate risk,

assuming a 10-year investment horizon?

Shares outstanding Marginal tax rate

Answer 1

Ans. Economic Value added (EVA): - EVA is the economic profit by the company in a given period. it measures the company financial performance based on the residual wealth calculated by deducting its cost of capital from its operating profit, adjusted for taxes on cash basis.

Calculation of EVA = NOPAT-(WACC*capital invested)

WACC = Weighted Average cost of capital

capital invested= Equity+long-term debt at the beginning of the period.

1. Calculation of Economic value added

EVA = 500000- (1250000X.10) = 375000

2. in the current situation EVA is the Positive value than the company doing well.

EVA is measure used for estimating the economic performance of an organization.

EVA is $375000, that means company performance is good they are earning on investment more than Required rate of return.

Calculation of market price of the stock = EPSXP/E Ratio

Tech temps P/E ratio = 20

EPS = 30

Market value = 30X20 = 600

Key Features of Bond

1. Face value: The principal portion of the loan, usually either $1000 or $5000

2.Maturity: The day bond comes due

3. Coupon:- Rate of interest of the bond

4.Yield : Bond pricing is decided based on yield

Determination of value of bond: bond value to be calculation, it is Discounted future cash inflow it's include annual coupon payment plus maturity value of the bond.

Discount rate: discount rate is market yield

coupon payment: Interest payment as per contract

Value of bond for 1yrs = (1100)X.909 = 1000

value of 10yrs bond = Annual coupon payment X Discounted Cumulative PV@10%+ maturity value XPV of last 10th yrs @10yrs

= (1000X.10)6.14 +1000X.386 = $1000

bond value will be same as the coupon rate and required rate of return (yield) is the same

interest risk : risk that arise for bond owners from fluctuating interest rates.how much interest rate risk a bond has depends how sensitive its price is to interest rate change in the market.

a interest rate is hike than the bond price is fall and vice versa. The rationale is that to as interest rate increase , the opportunity cost of holding a bond decrease since investor are able to realize greater yields by switching to other investment that reflect higher interest rate.

in the present situation one year bond holder having enough time to switch new bond if bond price is increase , so 10yrs bond are having more interest price risk as compare of 1yrs risk.

Reinvestment risk is the probability that the investor will be unable to reinvest cash flow (eg coupon payment) at a rate comparable to the current investment rate of return. zero coupon bonds are the only fixed income instrument to have no investment to have no investment risk since they issue no coupon payments.

Reinvestment risk is the likelihood that an investment cash flow will earn less in a new security. for example 10yrs bond 100000/- treasury note with an interest rate of 6yrs, the investor expects to earn 6000 per year from the security.however at the end of the term, interest rates are 4%. if the investor buys another 10yrs 100000 treasury note he will earn 4000 annually rather than 6000. Also if interest rate subsequently increase and he sells the note before its maturity date, he loses part of the principal.

Investment in 1yrs bond is less riskier than 10yrs bond