1.

Answer the following questions

(a) A company has issued bonds that have a 10% coupon rate, payable semi-annually. The
bonds mature in 8 years, have a face value of INR 1,000, and a yield to maturity of 8.5%.
What is the price of the bonds?

(b) A bond trader purchased each of the following bonds at a yield to maturity of 8%.
Immediately after she purchased the bonds, the interest rates fell to 7%. What is the
percentage change in the price of each bond after the decline in interest rates?
i. 10-year, 10% annual coupon bond
ii. 10 year zero coupon bond
iii. INR 100 annual coupon, perpetual bond

(c) A bond that matures in 7 years sells for INR 1,020. The bond has a face value of INR 1,000,
and a yield to maturity of 10.5883%. The bond pays coupon semi-annually. What is the
bond’s current yield?

2. Assume a company has the following capital structure, which it considers to be optimal:
LongTerm Debt = 25%, Preferred Stock = 15%, Common Stock = 60%. The company has
marginal tax rate of 40%, and investors expect earnings and dividends to grow at a constant
rate of 6% in the future. The company paid a dividend of INR 5.00 per common share last
year (DPS0).
Ten-year Treasury bonds yield 6%, the market risk premium is 5%, and the stock beta is 1.3.
The following terms would apply to new security offerings:
Preferred Stock: Preferred stock is trading at a price of INR 100 per share, with a fixed
preferred dividend of INR 10 per share.
Long Term Debt: Long Term Debt has an interest rate of 9% per annum.
Common Stock: All new common equity will be raised internally by reinvesting earnings.

Based on the above information, answer the following questions

(a) What is the cost of common equity of the firm?

(b) What is the cost of preferred equity of the firm?
(c) What is the Weighted Average Cost of Capital (WACC) of the firm?
(d) What is the intrinsic value of common share price of the firm?

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3. You run a regression of stock returns of Thakurpukur Chemicals Ltd. (TCL) against market
returns and arrive at the following estimated regression model:

R(i) = 0.15% + 1.50*R(mkt)

The company has, in market value terms, INR 500 million of debt and INR 500 million of
equity. The company currently has two divisions. Division A, whose assets have a market
value of INR 600 million, produces only inorganic chemicals. You have found five listed
companies on the exchange which make only inorganic chemicals which have an average
levered beta of 1.31 and an average debt equity ratio of 20%. Division B produces only
organic chemicals and you could not find any comparable companies. Assume that all
companies face a tax rate of 50%.

Based on the information above, answer the following questions

(a) What is the asset beta for division B?

(b) If the company divests itself of Division A and reduces its debt-equity ratio to 0.5, what
would the company’s levered beta be?

(c) If the company divests itself of Division B and increases its debt-equity ratio to 2, what
would the company's levered beta be?

4. You have been asked to analyze the capital structure of a company, which have the following
details:

There are 100 million shares outstanding, trading at INR 10 per share. The firm has debt
outstanding of INR 500 million, in market value terms. The levered beta for the firm
currently is 1.04. The risk-free rate is 5% and the market risk premium is 5.50%. The firm’s
current bond rating is A, and the default spread for A rated bonds is 1.5%. Marginal tax rate
of the firm is 40%.

Based on the above information, answer the following questions

(a) Estimate the current cost of capital of the firm

(b) Assume that you have computed the optimal debt to value ratio to be 60%. The average
pretax cost of debt will rise by 50 basis points, if the company moves to the optimal capital
structure. Then, estimate the new cost of equity of the company at its optimal capital
structure.

(c) Estimate the new cost of capital of the firm at its optimal capital structure.

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5. Pailan Financial Services Ltd. (PFSL) is a publicly traded financial services company that has
INR 200 million in debt outstanding, in both book value and market value terms. The book
value of equity in the company is INR 400 million and there are 40 million shares
outstanding, trading at INR 20 per share. The company currently has an Earnings before
Interest and Tax (EBIT) of 100 million. The current levered beta for the company is 1.15, and
the company’s pre-tax cost of borrowing is 5%. The current risk free rate is 3%, the equity
risk premium is 5% and the tax rate is 40%.

The company has plans to triple its debt to capital ratio through buyback of its outstanding
shares. The shares will be bought back at its current traded price, and the entire buyback will
be funded by issuance of new debt. This will raise the average pre-tax cost of debt to 8%.
(Assume no change in market value of firm due to this restructuring).

Based on the above information, answer the following questions

(a) Cost of equity under existing capital structure

(b) Cost of capital under existing capital structure
(c) Earnings Per Share (EPS) under existing capital structure
(d) Cost of equity under proposed capital structure
(e) Cost of capital under proposed capital structure
(f) Earnings Per Share (EPS) under proposed capital structure

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6. You have run a regression of annual stock returns of Joka Corporation against the annual
market portfolio returns, and arrived at the following estimated regression model:

R(stock) = – 0.1% + 1.43 * R(market), R-Square = 0.3383

The following information are also available:

Market Portfolio Joka Corporation Pailan Corporation

Annual expected
* 15.15% 11.00%
return as per CAPM
Standard
Deviation 20.0% * 25.8%
(annual)
Correlation with
* 0.465
Market Portfolio
Stock Beta * *

Based on above information, answer the following questions

(a) Stock Beta of Joka Corporation?

(b) Stock Beta of Pailan Corporation?

(c) Correlation coefficient of Joka Corporation stock return with Market return

(d) Proportion of variance of Joka Corporation stock return which is not explained by the
variance of market portfolio return

(e) Standard deviation of annual stock returns of Joka Corporation?

(f) Annual risk-free rate of return?

(g) Annual expected return from market portfolio?

(h) Expected annual return from a portfolio which is 50% invested in Joka Corporation and
50% invested in Pailan Corporation?

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 7. Assume that you manage a portfolio of 4 crores and your portfolio consists of four
stocks

Stock Amount Beta

A 40 lakhs 1.5
B 60 lakhs -0.5
C 1 crore 1.25
D 2 crore 0.75
If the market is expected to deliver 14% and the risk-free rate is 6%, what is the expected
return on your portfolio?

8. Suppose you have 2million portfolio consisting of 100,000 investment in each of the
20 different stocks. The portfolio has a beta of 1.1. You are planning to selling 100,000 worth
of stock with a beta of 0.9 and use the proceeds to buy another stocks with a beta of 1.4.
what will be the new portfolio beta?

9. Stock A has a beta of 1.5 and stock B has as beta of 0.75. The expected return of a
50-50 portfolio of stock A and B is 13% and the risk free rate is 7%. What is the difference
between the required return of the stock A and B?

10. Assume that two securities A and B form the market portfolio. Their proportion and
variances are given below

Stock Weight Variance

A 0.39 160
B 0.61 340

The covariance between the two securities is 190. Calculate the beta of the two securities
and the market beta.

11. You are given following information

Stock Mean SD
A 20% 30%
B 10% 20%
The correlation between the returns of A and B is 0.5. You can borrow and lend at the risk-
free rate of 3%.
a) Which stock provides a better risk-return trade off when combined with the risk-free
asset?
b) Find the portfolio weights of a risk-free asset and stock A that gives an expected return
of 25%
c) What is the standard deviation of the portfolio above?

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 12. A company has a weighted average cost of capital of 8%. Its debt-to-equity ratio is
1:2 and its beta equity is 1.5 and the equity risk premium is 6%. It raised its debt at a cost of
3% per annum. There is an opportunity raise additional debt to bring the debt to equity ratio
to 1:1. If everything else is the same then what would be the updated WACC? Should the
company consider it? Assume tax rate is 0. What would be the answer is tax rate is 35%

13. A firm has a debt-to-equity ratio of 2:1. Its cost of debt is 5%. The variance of the
equity returns of the company is 300%. The expected return on the market is 8% and the
variance of the market returns is 200%. The correlation between a return of the company
and the market is 0.4. The risk-free rate is 5% and the corporate tax rate is 30%. What is the
weighted average cost of capital of the company at the present leverage ratio. If the debt to
equity ratio increases to 4:1, what would be the cost of capital of the firm?

14. A firm has 10 million of notes payable and one million shares outstanding with a
price of 60. The firm has also issued 30,000 bonds with a face value of 1000. The bonds carry
coupon rate of 6% and the yield to maturity on the bonds is 10%. Compute the market-
based weights of the different sources of financing of the firm.

15. You are given the following information about the book value of the capital raised through
Bonds, Preferred shares and Common shares of a company.

Instrument Book Value in Millions

Bonds 30
Preferred Shares 5
Common Equity 40

In addition, you know the following:

 The face value of the bond is 100 and pays a semi-annual coupon of 8%. The bond will
mature in 20 years and its present yield is 12%
 Preferred shares have a par value of 100 and pays an annual dividend of 8. The expected
return on the preferred shares by the market is 12%
 There are 4 million common shares outstanding, and the present market value is 20

Compute the following:

a) Weights of Bonds, Preferred shares and Common shares in market value terms
b) If the flotation cost associated with preferred shares is 5%. What is the return
demanded by investors while investing in the preferred shares of the company?