Question

1.What is the correct way to annualize an interest rate in financial decisions?

2.John is watching an old game show on rerun television called Let’s Make a Deal in which you have to choose a prize behind one of two curtains. Behind one of the curtains is a gag prize worth $ 150, and behind the other is a round-the-world trip worth $7,200. The game show has placed a subliminal message on the curtain containing the gag prize, which makes the probability of choosing the gag prize equal to 75 percent. What is the expected value of the selection, and what is the standard deviation of that selection?

3.Zippy Corporation just sold $30 million of convertible bonds with a conversion ratio of 40. Each $1,000 bond is convertible into 25 shares of Zippy’s stock.

a. What is the conversion price of Zippy’s stock?

b. If the current price of Zippy’s stock is $15 and the Company’s annual stock return is normally distributed with a standard deviation of $5, what is the probability that investors will find it attractive to convert the bond into Zippy stock in the next year?

4.Courtesy Bancorp issued perpetual preferred stock a few years ago. The bank pays an annual dividend of $4.27, and your required rate of return is 12.2 percent.

a. What is the value of the stock given your required rate of return?

b. Should you buy this stock if its current market price is $34.41? Explain.

5.The cyclone golf resorts is redoing its golf course at a cost of $2,744,320. It expects to generate cash flows of $1, 223,445, $2,007,812, and $3,147,890 over the next three years. If the appropriate discount rate for the firm is 13 percent, what is the NPV of this project?

Answer 1

1. Effective annual rate = (1+Interest Rate/compounding factor)^compounding factor - 1

2. Expected Value of selection = 75%*150 + 25%*7200 = $ 1912.5

Standard Deviation = sqrt(75%*(150-1912.5)^2+25%*(7200-1912.5)^2) = $ 3052.74

3. The conversion ratio of 40 means 25 shares for each bond of $1000

a. Conversion price = 1000/25 = $40

b. Z value = Stock price-conversion price/standard deviation = (15-40)/5 = -5

Probability = NORM.S.DIST(-5,True) = 0.00000029 ~ 0

4. Stock price for perpetual preferred stock = Dividend/Rate of return = 4.27/12.2% = $ 35

If its current market price is $34.41, then he should buy it as it is undervalued

5. NPV = -2,744,320 + 1223445/(1+13%) + 2007812/(1+13%)^2 + 3147890/(1+13%)^3 = $ 2092431.67