“MOCK 1 ” 1

QUESTION 1 1
QUESTION TWO 6
QUESTION THREE 10
QUESTION FOUR 13
QUESTION FIVE 18

MOCK 2 22

QUESTION 1 22
QUESTION TWO 25
QUESTION THREE 27
QUESTION FOUR 32

EXTRA SET OF QUESTIONS 38

QUESTION 1: EXPECTED PRICE OF A HOUSE AFTER FOUR YEARS WITH INFLATION RATE 38
QUESTION 2: IMPLIED RATE OF INTEREST FOR A LOAN 38
QUESTION 3: MONTHLY-COMPOUNDED RATE OF RETURN FOR TWO CERTIFICATES OF DEPOSIT 38
QUESTION 4: TOTAL AMOUNT IN AN ACCOUNT AFTER 25 MONTHS WITH MONTHLY DEPOSITS 39
QUESTION 5: MONTHLY INSTALLMENT FOR A LOAN WITH SPECIFIC CONDITIONS: 39
QUESTION 6: PRESENT VALUE OF LOTTERY PAYMENTS: 40
QUESTION 7: YIELD TO MATURITY ON A COUPON BOND: 40
QUESTION 8: STOCK PRICE BASED ON CONSTANT RATE OF GROWTH MODEL 40
QUESTION 9: CURRENT VALUE OF A COUPON BOND WITH SEMIANNUAL: 41
QUESTION 10: NET PRESENT VALUE (NPV) OF AN INVESTMENT: 41
QUESTION 11: NPV OF AN INVESTMENT WITH PERPETUAL CASH FLOWS 42
QUESTION 12: CURRENT STOCK PRICE BASED ON CONSTANT GROWTH RATE 42
QUESTION 13: CURRENT STOCK PRICE BASED ON EXPECTED DIVIDEND AND EQUITY COST OF CAPITAL: 42
QUESTION 14: DIVIDEND PAYOUT RATIOS, EXPECTED DIVIDEND GROWTH RATES, AND STOCK VALUES FOR TWO
STOCKS: 43
QUESTION 15: REQUIRED RETURN, DIVIDEND YIELD, AND CAPITAL GAINS YIELD FOR A STOCK 43
QUESTION 16: DIVIDEND GROWTH RATE AND P/E RATIO ESTIMATION FOR A COMPANY 44
QUESTION 17: PRESENT VALUE OF CASH FLOWS AND PRICE PER SHARE CALCULATION FOR A COMPANY 45
QUESTION 18: INVESTMENT DECISIONS BASED ON NPV AND AVAILABLE FUNDS 45
QUESTION 19 EXPECTED YEAR-END PRICE CALCULATION / RETURN 46
QUESTION 20: PORTFOLIO EXPECTED RETURN AND STANDARD DEVIATION 47
QUESTION 21: AFTER-TAX WACC CALCULATION 48
QUESTION 22: ASSET BETA CALCULATION: 48
QUESTION 23: PORTFOLIO VARIANCE AND STANDARD DEVIATION CALCULATION: 48
“MOCK 1 ”
Question 1
a. You have information about three stocks:
1) Stock A is expected to provide a dividend of $13 a share forever

2) Stock B is expected to pay a dividend of $8 next year. Thereafter, the company expects
that the dividend will grow constantly by 3% a year.

3) Stock C is expected to pay a dividend of $6.5 next year. Thereafter, dividend growth is
expected to be 18% a year for 5 years (from year 2 to 6) and zero growth thereafter.

Question: If the required return for each stock is 8,5%, calculate the value of each stock and
find out which stock is the most valuable?

Stock A:
Div_1: $13
Return = R_E: 8.5%
𝐷𝑖𝑣1
𝑃𝑜 =
𝑟𝐸

13
𝑃𝑜 = ≈ 152,9412
0.085

Thus, the value of of stock a is $152,94

Stock B:
Div_1: 8$
G: 3%
R_E: 8,5%

Vi bruger følgnede formel her, da vi har g, R_e, Div_1 og skal finde

𝐷1
V_0 / P_0: 𝑉0 =
𝑟𝐸 −𝑔
Her med tallene indsat:
8
𝑃0 = ≈ 145,4545
0.085 − 0.03

Thus, the value of of stock a is $145,45

Stock C:

Div_1: 6.5
𝐷𝑖𝑣1 = 6.5 = 6,5
𝐷𝑖𝑣2 = 6.5 · (1 + 0.18) = 7,67
𝐷𝑖𝑣3 = 6.5 · (1 + 0.18)2 = 9,0506
𝐷𝑖𝑣4 = 6.5 · (1 + 0.18)3 ≈ 10,67971
𝐷𝑖𝑣5 = 6.5 · (1 + 0.18)4 ≈ 12,60206
𝐷𝑖𝑣6 = 6.5 · (1 + 0.18)5 ≈ 14,87043
𝐷𝑛+1 7
𝑉𝑛 = =
𝑟𝐸 − 𝑔𝐿 𝑟𝐸 − 𝑔𝐿
𝐷7
=
𝑟𝐸 − 𝑔𝑙
14.87043
𝑉6 = ≈ 174,9462
0.085 − 0.0
Terminal value for år 6 (V6) er dermed 174,95

6.5 7.67 9.05 10.68 12.60 14.87

𝑉0 = 1
+ 2
+ 3
+ 4
+ 5
+
(1 + 0.085) (1 + 0.085) (1 + 0.085) (1 + 0.085) (1 + 0.085) (1 + 0.085)6
174.95
+ ≈ 152,0266
(1 + 0.085)6

Thus, the value of of stock a is $152,94

Thus, The most valuable stock is Stock A

[8 marks]

b. ABC Bonds have a coupon rate of 9% and a par value of $1,000 and will mature in 8 years.
Coupons are paid semi-annually. If you require a return of 8%, what price would be willing to
pay for the bond? What happens if you pay more for the bond? What happens if you pay less
for the bond?

Coupon rate: 9%

Par value/future value: $1000

Return/YTM: 8%
 𝐶 1 𝐹𝑉
𝑃𝑉 = · (1 − 𝑛
)+
𝑟 (1 + 𝑟) (1 + 𝑟)𝑛

Vi skal nu finde coupon payment (C)

𝐶𝑜𝑢𝑝𝑜𝑛 𝑟𝑎𝑡𝑒/ 𝑓 · 𝑃𝑎𝑟 𝑉𝑎𝑙𝑢𝑒
0.09
· 1000 = 45 = 𝐶
2

We will now calculate periods, as there are 2 periods pr year

2x8=16

We also divide YTM by two, as there two periods each year:

0.08/2=0.04
45 1 1000
𝑃𝑉 = · (1 − 16
)+ ≈ 1058,261
0.04 (1 + 0.04) (1 + 0.04)16

If we decide to hypothetically be willing to pay $1100, which is more than the current PV, we can put
1100 dollar in PV’s place, and see what FV/Par value would be

45 1 𝐹𝑉
1100 = · (1 − 16
)+
0.04 (1 + 0.04) (1 + 0.04)16
⇕ Ligningen løses for FV vha. WordMat.
𝐹𝑉 = 1078,175

This means that the par value/FV will be more, as you are willing to pay more

If we decide to hypothetically be willing to pay $950, which is less than the current PV, we can put
950 dollar in PV’s place, and see what FV/Par value would be
45 1 𝐹𝑉
950 = · (1 − ) +
0.04 (1 + 0.04)16 (1 + 0.04)16
⇕ Ligningen løses for FV vha. WordMat.
𝐹𝑉 = 797,2283

This means that the par value/FV will be less, as you are willing to pay less

[7 marks]
c. Why can it be a problem to use IRR to choose between mutually exclusive projects?
The IRR rule is only guaranteed to work for a stand-alone project if all of the projects
negative cash flows precede its positive cash flows. If this is not the case, the IRR rule can
lead to incorrect decisions. In a case of mutually exclusive projects where only one of two or
more projects being considered can be selected the NPV rule provides the best answer: Pick
the project with the highest NPV. Picking one project over another simply because it has a
larger IRR can lead to errors.
Problems with IRR that can lead to incorrect decisions:
1) Economies of scale is ignored
2) Impractical implicit assumption of reinvestment rate at the IRR itself for remaining period
of the project.
3) Ranking projects by their IRRs ignores risk differences
4) The late costs problem
5) Differences in timing are ignored

Other pitfalls of the IRR rule:

1. Delayed investments
2. Multiple IRRs
3. Non-existent IRR

[5 marks]

d. Ampere Banking Corporation offers two types of certificates of deposit, each requiring a
deposit of $10,000. The first one pays $12,183.02 after 36 months, and the second one pays
$13,199.53 after 48 months. Find their monthly-compounded rate of return, compare, and
explain the difference in returns.

PV = 10.000

Bank A - FV = 12,183.02
Bank A period in months: 36

Bank B - FV = 13,199.53
Bank B period in months: 48

We need to find the monthly compounded rate for each:

We use this formula here:

𝐹𝑉 = 𝑃𝑉(1 + 𝑟)𝑛
Bank A:
12183.02 = 10000(1 + 𝑟)36
 ⇕ Ligningen løses for r vha. WordMat.
𝑟 = −2,0055 ∨ 𝑟 = 0,005500017
0,0055 · 100 = 0,55 = 0.55% monthly compounded rate for Bank A

Bank B
13199.53 = 10000(1 + 𝑟)48
⇕ Ligningen løses for r vha. WordMat.

𝑟 = −2,0058 ∨ 𝑟 = 0,005800008
0,0058 · 100 = 0,58 = 0.58% monthly compounded rate for Bank B

Bank B / the second bank offers a higher monthly compounded rate of 0.58 % compared
to Ampere Banking which provides a monthly compounded rate of 0.55 %.
Hence should you select Bank B since it provides a higher monthly compounded rate
But it is important to notice that the period of Bank B is 12 months longer than Ampere
Banking which should be taken into consideration that in order to get the higher rate we
need to bind the money for 4 years instead of 3 years.

[5 marks]
[Total 25 marks]
Question Two
a. In order to buy a house you want to accumulate a down payment of $35,000 over the next
four years. You can do that by putting a certain sum of money in a savings account on the
first day of every month for the next 48 months. The account credits interest every month
at the annual rate of 8.4%. What is your required monthly deposit?

FV=35000
R=8.4
We need to find the monthly rate, as deposits are monthly:
0.084
= 0,007
12
We need to find C (the monthly deposit)
 𝐹𝑉
𝑐=
1
1−
(1 + 𝑟)𝑁
[ 𝑟 ]

35000
𝑐= ≈ [861,0391]
1
1−
(1 + 0.007)48
[ 0.007 ]

Thus, the monthly deposit will be $861,04

[6 marks]

b. Arcon comp. is planning to invest $800 in new stores. This is new and unexpected
information to the market. The company has 150 millions of shares outstanding, the
current market price per share is $45.00. The projected present value of the future after
tax cash flows is $900 million. Estimate the impact of the decision on the value of the
company and the stock price?

Investment in new stores: 800$ million

Price pr. Share: 45.00$
Shares outstanding = $150 million
The projected present value of the future after tax cash flows $900 million

First off, the current enterprise value will be calculated:

150 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 · 45 = 6750 𝑚𝑖𝑙𝑙𝑖𝑜𝑛

We need find how it impacts the enterprise value by substracting the investment on 800
million
6750 − 800 = 5950

Then we add the present value of the future after tax cash flows:
5950 + 900 = 6850

The new enterprise value will be 6850 million

6850 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 137
= ≈ 45,66667
150 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 3

Thus, the new stock price will be $45,67

As a whole, the companys’ value and stock value will rise.

[6 marks]

c. Explain Modigliani-Miller Propositions I and II (Capital structure in Perfect

capital markets).

Proposition 1
In a perfect capital market, the total value of a firm is equal to the market value of the free
cash flows generated by its assets and is not affected by its choice of capital structure.

𝑽𝑳=_𝑬+_𝑫=_𝑽𝑼
Where,
Vu is the value of the unlevered firm(financingonlythroughequity)
VL is the value of the levered firm(financingthroughamixofdebtandequity)

Proposition 2:

The cost of capital of levered equity is equal to the cost of capital of unlevered equity plus a
premium that is proportional to the debt-equity ratio (measured using market values)
Example:Coffeeshop
𝒓𝑬=_𝒓𝑼+_𝑫𝑬𝒓𝑼−𝒓𝑫=_𝟏𝟓%_+_𝟏𝟓,_𝟎𝟎𝟎𝟏𝟓,_𝟎𝟎𝟎𝟏𝟓%_−𝟓%_=_𝟐𝟓%_
Where,
𝒓𝑬 is the cost of capital of levered equity

𝒓𝑼is the cost of capital of unlevered equity

[5 marks]

d. Bayker Motors has 58 millions of shares outstanding with a price of $26 per share. In
addition, Bayker has issued bonds with a total current market value of $991 million. Suppose
Bayker’s beta of equity is 1.1, the yield on Treasury bonds is 2.5%, the market risk premium
is 6%, and Bayker’s debt cost of capital is 7%.

1) What is Bayker’s pretax WACC?

We will find the equity market value:

58 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 · 26 = 1508𝑚𝑖𝑙𝑙𝑖𝑜𝑛

Equity market value: 1508 million.

Value of the company needs to be calculated:

 1508 + 991 = 2499

Thus, the total value of the company: 2499 million.

Bonds issued = Debt value: $991 million

Market Risk premium: 6%

Debt Cost of capital: 7%

Treasury bonds = risk free rate (𝑟𝑓 ): 2.5%

Beta Equity (𝛽): 1.1

We need to find cost of capital equity using this formula:

𝐸[𝑅𝑖 ] = 𝑟𝑓 + 𝛽𝑖 (𝑅𝑀 )

𝐸[𝑅𝑖 ] = 0.025 + 1.1(0.06) = 0,091

Thus, The cost of capital equity: 𝐾𝑒 = 0.091

Pretax WACC formula:

𝐷 𝐸 𝑃
𝑃𝑟𝑒𝑡𝑎𝑥 𝑊𝐴𝐶𝐶 = 𝑘𝑑 𝑥 ( ) + 𝑘𝑒 𝑥 ( ) + 𝑘𝑝 𝑥 ( )
𝑉 𝑉 𝑉

Da vi ingen Preferred shares har, bliver formlen således:

𝐷 𝐸
𝑃𝑟𝑒𝑡𝑎𝑥 𝑊𝐴𝐶𝐶 = 𝑘𝑑 𝑥 ( ) + 𝑘𝑒 𝑥 ( )
𝑉 𝑉
991𝑚𝑖𝑙𝑙𝑖𝑜𝑛 1508𝑚𝑖𝑙𝑙𝑖𝑜𝑛
𝑃𝑟𝑒𝑡𝑎𝑥 𝑊𝐴𝐶𝐶 = 0.07 · ( ) + 0.091 · ( ) ≈ 0,08267227
2499𝑚𝑖𝑙𝑙𝑖𝑜𝑛 2499𝑚𝑖𝑙𝑙𝑖𝑜𝑛

Thus, WACC for Bayker Motors is 8,27%

2) If Bayker’s corporate tax rate is 30%, what is its after-tax WACC?

991𝑚𝑖𝑙𝑙𝑖𝑜𝑛 1508𝑚𝑖𝑙𝑙𝑖𝑜𝑛
𝐴𝑓𝑡𝑒𝑟𝑡𝑎𝑥 𝑊𝐴𝐶𝐶 = 0.07 · (1 − 0.30) ( ) + 0.091 · ( ) ≈ 0,07434454
2499𝑚𝑖𝑙𝑙𝑖𝑜𝑛 2499𝑚𝑖𝑙𝑙𝑖𝑜𝑛
Thus, aftertax WACC for Bayker Motors is 7,43%

[8 marks]
[Total 25 marks]

Question Three
a. Consider projects A and B
Cash flows ($)

Project Year 0 Year Year Year Year Year 5 IRR NPV

1 2 3 4 (%)

A -1,000 100 120 130 140 1,200 13.27% 128.5

B -2,000 180 210 250 300 2,400 12.78% 220.1

The opportunity cost of capital is 10%. Projects are mutually exclusive. The projects are of
different size. Use incremental IRR for the final decision. Explain the results.

𝐶1 𝐵−𝐴 𝐶2 𝐵−𝐴
𝑁𝑃𝑉𝐵−𝐴 = 0 = + − 𝐼0𝐵−𝐴
1 + 𝐼𝑅𝑅𝐵𝐴 (1 + 𝐼𝑅𝑅𝐵𝐴 )2

OBS: HVORDAN VÆLGER VI OM DET ER A-B ELLER B-A: VI tager altid det
project som har den højeste investering altså Year 0, hvoraf vi kan se Projekt B har
-2000 og projekt A har -1000, hvorfor vi siger B-A som nedenfor altså udregner for B:

180 − 100 210 − 120 250 − 130 300 − 140

𝑁𝑃𝑉𝐵−𝐴 = 0 = (−2000 − (−1000)) + + + + +
(1 + 𝑟)1 (1 + 𝑟)2 (1 + 𝑟)3 (1 + 𝑟)4
2400 − 1200
+
(1 + 𝑟)5
= 80/(𝑟 + 1) + 90/(𝑟 + 1)^(2) + 120/(𝑟 + 1)^(3) + 160/(𝑟 + 1)^(4)
+ 1200/(𝑟 + 1)^(5) − 1000

Det resultat vi har fået efter =, det sætter vi ind I en ny ligning nedenfor, heraf sætter vi også
det lig med 0 og trykker løs ligning:
 80 90 120 160 1200
0= + 2
+ 3
+ 4
+ − 1000
𝑟 + 1 (𝑟 + 1) (𝑟 + 1) (𝑟 + 1) (𝑟 + 1)5
⇕ Ligningen løses for r vha. WordMat.
𝑟 = 0,1229468
The IRR is therfore 12,3 % and should therefore go for option B
Så længe irr er over cost of capital, skal man vælge det store projekt, B
Hvis den er under 10, skal man vælge det lille projekt, A

[8 marks]

b. A zero-coupon bond maturing in eight years has a face value of $100 and is currently
trading with a yield to maturity of 9%.
1. What is the price of the bond?
FV= 100
Kd= 9
N= 8
𝐹𝑉
𝑃𝑉 =
(1 + 𝑘𝑑 )𝑛

100
𝑃𝑉 = ≈ 50,18663
(1 + 0.09)8

The price of the bond will therefore be $50,18

[4 marks]

c. ABC corp. faltered in the recent recession but is recovering. Free cash flow has grown
rapidly. Forecasts made in 2020 are as follows: (SAMME SOM QUESTION 17)
($ millions) 2021 2022 2023 2024 2025

Net income 1.0 2.0 3.2 3.7 4.0

Investment 1.0 1.0 1.2 1.4 1.4

Free cash flow 1.5 1.8 2.0 2.3 3.2

ABC recovery will be complete by 2025, no further growth in net income or free cash flow is
expected thereafter, it will remain constant.
1) Calculate the PV of the cash flow, assuming a cost of equity of 8.5%

To find V_N, we need to use this formula:

We know we have 5 periods, because of the forecast above = n = 5

3.2
𝑉5 = ≈ 37,64706
0.085
Vi bruger følgende formel for at finde Enterprise Value og heraf PV:
𝑛
𝐹𝐶𝐹𝑛 𝑉𝑛 𝐹𝐶𝐹𝑁+1
𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑉𝑎𝑙𝑢𝑒: 𝑉0 = ∑⬚ + = 𝑉0 =
(1 + 𝑟𝑊𝐴𝐶𝐶 )𝑁 (1 + 𝑟𝑊𝐴𝐶𝐶 )𝑛 𝑟𝑒 − 𝑔𝐹𝐶𝐹
𝑡=1

Her med tallene indsat:

1.5 1.8 2.0 2.3 3.2

𝑃𝑉 = 1
+ 2
+ 3
+ 4
+
(1 + 0.085) (1 + 0.085) (1 + 0.085) (1 + 0.085) (1 + 0.085)5
37.65
+ ≈ 33,30405
(1 + 0.085)5

Thus, the enterprise value is 33,30405

2) Assume that ABC has 13 million shares outstanding. What is the price per share?

𝑉0 + 𝐶𝑎𝑠ℎ0 − 𝐷𝑒𝑏𝑡0
𝑃0 =
𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔0

33.30405 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
𝑃0 = ≈ 2,56185
13 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
Thus, the stock price will be $2.56

[8 marks]
d. Suppose you borrow $20,000 at the annual interest rate of 9.5%, and you are required to
pay it back in 72 equal monthly instalments, the first one is due at the end of the
first month. How much is the monthly instalment?
0.095
Effective interest ≈ 0,007916667
12

We need to find C (the monthly deposit)

20000
𝑐= ≈ [365,4938]
1
1−
(1 + 0.007916667)72
[ ]
0.007916667

KONTROL BEREGNING (BEHØVES IKKE TIL EKSAMEN)

1
1−
(1 + 0.0079)72
𝑃𝑉 = 365.49 × [ ] ≈ [20010,75]
0.0079

GIVER NÆSTEN 20,000 GRUNDET KOMMATAL

[5 marks]
[Total 25 marks]
Question Four
a. Consider a project with the following cash flows:
Cash flows (000,$)
𝐶𝐹0 𝐶𝐹1 𝐶𝐹2 𝐶𝐹3 𝐶𝐹4 𝐶𝐹5

-1,000 1,000 1,100 1,300 1,000 -3,700

1) How many internal rates of return does this project have?

Projektet har 2 IRR fordi der er 2 skift i fortegnet på de kontante strømme, ét fra negativt
til positivt og så fra positivt til negativt igen

2) Which of the following numbers is the project IRR:

a) 2.0712%,
b) 5.0699%. 🡨 Possible IRR
c) 54.4254%,
d) 82.4254%. 🡨 Possible IRR
 𝐶1 𝐶2 𝐶𝑁
𝑁𝑃𝑉 = 0 = + 2
+ ⋯+ − 𝐼0
(1 + 𝑟) (1 + 𝑟) (1 + 𝑟)𝑁

1000 1100 1300 1000 3700

0 = −1000 + + 2
+ 3
+ 4
−
(1 + 𝑟) (1 + 𝑟) (1 + 𝑟) (1 + 𝑟) (1 + 𝑟)5
⇕ Ligningen løses for r vha. WordMat.
𝑟 = −2,224106 ∨ 𝑟 = 0,05069883 ∨ 𝑟 = 0,824254

BEMÆRK I LØSNINGEN OVENFOR, at VI FÅR 3 MULIGE SVAR, men vores IRR

er ikke negativ, hvorfor det er de to til højre som anvist ovenfor.

3) The opportunity cost of capital is 15%. Is this an attractive project? Briefly explain.
1000 1100 1300 1000 3700
𝑁𝑃𝑉 = −1000 + + 2
+ 3
+ 4
−
(1 + 0.15) (1 + 0.15) (1 + 0.15) (1 + 0.15) (1 + 0.15)5
≈ 288,2937

NPV = 288.29

Yes, this is an attractive project as NPV is positive with a cost of capital at 15%

b. Suppose a firm’s stock is selling for $10.50. It just paid a $1 dividend, and dividends are
expected to grow at 6% per year.

What is the required return?

Vi har V_0 = 10.50,

Div_0 = 1

Growth (g) = 0.06 / 6%

Her bruger vi så følgende formel:

𝐷0 · (1 + 𝑔)
𝑉𝑜 =
𝑟𝐸 − 𝑔
Med tallene indsat:
1 · (1 + 0.06)
10.50 =
𝑟𝑒 − 0.06
⇕ Ligningen løses for r_e vha. WordMat.

𝑟𝑒 = 0,1609524
Thus, the required return is 16.10%

What is the dividend yield?

𝐷𝑖𝑣1
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑦𝑖𝑒𝑙𝑑 =
𝑃0
1.06
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑦𝑖𝑒𝑙𝑑 = ≈ 0,1009524
10.5
Thus, dividend yield is 10.1%

What is the capital gains yield?

𝐷𝑖𝑣1 + 𝑃1
𝑃0 =
1 + 𝑟𝐸

Vi løser hermed ligningen, for at finde P_1

1.06 + 𝑃1
10.5 =
1 + 0.161
⇕ Ligningen løses for P_1 vha. WordMat.
𝑃1 = 11,1305

𝑃1 − 𝑃0
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑔𝑎𝑖𝑛 =
𝑃0
11.1305 − 10.5
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑔𝑎𝑖𝑛 = ≈ 0,06004762
10.5

Capital gains yield is: 6%

[6 marks]
c. According to the Internal Rate of Return (IRR) method, when do you accept an
independent project?
According to the Internal Rate of Return (IRR) method, you accept an independent project
when its internal rate of return is greater than the required rate of return or the company's
cost of capital.
2. What does the Incremental IRR tell us?
The incremental IRR investment rule applies the IRR rule to the difference between the cash
flows of the two mutually exclusive alternatives. For example, assume you are comparing
two mutually exclusive opportunities, A and B, and the IRRs of both opportunities exceed the
cost of capital. If you subtract the cash flows of opportunity B from the cash flows of
opportunity A, then you should take opportunity A if the incremental IRR exceeds the cost of
capital. Otherwise, you should take opportunity B. Although the incremental IRR rule often
provides a reliable method for choosing among mutually exclusive projects, it can be difficult
to apply correctly, and it is much simpler to just use the NPV rule.

[3 marks]

e. Shown below is information from the Bolman corp. income statement. The firm has debt
outstanding that is expected to be paid in full by 2026, its risk is the same as the cost of
debt 8.5%.
Based on the given information, estimate how much does the interest tax shield will
increase the value of Bolman? Present value to be calculated for 2022.
f.
($ million) 2023 2024 2025 2026

EBIT 620 690 750 810

Interest Expense -40 -90 -90 -90

Income Before Tax 580 600 660 720

Taxes (35%) 203 210 231 252

Net Income 377 390 429 468

Cost of debt : 8.5 %

Risk: 8.5%

Vi udregner her, hvad vores tax shield hvert år vil være:

𝑇𝑎𝑥 𝑠ℎ𝑖𝑒𝑙𝑑 = 𝑇𝑎𝑥 · 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒
2023: 0.35 · (−40) = −14

2024: 0.35 · (−90) ≈ −31,5

2025: 0.35 · (−90) ≈ −31,5

2026: 0.35 · (−90) ≈ −31,5

Heraf skal vi have tilbagediskonteret værdierne til 2022
værdier, hvorfor vi sætter dette ind i PV-formlen:
𝐹𝑉
𝑃𝑉 =
1 + 𝑟𝑛
Vi gør det her nedenfor for hvert år:
14 31.5 31.5
𝑃𝑉 = + +
1 + 0.085 (1 + 0.085)2 (1 + 0.085)3
31.5
+ ≈ 87,05226
(1 + 0.085)4
Heraf får vi, at de opnår et tax shield i 2022 værdier til 87,05 millioner.

[8 marks]
[Total 25 marks]
Question Five
a. The forecasts for next year for stock A and B are provided below:
Stock A Stock B

Return on equity 15% 12%

Earnings per share $2.50 $2.00

Dividends per share $1.70 $1.50

1) What are the dividend payout ratios for each firm?

𝐷𝑛 = 𝐸𝑃𝑆𝑛 𝑥 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑎𝑦𝑜𝑢𝑡 𝑅𝑎𝑡𝑒𝑛

Vi tager formlen ovenfor fra formelsamlingen, hvoraf vi dog omskriver formlen således vi
finder Dividend Payout Rate_n og heraf sætter D_n i division med EPS_n som vist nedenfor:

𝐷𝑛
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑎𝑦𝑜𝑢𝑡 𝑅𝑎𝑡𝑒𝑛 =
𝐸𝑃𝑆𝑛
Stock A
 1.70
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑦𝑜𝑢𝑡 𝑟𝑎𝑡𝑒𝐴 = ≈ 0,68
2.5

Stock B
2
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑦𝑜𝑢𝑡 𝑟𝑎𝑡𝑒𝐵 = ≈ 1,333333
1.5

2) What are the expected dividend growth rates for each stock?

𝑔 = 𝑅𝑒𝑡𝑒𝑛𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 · 𝑅𝑂𝐸 (𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑛𝑒𝑤 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡)

𝑔𝑎 = (1 − 0.68) · 0.15 ≈ 0,048

𝑔𝑏 = (1 − 1.33) · 0.10 ≈ −0,033

3) If investors require a return of 14% on each stock, what are their values?
Consider return on equity as the return on new investment

𝐷1
𝑉0 =
𝑟𝐸 − 𝑔
Stock A
1.70
𝑉𝐴 = ≈ 18,47826
0.14 − 0.048

Stock B
1.50
𝑉0 = ≈ 8,67052
0.14 − (−0.033)

[7 marks]

b. Your company is considering the following five projects. The company have a total amount
of $27 million available to invest in new projects. The NPV and initial investment for the five
projects are as follows ($ million):
Project NPV Initial investment

A $ 36 $ 12
 B $ 12 $3

C $ 22 $ 10

D $8 $3

E $ 25 $9

1. Rank the projects using the profitability index and show which projects you should
invest in
𝑁𝑃𝑉
𝑃𝑟𝑜𝑓𝑖𝑡𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑖𝑛𝑑𝑒𝑥 =
𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
Project A:
36
𝑃𝑟𝑜𝑓𝑖𝑡𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑖𝑛𝑑𝑒𝑥 = =3
12
Project B:
12
𝑃𝑟𝑜𝑓𝑖𝑡𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑖𝑛𝑑𝑒𝑥 = =4
3
Project C:
22 11
𝑃𝑟𝑜𝑓𝑖𝑡𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑖𝑛𝑑𝑒𝑥 = = = 2,2
10 5
Project D:
8
𝑃𝑟𝑜𝑓𝑖𝑡𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑖𝑛𝑑𝑒𝑥𝐷 = ≈ 2,666667
3
Project E:
25
𝑃𝑟𝑜𝑓𝑖𝑡𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑖𝑛𝑑𝑒𝑥 = ≈ 2,777778
9
Ranking:
B>A>E>D>C

2. Given the cash restrictions which projects should your company invest in? (27 mil$)

3. Project NPV Initial investment Profit. Index Accumulate

B $ 12 $3 4 3$

A $ 36 $ 12 3 15$

E $ 25 $9 2.77 24$

D $8 $3 2.67 27$
 C $ 22 $ 10 2.2

[7 mark]

c. Explain the difference between The Discounted Free Cash Flow method (DCF) and The
Comparable Company Analysis (“Comps”). Highlight benefits of each method.

The Discounted Free Cash Flow (DCF) method values a company by estimating its future
cash flows and discounting them back to their present value. It focuses on actual cash
generated, incorporates future growth, and offers flexibility in assumptions.

The Comparable Company Analysis (Comps) method values a company by comparing it to

similar publicly traded companies. It selects comparable companies based on industry and
other factors, analyzes their valuation multiples, and applies those multiples to the target
company. It relies on market perception and provides a benchmark for valuation.

In summary, DCF emphasizes cash flows and growth potential, while Comps relies on
market multiples and comparable companies for valuation.

[5 marks]

g. Two stocks have the same return and risk (standard deviation): 10 percent return with 20
percent risk. You form a portfolio with 50 percent each of stock 1 and stock 2 to examine
the effect of correlation on risk.
A B
Expected Return (%) 10% 10.0%
Standard deviation (risk) 20% 20%

1. Calculate the portfolio return and risk f the correlation is 1.0

Brug følgende til at beregne return

𝐸(𝑅)𝑝 = ∑ ⬚ 𝑊𝑖 𝑥𝐸(𝑅𝑖 )
𝑖=1

𝐸(𝑅)𝑝 = 0.5 · 0.10 + 0.5 · 0.10 = 0,1

Thus, portfolio return is 10%

Brug følgende til at regne risk ud
𝜎𝑝 = √𝑊𝐴2 · 𝜎𝐴2 + 𝑊𝐵2 · 𝜎𝐵2 + 2𝑊𝐴 · 𝑊𝐵 · (𝐶𝑜𝑟 · (𝑅𝐴 · 𝑅𝐵 ))

Bemærk, at ovenfor Cor.i parentes ikke behøver dette, men blot er for nemmere overblik ^^^

𝜎𝑝 = √0.52 · 0.202 + 0.52 · 0.22 + 2 · 0.5 · 0.5 · 1 · 0.10 · 0.10 ≈ 0,1581139

Portfolio risk with correlation of 1.0 is 15,81%

2. Calculate the portfolio return and risk f the correlation is -1.0

𝑚

𝐸(𝑅)𝑝 = ∑ ⬚ 𝑊𝑖 𝑥𝐸(𝑅𝑖 )
𝑖=1

𝐸(𝑅)𝑝 = 0.5 · 0.10 + 0.5 · 0.10 = 0,1

Thus the return is 10%

𝜎𝑝 = √0.52 · 0.202 + 0.52 · 0.202 + 2 · 0.5 · 0.5 · ((−1.0) · 0.10 · 0.10) ≈ 0,1224745

Portfolio risk with correlation of -1.0 is 12,25%

3. Compare the return and risk of portfolios with different correlations.

In the case where the correlation is 1.0, the portfolio risk is higher at 15.81% compared to the
case where the correlation is -1.0, where the portfolio risk is lower at 12.25%. This is
because in the case of a correlation of 1.0, the assets move in the same direction and are
highly positively correlated, amplifying the overall risk of the portfolio. On the other hand,
with a correlation of -1.0, the assets move in opposite directions, minimizing the overall risk
of the portfolio.

[6 marks]
[Total 25 marks]
MOCK 2
Question 1
a. Snufty corp. is considering investing in a new boring machine. It costs $380,000 and is
expected to produce the following cash flows:
Year 1 2 3 4 5 6 7 8 9 10
Cash flow 50 57 75 80 85 92 92 80 68 50
($000s)

If the cost of capital is 12%, what is the machine’s NPV

𝐶1 𝐶2 𝐶𝑁
𝑁𝑃𝑉 = + 2
+ ⋯++ − 𝐼0
(1 + 𝑘) (1 + 𝑘) (1 + 𝑘)𝑁
50 57 75 80 85 92
𝑁𝑃𝑉 = + 2
+ 3
+ 4
+ 5
+
(1 + 0.12) (1 + 0.12) (1 + 0.12) (1 + 0.12) (1 + 0.12) (1 + 0.12)6
92 80 68 50
+ 7
+ 8
+ 9
+ − 380 ≈ 23,69615
(1 + 0.12) (1 + 0.12) (1 + 0.12) (1 + 0.12)10

23.69615 · 1000 ≈ 23696,15

Thus, NPV is $23,696
[5 marks]

b. True or false
1. Investors prefer diversified companies because they are less risky
False (Investors prefer diversified companies because diversification can reduce specific or
unsystematic risk, but it does not eliminate systematic or market risk.)
2.If stocks were perfectly positively correlated, diversification would not reduce risk
True (If stocks were perfectly positively correlated, diversification would not reduce risk
because all stocks would move in the same direction and be influenced by the same factors.)
3.Diversification over a large number of assets completely eliminates risk
False (Diversification over a large number of assets can reduce unsystematic risk, but it does
not completely eliminate risk. There will still be systematic or market risk that affects all
investments.)

[3 marks]

c. You would like to buy a house that is currently on the market at $85,000, but you
cannot afford it right now. However, you think that you would be able to buy it after
4 years. If the expected inflation rate as applied to the price of this house is 6% per
year, what is its expected price after four years?
𝐹𝑉 = 𝑃𝑉 · (1 + 𝑖)𝑛
𝐹𝑉 = 85000 · (1 + 0.06)4 ≈ 107310,5
[3 marks]

d. Consider projects A and B

Cash flows ($)
Project 𝐶𝐹0 𝐶𝐹1 𝐶𝐹2 IRR (%)
A -400,000 +241,000 +293,000 21
B -200,000 +131,000 +172,000 31

The opportunity cost of capital is 8%. Projects are mutually exclusive. The projects are of
different size. Use incremental IRR for the final decision. Explain the results.
Vi skal trække A fra B da det er det større projekt
𝐶1 𝐵−𝐴 𝐶2 𝐵−𝐴
𝑁𝑃𝑉𝐵−𝐴 = 0 = + − 𝐼0𝐵−𝐴
1 + 𝐼𝑅𝑅𝐵𝐴 (1 + 𝐼𝑅𝑅𝐵𝐴 )2
Vi skal trække A fra B da det er det større projekt

𝐶1 𝐴−𝐵 𝐶2 𝐴−𝐵
𝑁𝑃𝑉𝐴−𝐵 = 0 = + − 𝐼0𝐴−𝐵
1 + 𝐼𝑅𝑅𝐵𝐴 (1 + 𝐼𝑅𝑅𝐵𝐴 )2
241000−131000 293000−172000
𝑁𝑃𝑉𝐴−𝐵 = 0 = (−400000 − (−200000)) + (1+𝑟)1
+ (1+𝑟)2
= 110000/(𝑟 + 1) +
121000/(𝑟 + 1)^(2) − 200000
 110000 121000
0= + − 200000
𝑟+1 (𝑟 + 1)2
⇕ Ligningen løses for r vha. WordMat.
𝑟 = −1,55 ∨ 𝑟 = 0,1

𝐼𝑅𝑅𝐴−𝐵 − 10%, compared to the cost of capital, which is 8%.

Hence, project A is preferred to B

[6 marks]

e. Calculate the effective annual interest rate of a credit card with an annual rate of 36% and
interest charged monthly.
Vi bruger følgende formel til denne beregning:
𝑟𝑛𝑜𝑚 𝑓
Effective Annual Rate = 𝐸𝐴𝑅 = (1 + ) −1
𝑓

Her med tallene indsat:

36% 12 425760886846178945447841
𝐸𝐴𝑅 = (1 + ) −1= ≈ 0,4257609
12 1000000000000000000000000

Den effektive årlige rente bliver derfor: 42,57%.

[3 marks]
[Total 20 marks]

Question Two
a. Ampere Banking Corporation offers two types of certificates of deposit, each requiring
a deposit of $10,000. The first one pays $11,271.60 after 24 months, and the second
one pays $12,139.47 after 36 months. Find their monthly-compounded rate of return,
compare and explain the difference in returns.

PV = 10.000

Option A - FV = 11,271.60
Option A period in months: 24

Option B - FV = 12,139.47
Option B period in months: 36

We need to find the monthly compounded rate for each:

We use this formula here:

𝐹𝑉 = 𝑃𝑉(1 + 𝑟)𝑛
Option A:
11271.60 = 10000(1 + 𝑟)24
⇕ Ligningen løses for r vha. WordMat.
𝑟 = −2,005 ∨ 𝑟 = 0,005000008

0,005 · 100 = 0.50% monthly compounded rate for Option A

Option B
12139.47 = 10000(1 + 𝑟)36
⇕ Ligningen løses for r vha. WordMat.

𝑟 = −2,0054 ∨ 𝑟 = 0,005400001

0,0054 · 100 = 0,54 = 0.54% monthly compounded rate for Option B

The first certificate A / Option A gives a return of 0.5%, and the second one (Option B)
0.54% per month. The second one is higher because the investor must tie up the money for a
longer period (3 years instead of 2 years).
[4 marks]
b. An investment costs 1,548 and pays 138 in perpetuity. If the interest rate is 9%, what is
the NPV?

The formula is used to find present value:

𝑐
𝑃𝑉 =
𝑟
138
𝑃𝑉 = ≈ 1533,333
0.09
With this result, we can calculate the NPV by substracting the PV with the investment costs.
 𝑁𝑃𝑉 = 𝑃𝑉(𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠) − 𝑃𝑉(𝐶𝑜𝑠𝑡𝑠)

𝑁𝑃𝑉 = 1533,333 − 1548 ≈ −14,667

[5 marks]

c. Explain the meaning and difference between primary and the secondary markets
When a corporation itself issues new shares of stock and sells them to investors, it does so
on the primary market. After this initial transaction between the corporation and investors,
the shares continue to trade in a secondary market between investors without the
involvement of the corporation. For example, if you wish to buy 100 shares of Starbucks
Coffee, you would place an order on a stock exchange, where Starbucks trades under the
ticker symbol SBUX. You would buy your shares from someone who already held shares
of Starbucks, not from Starbucks itself. Because firms only occasionally issue new shares,
secondary market trading accounts for the vast majority of trading in the stock market.

[3 marks]

d.Suppose you deposit $350 at the beginning of each month in an account that pays 6%
annual interest, compounded monthly. Find the total amount in this account at the end of 25
months.
6% 1
Interest rate pr. Month = 200 = 0,005
12

Siden vi sætter 350 $ ind hver måned, så bruger vi følgende formel:

(1 + 𝑟)𝑛 − 1
𝐹𝑉 = 𝐶 × [ ] · (1 + 𝑟)
𝑟

Heraf med tallene indsat:

(1 + 0.005)25 − 1
𝐹𝑉 = 350 × [ ] · (1 + 0.005) ≈ [9342,169]
0.005

Efter 25 måneder: $ 9342.17

[5 marks]

e. Suppose a company had earnings per share of $3 over the past year. The industry average
PE ratio is 12. Use this information to value this company’s stock price.

𝑃 𝑃0
𝐹𝑜𝑟𝑤𝑎𝑟𝑑 =
𝐸 𝐸𝑃𝑆1
 𝑃
𝑟𝑎𝑡𝑖𝑜 · 𝐸𝑃𝑆 = 𝑃0
𝐸
12 · 3 = 36
Thus, the company’s stock price is $36

[3 marks]

[Total 20 marks]

Question Three (Se extra question 9 I dette dok. For bedre overblik)
a. Calculate the current value of a 20-year, 6% coupon bond, with semiannual payments. The
bond has a par value of $1,000, and a required return of 8%

FV:1000
N:20
Coupon rate: 6%
YTM/Required return: 8%

Effective coupon rate: 6 / 2 = 3%

Effective period (n): 20 * 2 = 40
𝐶𝑜𝑢𝑝𝑜𝑛 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 = 𝐶𝑜𝑢𝑝𝑜𝑛 𝑟𝑎𝑡𝑒/ 𝑓 · 𝑃𝑎𝑟 𝑉𝑎𝑙𝑢𝑒

0.06
· 1000 = 30
2

YTM Annual to Semi = 8% / 2 = 4 %

Bond Value formula:

𝐶 1 𝐹𝑉
𝑃𝑉 = · (1 − 𝑛
)+
𝑟 (1 + 𝑟) (1 + 𝑟)𝑛
Med tallene indsat:
30 1 1000
𝑃𝑉 = · (1 − 40
)+ ≈ 802,0723
0.04 (1 + 0.04) (1 + 0.04)40
Heraf får vi resultatet med current value til 802.07.
 [6 marks]

b. Consider a project with the following cash flows:

Cash flows ($)
𝐶𝐹0 𝐶𝐹1 𝐶𝐹2
-100 +200 -75

1. How many IRRs does this project have?

Projektet har 2 IRR fordi der er 2 skift i fortegnet på de kontante strømme, ét fra negativt til
positivt og så fra positivt til negativt igen
2. Which of the following numbers is the project IRR: a) -50%, b) -12%, c) +5%, d) +50%

Kan bruges til at vise hvilke forksllige IRR der

𝐶1 𝐶2 𝐶𝑁
𝑁𝑃𝑉 = 0 = + 2
+ ⋯+ − 𝐼0
(1 + 𝑟) (1 + 𝑟) (1 + 𝑟)𝑁

200 −75
0 = −100 + +
(1 + 𝑟) (1 + 𝑟)2
⇕ Ligningen løses for r vha. WordMat.
𝑟 = −0,5 ∨ 𝑟 = 0,5

-50% and +50%, grundet de to skift i kontante strømme, selvom vi ikke kender de præcise
IRR.
1. Forklaring fra botten: Projektet har 2 IRR fordi der er to skift i fortegnet på
de kontante strømme: Fra -100 til +200 og fra +200 til -75.
2. Det første IRR vil være lavere end markedsprisen, da strømmen starter
med at være negativ. Lad os sige markedet har en pris på 20%. Så vil
IRR være lav, måske omkring -50%.
3. Det andet IRR vil være højere end markedsprisen, da strømmen senere
bliver negativ igen. Så lad os sige det ligger omkring 50%.
4. Når kontante strømme skifter fra negativ til positiv, vil NPV blive 0 ved
et lavere IRR (f.eks. -50%).
5. Når strømmen skifter fra positiv til negativ, vil NPV igen blive 0, men
ved et højere IRR (f.eks. 50%).
 6. Så selvom vi ikke kender de præcise IRR tal, giver kontante
strømmenes udformning og skift i fortegn mening i at de to IRR ligger
omkring -50% og 50%.
7. Dette stemmer overens med at NPV er positiv ved 20% (den givne
kapitalkrav/afkastkrav), da det ligger mellem de to IRR på omkring -
50% og 50%.

3. The opportunity cost of capital is 20%. Is this an attractive project? Briefly explain
200 75
𝑁𝑃𝑉 = −100 + (1+0.2)1 − (1+0.2)2 ≈ 14,58333

(NPV is positive for any r between the two IRRs). Det er et attraktivt projekt, så længe NPV
er over 0
Da NPV er positiv ved en rente på 20%, indikerer det, at nutidsværdien af projektets kontante
strømme er højere end den oprindelige investering. Derfor forventes projektet at generere en værdi
over den krævede afkast ved en diskonteringsrate på 20%.

c. Define systematic and unsystematic risk and explain why an investor should not expect
to receive additional return from assuming unsystematic risk. (Se evt. Risk and Return
F6)
When you diversify across assets that are not perfectly correlated, the portfolio’s risk
is less than the weighted sum of the risks of the individual securities in the portfolio.
The risk that disappears in the portfolio construction process is called the asset’s
unsystematic risk (also called, unique, diversifiable, or firm-specific risk). Since the
market portfolio contains all risky assets, it must represent the ultimate in
diversification. All the risk that can be diversified away must be gone. The risk that is
left cannot be diversified away, since there is nothing left to add to the portfolio. The
risk that remains is called the systematic risk (also called non-diversifiable risk or
market risk). Therefore investors cannot expect to receive additional return from a
risk that can be diversified away.
Total risk = Systematic risk + Unsystematic risk

[3 marks]

d. The forecasts for next year for stock A and B are provided below:
Stock A Stock B
Return on investment 15% 10%
Earnings per share $2.00 $1.50
Dividends per share $1.00 $1.00

1) What are the dividend payout ratios for each firm?

𝐷𝑛 = 𝐸𝑃𝑆𝑛 𝑥 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑎𝑦𝑜𝑢𝑡 𝑅𝑎𝑡𝑒𝑛

Vi tager formlen ovenfor fra formelsamlingen, hvoraf vi dog omskriver formlen

således vi finder Dividend Payout Rate_n og heraf sætter D_n i division med EPS_n
som vist nedenfor:

𝐷𝑛
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑃𝑎𝑦𝑜𝑢𝑡 𝑅𝑎𝑡𝑒𝑛 =
𝐸𝑃𝑆𝑛
Stock A
1.00
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑦𝑜𝑢𝑡 𝑟𝑎𝑡𝑒𝐴 = = 0,5
2.00

Stock B
1
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑦𝑜𝑢𝑡 𝑟𝑎𝑡𝑒𝐵 = ≈ 0,6666667
1.5
Bemærk, at vi I næste opgave skal bruge retension rate, hvilket findes ved

(1-Diviend Payout Rate)

2) What are the expected dividend growth rates for each stock?
𝑔 = 𝑅𝑒𝑡𝑒𝑛𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 · 𝑅𝑂𝐸 (𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑛𝑒𝑤 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡)

Bemærk at vi ved retention rate skal bruge beregningen i delopgaven før - altså dividend
payout rate

𝑅𝑒𝑡𝑒𝑛𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 = (1 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑦𝑜𝑢𝑡 𝑟𝑎𝑡𝑒𝑛 )

ALTSÅ, kan g-formlen omskrives således, så brug denne:

𝑔 = (1 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑦𝑜𝑢𝑡 𝑟𝑎𝑡𝑒𝑛 ) · 𝑅𝑂𝐸 (𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑛𝑒𝑤 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡)

𝑔𝑎 = (1 − 0.5) · 0.15 = 0,075

𝑔𝑏 = (1 − 0.66) · 0.10 ≈ 0,034
Thus, expected dividend growth rate for Stock A is: 7.5% and for B: 3.4%

3) If investors require a return of 15% on each stock, what are their values?

𝐷1
𝑉0 =
𝑟𝐸 − 𝑔
Stock A
1
𝑉𝐴 = ≈ 13,33333
0.15 − 0.075

Stock B
1
𝑉0 = ≈ 8,62069
0.15 − 0.034

[7 marks]

e. Stars corp. starts life with all-equity financing and a cost of equity of 14%. Suppose it
refinances to the following market-value capital structure:
Debt (D) 45% 𝑟𝐷 = 9.5%
Equity (E) 55%

1) Use MM’s preposition 2 to calculate the new cost of equity (the return on (levered)
equity). Stars pays taxes at a marginal rate of 𝑡𝑐 = 40%
𝐷
𝑀𝑀 𝑝𝑟𝑜𝑝𝑜𝑠𝑖𝑡𝑖𝑜𝑛 2: 𝑟𝐿 = 𝑟𝑈 + (𝑟 − 𝑟𝐷 )
𝐸 𝑈
Currently:
𝑅𝑢 = 𝑅𝐿 = 14%

𝐷
𝑟𝐿 = 𝑟𝑈 + (𝑟 − 𝑟𝐷 )
𝐸 𝑈
45
𝑟𝐿 = 𝑅𝐸 = 0.14 + ( ) · (0.14 − 0.095) ≈ 0,1768182
55
Thus, return on equity is 17,68%

2) Calculate Stars after-tax weighted-average cost of capital.

Then we use the after tax WACC formula:

𝐷 𝐸
𝑊𝐴𝐶𝐶 = 𝑘𝑑 × (1 − 𝑡𝑐 ) 𝑥 ( ) + 𝑘𝑒 𝑥 ( )
𝑉 𝑉
𝑊𝑎𝑐𝑐 = 0.095 · (1 − 0.40) · 0.45 + 0.1768 · 0.55 ≈ 0,12289

= 12%
Thus, the new WACC After tax is: 12,29%

[8 marks]

[Total 30 marks]
Question Four
a. You have information about three stocks:

If the required return for each stock is 10%, calculate the value of each stock and find out which
stock is the most valuable?

Stock A:
Div_1: $10
Return = R_E: 10%
𝐷𝑖𝑣1
𝑃𝑜 =
𝑟𝐸

10
𝑃𝑜 = = 100
0.1

Thus, the value of of stock a is $100.

Stock B:
Div_1: 5$
G: 4%
R_E: 10 %
Vi bruger følgnede formel her, da vi har g, R_e, Div_1 og skal finde
𝐷1
V_0 / P_0: 𝑉0 =
𝑟𝐸 −𝑔
Her med tallene indsat:
5
𝑃0 = ≈ 83,33333
0.10 − 0.04

Thus, the value of stock B is 83,33 $

2) Stock C is expected to pay a dividend of $5 next year. Thereafter, dividend growth

is expected to be 20% a year for 5 years (from year 2 to 6) and zero growth
thereafter.

3) 3) Stock C is expected to pay a dividend of $5 next year. Thereafter, dividend growth

is expected to be 20% a year for 5 years (from year 2 to 6) and zero growth thereafter.

Stock C:

Div_1: 5
Growth : 20%

𝐷𝑖𝑣1 = 5 = 5
𝐷𝑖𝑣2 = 5 · (1 + 0.20) = 6
𝐷𝑖𝑣3 = 5 · (1 + 0.20)2 ≈ 7,2
𝐷𝑖𝑣4 = 5 · (1 + 0.20)3 ≈ 8,64
𝐷𝑖𝑣5 = 5 · (1 + 0.20)4 ≈ 10,368
𝐷𝑖𝑣6 = 5 · (1 + 0.20)5 ≈ 12,4416
𝐷𝑛+1 7
𝑉𝑛 = =
𝑟𝐸 − 𝑔𝐿 𝑟𝐸 − 𝑔𝐿
𝐷7
=
𝑟𝐸 − 𝑔𝑙
12.44
𝑉6 = ≈ 124,4
0.10 − 0.0
Terminal value for år 6 (V6) er dermed 124,4
 5 6 7.2 8.64 10.368 12.4416
𝑉0 = 1
+ 2
+ 3
+ 4
+ 5
+
(1 + 0.10) (1 + 0.10) (1 + 0.10) (1 + 0.10) (1 + 0.10) (1 + 0.10)6
124.4
+ ≈ 104,4961
(1 + 0.10)6

Thus, the value of of stock a is $104,5

Thus, The most valuable stock is Stock C

[8 marks]

b. You plan to buy a Jaguar XJ for $28,000, but you have only $6,000 in cash. The bank will
loan you the rest at the annual interest rate of 12%, with the payments spread over 60 months.
Find your monthly payment.
We need to find c
We need to loan $22,000
The effective rate is 12%/12=1%
22000
𝑐= ≈ [489,3778]
1
1−
(1 + 0.01)60
[ 0.01 ]

Thus, the monthly payment will be $489,37

[5 marks]

c. Distinguish between the market value and book value of equity securities.

The book value of equity is the difference between the financial statement value of the firm’s
assets and liabilities. Positive retained earnings increase the book value of equity. Book
values reflect the firm’s past operating and financing choices. The market value of equity is
the share price times the number of shares outstanding. Market value reflects investors’
expectations about the timing, amount, and risk of the firm’s cash flows.

[3 marks]
d. What is the payback period on each of the following projects?
Cash flows ($)
Project 𝐶𝐹0 𝐶𝐹1 𝐶𝐹2 𝐶𝐹3 𝐶𝐹4
A -5,000 +1,000 +1,000 +3,000 0
B -1,000 0 +1,000 +2,000 +3,000
C -5,000 +1,000 +1,000 +3,000 +5,000

What is the payback period on each of the following projects?

Vejledning: For at løse denne opgave, så skal vi bare se på, hvad det har kostet at lave den
pågældende investering til det pågældende projekt. Herefter skal vi så se på hvor mange cashflows
(C1, C2…) der er påkrævet for at vi er gået i 0. De forskellige cashflows lægges derfor bare sammen
indtil vi rammer 0.
A:
Project A: Initial investment: €5000
C0=-€5000
C1=€1000
C2=€1000
C3=€3000
(−5000) + 1000 + 1000 + 3000 = 0

Thus, C3 (year 3) is the payback period for project A

B:
Project B: Initial investment: €1000
Tilbagebetalings-perioden er 2 år: 𝐶1 + 𝐶2 = 0 + 1000 = €1000
C:
Project C: Initial investment: €5000
Tilbagebetalings-perioden er 3 år: 𝐶1 + 𝐶2 + 𝐶3 = 1000 + 1000 + 3000 = €5000

2.Given that you wish to use the payback rule with a cutoff period of two years, which projects would
you accept?
B

3.If you use a cutoff period of three years, which projects would you accept?
A, B and C
4.If the opportunity cost of capital is 10%, which projects have positive NPVs?
Formula:
𝑁
𝐶𝑡
∑⬚ − 𝐼0
(1 + 𝑘)𝑡
𝑡=1

A
1000 1000 3000
𝑁𝑃𝑉 = 1
+ 2
+ − 5000 ≈ −1010,518
(1 + 0.1) (1 + 0.1) (1 + 0.1)3
B:
1000 2000 3000
𝑁𝑃𝑉 = + + − 1000 ≈ 3378,116
(1 + 0.1)2 (1 + 0.1)3 (1 + 0.1)4
C:
1000 1000 3000 5000
𝑁𝑃𝑉 = 1
+ 2
+ 3
+ − 5000 ≈ 2404,549
(1 + 0.1) (1 + 0.1) (1 + 0.1) (1 + 0.1)4

Projects B and C FORDI DE ER I PLUS

[7 mark]

e. Alton Cooper has invested 60% of his money in share A and the remainder in share B. He
assesses their prospects as follows:
A B
Expected return (%) 15 20
Standard deviation (%) 20 22
Correlation between returns 0.5

1) What are the expected return and standard deviation of returns on his portfolio?
60% is invested in share A, 100%-60%= 40% is invested in share B
𝑚

𝐸(𝑅)𝑝 = ∑ ⬚ 𝑊𝑖 𝑥𝐸(𝑅𝑖 )
𝑖=1

𝐸(𝑅)𝑝 = 0.6 · 0.15 + 0.4 · 0.20 = 0,17 = 17%

Thus, portfolio return is 17%

Brug følgende til at regne risk ud
𝜎𝑝 = √𝑊𝐴2 · 𝜎𝐴2 + 𝑊𝐵2 · 𝜎𝐵2 + 2𝑊𝐴 · 𝑊𝐵 · (𝐶𝑜𝑟 · (𝑅𝐴 · 𝑅𝐵 ))

Bemærk, at ovenfor Cor.i parentes ikke behøver dette, men blot er for nemmere overblik ^^^

𝜎𝑝 = √0.62 · 0.202 + 0.42 · 0.222 + 2 · 0.6 · 0.4 · 0.5 · 0.20 · 0.22 ≈ 0,1808425

Heraf giver det 18,08% i risk i porteføljen

2) How would your answer change if the correlation coefficient were 0 or -0.5?

𝜎𝑝 = √0.62 · 0.202 + 0.42 · 0.222 + 2 · 0.6 · 0.4 · 0 · 0.20 · 0.22 ≈ 0,1488086

Having a correlation coefficient at 0 results in a lower risk, which is at 14.88%

𝜎𝑝 = √0.62 · 0.202 + 0.42 · 0.222 + 2 · 0.6 · 0.4 · (−0.5) · 0.20 · 0.22 ≈ 0,107629

Having a correlation coefficient at -0.5 results in an even lower risk, which is at 10,76%

3) Is the constructed portfolio better or worse than one invested entirely in share A, or it is not
possible to say?
The combined portfolio is better. It has a higher return and lower standard deviation.

[7 marks]
[Total 30 marks]

EXTRA SET OF QUESTIONS

Question 2: Implied rate of interest for a loan You have borrowed $850 from your sister
and you have promised to pay her $1000 after 3 years. With annual compounding, find the
implied rate of interest for this loan.
Answer
The future value of the loaned money is FV = $1000, while its present value is PV = $850. The
time for compounding is n = 3 years. The interest rate r is unknown
 𝐹𝑉 = 𝑃𝑉 · (1 + 𝑖)𝑛
1000 = 850 · (1 + 𝑟)3
⇕ Ligningen løses for r vha. WordMat.

𝑟 = 0,05566719
𝑟 = 0.0557 = 5.57%

Question 5: Monthly installment for a loan with specific conditions: Suppose you
borrow $10,000 at the annual interest rate of 9%, and you are required to pay it back in 60
equal monthly instalments, the first one is due at the end of the first month. How much is the
monthly instalment?
Answer
The interest rate is 9% / 12 = 0.75 % per month.
1
1−
(1 + 𝑖)𝑛
𝑃𝑉𝐴𝐷 =𝐴×[ ]
𝑖

𝑃𝑉𝐴𝐷
𝐴=
1
1−
(1 + 𝑖)𝑛
[ ]
𝑖

10000
𝐴= = 207.58
1
1−
(1 + 0.0075)60
[ ]
0.0075

Question 6: Present value of lottery payments: Roman has won a million dollars in the
state lottery that will pay him $50,000 annually in 20 annual instalments. He will get the first
instalment right now. Using a discount rate of 10% per year, find the present value of all these
payments.

Answer
 1
1−
(1 + 𝑖)𝑛
𝑃𝑉𝐴𝐷 =𝐴·[ ] (1 + 𝑟)
𝑖

1
1−
(1 + 0.1)20
𝑃𝑉𝐴𝐷 = 50000 · [ ] (1 + 0.1) = 468,246
0.1

Thus, the million-dollar lottery is worth only $468,246 in current dollars.

Question 7: Yield to maturity on a coupon bond: A coupon bond that pays interest
of $100 annually has a par value of $1,000, matures in 5 years, and is selling today at a $72
discount from par value (FV).
Is the yield to maturity on this bond…: a) 6.00% b) 8.33% c) 10.39% d) 12.00% e) 60.00%
Answer
OBS på, at vi her har en discount på 72$
PV = FV - DISCOUNT = 1000$ - 72$ = 928 = PV
𝑛
𝐶𝑛 𝐹𝑉
𝑃𝑉 = ∑ ⬚ +
(1 + 𝑘𝑑 )𝑡 (1 + 𝑘𝑑 )𝑛
𝑡=1

100 100 100 100 100 1000

928 = + + + + +
(1 + 𝑘𝑑 )1 (1 + 𝑘𝑑 )2 (1 + 𝑘𝑑 )3 (1 + 𝑘𝑑 )4 (1 + 𝑘𝑑 )5 (1 + 𝑘𝑑 )5
⇕ Ligningen løses for k_d vha. WordMat.

𝑘𝑑 = 0,1199721
Kd = 12%

Question 8: Stock price based on constant rate of growth model: Assume next year's
dividends are $3.00 per share and they are expected to grow at 4 percent per year. If the risk
adjusted discount rate is 7 percent, then the constant rate of growth model implies a stock price
of….:
(a) 80 (b) 90 (c) 100 (d) pik
Answer

𝐷𝑛+1
𝑉𝑛 =
𝑟𝐸 − 𝑔𝐿
3
𝑉𝑛 = = 100
0.07 − 0.04
Question 9: Current value of a coupon bond with semiannual: payments Calculate the
current value of a 20-year, 6% coupon bond, with semiannual payments. The bond has a par
value of $1,000, and a required return of 8%
Answer
N = number of periods = 40 [= (20 years * 2 (semi-annual))]
F = $1,000
0.06
C = semi-annual coupon = ( 2 ) · ($1,000) = $30
R = required semi-annual rate = 0.08 / 2 = 0.04
1
1− 𝐹𝑉
(1 + 𝑟)𝑛
𝑉 =𝐶·[ ]+
𝑟 (1 + 𝑟)𝑛

1
1− 1000
(1 + 0.08)40
𝑃𝑉 = 30 · [ ]+ = 802.07
0.08 (1 + 0.08)40

VORES LØSNING(GIVER SAMME)

30 1 1000
𝑃𝑉 = · (1 − 40
)+ ≈ 802,0723
0.04 (1 + 0.04) (1 + 0.04)40

Question 10: Net present value (NPV) of an investment: Snufty corp. is considering
investing in a new boring machine. It costs $380,000 and is expected to produce the following
cash flows:
Year 1 2 3 4 5 6 7 8 9 10
Cash flow 50 57 75 80 85 92 92 80 68 50
($000s)

If the cost of capital is 12%, what is the machine’s NPV

Answer:
𝐶𝐹1 𝐶𝐹2 𝐶𝐹3 𝐶𝐹𝑛
𝑃 = + 2
+ 3
+ ⋯+
(1 + 𝑟1 ) (1 + 𝑟2 ) (1 + 𝑟3 ) (1 + 𝑟𝑛 )𝑛
 50 57 75 80 85 92
𝑃 = + 2
+ 3
+ 4
+ 5
+
(1 + 0.12) (1 + 0.12) (1 + 0.12) (1 + 0.12) (1 + 0.12) (1 + 0.12)6
92 80 68 50
+ 7
+ 8
+ 9
+
(1 + 0.12) (1 + 0.12) (1 + 0.12) (1 + 0.12)10
= 403.69($000𝑠)
𝑁𝑃𝑉 = 𝑃𝑉(𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠) − 𝑃𝑉(𝐶𝑜𝑠𝑡𝑠)
𝑁𝑃𝑉 = 403,696 − 380,000 = 23,696

Question 11 (Findes også I mock): NPV of an investment with perpetual cash flows
An investment costs 1,548 and pays 138 in perpetuity. If the interest rate is 9%, what is the
NPV?

Answer:
𝐶
𝑃𝑉 =
𝑟
138
𝑃𝑉 = = 1,533.33
0.09
𝑁𝑃𝑉 = 𝑃𝑉(𝐵𝑒𝑛𝑒𝑓𝑖𝑡𝑠) − 𝑃𝑉(𝐶𝑜𝑠𝑡𝑠)
𝑁𝑃𝑉 = 1,533.33 − 1,548 = −14.67

Question 12: Current stock price based on constant growth rate

Company Z’s earnings and dividends per share are expected to grow constantly by 5% a year.
If the last company’s dividend was 9$ and the cost of equity is 8%, what is the current stock
price?
Answer:
D_0 = 9$
g= 5%
r_e = 8%
𝐷0 · (1 + 𝑔)
𝑉0 = ⬚
𝑟𝐸 − 𝑔
9 · (1 + 0.05)
𝑉0 = = 315
0.08 − 0.05

Question 13: Current stock price based on expected dividend and equity cost of
capital: Company X is expected to pay an end-of-year dividend of 5$ a share. After the
dividend, its stock is expected to sell at $110. If the equity cost of capital is 8%, what is the
current stock price?
Answer:
𝐷𝑖𝑣1 + 𝑃1
𝑃0 =
1 + 𝑟𝐸
5 + 110
𝑃0 = = 106.48
1 + 0.08
Question 15: Required return, dividend yield, and capital gains yield for a stock

Suppose a firm’s stock is selling for $10.50. It just paid a $1 dividend, and dividends are
expected to grow at 5% per year.

What is the required return?

𝐷1
𝑃0 =
𝑟𝐸 − 𝑔
𝐷1
𝑟𝐸 = +𝑔
𝑃0
1 · (1 + 0.05)
𝑟𝐸 = + 0.05 = 0.15 𝑜𝑟 15%
10.50
What is the dividend yield?
𝐷𝑖𝑣1
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑦𝑖𝑒𝑙𝑑 =
𝑃0
1 · (1 + 0.05)
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑦𝑖𝑒𝑙𝑑 = = 0.1 𝑜𝑟 10%
10.50
What is the capital gains yield?
𝑃1 − 𝑃0
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑔𝑎𝑖𝑛 𝑦𝑖𝑒𝑙𝑑 =
𝑃0
1(1 + 0.05) − 1
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑔𝑎𝑖𝑛 𝑦𝑖𝑒𝑙𝑑 = = 0.05 𝑜𝑟 5%
1
Question 16: Dividend growth rate and P/E ratio estimation for a company
The Standorf corp. has consistently paid out 40 percent of its earnings in dividends. The
company’s return on equity is 16 percent. a) What would you estimate as its dividend growth
rate?
Answer
a) 𝑔 = 𝑅𝑒𝑡𝑒𝑛𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 · 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑛𝑒𝑤 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
Dividend Payout Rate = 40 %
Retention rate = 1 - 40% = 60%
g = 60% x 0.16 = 9.6%
b) Given the low company’s risk your required rate of return on Standorf is 13 percent. What
P/E ratio would you apply to the firm’s earnings.
𝑃 𝑃0 𝐷1 /𝐸𝑃𝑆1 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑦𝑜𝑢𝑡 𝑟𝑎𝑡𝑒 0.4
𝐹𝑜𝑟𝑤𝑎𝑟𝑑 = = = = = 11.76𝑥
𝐸 𝐸𝑃𝑆1 𝑟𝐸 − 𝑔 𝑟𝐸 − 𝑔 0.13 − 0.096
FOKUSER PÅ DETTE:
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑦𝑜𝑢𝑡 𝑟𝑎𝑡𝑒 0.4
= = 11.76𝑥
𝑟𝐸 − 𝑔 0.13 − 0.096

Question 17: Present value of cash flows and price per share calculation for a
company (Samme som side 12 I dette dokument)
ABC corp. faltered in the recent recession but is recovering. Free cash flow has grown rapidly.
Forecasts made in 2020 are as follows:

($ millions) 2021 2022 2023 2024 2025

Net income 1.0 2.0 3.2 3.7 4.0
Investment 1.0 1.0 1.2 1.4 1.4
Free cash flow 0 1.0 2.0 2.3 2.6

ABC recovery will be complete by 2025, no further growth in net income or free cash flow is
expected thereafter, it will remain constant.
1) Calculate the PV of the cash flow, assuming a cost of equity of 9%
2) Assume that ABC has 12 million shares outstanding. What is the price per share?
Answer:
𝐶𝐹1 𝐶𝐹2 𝐶𝐹3 𝐶𝐹4 𝐶𝐹5 𝑃5
𝑃0 = + + + + +
(1 + 𝑟𝐸 ) (1 + 𝑟𝐸 )2 (1 + 𝑟𝐸 )3 (1 + 𝑟𝐸 )4 (1 + 𝑟𝐸 )5 (1 + 𝑟𝐸 )5
𝐶𝐹5
𝑃5 =
𝑟
2.6
𝑃5 = = 28.89
0.09
0 1 2 2.3 2.6 28.89
𝑃0 = + 2
+ 3
+ 4
+ 5
+
(1 + 0.09) (1 + 0.09) (1 + 0.09) (1 + 0.09) (1 + 0.09) (1 + 0.09)5
= 24.48 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
Price per share = 24.48 million / 12 million = $2.04 pr. Share.

Question 18: Investment decisions based on NPV and available funds

Suppose you have the following investment opportunities, but only $90,000 available for
investment. Which projects should you take?
Project NPV ($) Investment ($)
1 5,000 10,000
2 5,000 5,000
3 10,000 90,000
4 15,000 60,000
5 15,000 75,000
6 3,000 15,000

Answer:
𝑁𝑃𝑉
𝑃𝑟𝑜𝑓𝑖𝑡𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑖𝑛𝑑𝑒𝑥 =
𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

5,000
𝑃𝐼1 = = 0.5
10,000
5,000
𝑃𝐼2 = =1
5,000
10,000
𝑃𝐼3 = = 0.11
90,000
15,000
𝑃𝐼4 = = 0.25
60,000
15,000
𝑃𝐼5 = = 0.2
75,000
3,000
𝑃𝐼6 = = 0.2
15,000
Ranking
Project PI Accumulated Investment ($)
2 1 5,000
1 0.5 15,000
4 0.25 75,000
6 0.2 90,000
5 0.2
3 0.11
Projects 2,1,4,6

Question 19 Expected Year-End Price Calculation / Return: Clayton corp. does not pay
a dividend. Its current stock price is $150 and there is an equal probability that the return over
the coming year will be -10%, +20%, or +50%
What is the expected price at the year-end?
Answer:
-10% return is 0.9
+20% return is 1.2
+50% return is 1.5
There is an equal probability of each return occurrence
𝑛

𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 (𝑚𝑒𝑎𝑛) 𝑟𝑒𝑡𝑢𝑟𝑛 (𝐸(𝑅)) = ∑ ⬚ (𝑅𝑖 )(𝑃𝑖 )

𝑖=1

𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 (𝑚𝑒𝑎𝑛) 𝑟𝑒𝑡𝑢𝑟𝑛 (𝐸(𝑅)) = 0.3333 · 0.9 + 0.3333 · 1.2 + 0.3333 · 1.5
= 1.19988
Following the expected mean return the expected year-end price will be $150x1.19988=$180

Question 20: Portfolio Expected Return and Standard Deviation

Alton Cooper has invested 60% of his money in share A and the remainder in share B. He
assesses their prospects as follows:
A B
Expected return (%) 15 20
Standard deviation (%) 20 22
Correlation between returns 0.5

1) What are the expected return and standard deviation of returns on his portfolio?
2) How would your answer change if the correlation coefficient were 0 or -0.5?
3) Is the constructed portfolio better or worse than one invested entirely in share A, or it is not
possible to say?
Answer:
60% is invested in share A, 100%-60%= 40% is invested in share B
 𝑚

𝐸(𝑅)𝑝 = ∑ ⬚ 𝑊𝑖 𝑥𝐸(𝑅𝑖 )
𝑖=1

𝐸(𝑅𝑝 )= 0.6 x 15.0% + 0.4 x 20% = 17%

𝜎𝑝 = √𝑊𝐴2 𝜎𝐴2 + 𝑊𝐵2 𝜎𝐵2 + 2𝑊𝐴 𝑊𝐵 𝜌𝐴,𝐵 𝜎𝐴 𝜎𝐵

𝜎𝑝 = √0.62 𝑥0.22 + 0.42 𝑥0.222 + 2𝑥0.6𝑥0.4𝑥0.5𝑥0.2𝑥0.22 = 18.1%

𝜎𝑝 = √0.62 𝑥0.22 + 0.42 𝑥0.222 + 2𝑥0.6𝑥0.4𝑥0.5𝑥0.2𝑥0.22 = 18.1%

2)

𝜎𝑝 = √0.62 𝑥0.22 + 0.42 𝑥0.222 = 14.9%

𝜎𝑝 = √0.62 𝑥0.22 + 0.42 𝑥0.222 + 2𝑥0.6𝑥0.4𝑥(−0.5)𝑥0.2𝑥0.22 = 10.8%

3)
The combined portfolio is better. It has a higher return and lower standard deviation.

Question 21: After-Tax WACC Calculation

A company is 40% financed by risk-free debt. The interest rate is 10%, the expected market
risk premium is 8%, and the beta of the company’s common stock is 0.5. What is the after tax
WACC, assuming that the company pays tax at a 20% rate.
D = 40% = 0.40
E = 1 - 0.40 = 0.60
V = 0.60 + 0.40 = 1
Interest rate 𝑟𝑓 = 10%

Beta = 0.5
Risk premium 𝑅𝑀 = 8%
Taxes = 20%

Vi finder først Expected Rate of Return:

𝐸[𝑅𝑖 ] = 𝑟𝑓 + 𝛽𝑖 (𝐸[𝑅𝑀 ] − 𝑟𝑓 )

Da vi har Risk Premium omskrives den således vi faktisk bruger denne:

𝐸[𝑅𝑖 ] = 𝑟𝑓 + 𝛽𝑖 (𝑅𝑀 )

HVIS MAN IKKE HAR RISK MARKET PREMIUM, så SE OPG A4, Lektion 6
 𝐸[𝑅𝑖 ] = 𝑘𝑒 = 0.1 + 0.5 · 0.08 = 0.14

𝐷 𝐸
𝑊𝐴𝐶𝐶 = 𝑘𝑑 (1 − 𝑡𝑐 )𝑥 ( ) + 𝑘𝑒 𝑥 ( )
𝑉 𝑉
𝑊𝐴𝐶𝐶 = 0.1 · (1 − 0.2) · 0.4 + 0.14 · 0.6 = 0.116 𝑜𝑟 11.6%

Question 22: Asset Beta Calculation: Albesto corp. is 50% financed with long-term bonds
and 50% with common equity. The debt securities have a beta of 0.15. The company’s equity
beta is 1.25. What is Albesto’s asset beta?
Answer:
𝛽𝑝 = 𝑤𝐴 𝛽𝑝 + 𝑤𝐵 𝛽𝐵 + ⋯ + 𝑤𝑛 𝛽𝑛

Vi tager vægten W til hver, hvoraf vi sætter 𝑊 · 𝛽 for både Long bonds og Common Equity
𝛽𝑝 = 0.5 · 0.15 + 0.5 · 1.25 = 0.7

Question 23: Portfolio Variance and Standard Deviation Calculation (SE EVT OGSÅ
A3, LEKTION 6): Teresa Smith invests 60% of her funds in stock A and the remaining balance
in stock B (40%). The standard deviation of returns on A is 10%, and on B it is 20%. Calculate
the variance and standard deviation of portfolio returns, assuming
1) The correlation between the returns is 1.0
2) The correlation is 0.5
3) The correlation is 0.
Variance:
𝜎𝑝 2 = 𝑊𝐴2 𝜎𝐴2 + 𝑊𝐵2 𝜎𝐵2 + 2𝑊𝐴 𝑊𝐵 𝜌𝐴,𝐵 𝜎𝐴 𝜎𝐵

Standard Deviation

𝜎𝑝 = √𝑊𝐴2 𝜎𝐴2 + 𝑊𝐵2 𝜎𝐵2 + 2𝑊𝐴 𝑊𝐵 𝜌𝐴,𝐵 𝜎𝐴 𝜎𝐵

Eller hvis man allerede har Variance:

𝜎𝑝 = √𝜎𝑝2

1)
Variance:
𝜎2 = 0.62 · 0.12 + 0.42 · 0.22 + 2 · 0.6 · 0.4 · 1 · 0.1 · 0.2 = 0.0196

𝜎2 = 0.0194

Standard Deviation:

𝜎𝑝 = √0.0196 = 0.14

2)
2 2 2 2 2
𝜎 = 0.6 𝑥0.1 + 0.4 𝑥0.2 + 2𝑥0.6𝑥0.4𝑥0.5𝑥0.1𝑥0.2 = 0.0148

𝜎𝑝 = √0.0148 = 0.122

3)
𝜎 = 0.6 𝑥0.1 + 0.42 𝑥0.22 = 0.01
2 2 2

𝜎𝑝 = √0.01 = 0.10