Homework

11.1 – The four fundamental factors that affect the supply of and demand for investment capital –

which affect interest rates – are productive opportunities, time preferences for consumption, risk,

and inflation. Explain how each of these factors affects the cost of money.

11.2 – The interest rate required by investors on a debt security can be expressed by the

following equation: Interest rate = RRF + IP + DRP + LP + PRP + CRP.

Define each term of the equation, and explain how it affects the interest rate.

11.5 – Briefly explain the following debt features:

(a) Indenture

(b) Restrictive convenant

(c) Trustee

(d) Call provision

11.6 – (a)

(b)

(c)

(d)

(e)

(f)

What are the three primary bond rating agencies?

What do bond ratings measure?

How do investors interpret bond ratings?

What is the difference between an A-rated bond and a B-rated bond?

Why are bond ratings important to investors?

Why are ratings important to businesses that issue bonds?

12.1 – A person is considering buying the stock of two home health companies that are similar in

all respects except the proportion of earnings paid out as dividends. Both companies are

expected to earn $6 per share in the coming year, but Company D (for dividends) is expected to

pay out the entire amount as dividends, while Company G (for growth) is expected to pay out only

one-third of its earnings, $2 per share. The companies are equally risky, and their required rate of

return is 15 percent. D’s constant growth rate is zero and G’s is 8.33 percent. What are the

intrinsic values of stocks D and G?

12.2 – Medical Corporation of America (MCA) has a current stock price of $36 and its last

dividend (Do) was $2.40. In view of MCA’s strong financial position, its required rate of return is

12 percent. If MCA’s dividends are expected to grow at a constant rate in the future, what is the

firm’s expected stock price in five years?

12.3 – A broker offers to sell you shares of Bay Area Healthcare, which just paid a dividend of $2

per share. The dividend is expected to grow at a constant rate of 5 percent per year. The stock’s

required rate of return is 12 percent.

(a) What is the expected dollar dividend over the next three years?

(b) What is the current value of the stock and the expected stock price at the end of each

of the next three years?

(c) What is the expected dividend yield and capital gains yield for each of the next three

years?

(d) What is the expected total return for each of the next three years?

(e) How does the expected total return compare with the required rate of return on the

stock? Does this make sense? Explain your answer?

12.7- Lucas Clinic’s last dividend (Do) was $1.50. Its current equilibrium stock price is $15.75,

and its expected growth rate is a constant 5 percent. If the stockholders’ required rate of return is

15 percent, what is the expected dividend yield and expected capital gains yield for the coming

year?

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