Why do lower transaction costs make a market more efficient?

Short Answer Questions: You should be able to answer these in a sentence or two (Limit explanations to half page maximum). Questions are worth 5 points each.

 

  1. Why do lower transaction costs make a market more efficient?

 

  1. If a firm’s ROE is less than the required return, what will happen to net present value of the growth opportunities (NPVGO)?

 

PROBLEMS:

For all problems, show you work and highlight your answer. Numbers in ( ) indicate how many points each item is worth. No credit will be given on problems without supporting work, even if the final answer is correct.  Unless stated otherwise, interest is compounded annually and payments occur at the end of the period.  Face value for bonds is $1000.

 

  1. (10) You have the following financial needs: At the end of year 5, you need $6000; at the end of years 6 and 7, you need $4000 (each year); at the end of year 8, you need $3000. You plan to set aside equal annual payments (at the end of) each year for the next 4 years to provide for your needs.  If the interest rate is 6%, how much do you set aside each year?

 

  1. (5) Faraday issued preferred stock with a $4.80 dividend per year.    If you buy the stock for $60, what is your return?

 

  1. (10) Five years ago, Acme issued 15-year bonds at par.  The bonds have a coupon rate of 7.6% with coupons paid semiannually.  They currently trade at $1151.50 per bond.
  2. a)Find the yield to maturity on the bonds.
  3. b)Acme wants to issue more debt.  They are considering 10-year bonds.  What coupon rate will the new bonds have if the added debt does not change the chance that Acme will default? Explain.

 

  1. (10) Gif Energy expects to have earnings per share (EPS) of $1.14 next year.  They have a retention rate of 26% and their return on equity (ROE) is 15.2%.  If the investors’ required return (cost of capital) is 6.6%, find the current stock price.

 

  1. (10) Hunt Inc. just paid a dividend of $2.60.  They expect dividends to grow at 25% for the next 2 years.  After year 2, the firm will have a retention rate of 20%.  The ROE will remain at 40%. If the required return is 17%, find the current price

 

  1. (10) Calculate the payback and profitability index. The maximum payback period is 2 years and the cost of capital is 12%.

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