Question

1. Ten years ago, the Circus Corp. sold a 20-year bond issue with a 9 percent annual coupon rate and a 3 percent call premium. Today, Circus called the bonds. The bonds originally were sold at their face value of $1,000. Compute the realized rate of return (yield to call) for investors who purchased the bonds when they were issued and who surrender them today in exchange for the call price.

2.   (EXCEL TEMPLATE) Grass Whacker’s is considering whether or not to refund a $90 million, 6 percent coupon, 30 year bond issue that was sold 8 years ago. It is amortizing $1.8 million of flotation costs over the issue’s 30-year life. A new 22-year issue would carry an interest rate of 5.35 percent. A call premium of 5 percent would be required to retire the old bonds and flotation costs on the new issue would be $1.35 million (also to be amortized). Grass Whacker’s marginal tax rate is 34 percent. The new bonds would be issued 1 month before the old bonds are called, with the proceeds being invested in short-term securities returning 1.5 percent annually. What is the NPV of the refund? Use the NPV function in Excel and the PV function in Excel. Answers should be the same.

Use the Excel Template and the following information to answer the next three questions:

Peterson Packaging Inc. does not currently pay dividends. The company will start with a $0.50 dividend at the end of year three and grow it by 10% for each of the next seven years until it nearly reaches $1.00. After seven years of growth, it will fix its dividend at $1.00 forever. The required return on the stock is 15%.

3. (EXCEL TEMPLATE) What is the current stock price? Use the NPV function.

4. (EXCEL TEMPLATE) What is the expected stock price in years 1-10? Use the NPV function.

5. (EXCEL TEMPLATE) Calculate the dividend yield and capital gains yield that an investor should expect for each year.

Use the financial statements shown below to answer the next three questions. Free cash flow is expected to grow at 4 percent after 2019. The weighted average cost of capital is 6.9 percent. The bonds are currently selling at 103% of par. The preferred stock has a current market value of $51.51 million.

Balance Sheet (in millions)

	Actual 2018	Projected 2019		Actual 2018	Projected 2019
Cash	81.90	61.60	Accounts payable	26.10	22.20
Marketable securities	53.80	54.20	Notes payable	101.00	4.70
Accounts Receivable	26.40	27.00	Accruals	8.00	7.37
Inventory	198.20	186.90	Total current liabilities	135.10	34.27
Total Current Assets	360.30	329.70	Long term bonds	9.20	4.50
			Preferred Stock	50.20	52.40
			Common stock	230.00	230.00
			Retained earnings	307.00	367.23
Net fixed assets	371.20	358.70	Total common equity	537.00	597.23
Total assets	731.50	688.40	Total liabilities & equity	731.50	688.40

Income Statement (in millions)

	Actual 2018	Projected 2019
Sales	907.30	955.10
Operating expenses	764.40	802.80
Depreciation	21.30	21.30
Earnings before interest & taxes	121.90	131.00
Interest	0.60	0.60
Earnings before taxes	121.30	130.40
Taxes	45.90	50.10
Net income before preferred dividends	75.40	80.30
Preferred dividends	2.50	1.60
Net Income available for common	72.90	78.70
Common dividends	16.40	18.47
Addition to retained earnings	56.50	60.23
Number of shares (in millions)	12.70	12.70

6. What is the free cash flow for 2019?

7. What is the value of operations as of 2018?

8. What is the price per share for 2018?

Answer 1

1)

A1	B	C	D	E	F	G	H	I	J	K	L	M	N	O
2
3		Face Value	$1,000
4		Issue Price	$1,000
5		Coupon Rate	9%
6		Call Premium	3%
7		Number of years before bond was called	10	Years
8		Annual Coupon	$90	=D3*D5
9		Since call premium is 3%, amount paid by company at the time of calling the bond is $1,000*(1+3%) = $1,030 for each bond.
10
11		Cash Flow to investor is
12		Year	0	1	2	3	4	5	6	7	8	9	10
13		Price paid to purchase the bond	($1,000)
14		Coupon Received		$90	$90	$90	$90	$90	$90	$90	$90	$90	$90
15		Amount received when bond was recalled											$1,030
16		Total Cash Flow to investor	($1,000)	$90	$90	$90	$90	$90	$90	$90	$90	$90	$1,120	=N13+N14+N15
17
18		Realized return to investor will be the rate at which Net Present Value of above cash flow will be zero.
19		This can be calculated using IRR function as follows:
20		Realized rate of return	9.20%	=IRR(D16:N16)
21
22		Hence realized rate of return to the investor is	9.20%
23

Formula sheet

A1

B

C

D

E

F

G

H

I

J

K

L

M

N

O

2

3

Face Value

1000

4

Issue Price

1000

5

Coupon Rate

0.09

6

Call Premium

0.03

7

Number of years before bond was called

10

Years

8

Annual Coupon

=D3*D5

=D3*D5

9

Since call premium is 3%, amount paid by company at the time of calling the bond is $1,000*(1+3%) = $1,030 for each bond.

10

11

Cash Flow to investor is

12

Year

0

=D12+1

=E12+1

=F12+1

=G12+1

=H12+1

=I12+1

=J12+1

=K12+1

=L12+1

=M12+1

13

Price paid to purchase the bond

=-D4

14

Coupon Received

=$D$8

=$D$8

=$D$8

=$D$8

=$D$8

=$D$8

=$D$8

=$D$8

=$D$8

=$D$8

15

Amount received when bond was recalled

1030

16

Total Cash Flow to investor

=D13+D14+D15

=E13+E14+E15

=F13+F14+F15

=G13+G14+G15

=H13+H14+H15

=I13+I14+I15

=J13+J14+J15

=K13+K14+K15

=L13+L14+L15

=M13+M14+M15

=N13+N14+N15

=N13+N14+N15

17

18

Realized return to investor will be the rate at which Net Present Value of above cash flow will be zero.

19

This can be calculated using IRR function as follows:

20

Realized rate of return

=IRR(D16:N16)

=IRR(D16:N16)

21

22

Hence realized rate of return to the investor is

=D20

23