25. A stock is expected to return 13 percent in an economic an economic boom. 10

Question

25. A stock is expected to return 13 percent in an economic an economic boom. 10 percent in a normal economy, and 3 percent in a Which one of the following wil return on this stock? percent in a recessionary economy 1 lower the overall expected rate of a. An increase in the rate of return in a recessionary economy b. An increase in the probability of an economic boom : A decrease in the probability of a recession occurring A decrease in the probability of an economic boom e. An increase in the rate of return for a normal economy To help finance a major expansion, Dimkott Development Company sold a bond several years ago that now has 20 years to maturity.This annual coupon, paid quarterly, and it now sells at a price of $1.103.58 The bond cannot be called and has a par value of $1,000 IE Dimkoff's tax rate is 40%, what after-tax cost of debt should be used in the calculation? 26. bond has a 7 WACC 3.03 3.03% a. 3.281 668 c. d. e. 3.66% 3.85% 4.04% Your family recently obtained a 30 mortgage. Which of the following statements is most all taxes and transactions costs.) -year (360-month) $100,000 tixed-rate correct? (Ignore 27. a. The remaining balance after three years will be $100,000 less the total amount of interest paid during the first 36 months. b. The proportion of the monthly payment that goes towards repayment of principal will be higher 10 years from now than it will be this year c. The monthly payment on the mortgage wil1 steadily decline over time d. Because it is a fixed rate mortgage, the amount paid in interest per payment is constant e. None of the statements above is correct. 28. Shrives Publishing recently reported $10,750 of sales, $5, 500 of operating costs other than depreciation, and $1,250 of depreciation. The co pany had $3,500 of bonds that carry a 6.25% interest rate, and its income tax rate was 35%. During the year, the firm had expenditures on fixed assets and net working capital that totaled $1,550. These expenditures were necessary for it to sustain operations and generate future sales and cash flows. What was its free cash flow? $1,873 b. $1,972 2,076 c. $2,076 d. $2,185 e. $2,300

Explanation / Answer

25. expected rate of return of the stock = return during boom*probability of boom + return during normal economy*probability of normal economy + return during recession * probability of a recession.

For the sake of assumptions, let the probability of each economic state be = 1/3 = 0.33333

Thus expected return = 13%*0.33333 + 10%*0.33333+3%*0.33333 = 4.33333+3.33333+1 = 8.67%

Now, we will change the rate of recessionary economy to say 5%, return in this case = 13%*0.33333 + 10%*0.33333+5%*0.33333 = 9.33%. The rate has increased.

If the probability of economic boom is increased, the average return will increase as the higher rate in case of an economic boom will get a higher weightage.

Similarly, if the probability of recession decreases then the average return will increase as the lower rate in case of a recession will get a lower weightage.

However, a decrease in the probability of economic boom will reduce the weightage for the higer return. This will pull down the expected return or the average return.

Suppose that the prabability of boom decreases to 0.3 and the balance weight of 0.7 is shared equally between normal economy and recession. The return will be:

0.3*13+0.35*10+0.35*3 = 8.45%. Thus the return has decreased from the earlier 8.67%

Hence the answer is option "d".

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