Q2. Explain how valuing preferred stock with a stated maturity differs from valu
ID: 2794335 • Letter: Q
Question
Q2. Explain how valuing preferred stock with a stated maturity differs from valuing preferred stock with no maturity and calculate the price of a share of preferred stock under both condition
Q3. Describe how distinguishing between variable and fixed costs can be useful in forecasting operating expenses.
Q4. What is the effective annual yield of a bond that promised an annual yield of 7.5% if this bond pays coupons twice a year?
Q5. What is the EAC of two projects: project A, which costs $230 and is expected to last two years, and project B, which costs $300 and is expected to last three years? The cost of capital is 12%. (2 Marks)
Explanation / Answer
5-
present value annuity factor for A
A(t,r) = (1 - (1 / (1 + r) ^ t)) / r
(1-(1/(1.12)^2))/.12
1.690051
present value annuity factor for Y
A(t,r) = (1 - (1 / (1 + r) ^ t)) / r
(1-(1/(1.12)^3))/.12
2.401831
EAC of Machine A
initial investment in machine/present value annuity factor)-after tax cash flow
(230/1.690051)
136.0906
EAC of Machine B
initial investment in machine/present value annuity factor)-after tax cash flow
(300/2.401831)
124.9047
Machine Ashould be choosen as it results in less cost
4-
effective annual yield
(1+r/n)^n -1
1+(7.5%/2)^2 -1
1.076406-1
7.64%
3-
distinguishing between variable costing and fixed costing will be very helpful in forecasting of operating expenses because fixed cost is fixed in nature in short run and does not change while variable cost will varry according to level of production so it will vary with any change in units sold or produced
2-
This difference is due to the treatment, preferred stock with maturity are valued as debentures are value while when maturity is not specified it is treated as case of perpetuity
case of perpetuity
value of preferred stock
preferred dividend/cost of preferred capital
5/10%
50
preferred dividend
5
cost of preferred stock
10%
In case of maturity
value of preferred stock
preferred dividend +(par value-market value)/ years to maturity / (par value+market value)/2
value of preferred stock
50+(1000-1100)/5 / (1000+1100)/2
30/1050
2.86%
5-
present value annuity factor for A
A(t,r) = (1 - (1 / (1 + r) ^ t)) / r
(1-(1/(1.12)^2))/.12
1.690051
present value annuity factor for Y
A(t,r) = (1 - (1 / (1 + r) ^ t)) / r
(1-(1/(1.12)^3))/.12
2.401831
EAC of Machine A
initial investment in machine/present value annuity factor)-after tax cash flow
(230/1.690051)
136.0906
EAC of Machine B
initial investment in machine/present value annuity factor)-after tax cash flow
(300/2.401831)
124.9047
Machine Ashould be choosen as it results in less cost
4-
effective annual yield
(1+r/n)^n -1
1+(7.5%/2)^2 -1
1.076406-1
7.64%
3-
distinguishing between variable costing and fixed costing will be very helpful in forecasting of operating expenses because fixed cost is fixed in nature in short run and does not change while variable cost will varry according to level of production so it will vary with any change in units sold or produced
2-
This difference is due to the treatment, preferred stock with maturity are valued as debentures are value while when maturity is not specified it is treated as case of perpetuity
case of perpetuity
value of preferred stock
preferred dividend/cost of preferred capital
5/10%
50
preferred dividend
5
cost of preferred stock
10%
In case of maturity
value of preferred stock
preferred dividend +(par value-market value)/ years to maturity / (par value+market value)/2
value of preferred stock
50+(1000-1100)/5 / (1000+1100)/2
30/1050
2.86%
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