Cal State University Northridge Free cash approach excel

FIN359 Quant Finance- Homework Problem Set 02 FIN359 – Quant Finance HOMEWORK #02 I. Question 1 (Free Cash Flow Approach, past exam question) Green Planet, Inc., a manufacturer of air filter systems for industrial facilities, is considering the addition of a new system to its current product line. The following data has been forecasted: The market value of the firm’s debt is $300,000, and it has $150,000 in marketable securities. The company also has 10,000 shares of preferred stock that pay an annual dividend of $0.75 per share. Investors require a rate of return of 7% on preferred stocks of similar risk. The firm has 100,000 shares of common stock outstanding, and its weighted average cost of capital is 12%. The expected tax rate is 35% in the next two years and 40% after that. • a) Calculate the free cash flow for each of the next four years. • b) After 2021 the firm’s free cash flow is expected to grow at 5% per year indefinitely. What is the value of the stock today? • c) Assume that after 2021 the firm’s free cash flow is expected to grow at 9% per year for four years. After that time, the firm’s free cash flow will grow at 5% indefinitely. Using the two-stage dividend growth model, what is the value of the stock? II. Question 2 (Bond) Consider the following two bonds: Band A: • Term to maturity: 10 years from today • Face value: $1,000 • Annual Coupon rate: 6% • Number of payments per year: 1 Band B : Page 1 FIN359 Quant Finance- Homework Problem Set 02 • Term to maturity: 20 years from today • Face value: $1,000 • Annual Coupon rate: 10% • Number of payments per year: 1 • Compute the price for each bond. The current market interest rate for the bonds is 8%. Assume that YTM of each bond equals the current market interest rate. Then make a table comparing the bond prices when the YTM varies from 1%, 2% . . . 17%. • Compute duration and modified duration for each bond. • Use (modified) duration to estimate the percentage change of price for each bond if the YTM increases from 8% to 12%. Page 2