Corporate Finance 2014 Answers

1. See question below:

A) What is the unlevered net income for year 1?

B) What is the unlevered net income for year 2?

2. Chanda Co’s stock price is $48. Dividends this year were $ 2.23 per share. The firm has a BETA of 1.1. Given a market return of 9% and a risk free rate of 2% solve the following questions:

A) What is Chanda Co’s required rate of return:

1.1(.09-.02)+.02=.097

B) If we assume the firm will grow at 5% rate, what should be the firm value today?

2.23(1.05)/(.097-.05)=49.82

C) Explain only: If in you are certain that the stock price will converge to the amount solved for in part B and you have limited amount of resources (say $1000), discuss three strategies that can be used to make money off this situation .

1. You could simply buy the stock as you would expect it to go up in value.

2. You could buy a call on the stock with a strike price that would end in the money.

3. You could enter into a forward contract or buy a future contract on the firm, if one exists.

4. You could buy stock or calls on margin, meaning you borrow money to invest more than you have.

D) Assuming no transaction fees(such as brokerage fees), explain only what must be true for you to make a profit for each of the above strategies. (It may also be helpful to think under what circumstances you will not make money)

1. As long as you can buy the stock for less than 49.82 (that the ask price is less than 49.82) then you will make a profit.

2. As long as the price of the call is less than 49.82-X, where X is the strike price then you will make a profit

3. As long as the forward or future price is below 49.82 then you should be able to make money off of this contract.

4. As long as the interest rate on the money you borrow is not large enough to erode gains from doing strategy 1 or 2, then you should make money.

3. Use the following table for the next problem

Solution:

4. See the problem below:

Solution:

5. Answer the question...