Problem Set 1

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Instructions: 1) Open book, open notes limited to only class materials. 2) Unlimited time. 3) This must be reflective of your individual effort. GMU Honor Code applies. 4) The Problem Set #1 (only the question solutions portion) is due at the end of the day on September 24th. 5) Show all work, as partial credit will be given for each question’s answer. Organize your work so it is easy to follow. You can use word, power point, excel or combinations of the above. 6) Return the Solutions pages to be graded. Put a copy in the course folder and send me an electronic copy that I will grade and return to you along with the approved solution. 7) The exercise is worth 100 points. 8)
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The semi-annual compounded interest rate is 5.2% (a six-month discount rate of 5.2/2 = 2.6%). (15 points)

a. What is the present value of the bond? b. Generate a graph or table showing how the bond’s present value changes for semi-annually compounded interest rates between 1% and 15%.

4) Company Q’s current rate of return (ROE) is 14%. It pays out (payout ratio) half of its earnings as dividends. Current book value is $50 per share. Book value per share will grow as Q reinvests earnings.

Assume the ROE and payout ratio stay the same for the next 4 years. After that competition forces ROE down to 11.5% and the payout increases to 0.8. The cost of capital is 11.5%. (15 points)

a. What are Q’s EPS and dividends next year? How will EPS and dividends grow in years 2, 3, 4, and 5 and subsequent years? b. What is Q’s stock worth per share? How does that value depend on the payout ratio and growth rate after year 4?

5) Consider two mutually exclusive R&D projects that AMD, a chip manufacturer, is considering. Assume the corporate discount rate is 15 per cent and the minimum acceptable IRR is 25 per cent.

Project A: Server CPU 0.13 micron processing project. By shrinking the die size to 0.13 micron, AMD will be able to offer server CPU chips with lower power consumption and heat generation, meaning faster CPUs.
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