Formula sheets, the key method steps for every topic and 8 practice problems, with full solutions at the back.
A credit card charges a nominal interest rate of 21% per year, compounded quarterly. Find the effective annual rate EAR in percent.
You save €50 at the end of every month for 29 years. The account pays 5.4% per year, compounded monthly. How much have you saved at the end? Find FV.
A bond with a face value of €1 000 pays an 8% annual coupon in two half-yearly payments and matures in 11 years. The yield to maturity is 4% per year. Find the price P of the bond.
A bond trades at €935 with a yield to maturity of 7% (annual compounding) and a Macaulay duration of 11.1 years. Use the modified duration to estimate the new price P if the yield falls by 75 basis points.
A company has a debt-to-equity ratio (at market values) of 1.5. Its cost of equity is 14%, its pre-tax cost of debt is 3.5% and the tax rate is 30%. Find the WACC.
A company has 5 000 000 shares trading at €36.00; the book value of its equity is €90 000 000. It just paid a dividend of €0.80 per share, and dividends grow by 5% per year. Its debt has a market value of €90 000 000 and a pre-tax cost of 3%. The tax rate is 20%. Find the WACC, using the dividend growth model for the cost of equity.
An investment of €45 000 gives these cash flows at the end of years 1 to 4: €13 000, €16 000, €17 000, €15 000. The cost of capital is 12%. Find the net present value NPV.
A project costs €40 000 and returns €17 000, €15 000, €15 500 at the end of years 1 to 3. Find its internal rate of return IRR in percent.
Answer: EAR = 22.71 %
Time value of money: money today is worth more than the same amount later, because it can earn interest. With interest rate i per period, an amount grows as FV = PV·(1 + i)n. A series of equal payments (an annuity) is valued by adding up each payment, which gives the annuity formulas.
The EAR is always above the nominal rate when interest compounds more than once a year.
Answer: FV = 41896 €
Time value of money: money today is worth more than the same amount later, because it can earn interest. With interest rate i per period, an amount grows as FV = PV·(1 + i)n. A series of equal payments (an annuity) is valued by adding up each payment, which gives the annuity formulas.
You paid in €17 400 yourself; the rest is interest.
Answer: P = 1353 €
Bond pricing: a bond’s price is the present value of its cash flows, discounted at the yield to maturity (YTM): the coupons form an annuity and the face value is paid back at maturity. P = C·(1 − (1 + y)⁻ⁿ)/y + F/(1 + y)ⁿ. When the yield is above the coupon rate the bond trades below face value, and the other way round.
The yield is below the coupon rate, so the bond sells at a premium.
Answer: P = 1008 €
Duration: the Macaulay duration is the weighted average time at which a bond pays its cash flows, with the present values of the cash flows as weights: D = Σ t·PVₜ/P. The modified duration D/(1 + y) estimates the percentage price change for a small change in yield: %ΔP ≈ −Dmod·Δy.
Duration is a linear estimate; for large yield changes convexity makes the true price a little higher.
Answer: WACC = 7.07 %
Cost of capital: CAPM gives the return shareholders require: re = rf + β·(rm − rf). The weighted average cost of capital mixes equity and debt by their market values: WACC = E/V·re + D/V·rd·(1 − T), with V = E + D. Interest is tax-deductible, hence the (1 − T).
Answer: WACC = 5.689 %
Cost of capital: CAPM gives the return shareholders require: re = rf + β·(rm − rf). The weighted average cost of capital mixes equity and debt by their market values: WACC = E/V·re + D/V·rd·(1 − T), with V = E + D. Interest is tax-deductible, hence the (1 − T).
Answer: NPV = 995.3 €
Net present value: discount every cash flow back to today with the required rate of return r, then add them up: NPV = Σ CFₜ/(1 + r)ᵗ. A project with NPV > 0 earns more than r and adds value. The internal rate of return (IRR) is the rate at which NPV = 0.
NPV is positive, so the project earns more than the required return.
Answer: IRR = 9.271 %
Net present value: discount every cash flow back to today with the required rate of return r, then add them up: NPV = Σ CFₜ/(1 + r)ᵗ. A project with NPV > 0 earns more than r and adds value. The internal rate of return (IRR) is the rate at which NPV = 0.
NPV falls as the rate rises, so the IRR lies between a rate with positive NPV and one with negative NPV.
Linear interpolation gives a first estimate; repeating it (or a calculator's IRR function) gives the exact rate.
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