1. Time value of money (25 points)
You are wo
ied about saving enough money for the college education of your two kids, cu
ently aged 7 and 9. Both will go to college at age 18 and will graduate in 4 years. By the time they go off to college, tuition at a four year public in-state university will likely be $65,000 per year. Assume a 6% per year required rate of return and assume that you make annual contributions starting today and lasting until the second child graduates from college. Finally, assume that you cu
ently have $160,000 in a college savings account. How much do you need to save each year to pay for the college education of your two kids?
2. Bond Pricing (25 points)
Suppose a bond has 20 years to maturity; a $1,000 face value; a coupon of 5%; and a yield to maturity of 6%. The coupon is paid semi-annually.
· What is the price of this bond? (10 points)
· If the yield to maturity suddenly rises to 8%, what is the new price of the bond? (10 points)
· On October 30th, the Federal Reserve cut interest rates for the third time in 2019. What impact should this have on bond prices? Will long-term or short-term bonds be more impacted? Why? (5 points)
3. Stock pricing (25 points)
A recent headline from MarketWatch stated that “Microsoft’s stock is getting increasing overvalued.” The stock is now trading at a price of $185.35. You wish to examine the issue using the dividend discount model.
Microsoft just paid a dividend of $2.04. Analysts expect growth over the next five years of 14.60%. Thereafter, the dividend will grow at a rate of 5%. Assuming a discount rate of 10%, estimate the price of Microsoft’s stock. (15 points)
Assuming everything else remains the same as in part (a), how high would the dividend need to be to justify the cu
ent stock price? (10 points)
4. NPV (25 point)
GE is in the process of assessing the attractiveness of a new project. The project has an estimated life of three years. The project’s revenue estimates are as follows:
· Sales = 50,000 units/year.
· Per unit price: $100 in year 1, $110 in year 2, $130 in year 3.
The project’s cost estimates are as follows:
· Up-front for new equipment = $2,400,000.
· Annual overhead = $1,300,000.
· Per unit cost = $50.
The expected life of the new equipment is 3 years, and it will be depreciated straight-line over that time. GE plans to resell this equipment for $800,000 at the end of year 3.
An investment of $100,000 in net working capital will be made in year 0, which will be recovered at the end of the project.