Exam 2 Review
Bonds
Stocks
Capital Budgeting 1
Bonds
Know all bond features / terminology
 Know how to read WSJ quotations for
corporate and treasury bonds
 Know how to calculate bond value
 Understand yield, YTM, coupon rate,
current yield and their relation
 Understand interest rate risk, default risk

Stocks
WSJ quotations
 Stock valuation models: General DDM,
Constant Growth DDM, Multi-Stage
 Assumptions behind various DDM
models
 No dividend case
 Required return based on constant
growth

Capital Budgeting
NPV, IRR, PI, Payback, Disc. Payback,
AAR Rules
 Cross over rate
 Know how to make decisions using
various rules
 Know the weaknesses of the rules
 Understand NPV profile diagrams
 Understand terms: conventional,
unconventional, mutually exclusive etc.

Treasury Bonds
Maturity
Rate Mo/Yr
Bid
5 7/8 Feb 08n
96:17
Asked
96:19
Chg.
-6
Ask
Yld.
6.46
Semi-annual coupon - _____
 Maturity date = ______
 Price you can buy 1 bond = _____
 Price you can sell 1 bond = _____
 YTM based on purchase price = ______

Bond Example 1

Calculate the value of 10-year, 7%
annual coupon bond with a yield of 5.5%

Answer: ______
Bond Example 2

Calculate the value of a 20-year, 8%
semi-annual coupon bond yielding 11%

Answer: ________
Stock Example 1

Bozo corp. will pay a constant $7
dividend for the next seven years after
which it will stop paying dividends
forever. r = 12? What is the current
stock price?

Answer: _______
Stock Example 2
T. Amos Corp. is a young start-up
company. No dividends will be paid for
the next five years. In the 6th year a
dividend of $6 per share will be paid
which will increase at 5% forever
thereafter. r = 23%. What is the stock
price?
 Answer: _____

Stock Example 3

J Osborne Corp just paid a dividend of
$1.50 which will grow at 30% for the
next three years. Thereafter the growth
will fall back to 7%. r = 23%. What is
the current stock price?

Answer: ________
Capital Budgeting
Year
Proj. A
Proj. B
0
-$175,000
-20,000
1
10,000
10,000
2
25,000
5,000
3
25,000
3,000
4
375,000
1,000
5

The projects are mutual exclusive. r = 15%
NPV
NPV (A) = _____
 NPV (B) = _____


Which project to accept?

If they were not mutually exclusive,
which one(s) will you accept?
IRR
IRR (A) = _____
 IRR (B) = _____


Which project to accept?

If they were not mutually exclusive,
which one(s) will you accept?
Profitability Index
PI (A) = _____
 PI (B) = _____


Which project to accept?

If they were not mutually exclusive,
which one(s) will you accept?
Crossover rate

Find the crossover rate of the two
projects

Crossover rate = ______

Roughly draw the NPV profiles, labelling
all points of interest carefully
Unconventional Cash flows
Year
Cash flow
0
-$4,000
1
+25,000
2
-25,000
IRR = ?

r = 25%, 35%, 400%. What is the NPV?
Payback
Payback (A) = _____
 Payback (B) = _____


Which project to accept?

If they were not mutually exclusive,
which one(s) will you accept?
Discounted Payback
Disc. Payback (A) = _____
 Disc. Payback (B) = _____


Which project to accept?

If they were not mutually exclusive,
which one(s) will you accept?
NPV Profiles
Understand
 What is being plotted

 Axes,

IRR, Accept/Reject regions, etc.
How to interpret them
 Unconventional
cash flows
 Mutually exclusive projects
Net Present Value Profile
Net present value
120
Year
100
0
1
2
3
4
80
60
40
Cash flow
– $275
100
100
100
100
NPV>0
20
0
NPV < 0
– 20
– 40
Discount rate
2%
6%
10%
14%
18%
IRR
22%
NPV Profile - Multiple IRR Problem
NPV
$0.06
$0.04
$0.02
IRR = 25%
$0.00
($0.02)
IRR =
33.3%
IRR =
42.8%
($0.04)
IRR =
66.6%
($0.06)
($0.08)
0.2
0.28
0.36
0.44
0.52
Discount rate
0.6
0.68
IRR, NPV, and Mutually Exclusive Projects
Net present value $
160
140
Project A
120
100
80
Project B
60
40
20
NPV A >NPV B
0
– 20
– 40
– 60
NPV B >NPV A
– 80
– 100
0
2%
Crossover rate
6%
10%
16%
IRR A < IRR B
20%
24%
Discount
rate %