Description

Directions:  Answer the following problems IN DETAIL. Your analysis must be typed and should be free of grammatical errors and “slang” terms.” There are no restrictions or requirements on working in groups. The one exception is that each person must hand in his/her OWN work.  In economic terms, there are no input restrictions; however, the output MUST be yours.

1. When looking at current macroeconomic conditions with COVID-19, please list five companies that are especially vulnerable to a recession and five companies that are less vulnerable. Each of the two lists should contain at least three industries.

2. New Jersey-based Johnson & Johnson is one of only two U.S. firms with debt rated as “Aaa” by Moody’s Investor Services and AAA by the Standard & Poor’s Corporation, the highest global credit rating. Given the firm’s cash-debt ratio, its cash per share ratio, and its rising cash flows, would you advise the firm to raise additional capital by issuing more debt given the 30-year U.S. Treasury bond rate at under 2%, a record low, as displayed within the current term structure of the U.S. Treasury yield curve?

3. After considerable negotiation with its owners, you have purchased a home for $525, 000. After a 20 percent down payment, you finance the remainder under a twenty-year mortgage at the annual percentage rate (APR) of 3.44%).

a. What are your monthly payments? Show ALL your work, including your use of the formula.

b. Over time, what is the total cost of the home?  After the second monthly payment, what is the total amount that you owe each in interest and principal? (Note: The q“total” amount is the total amount of the loan split into the total amount of interest and the total amount of principal.)  Show ALL your work, including your use of the formulas.  (Note:  In the intermediate steps of your calculations, take the decimal point to four places.  At the final calculation, round off to two places.)

4. Practically speaking, why bother with a zero-coupon bond – a fixed-income security that does not explicitly pay interest – when you can receive periodic interest payments from a coupon bond?

5. Demonstrate that you understand the difference among coupon yield, current yield, and yield to maturity with the following illustration for Morgan Stanley debt, par value of $1000: current price of $1011, coupon rate of 3.7%, issue date of September 15, 2012, settlement date of September 25, 2012, and maturity date of December 1, 2020. To solve for the yield to maturity, please use the yield formula (i.e., “Yield Example”) provided on Blackboard). Please follow it EXACTLY, noting that bond pricing is conventionally expressed in hundreds, not thousands).

6. What is the maximum price that you would pay up for a series of A-rated

corporate bonds each with a face value of $1000, that promise to pay 33 more semi-annual coupons of $18.50 each at a yield to maturity of 3.53%? Please show how you arrive at your result. (This is a test to see if you understand the inverse relationship between interest rates and bond prices.)

7. You are provided with the following monthly expected returns, each of which is represented by E(Ri), and betas for the following stocks. Please estimate the capital asset pricing model and draw conclusions about the significance and realism of the results.  (Note: Please use conventional tests of the R-squared and coefficients.) On the basis of your results, please name at least three of the stocks that you would recommend as “buys.”

Symbols: Alcoa (AA), American Express (AXP), AT&T (T), Boeing (BA), Citigroup (C), Caterpillar (CAT), Coca Cola (KO), Consolidated Edison (ED). Disney (DIS), Dupont (DD), Consolidated Edison (ED), Exxon Mobil (XOM), General Electric (GE), General Motors (GM), Hewlett-Packard (HPQ), Home Depot (HD), Honeywell (HON), Intel (INTC), International Business Machines (IBM), International Paper (IP), Johnson and Johnson (JNJ), McDonalds (MCD), Microsoft (MSFT), 3M (MMM), J.P. Morgan Chase (JPM), Procter and Gamble (PG), Dominion Energy (D), United Technologies (UTX), Wal-Mart (WMT), and Wells Fargo (WFC)

8.

a. According to the CFO of Kansas City Southern (KSU), the railroad spent $175 million by to rebuild 83 miles of an abandoned rail line previously owned by Union Pacific to provide the railroad with ready access to growing markets in Mexico. The railroad predicts a free cash flow of $24 million per year from the project. From the standpoint of net present value, do you think this is a good investment? To begin, the company’s WACC was 8.71% from 2009 through 2017. You will need its WACC for 2018, 2019, and 2020. To guide your analysis, please see the railroad’s Value Line summary page on Blackboard under “KSU 2020,” which includes KSU’s (financial) capital structure and estimated beta. The company’s bond rating is “BBB,” as assessed by the Standard & Poor’s Corporation, with an interest rate of 4.4%. For ease of estimation, assume a corporate tax rate of 21%. Please show all your work. (Hint: To estimate the WACC, you will need the cost of equity from the estimates of the capital asset pricing model in problem 7. Because the KSU data are annual but the CAPM data are monthly, you will have to annualize the CAPM estimates before estimating KSU’s cost of equity.)

b. In what year does the internal rate of return exceed the WACC? What do you conclude by comparing the internal rate of return to a less formal means of estimating the cost of capital, such as the current interest rate on the bonds plus three percentage points? What do you conclude about the profitability of the project now? Please show your work.

9. In the world of stock selections, it is common to find statements such as “Automatic Data Processing gets an upgrade from a ‘hold to a buy’ at J.P. Morgan Chase, with a target price of $190,” and “Apple is downgraded from a ‘buy” to a hold’ at Goldman Sachs, with a target price of $280.” In terms of the rapidity and breadth with which financial markets incorporate new information, should any of us believe these recommendations are valuable; that is, will investments in these stocks lead to superior gains? Please be precise and thorough. (Note: Your answer cannot be a simple opinion. There is a definite and factual answer.)