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Exercise Numericals

This document contains 6 numerical problems related to bond and stock valuation. Problem 1 asks the reader to calculate the price per bond for a 10% bond with 3 years remaining and a required annual return of 14%. Problem 2 asks what the price would be if interest on the bond from Problem 1 was paid semiannually instead of annually. Problem 3 asks the reader to calculate the current and future market price of a preferred stock paying 8% annually that has yields of 10% and 12% respectively. Problem 4 asks the reader to calculate the rate of return from buying a stock at $20 that pays a $1 dividend and is then sold for $23. Problem 5 asks the reader to value a stock with growing dividends over several periods

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Sardar Ghayoor Zaheen
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119 views21 pages

Exercise Numericals

This document contains 6 numerical problems related to bond and stock valuation. Problem 1 asks the reader to calculate the price per bond for a 10% bond with 3 years remaining and a required annual return of 14%. Problem 2 asks what the price would be if interest on the bond from Problem 1 was paid semiannually instead of annually. Problem 3 asks the reader to calculate the current and future market price of a preferred stock paying 8% annually that has yields of 10% and 12% respectively. Problem 4 asks the reader to calculate the rate of return from buying a stock at $20 that pays a $1 dividend and is then sold for $23. Problem 5 asks the reader to value a stock with growing dividends over several periods

Uploaded by

Sardar Ghayoor Zaheen
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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chapter4

Exercise numericals
PROBLEM
Gonzalez Electric Company has outstanding a 10 percent bond issue
with a face value of $1,000 per bond and three years to maturity.
Interest is payable annually. The bonds are privately held by Suresafe
Fire Insurance Company. Suresafe wishes to sell the bonds, and is
negotiating with another party. It estimates that, in current market
conditions, the bonds should provide a (nominal annual) return of 14
percent. What price per bond should Suresafe be able to realize on the
sale?
Solution
• End of Discount
• Year Payment Factor (14%) Present Value
•1 $ 100 .877 $ 87.70
•2 100 .769 76.90
•3 1,100 .675 742.50
Price per bond $ 907.10
Problem#2
What would be the price per bond in Problem 1 if interest payments
were made semiannually
Solution
Problem#3
Superior Cement Company has an 8 percent preferred stock issue
outstanding, with each share having a $100 face value. Currently, the
yield is 10 percent. What is the market price per share? If interest rates
in general should rise so that the required return becomes 12 percent,
what will happen to the market price per share
Solution

Current price: P0 = Dp/kp = (.08)($100)/(.10) = $80.00

Later price: P0 = Dp/kp = ($8)/(.12) = $66.67

The price drops by $13.33 (i.e., $80.00 - $66.67).


Problem#4
The stock of the Health Corporation is currently selling for $20 a share
and is expected to pay a $1 dividend at the end of the year. If you
bought the stock now and sold it for $23 after receiving the dividend,
what rate of return would you earn?
Solution
Problem#5
Delphi Products Corporation currently pays a dividend of $2 per share,
and this dividend is expected to grow at a 15 percent annual rate for
three years, and then at a 10 percent rate for the next three years, after
which it is expected to grow at a 5 percent rate forever. What value
would you place on the stock if an 18 percent rate of return was
required?
Solution
Solution
Solution
Problem#6
North Great Timber Company will pay a dividend of $1.50 a share next
year. After this, earnings and dividends are expected to grow at a 9
percent annual rate indefinitely. Investors currently require a rate of
return of 13 percent. The company is considering several business
strategies and wishes to determine the effect of these strategies on the
market price per share of its stock.
a)Continuing the present strategy will result in the expected growth rate and
required rate of return stated above.
b)Expanding timber holdings and sales will increase the expected dividend
growth rate to 11 percent but will increase the risk of the company. As a result,
the rate of return required by investors will increase to 16 percent.
c)Integrating into retail stores will increase the dividend growth rate to 10
percent and increase the required rate of return to 14 percent. From the
standpoint of market price per share, which strategy is best
Solution
a) P0 = D1/(ke - g): ($1.50)/(.13 - .09) = $37.50
b) P0 = D1/(ke - g): ($1.50)/(.16 - .11) = $30.00
c) P0 = D1/(ke - g): ($1.50)/(.14 - .10) = $37.50
Either the present strategy (a) or strategy (c). Both result in
the same market price per share

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