QUESTION 5 [Total 14 marks]
(a) A company listed on the Australian share market is expected to pay a dividend of $2 next year and it has a constant growth rate for dividends of 5% per year. The expected rate of return for shareholders is 8% per year. Calculate the price of a share in the company. (4 marks)
(b) What is the annual yield on a 4 year bond with a face value of $100,000 and annual coupon interest payments at 14% per annum if the price of the bond is $127,721? (4 marks)
(c) A sole proprietor intends to invest $30,000 in a project that will generate cash flows before tax of $8,000 per year for 5 years. Depreciation is straight line to zero (i.e. 20% per year). The estimated salvage value is $5,000. The before tax required rate of return is 10% and the sole proprietor is taxed at 40%. What is the appropriate discount rate to use in the capital budgeting analysis? (2 marks)
(d) What is the expected return on the market if the expected return on Asset A is 15%, the risk-free rate is 6% and Asset A has a beta of 0.9? (4 marks)
QUESTION 5 [Total 14 marks]
(a) A company listed on the Australian share market is expected to pay a dividend of $2 next year and it has a constant growth rate for dividends of 5% per year. The expected rate of return for shareholders is 8% per year. Calculate the price of a share in the company. (4 marks)
(b) What is the annual yield on a 4 year bond with a face value of $100,000 and annual coupon interest payments at 14% per annum if the price of the bond is $127,721? (4 marks)
(c) A sole proprietor intends to invest $30,000 in a project that will generate cash flows before tax of $8,000 per year for 5 years. Depreciation is straight line to zero (i.e. 20% per year). The estimated salvage value is $5,000. The before tax required rate of return is 10% and the sole proprietor is taxed at 40%. What is the appropriate discount rate to use in the capital budgeting analysis? (2 marks)
(d) What is the expected return on the market if the expected return on Asset A is 15%, the risk-free rate is 6% and Asset A has a beta of 0.9? (4 marks)
Related questions
A company is evaluating a security as a standalone investment. The risk-free rate of return is 5.1% per annum. The probability distribution of annual returns for the security is given in the table below:
| Return | Probability |
| -2% | 0.15 |
| 5% | 0.3 |
| 7% | 0.4 |
| 10% | 0.15 |
(a) Calculate the expected return of the security. (2 marks)
(b) Calculate risk (standard deviation) of the security. (4 marks)
(c) Explain whether the company should invest in this security. (3 marks)
