# Chapter 5 finance bond and stock valuation

Chapter 5

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1. (Bond valuation) Michael Motors’ bonds have 10 years remaining to maturity.  Interest is paid annually, the bonds have a \$1000 par value and the coupon interest rate is 8 percent.  The bonds have a yield to maturity of 9 percent.  What is the current market price of these bonds?

Use the formula there and calculate by hand, use a financial calculator (like an HP12C or TI BA) or use the excel PV formula.  The excel formula is =PV(rate, number of periods, coupon payment, future value) and the future value is \$1000.

2. (Valuation a preferred stock)  Susie’s Pet Supplies issued preferred stock with a state dividend of 10 percent at par.  Preferred stock of this type currently yields 8 percent and the par value is \$100.  Assume dividends are paid annually.

a) What is the value of Susie’s preferred stock?

b) Suppose interest rate levels rise to the point where the preferred stock now yields 12 percent.  What would  be the value of Susie’s preferred stock?  Hint: Repeat the above steps with 12% instead of 8%.

3. (Constant growth model) Your firm is considering an investment in the common stock of Bob’s Kite Corporation but you need to know what it is worth and what price to pay. Bob’s dividend is expected to be \$1.75 next year.   a) If the growth rate is 5% and the required return is 7%, what should the fair price be?  B) What if the growth rate is only 3%, what should the fair price be?

4. (Bond valuation) Eagle Ventures has a bond issue outstanding with an annual coupon rate of 7 percent and 4 years remaining until maturity.  The par value of the bond is \$1,000.  (a) Determine the current value of the bond if present market conditions justify a 14 percent required rate of return.  Assume the bond pays interest annually.

(b) Using the information above, what should be the current value if the bond had a semi-annual coupon instead of an annual coupon?

(c) Assume an annual coupon but 20 years remaining to maturity.  What is the current value under these conditions?

(d) Using the conditions in (c), what is the bond’s current yield?

5. (Stock valuation) A company in your portfolio, Sears, has a perpetual preferred stock (non-maturing) currently outstanding that pays a \$2.00 quarterly dividend.  With a required return of 12% APR (3% per quarter), can you calculate what the stock is worth?

6. (Interest-rate risk)   Radiologic Technologies has several bond issues on The New York Stock Exchange.   With identical coupon rates of 8.75%, Radiologic Technologies has one issue that matures in 1 year, one in 7 years, and the third in 15 years. A coupon payment was made yesterday. (Set up a spreadsheet or a table to calculate these in an easier manner. Each question a-c below has a 1, 7 and 15 year answer.)

a. If the yield to maturity for all three bonds is 8.15%, what is the fair price of each bond?

b. Suppose that the yield to maturity for all of these bonds changed instantaneously to 7.25%.  What is the fair price of each bond now?

c. Suppose that the yield to maturity for all of these bonds changed instantaneously again, this time to 9.5%. Now what is the fair price of each bond?

d. Given the fair prices at the various yields to maturity, can you assume interest-rate risk the same, higher, or lower for longer- versus shorter-maturity bonds?

7. (Dividend discount model) Celtic Jewelry Designs has experienced recent growth, which is expected to continue at a 6% rate per year forever.  Next year, it plans on paying a total cash dividend of \$8.75 next year increasing by 5.5% per year thereafter. Calculate the current market value of a share of Celtic Jewelry Designs stock – given annual dividend payments – if the required return on Celtic Jewelry Designs common stock is 10.25%.

8. (Stock valuation) What will be the nominal rate of return on a preferred stock with a \$100 par value, a stated dividend of 8 percent of par and a current market price of (a) \$60, (b) \$80 (c) \$100, and (d) \$140?  Hint: The Nominal rate of return(r) is equal to dividend/market price.

9.  (Dividend Per Share Calculation) Simple Moves Corporation just paid a dividend of \$1.50 a share (i.e. D0 = \$1.50).  The dividend is expected to grow at 5 percent a year for the next three years, then 10 percent per year thereafter. What is the expected dividend per share for each of the next five years?

Chapter 7

1. (Beta and required return) You have observed the following returns over time:

 Year Stock X Stock Y Market 2007 14% 13% 12% 2008 19% 7% 10% 2009 -16% -5% -12% 2010 3% 1% 1% 2011 20% 11% 15%

Assume that the risk-free rate is 6 percent and the market risk premium is 5 percent. What are the betas of Stocks X and Y?

1. What are the required rates of return for Stocks X and Y?
2. What is the require rate of return for a portfolio consisting of 80 percent of Stock X and 20 percent of Stock Y?
3. If Stock X’s expected rate of return is 22 percent, is Stock X under or overvalued?