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NAME: PROBLEM SET 3 Chapter 6 -- Debt Financing Assigned Problem 1 Twin Oaks Health Center has a bond issue outstanding with a coupon rate of 7 percent and four years remaining until maturity. The par value of the bond is $1,000, and the bond pays interest annually. a. Determine the current value of the bond if present market conditions justify a 14 percent required rate of return. b. Now, suppose Twin Oaks' four-year bond had semiannual coupon payments. What would be its current value? (Assume a 7 percent semiannual required rate of return. However, the actual rate would be slightly less than 7 percent because a semiannual bond is slightly less risky than an annual coupon bond.) c. Assume that Twin Oaks' bond had a semiannual coupon but 20 years remaining to maturity. What is the current value under these conditions? (Again, assume a 7 percent semiannual required rate of return, although the actual rate would probably be greater than 7 percent because of increased price risk.) ANSWER a. Interest rate rate 14% Coupon rate 7% Years to maturity nper 4 Par value FV $1,000 Annual coupon payment pmt $70 Bond value PV $796.04 b. Interest rate rate 7% Coupon rate 7% Semiannual periods to maturity nper 8 Par value FV $1,000 Semiannual coupon payment pmt $35 Bond value PV $791.00 c. Interest rate rate 7% Coupon rate 7% Semiannual periods to maturity nper 40 Par value FV $1,000 Semiannual coupon payment pmt $35 Bond value PV $533.39 A B C D E F G H I 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52

NAME: PROBLEM SET 3 Chapter 6 -- Debt Financing Assigned Problem 2 Tidewater Home Health Care, Inc., has a bond issue outstanding with eight years remaining to maturity, a coupon rate of 10 percent with interest paid annually, and a par value of $1,000. The current market price of the bond is $1,251.22. a. What is the bond current yield? What is the bond's yield to maturity? b. Now, assume that the bond has semiannual coupon payments. What is its yield to maturity in this situation? ANSWER a. Years to maturity nper 8 Coupon rate 10% Par value fv $1,000 Annual coupon payment pmt $100 Current price pv $1,251.22 Current yield 7.99% Yield to maturity rate 5.96% b. Semiannual periods to maturity nper 16 Coupon rate 10% Par value fv $1,000 Semiannual coupon payment pmt $50 Current price pv $1,251.22 rate 3.00% Yield to maturity 6.00% A B C D E F G H I 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

PROBLEM SET 3 Chapter 7 -- Equity Financing Assigned Problem 3 PROBLEM 6 Jane's sister-in-law, a stockbroker at Invest, Inc., is trying to get Jane to buy the stock of HealthWest, a regional HMO. The stock has a current market price of $25, its last dividend (D0) was $2, and the company's earnings and dividends are expected to increase at a constant growth rate of 10 percent. The required return on this stock is 20 percent. From a strict valuation standpoint, should Jane buy the stock? ANSWER Market Price $25 $2 20.00% 10.00% Current Price $22 Share is over valued and should not be purchased. D0 = dividend in year 0 r = return on stock g = growth rate of dividends

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NAME: PROBLEM SET 3 Chapter 7 -- Equity Financing Assigned Problem 4 Assume the risk-free rate is 6 percent and the market risk premium is 6 percent. The stock of Physicians Care Network (PCN) has a beta of 1.5. The last dividend paid by PCN (D0) was $2 per share. a. What would PCN's stock value be if the dividend was expected to grow at a constant -5 percent? 0%? 5%? Hint: First, use the SML of the CAPM to show that the stock's required rate of return is 15%. b. What would be the stock value if the growth rate is 10 percent, but PCN's beta falls to 1.0? 0.5? ANSWER Risk Free Rate 6% Market Risk Premium 6% Beta 1.5 Last Dividend Paid $2 Required Return 15% a. Growth Rate -5% Stock Value $9.50 Growth Rate 0% Stock Value $13.33 Growth Rate 5% Stock Value $21.00 b. Risk Free Rate 6% Market Risk Premium 6% Beta 1 Last Dividend Paid $2 Required Return 12% Growth Rate 10% Stock Value $110 Risk Free Rate 6% Market Risk Premium 6% Beta 0.5 Last Dividend Paid $2 Required Return 9%