Homework answers / question archive / Problem 1: Calculating Holding Period Return                                                                                                                      Information about three securities is listed below:                                                                                                                                                                                                                                                                                                                           Security                Beginning of Year Price  End of Year Price              Interest or Dividend Paid During Year                                                                                                     Stock A $106

Problem 1: Calculating Holding Period Return                                                                                                                      Information about three securities is listed below:                                                                                                                                                                                                                                                                                                                           Security                Beginning of Year Price  End of Year Price              Interest or Dividend Paid During Year                                                                                                     Stock A $106

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Problem 1: Calculating Holding Period Return                                                                                                                     

Information about three securities is listed below:                                                                                                                                                          

                                                                                                                                                               

Security                Beginning of Year Price  End of Year Price              Interest or Dividend Paid During Year                                                                                    

                Stock A $106.35 $112.40 $1.85                                                                                    

                Stock B $1.65     $1.85     $0.00                                                                                    

                Bond X  $1,052.00             $1,028.00             $47.00                                                                                                   Use the information provided above to answer the following questions.                                                                                a) What is the Holding Period Return for each of these securities?                                                                         b) Suppose that during the year, the executives of Stock A decided to spend spent $185 million repurchasing the company's shares.  How, if at all, does this information affect the calculation of the Holding Period Return?                    

Assignment 5.4 Exercises                                                                                                                                                            

Problem 2: Calculating Holding Period Return                                     

Information about three securities is listed below:                                                                                                                                                          

                                                                                                                                                               

                Security                Beginning of Year Price  End of Year Price              Interest or Dividend Paid During Year                                                                                    

                Preferred A        $10.00   $10.00   $0.75                                                                                    

                Common B          $38.00   $36.50   $3.35                                                                                    

                Bond C  $985.00 $1,035.00             $78.00                                                                                  

Use the information provided above to answer the following questions for EACH security.                          

a) What is the Capital Gain (loss) in dollar terms?  What is the Capital Gain Yield (%)?                                    

b) What is the Dividend Yield (%)?                                                                                                                                      

c) What is the total Holding Period Return (%)?

Assignment 5.4 Exercises                                                                                                                                            

Problem 3: Calculating Return Components                                                                                               

An investor purchases one share of stock for $50.  After one year, they sell the share for $55.  During the year, they receive $7 in dividends.                                                                                                                

a) What was the dividend yield, in percentage terms?                                                                                                   

b) What was the capital gain from price appreciation on the stock, in percentage terms?                                         

c) What was the total return in dollars?  What was the total return, in percentage terms?

Assignment 5.4 Exercises                                                                                                                                            

Problem 4: Calculating Dollar Returns with Exchange Rates                                                                                

An American investor purchases a single Eurobond from their personal financial advisor.  The bond is denominated in Euros, but the investor uses their American dollars to make the purchase.   The bond sells for 1023 euros, and has a par value of 1000 euros.  At the time of purchase, the exchange rate is 1.24 US dollars per euro.  The coupon rate on the bond is 8%, paid annually.  One year later, the coupon is paid and the investor sells the bond for 918 euros.  The exchage rate at the time of sale has fallen to 1.10 US dollars per euro.                                                                                                                                     

a) What was the purchase price in US Dollars?                                                                                                                  

b) How much money did the investor earn from coupon interest, in dollars?  How much did they lose due to the decline in the bond's price?  How much did they gain from the change in the exchange rate?             

c) What was the bond's selling price, in US Dollars?                                                                                                   

d) What was the investor's total earnings during the year, in US Dollars?                                                                      

e) The bond fell in value dramatically during the year.  Its price fell by over 10% in Euros!  Nevertheless, the investor sold the bond for more money, in US Dollars, than they bought it for, and earned a substantial return.  How is this possible?  Explain.

Assignment 5.4 Exercises

Problem 5: Determining Issue Costs       

A growing company wants to raise $275 million in a new stock issue.  Its investment banker indicates the sale of stock will require 9 percent underpricing to attract new investors.  They will also charge an 8 percent spread.  Underpricing is expressed as a percentage of the current public stock price, while the spread represents a cut of the issue price.  The company's current stock price is $38 per share.                        

a) At what price will the shares be sold to the public?                                                                                                               

b) What price per share will the company actually receive?                                                                                               

c) How many shares must the company sell to raise the desired funds?                                                                 

d) How much money will the investment banking syndicate earn on the sale?                                                     

e) What is the total cost of raising the funding, due to both investment bank costs and underpricing?          

Assignment 5.4 Exercises                                                                                                                                            

Problem 6: Determining Issue Costs                                                                       

A large, mature company wants to raise $680 million in a new stock issue.  Its lead investment banker indicates the sale of stock will require 5 percent underpricing to attract new investors.  They will also charge a 4 percent spread.  The company expects they will incur $1,850,000 in legal and administrative fees to raise these funds.  The company's current stock price is $53 per share.                                                        

a) At what price will the shares be sold to the public?                                                                                                               

b) What price per share will the company actually receive?                                                                                               

c) How many shares must the company sell to raise the desired funds?

d) How much money will the investment banking syndicate earn on the sale?                                                   

e) What is the total cost of raising the funding, including all costs?

Problem 7: Impact of Financial Leverage                                               

Behemoth Enterprises needs to raise $10 Billion to fund a major new project designed to reinvigorate the giant company's growth.  The company's top executives are debating whether to raise the money by issuing debt or by issuing new shares of stock.  Their team of analysts predict that if the project goes through, the company's Earnings before Interest and Taxes (EBIT) will increase to $9.7 Billion.  However, if the company uses debt to fund the project, they will have to pay interest of 5% on this new debt, along with $200 million in annual sinking fund payments.  This would be on top of the $2.75 Billion the company already pays in interest on its existing debt, plus $2.3 Billion in annual sinking fund payments.  If the company instead chooses to issue new shares of stock, their investment banker predicts they will be able to issue additional shares at $10 per share.  The company currently has 8.7 Billion shares outstanding at $11.50 per share.  The company's effective tax rate is 21%.                                                         

a) If the company raises the funding with equity, what will be its times-interested earned ratio?  What will be its times-burden-covered ratio?  What will be its earnings per share?                                                       

b) If the company raises the funding with debt, what will be its times-interested earned ratio?  What will be its times-burden-covered ratio?  What will be its earnings per share?

Problem 8: Impact of Financial Leverage                                               

Pipsqueak Co. has an exciting opportunity to buy out its main local competitor for $200,000.  Doug Kindle, owner/operator of the business, calculates the combined EBIT of the merged companies would be $350,000.  To pay for the acquisition, he is considering taking out a loan with his local bank, backed by his home mortgage, at an interest rate of 8%.  In addition, $7500 of principal payments would be due each year.  Fortunately, the company only has a small amount of existing debt, necessitating $10,000 in annual interest payments and $3000 in principal payments.  However, the owner of Pipsquek's competitor has offered to instead take stock as a form of payment, rather than cash.  In this case, Doug would issue shares of stock at $10 per share, and the competitor's current owner would become a part-owner in Pipsqueak Co.  Doug's accountant tells him his current stock is worth about $15 per share.  Doug owns all 80,000 existing shares.  The company's tax rate is 21%.                                                                      

a) If the company raises the funding with equity, what will be its times-interested earned ratio?  What will be its times-burden-covered ratio?  What will be its earnings per share?                                                              

b) If the company raises the funding with debt, what will be its times-interested earned ratio?  What will be its times-burden-covered ratio?  What will be its earnings per share?                                                                        

c) Which option would you suggest Doug pursue?  Why?