Question

a) A beauty product company is developing a new fragrance. There is 50% probability that consumers will love the new product, in this case the annual sales will be 1 million bottles. There is a 40% probability the consumers will find the smell acceptable and annual sales will be 200,000 bottles. With10% probability consumers will find the smell unusual and annual sales will be only 50,000 bottles. The selling price is £38 and the variable cost is £8 per bottle. Fixed production costs are £1 million per year and depreciation is £1.2 million per year. Assume that the tax rate is 40%. What are the expected annual incremental cash flows for the new fragrance? [10 marks]

b) Information Systems Ltd is planning to issue 10-year bonds with £1,000 face value. The market rate for such bonds (yield) is 8.125%. Assume that coupon payments will be semi-annual. The firm is deciding between issuing an 8% coupon bond or a zero- coupon bond. The company needs to raise £1 million.

i) What will be the price of the 8% coupon bonds? How many coupon bonds would have to be issued? [7 marks]

ii) What will be the price of the zero-coupon bonds? How many zero-coupon bonds will have to be issued? [7 marks]

c) You know that the return of ordinary shares of ABC company reacts to macroeconomic information 1.6 times more than the return of the market. If the risk-free rate of return is 4% and the market risk premium is 6%, what is ABC’s cost of equity? [6 mark]

Answer #1

A beauty product company is developing a new fragrance named
Happy Forever. There is a probability of 0.50 that consumers will
love Happy Forever, and in this case, annual sales will be 1.00
million bottles; a probability of 0.36 that consumers will find the
smell acceptable and annual sales will be 218,000 bottles; and a
probability of 0.14 that consumers will find the smell unpleasant
and annual sales will be only 53,000 bottles. The selling price is
$36, and the...

A beauty product company is developing a new fragrance named
Happy Forever. There is a probability of 0.52 that consumers will
love Happy Forever, and in this case, annual sales will be 1.07
million bottles; a probability of 0.38 that consumers will find the
smell acceptable and annual sales will be 170,000 bottles; and a
probability of 0.10 that consumers will find the smell unpleasant
and annual sales will be only 53,000 bottles. The selling price is
$38, and the...

A beauty product company is developing a new fragrance named
Happy Forever. There is a probability of 0.52 that consumers will
love Happy Forever, and in this case, annual sales will be 1.07
million bottles; a probability of 0.38 that consumers will find the
smell acceptable and annual sales will be 170,000 bottles; and a
probability of 0.10 that consumers will find the smell unpleasant
and annual sales will be only 53,000 bottles. The selling price is
$38, and the...

A beauty product company is developing a new fragrance named
Happy Forever. There is a probability of 0.48 that consumers will
love Happy Forever, and in this case, annual sales will be 1.04
million bottles; a probability of 0.38 that consumers will find the
smell acceptable and annual sales will be 211,000 bottles; and a
probability of 0.14 that consumers will find the smell unpleasant
and annual sales will be only 48,000 bottles. The selling price is
$36, and the...

Company B had issued 10-year bonds a year ago at the coupon rate
4%. The bond makes annual payments. The yield to maturity (YTM) of
these bonds is 5%. The face value of the bond is $1000.
Calculate the current bond price.
Company B has a second debt issue on the market, a zero coupon
bond with 9.6 years left to maturity. The yield to maturity (YTM)
of these bonds is 8 %. The face value of the bond is...

XYZ Company is undergoing a major expansion. The expansion will
be financed by issuing new 16-year, $1,000 par, 8% annual coupon
bonds. The market price of the bonds is $1,020 each. Flotation
expense on the new bonds will be $60 per bond. The marginal tax
rate is 35%. What is the post-tax cost of debt for the newly-issued
bonds?

A company has 14 million common shares outstanding with a
current price $50 and the book value of $18 a share and a beta of
1.88. They also have two bond issues outstanding. The first bond
issue has a book value of $100 million, coupon rate of 11% and
currently sells at 125.678% of par. The second bond issue is a zero
coupon bond with a book value of $50 million and currently sells at
43%. Maturity of both bonds...

a. XYZ Company is undergoing a major expansion. The expansion
will be financed by issuing new 16-year, $1,000 par, 8% annual
coupon bonds. The market price of the bonds is $1,020 each.
Flotation expense on the new bonds will be $60 per bond. The
marginal tax rate is 35%. What is the post-tax cost of debt for the
newly-issued bonds?
b. ABC Corporation will issue new common stock to finance an
expansion. The existing common stock just paid a $1.25...

A major insurance company is reevaluating its bonds since it is
planning to issue a new bond in the current market. The firm's
outstanding bond issue has 7 years remaining till maturity. The
bonds were issued with an 8 percent coupon rate (paid quarterly)
and selling at par value. The required rate of return is 10
percent. What is the current value of these securities?

Company A issued 10-year bonds one year ago at par. Each of
these bonds had $1,000 face value and had a coupon rate of 4.25%
per year, with semi-annual coupon payments. Company A's credit risk
hasn’t changed, but the market has—and now 10-year corporate bonds
with similar risk are being issued with a yield-to-maturity of
3.75% per year.
One year ago, what was the required rate of return on these
bonds?
What is your best guess of the current required...

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