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Tutor profile: Trenton K.

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Trenton K.
Tutor specializing in how to think about Accounting and Business.
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Questions

Subject: Corporate Finance

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Question:

A firm has approached a ratings agency to propose issuing a bond for financing a future capital intensive project. Unfortunately, the ratings agency assessed the firm's future profitability dimly, assigning this proposed bond a BBB- rating (a "junk" bond). As a result, the firm has to issue a $1,000 Face Value bond at an annual coupon rate of 10% for the next five years. If a mutual fund offers to buy a batch of these bonds at a price that yields them 8%, what price is the firm offering to buy these bonds at?

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Trenton K.
Answer:

First, the student will have to understand how bond price relates to cash flows and interest rates and time periods. Using the formula: \[\textup{Bond Price = } \textup{ Cashflow } \ast \frac{\left ( 1 - \frac{1}{(1+\textup{interest rate})^n} \right )}{\textup{interest rate}}+ \left [\textup{ Maturity Value } * \frac{1}{(1+\textup{interest rate})^n} \right ]\] Then, substituting $1,000 times the 10% annual coupon rate (or $100) for Cashflows, 8% for the interest rate, and 5 for the "n", the Bond Price will eventually solve out to be $1,079.85. Alternatively, the student could use a financial calculator using: $1,000 as FV, $100 for PMT, 8 for I/Y, and 5 for N, then using CPT for PV. Intuitively, this makes sense because we know that bonds with coupon rates higher than the YTM will issue at a PREMIUM (i.e. the mutual fund should pay more than the face value of the bond).

Subject: Finance

TutorMe
Question:

If I have a stock that's issuing a $2 annual dividend, growing in perpetuity at 5%, and my investment firm's discount rate is 10%, what's the maximum I would be willing to pay for a stock?

Inactive
Trenton K.
Answer:

The dividend discount formula is the price of a stock equals the dividend divided by the discount rate less the growth rate. In this case, the formula doesn't need to be rearranged, it would be $2 divided by (10% - 5%) and a reasonable investor would pay a maximum of $40 for the stock.

Subject: Accounting

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Question:

Is revenue from Dividends recorded in the Operating, Investing, or Financing section of the Statement of Cash Flows?

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Trenton K.
Answer:

Dividend revenue trips many students up, because at first blow, many assume dividends come from stocks, which are investments, so it's investing. Also, students commonly associate dividend revenue with dividend payments, which would go in the Financing Section. However, the correct answer is that dividend revenue is a component of the Operating Section of the Statement of Cash Flows, because it is not a Long-Term Asset (Investing) and doesn't involve the financing of a business (Long-Term Debt or Equity), and these stocks are usually sold as a part of the business' usual operations.

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