Name: ___________________________________

NetID: _______________________

HADM 2250 Prelim II

Prof. Andrey D. Ukhov
Thursday, 18 Oct 2012
In Class.
Name (please print):

___________________________________

Cornell ID:

___________________________________

NetID:

_____________

Instructions:
- Print your name and ID on all pages.
- Close book, close notes.
- One or multiple financial calculators and non-financial calculators are allowed.
- You have exactly 75 minutes for the exam.
-

Total 16 questions, 32 points, and 7 pages (including the cover and 2 formula
pages).

Make sure that no page is missing in your exam.

When working on questions,
o For problem solving: show your work to earn partial credits; write your final
answers in the box below each question.
o For short answer questions: do not exceed the number of words specified.
The questions are NOT presented in the order of difficulty.
Allocate your time wisely.

By signing below you agree to the University rules on exams. Any violation of academic
integrity will result in serious penalty.

(Signature)
Tests without a signature will be discarded.
Good Luck!

Prof. Andrey D. Ukhov, HADM 2250 Fall 2012, Prelim II

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Name: ___________________________________

NetID: _______________________

Please double-check your answers before submitting the exam. No partial credit is possible
in multiple-choice questions.

For instructors use only

Score
Q01 6
Q7 10
Total

Prof. Andrey D. Ukhov, HADM 2250 Fall 2012, Prelim II

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Name: ___________________________________

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1. [2 points] What is the duration of a zero-coupon bond that matures18.5 years from now?
Duration equals maturity and equals 18.5 years.

2. [4 points] What is the duration of a bond with 2 years to maturity, with coupon rate of 18%,
semi-annual coupons, when APR is 10%?

Time (years) ,
t=
0.5
1.0
1.5
2.0

Payment
$
90.00
$
90.00
$
90.00
$
1,090.00
SUM =

Present Value of
Payment
85.71428571

Weight (w) = PV /
Total
0.07506694

81.63265306

0.071492323

77.74538387

0.068087927

896.7456975

0.78535281

1141.83802

1.00
Duration =

w*t
0.03753
3
0.07149
2
0.10213
2
1.57070
6

1.78186
3

3. [2 points] The APR (y) is 10%, your bond is worth 964.5405. Let interest rate increase by
0.5%. After this increase your bond price becomes 956.2751. What is the duration of your
bond?

Use
P D y
=
P
1+ y
P=956.2751964.5405, y=0.5 =0.005 .

And solve for D. D = 1.88523

Prof. Andrey D. Ukhov, HADM 2250 Fall 2012, Prelim II

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Name: ___________________________________

NetID: _______________________

4. [2 points] You have two bonds. Bond ONE has: maturity of 2 years, coupon rate of 12%,
semi-annual coupons, APR is 10%. Bond TWO has: maturity of 2 years, coupon rate of
15%, semi-annual coupons, APR is 10%. Which of the two bonds (ONE or TWO) has
longer duration? Briefly explain why.
The bond with lower coupon rate, all else equals, has longer duration, because you wait
longer for your money.
5. [5 Points] Exotic Dining Co. is experiencing rapid growth. The company expects dividends
to grow at 20 percent per year for the next seven years (last dividend from the first stage is
D7) before leveling off at 7 percent into perpetuity. The discount rate on the companys
stock is 21 percent. The company has just paid $1.50 per share dividend (D0 = $1.50). What
is its stock price at t = 0?
$20.9756
Standard two-stage valuation problem.
At t = 0 value of cash flows in stage 1 is given by the growing annuity:
g1 = 0.2, r = 0.21, t = 7
D1 = D0*(1+g1) = $1.50*(1 + 0.2) = $1.80
Stage 1 Value = [ $1.80 / (0.21 0.2) ]*[ 1 (1.2 / 1.21)^7 ] = $180 * [ 1 0.9436 ] = $10.1586
The first cash flow in 2nd stage is D8, D8 = D7*(1 + g2),
D7 = D1*(1+g1)^6 = $1.80*(1 + 0.2)^6 = $5.3748
D8 = D7* (1 + g2) = $5.3748*(1 + 0.07 ) = $5.751
Value at time t=7 is: P7 = D8 / (r g2) = $5.751 / (0.21 0.07) = $41.079
Value at t = 0 of the second stage is: P0 = P7 / ( 1 + 0.21)^7 = $10.817
Total Value = $10.1586 + $10.817 = $20.9756
6. [5 Points] You are buying a gold mine. In the first stage you will have access to rich ore. Your
profits in year one will equal $1 million and will grow at 10% per year. You will have 11 years in
this stage (last year in this stage is year 11 and the last payment in this stage is payment number
11).
Then the second stage begins. In years 12, 13, and 14 you receive zero cash flows (but growth at
the second-stage growth rate of 5% per year begins after the payment number 11). In year 15 you
receive a payment D15. The second stage growth rate is 5% per year and starting with payment
D15 you receive infinitely many growing payments. If the discount rate is 25% (APR), find the
value of this business t time zero (at t=0).
This is a two-stage growth problem, but the second stage is deferred.
At t=1 the value of 1st stage is given by the growing annuity:
Stage1Value = $1.00 / (0.25 0.1)*[ 1 (1.1 / 1.25)^11 ]
Stage two: D11 = D1* (1 + 0.25)^10
D15 = D11*(1+g2)^4 = D11*(1 + 0.05)^4
At t=14 perpetuity valuation gives: P14 = D15 / ( 0.25 0.05)
At t=0 the value of the second stage is: P0 = P14 / (1 + 0.25)^14
Company value = FirstStage + Second Stage
Prof. Andrey D. Ukhov, HADM 2250 Fall 2012, Prelim II
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Name: ___________________________________

NetID: _______________________

Problems (4 questions, 3 points each)

7. Jack & Jen Corp. is experiencing rapid growth. Dividends are expected to grow at 35
percent and 25 percent per year for the next two years, respectively and then 6 percent per
year indefinitely. The required return on this stock is 13 percent, and the stock currently
(t=0) sells for $75.00 per share. What is the projected dividend for the coming year (t=1
dividend)? (Draw the timeline and solve for D1)

Solution: timeline and cash flows.

D1/1.13 + 1.25D1/(.13-.06)/1.13=75 D1=4.49.
8. RTF, Inc. common stock sells for $25 a share and pays an annual dividend that increases
by 3.8 percent annually, perpetually. The market rate of return on this stock is 8.2 percent.
What is the amount of the last dividend paid? (Timeline and you are solving for D0, not for
D1)

Solution:
Constant dividend model with P0=25, g=3.8% and R=8.2%, we need D0. From P0=D0(1+g)/(R-g)
we have D0=25*(8.2% - 3.8%)/1.038=1.10/1.038=1.0597 or 1.06.
9. CHC Travel pays no dividend at the present time. The company plans to start paying an
annual dividend in the amount of $0.30 a share for three years commencing three years
from today. After that time, the company plans on paying a constant $2 a share dividend
indefinitely. How much are you willing to pay to buy a share of this stock if your required
return is 14.5 percent? (Time line and carefully label cash flows, then discount.)

Solution: timeline and cash flows.

Nonconstant dividend growth model. P5=2/.145=13.7931.
P0=.3/1.145^3+.3/1.145^4+(.3+13.7931)/1.145^5=7.5355 or $7.54.
10. Gordon Growth Company is expected to pay a dividend of $5 next period and dividends are
expected to grow at 7.5% per year. The required return is 17.5%. What is the price
expected to be in year 5?
P5 = D6/(r g)
D6 = D1*(1+g)^5 = $5*(1+0.075)^5

Prof. Andrey D. Ukhov, HADM 2250 Fall 2012, Prelim II

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Name: ___________________________________

Prof. Andrey D. Ukhov, HADM 2250 Fall 2012, Prelim II

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NetID: _______________________

Name: ___________________________________

NetID: _______________________

Formula sheet:

Chapter 5:
FV = PV (1+ r)T;

PV = FV / (1+ r)T ;

T = ln(FV/PV) / ln(1+ r) ;

r = (FV / PV)1/T 1

Chapter 6:
Annuity PV = C [1 1/(1 + r)T] / r ; Annuity FV= C [(1 + r)T 1] / r ;
Annuity T = ln (1 PV*r/C) / ln(1+r)
Annuity due value = ordinary annuity value * (1 + r);
Growing annuity PV = C {1 [(1 + g) / (1 + r)]T} / (r g)
PV of a perpetuity = C / r;
Growing perpetuity PV = C / (r g);
Chapter 7:
Bond value = C [1 1/(1 + r)T] / r + F / (1+r)T ;
FORMULA SHEET

DCF Analysis

FV
)
FV
PV
FV 1/ T
T
FV =PV ( 1+r ) ; PV =
;
T
=
;
r
=(
) 1.
PV
ln ( 1+r )
(1+ r)T
ln (

Single cash flow:

Multiple cash flows:

Annuity:

PV =C

1+ g
1
1+ r
PV =C
r g

( )

1
(1+r )T
(1+r )T 1
; FV =C
r
r

; Growing annuity

Annuity due value = ordinary annuity value * (1 + r).

Perpetuity:

PV =

C
; Growing perpetuity:
r

PV =

C
.
rg

Stock Valuation
Constant growth model:

P 0=

D1
D
; R= 1 + g ; Dt +1=D t ( 1+ g ) .
Rg
P0

Non-constant growth model:

P 0=

D1

D2
Dt
Pt
Dt+1
+
+
+
+
,
w
h
ere
P
=
.
t
Rg
(1+ R)1 (1+ R)2
(1+ R)t (1+ R)t

Two-stage growth model:

[ ( )]

D1
1+ g1
P 0=
1
Rg1
1+ R

Pt
t

(1+ R)

, w h ere P t=

Dt +1
.
Rg 2

Duration:

Prof. Andrey D. Ukhov, HADM 2250 Fall 2012, Prelim II

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Name: ___________________________________

NetID: _______________________

PV ( C 1 )
PV ( C 2)
PV ( C t )
PV ( C T )
1+
2+ +
t ++
T
P
P
P
P
Where P=PV ( C1 ) + PV ( C2 ) + + PV ( C T )
D=

Duration and changes in interest rates and changes in bond prices:

P D y
=
P
1+ y

Prof. Andrey D. Ukhov, HADM 2250 Fall 2012, Prelim II

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