Question

Q 5

You decide to start a new taxi service in your spare time. The first thing you need to do is buy a car. After visiting Mr. Charming Salesman at Sundance Used Cars, you have narrowed your choice to 3 possibilities. The three cars you can afford and their yearly net revenues (fares - gas & maintenance) are listed below. Remember each car must be replaced when it finally dies if you are to remain in business. Assuming an appropriate discount rate of 3.5% which one would you buy?

Year	VW Bug	Yugo	Ford Tempo
0	-$500	-$1,800	-$3,000
1	800	1,400	1,400
2	800	1,400	1,400
3	800		1,400
4			1,400

Question options:

1-	Buy the Yugo it has the highest NPV at $859.57
2-	Buy the VW it has the highest EAA at $621.53

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Q6

A common stock pays quarterly dividends. A dividend of $1.00 per share has just been paid. Dividends are expected to grow 5% per quarter for the next two years, then 2% per quarter forever. If the required rate of return is 16% per year, compounded quarterly, find the price of the stock.

Question options:

1- $63.41

2- $68.77

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Q7

The following two bonds are identical in every respect except for their coupon rates (assume both have a face value of $1,000). If interest rates suddenly increased by 5%, what will happen to the prices of these two bonds, all else held constant?

Bond	Coupon Rate	Bond Value
A	16%	$1,229.40
B	10%	$885.30

Question options:

	1- Bond A’s percentage drop in price will be greater than Bond B’s percentage drop in price
	2-Bond B’s percentage rise in price will be greater than Bond A’s percentage rise in price
	3-Bond B’s percentage drop in price will be greater than Bond A’s percentage drop in price

Answer 1

Q5

EAA of VW Bug=(-500+800/1.035+800/1.035^2+800/1.035^3)*3.5%/(1-1/1.035^3)=621.53

EAA of Yugo=(-1800+1400/1.035+1400/1.035^2)*3.5%/(1-1/1.035^2)=452.48

EAA of Ford Tempo=(-3000+1400/1.035+1400/1.035^2+1400/1.035^3+1400/1.035^4)*3.5%/(1-1/1.035^4)=583.25

We would buy highest EAA car that is VW

Option 2-Buy the VW it has the highest EAA at $621.53

Q6

Price=1.05/1.04+1.05^2/1.04^2+1.05^3/1.04^3+1.05^4/1.04^4+1.05^5/1.04^5+1.05^6/1.04^6+1.05^7/1.04^7+1.05^8/1.04^8+(1.05^8*1.02/(4%-2%))/1.04^8=63.41

Option 1- $63.41

Q7

Higher coupon means lower duration and lower duration means less fall when rates rise

Option 3-Bond B’s percentage drop in price will be greater than Bond A’s percentage drop in price