For the final exam you will be expected to make computations and/or present analysis/recommendations related to some, or all, of the following concepts:
You wish to retire in 14 years, at which time you want to have accumulated enough money to receive an annual annuity of $17,000 for 19 years after retirement. During the period before retirement you can earn 8 percent annually, while after retirement you can earn 10 percent on your money.
What annual contributions to the retirement fund will allow you to receive the $17,000 annuity?
Start making contributions today of $5,872.56
See Excel file for calculations
Review Risk-Return Workbook
Total return in $ = (Current price – Purchase price) + SUM of dividends received
Total return in % = Total return in $/Purchase price
Average return = arithmetic average (AVERAGE) of all the individual year returns
Geomean return = [(1 + r1)* (1 + r2)* (1 + r2)*… (1 + rn)]1/n – 1
On Excel first find the 1+return column, then use =GEOMEAN(range of 1+returns) – 1
Portfolio return = (W*r1 + W*r2+…W*rn), where W = weight of security in portfolio
For Caterpillar Inc. calculate their WACC based on 2019 financial data provided.
Additional data needed:
Market price of equity = $202.82
Caterpillar beta = 0.95
YTM of 30-yr Treasuries = 2.08%
YTM of other 30-yr A-rated bonds = 4.01%
Rm = 11.5%
Ke by CAPM = Rf + (Rm-Rf)B = 2.08% + (11.5% – 2.08%)0.95 = 11.03%
Ke by DVM = D0(1+g)/P0 + g = [3.95(1+0.0722)/202.82] + 0.0722 = 9.31%
g = 7.22%, D0 = 3.95, P0 = 202.82
Overall Ke = (11.03 + 9.31)/2 = 0.1017 or 10.17%
After-tax Kd = YTM(1-tax rate) = 4.01%(1-0.224) = 3.11%
Weight of equity/Total capital structure = (# shares outstanding * market price)/D + E =
Numerator = 561,600,000 * 202.82 = $113,903,700,000
Market value of debt = # of bonds outstanding * price of bond = 26,281,000 * 1413.15 = 37,137,580,000
Total value of capital structure = $113,903,700,000 + $37,137,580,000 = 113,904 + 37,138 = 151,042
WACC = 37,138/151,042*.0311 + 113,904/151,042 * .1017
WACC = 0.2459 * 0.0311 + 0.7541 * 0.1017 = 8.43%
Sample Problem: Caterpillar is considering two projects. Cash flows are provided below. Use WACC calculated above as the discount rate. Reinvestment rate is 3.75%.
Dollar values are in millions
|Year||Project A||Project B|
|0||$ -13,000||$ -20,000|
|Technique||Project A||Project B|
|3.17 years||2.5 years|
**See Excel for calculations**
Based on Caterpillar’s data, what type of dividend policy do they appear to be following?
Residual Theory while trying to steadily increase dollar amount of dividend.
What is Caterpillar’s dividend payout ratio?
Dividend per share/EPS = $3.95/$10.85 = 36.41%
What is Caterpillar’s dividend yield (use current market price and last declared dividend)
$3.95/$202.82 = 1.95%
Caterpillar needs to raise the $13,000,000,000 above. The finance team is creating a proposal with three different means.
What is the value of one right? R = (Me – S)/N = ($202.82 – $125.00)/3 = $25.94
What is the current market value of these bonds? $1,413.15
* Assume same YTM on similar A-rated bonds as above.
What is the conversion value of one bond? Stock price * Conversion ratio = $202.82 * 3 = $608.46
All your analysis is within the goal of the financial manager constrained by the three underlying rules of finance.
Goal of the financial manager – build long-term shareholder wealth while looking out for your stakeholders.
Underlying Rules of Finance –
1. Higher the risk, higher the required rate of return and vice versa.
2. For a given level of risk, select the option with the highest return.
3. A dollar today is worth more than a dollar sometime in the future.
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