(Stephanie Peter 20200269)

Q1
BioTech has decided to finance the project with initial investment of $50,000 through debt
financing. The bank has offered loan at 9% interest for a period of 5 years based on 3 different
repayment methods. Recommend which method of debt financing is most cost effective and
explain why. Support your recommendation with relevant workings.

(a) All principal and compound interest are paid back on the 5th year. Show the loan
amortization table.

FV = 50,000 X ( 1+ r )n

= 50,000 x ( 1 + 0.09 )5

= 50,000 x 1.53862

=$76931.20

Interest paid= Total payment - Loan amount

Interest paid = 76,931.20 - 50,000 = $26,931.20

Year Open bal Interest Payment Closing bal

1 50000 4500 0 54500

2 54500 4905 0 59405

3 59405 5346.45 0 64751.45

4 64751.45 5827.63 0 70579.08

5 70579.08 6352.12 76931.20 0

Total interest 26931.20

(8 marks)

(b) Interest are paid yearly with principal paid at end of the 5th year. Show the loan
amortization table.
Annual Interest Payment (Years 1-4) = 50,000 x 0.09 x 4 =18000
Year 5 payment= Annual interest payment + Principal payment
Year 5 payment = 4,500 + 50,000 = 54,500
Total payment = 18000+ 54,500 = 72500
Interest paid = 22,500
Year Open bal Interest Payment Closing bal

1 50,000 4500 4500 50000

2 50,000 4500 4500 50000

3 50,000 4500 4500 50000

4 50,000 4500 4500 50000

5 50,000 4500 54500 0

Interest 22,500

(8 marks)

(c) Pay 5 equal payments at each year inclusive of interest and principal. Show the loan
amortization table.

PMT = 12854.62
Total payment = 5 x 12854.62 = 64273.10
Interest paid= Total Payments - Loan Amount
Interest paid = 64273.10-50,000 = 14273.10

Year Open bal Interest Payment Closing bal

1 50,000 4500 12854.62 41645.38

2 41645.38 3748.08 12854.62 32538.84

3 32538.84 2928.50 12854.62 22612.72

4 22612.72 2035.14 12854.62 11793.24

5 11793.24 1061.40 12854.62 0

Total interest 14273.12

Beginning Annual Interest Principle paid Ending
balance payment balance

50,000 12854.62 4500 8354.62 41645.38

41645.38 12854.62 3748.08 9106.54 32538.84

32538.84 12854.62 2928.50 9926.12 22612.72

22612.72 12854.62 2035.14 10819.48 11793.24

11793.24 12854.62 1061.40 11793.22 -0.01

(8 marks)
(d) Recommend which method of debt financing is most cost effective and explain why.

● The amortized loan is the one with the lowest interest expense since it requires a
higher annual payment, part of which reduces the unpaid balance on the loan
and thus results in less interest being charged over the 5-year term
Q2
Bond prices and use the information in the following table.
Bond Par Value Coupon Rate Years to Yield to Price
Maturity Maturity

A $1000 10% 12 9% ?

B $1000 8% 12 9% ?

Par Value

(a) Price the bonds from the table with annual coupon payments.

Bond A:

PMT = [ 1-(1+r)n/r] + fv/(1+r)n

PMT= 100 [1-(1+0.09)^-12/0.09] + 1000/(1.09)^12

716.07 + 355.53
= 1071.60

Bond B :

Coupon payment = 8% x 100 = 80=40

=80[1-(1.09)^-12/0.09] + 1000/(1.09)^12

= 572.86 + 355.53

= 928.39
(10 marks)

(b) Price the bonds from the table with semiannual coupon payments.
(10 marks)
[20 marks]
Bond A :
Coupon rate = 10% [ 10/2 = 5% ]
Par value = 1000
Maturity = 12 [ 2 x 12 =24 ]
YTM = 9% [ 9/2 = 4.5 ]

Value of bond = 50 x [1-1/1.045]^24 /0.045 + 1000/1.045^24 = 1072.477

Bond B :
Coupon rate = 8% [8/2 =4% ]
Par value = 1000
Maturity 12[2x12=24]
Ytm 9%[9/2=4.5]

Value of bond = 40 x 91-1/1.045^24] / 0.045 + 1000/1.045^24= 927.5226

Q3
Preferred stock and common stock valuation: Constant growth. You are a financial analyst
for ProQuest Company, and you are looking for undervalued securities. After searching the
market, you identify Stock A and Stock B as potential purchases. Stock A is currently selling
at $380 with last dividend of $10 and constant growth rate of 5%, while Stock B is a
preferred stock, currently selling at $60 with a $5 dividend paid each year. Answer the
following questions on the basis that you believe the required rates of return for both stocks
should be 8%:

a. How much would you pay for Stock A?

D0 = 10

g= 5%

r=8%

D1=D0(1+g)

=10(1+0.05)

=10(1.05)

= 10.5

P0= D1/(R-g)

P0= 10.5 / (0.08 -0.05)

P0 = $350
(5 marks)
b. How much would you pay for Stock B?

Value = $60

Dividend = $5

R= 8%

Value of preferred share = dividend/r

Value of preferred share = 5 / 8%

Value of preferred share 5 / 0.08

Value of preferred share = $62.50

(5 marks)

c. Which security is overvalued? Why? What should you do?

Stock A is undervalued since current market price i.e. $100 is less than $120 as
calculated above.Stock B is overvalued since current market price i.e. $60 is higher than
$50 as calculated above.

(10 marks)
[20 marks]

Q4

You are given the following information concerning Orchids Enterprises:

Debt: 13,000, 6.2 percent coupon bonds outstanding, with 15 years to maturity and a
quoted price of 107. These bonds pay interest
semiannually.

Common stock: 345,000 shares of common stock selling for $73.50 per
share. The stock has a beta of .90 and will pay a
dividend of $3.35 next year. The dividend is expected
to grow by 5 percent per year indefinitely.

Preferred stock: 10,000 shares of 4.1 percent preferred stock selling at $86
per share.

Market: 12 percent expected return, risk-free rate of3.5 percent, and a 35 percent tax
rate.
Calculate the WACC for Parrothead Enterprises.

Outstanding bonds = 13000

fv= 1000

Current price = 107% x 1000=1070

Coupon rate 6.2 %

Semi annual coupon rate = 6.2 % / 2 = 3.1% x 1000=31

Year to maturity = 15 x 2 = 30 years

Semi annual yield to maturity= 2.75%

Annual ytm =2.75% x 2 = 5.50%

After tax cost of debt = 5.50 % x ( 1-0.35) = 3.575%

Market value of debt = 1070 x 13000= 13910000

Common stock

Common stock outstanding = 345000

fv= 1000

cp= 73.50

Cost of common stock with constant growth model

DI =3.35

P0 = 73.50

Growth rate = 5%

Cost of common stock = ( 3.35/73.50)+ 0.05

=0.0956

= 9.56 %

Common stock with CAPM

Cost of common stock = 0.035 + 0.90 x ( 0.12 - 0.035)

Cost of common stock = 0.115

= 11.15%

Average cost of common stock = (9.56% +11.15%) /2

= 10.355%

Value of common stock = 345000x73.50 = 25,357500

Preferred stock

Preferred stock = 10000

Cp = 86

Annual dividend = 100 x 4.1% = 4.1

Value of preferred stock = 10000x 86 = 860000

Total value of firm

13910000+860000+25357500=40127500

Weight of debt

860000/40127500=0.0214

Weight of preferred stock

860000/40127500=0.0214
Weight of common stock

25357500/40127500 = 0.6319

WACC= 0.3466x3.575% + 0.0214 x 4.88% + 0.6320 x 10.355% = 7.89%

[30 marks]
{100 marks}