Homework chapter 6

1- Zane Perelli currently has $100 that he can spend today on polo shirts costing $25 each. Alternatively, he could invest the $100 in a risk-free U.S. Treasury security that is expected to earn a 9% nominal rate of interest. The consensus forecast of leading economists is a 5% rate of inflation over the coming year.

a. How many polo shirts can Zane purchase today?
b. How much money will Zane have at the end of 1 year if he forgoes purchasing the polo shirts today?
c. How much would you expect the polo shirts to cost at the end of 1 year in light of the expected inflation?
d. Use your findings in parts b and c to determine how many polo shirts (fractions are OK) Zane can purchase at the end of 1 year. In percentage terms, how many more or fewer polo shirts can Zane buy at the end of 1 year?
e. What is Zane’s real rate of return over the year? How is it related to the percentage change in Zane’s buying power found in part d? Explain.

2-Bond interest payments before and after taxes Charter Corp. has issued 2,500 debentures with a total principal value of $2,500,000. The bonds have a coupon interest rate of 7%.

a. What dollar amount of interest per bond can an investor expect to receive each year from Charter?

b. What is Charter’s total interest expense per year associated with this bond issue?

c. Assuming that Charter is in a 35% corporate tax bracket, what is the company’s net after-tax interest cost associated with this bond issue?

3 – Valuation Fundamentals: Imagine that you are trying to evaluate the economics of purchasing an automobile. You expect the car to provide annual after-tax cash benefits of $1,200 at the end of each year and assume that you can sell the car for after tax proceeds of $5,000 at the end of the planned 5-year ownership period. All funds for purchasing the car will be drawn from your savings, which are currently earning 6% after taxes.

 A. Identify the cash flows, their timing, and the required return applicable to valuing the car.

 B. What is the maximum price you would be willing to pay to acquire the car? Explain.

4- Midland Utilities has outstanding a bond issue that will mature to its $1,000 par value in 12 years. The bond has a coupon interest rate of 11% and pays interest annually.
a. Find the value of the bond if the required return is
(1) 11%,
(2) 15%, and
(3) 8%.
b. Plot your findings in part a on a set of “required return (x axis)–market value of bond (y axis)” axes.
c. Use your findings in parts a and b to discuss the relationship between the coupon interest rate on a bond and the required return and the market value of the bond relative to its par value.
d. What two possible reasons could cause the required return to differ from the coupon interest rate?