The coupon rate of a bond is the rate of return

Reference no: EM13907457

[1] True or False?

(1) The coupon rate of a bond is the rate of return that an investor obtains by buying the bond in the market and holding it until the last cash flows are paid.

(2) If the cost of equity is 13.20%, the WACC is 11.73%, and next year's FCFF is €2.70 million, the value of the firm (using a FCFF model with stable growth) is €24.66 million if we use a 2.25% long-term rate of growth. Is that statement true or false?

(3) Most investment banks, when they underwrite an Initial Public Offering (IPO), want the offering price to be as high as possible, because that means higher underwriting fees and more revenue from trading commissions.

(4) When valuing a start-up company, using the cost of equity (with the CAPM) as the discount rate, instead of a much higher 'target rate of return', would yield a significantly overvalued estimate.

(5) One way for companies to enhance the value of the firm is to arrive at the debt ratio that minimizes their WACC.

(6) You expect that the yield-to-maturity of BBB-rated corporate bonds will increase over the next two months. At the same time, you expect that the yield-to-maturity of risk-free U.S. Treasury bonds (with similar maturity, coupon rate and face value) will fall. Therefore, you are expecting that the credit spread between BBB-rated and risk-free bonds will increase. Is that last statement true or false?

(7) SoftTech had a very successful IPO. As soon as trading started, the stock price went up, and it closed the day at $48/share. The offering price was $35. Two million shares were initially sold, although underwriter Stockman Saks had a greenshoe option to buy an additional 15% of stock from the company. With an underwriting spread of 6%, net proceeds to the company were €75,670,000. Is this last statement true or false?

(8) Two bonds by the same issuer have the same maturity and are valued with the same discount rate, but one is a zero-coupon bond and the other pays an annual coupon. The price of the zero-coupon bond is less sensitive to a change in the discount rate than the price of the coupon bond. Is this last statement true or false?

[2] Value of the Firm

Use the information on Company S to find the following values:

a. Value of the firm, using a Free Cash Flow to the Firm (FCFF) model with stable growth. The formula is: Value of the Firm = FCFF1 / (WACC - g)

b. Value of equity

c. Value per share

Company S: values forecasted for next year (year 1)

Sales $86,500

COGS $ 52,000

Other costs $ 10,800

Depreciation $ 7,670

Capital expenditure $ 4,300

Change in working capital mce_markernbsp; 875

Tax rate 35%

Stable growth rate g 2.75%

Value of debt $82,912

Stock price per share $20

Shares outstanding 4,000

Risk-free rate rf 3.00%

Interest payments $2,073

Beta β 2.00

Expected return on stocks rM 9.5%

Suggested steps for solving; (1) Calculate the cost of debt by estimating the pre-tax cost of debt with the interest coverage ratio, synthetic credit rating and credit spreads; then arrive at the after-tax cost of debt; (2) Calculate the cost of equity (you need the debt ratio); (3) Calculate WACC; (4) Calculate FCFF1, and the Value of the Firm.


Interest	Credit	Credit
coverage	Rating	Spread
ratio		over risk-free rate

Higher than 9	AAA	0,60%
6.51 - 8.90	AA	0,80%
4.01 - 6.50	A	1,00%
2.56 - 4.00	BBB	2,00%
2.21 - 2.55	BB	3,00%
1.48 - 2.20	B	4,50%
1.01 - 1.47	CCC	6,50%
0.81 - 1.00	CC	7,50%
0.59 - 0.80	C	10,00%
< 0.59	D	20,00%

[3] Venture Capital valuation method

You are a Venture Capitalist and have been approached by QuickSushi, a private firm that is expected to have an Initial Public Offering (IPO) in five years. With the information below, use the "Venture Capital valuation method" (Week 10) to calculate: (a) the exit value of QuickSushi; (b) the discounted value of QuickSushi; (c) the percentage of the firm that would you demand in return for a $18 million investment in the equity capital of the firm. (Note: not all the information provided may be relevant to your calculations).

Number of years to IPO: 5

Debt outstanding: $0

Expected net income in 5 years: $8,500,000

Expected Free Cash Flow to the Firm in 5 years: $12,750,000

Weighted Average Cost of Capital: 11.3%

Average price-earnings ratio (comparable firms) 26x

Venture capitalist target rate of return: 35%

Reference no: EM13907457

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