Week 4 Midterm Exam
(Problem 1): Esfahan Corporation stock is selling at $25 a share. The company will pay a dividend of $2.00 at the end of one year, $2.50 at the end of two years, and then $3.00 at the end of three years. However, this last dividend is expected to grow at the rate of 4% forever. If your required rate of return is 16%, do you think you should buy this stock?
(Problem 2): Tabriz Corporation has zero coupon bonds maturing after 5 years. The overall value of the firm is twice the face value of the bonds. The company has sigma of .55 and the riskless rate is 4%. Using the option pricing theory, find the market value of a $1000 bond.
(Problem 3): Tehran Corporation has borrowed $1 million from Mashhad National Bank with the following terms:
(A) Mashhad National Bank will charge interest at .5% per month on unpaid balance.
(B) Tehran will make $25,000 monthly installments for the first 12 months, then $50,000 per month thereafter until the loan is paid off.
Find the balance of the loan right after the 24th payment.
(Problem 4): Shiraz Company is planning to get a machine that will cost $100,000 and is expected to last for 5 years. The company uses straight-line depreciation. The tax rate of Shiraz is 32% and the proper discount rate in this case is 12%.
(A) Find the minimum pretax earnings per year that the machine must generate to become profitable.
(B) The machine is expected to have $25,000 pretax earnings annually, with a standard deviation of $5,000. Calculate the probability that the machine will turn out to be profitable.
(Problem 5): Karaj Company stock sells at $50 a share. It has ß = 1.64 and s = .5. The risk-free rate is 4%, and the expected return on the market is 11%. You have formed a portfolio with these two items in it:
(1) 800 shares of Karaj stock.
(2) A zero-coupon risk-free bond with face value $40,000, maturing after 1 year.
Calculate the following:
(A) Initial value of the portfolio
(B) Expected value of the…