Bond Stock

Fin 3322: Cashman

Bonds & Stocks In-class

1. Harris paid a $3 dividend yesterday. If the firm raises its dividend at 5 percent every year and the appropriate discount rate is 12 percent, what is the price of Harris stock?

P0 = Div1/(r – g)

Div1 = Div0 * 1.05 = 3 * 1.05 = $3.15

P0 = 3.15 / (0.12 - 0.05) = $45

2. Microhard has issued a bond with the following characteristics:

Principal: 1000

Term to maturity: 20 years

Coupon rate: 8 percent

Semiannual payments

Calculate the price of the bond if the annual interest rate is:

a) 8 percent. Is the bond selling at par, discount or premium? Briefly explain.

As the discount rate is equal to the coupon rate the bond is selling at par value.

Price = $1,000

b) 10 percent. Is the bond selling at par, discount or premium? Briefly explain.

As the discount rate is greater than the coupon rate the bond is selling at a discount.

Price = $828.41

3. Pagemaster Enterprises just paid a dividend of $4.50 per share (they pay dividends annually). If Pagemaster’s payout ratio is 65% and their historical ROE is 20%, what will be the dividend at the end of the year?

g = Plowback Ratio * ROE

g = (1 – Payout Ratio) * ROE

g = (1 - 0.65) * 0.20

g = 0.07

Div1 = Div0 * 1.07 = 4.50 * 1.07 = $4.82

4. Company X is expected to pay an end-of-year dividend of $10 per share. After the dividend its stock is expected to sell for $110. If the market capitalization rate is 10%, what is the current stock price?

P0 = (D1 + P1) / (1 + r)

P0 = (10 + 110) / (1.10) = $109.09

5. Company Y does not plow back any earnings and is expected to produce a level dividend stream of $5 a share. If the current stock price is $40, what is the market capitalization rate?

P0 = Div1/(r – g)

40 = 5 / (r – 0) = 5 / r

r = 5 / 40 = 0.125 = 12.5%

6. For a company to have a high P/E ratio it must have either?

a. r is low (investors think the firm is relatively safe)...