Fin 571 Week 2

Tae Heck

University of Phoenix

Week 2 problem set

FIN 571

Chapter 5 Problems:

A 1; (Bond valuation) A $1,000 face value bond has a remaining maturity of 10 years and a required return of 9%. The bond’s coupon rate is 7.4%. What is the fair value of this bond?

Annual coupon payment=C=1000*7.4%=$74

Required rate of return=r=9%

Number of coupon payments=n=10

Maturity amount=Face Value=M=$1000

Fair Value of a bond = C/r*(1-1/(1+r)^n)+M/(1+r)^n

=74/9%*(1-1/(1+9%)^10)+1000/(1+9%)^10

=$897.32

A 10; (Dividend discount model) Assume RHM is expected to pay a total cash dividend of $5.60 next year and its dividends are expected to grow at a rate of 6% per year forever. Assuming annual dividend payments, what is the current market value of a share of RHM stock if the required return on RHM common stock is 10%?

Expected dividend next year=D1=$5.60

Growth rate=g=6%

Required rate of return=r=10%

Price of stock=D1/(r-g)

=5.60/(10%-6%)

=$140

A 12; Required return for a preferred stock) James River $3.38 preferred is selling for $45.25. The preferred dividend is non growing. What is the required return on James River preferred stock?

Current Price of stock=Po=$45.25

Constant Preferred dividend=D=$3.38

Required rate of return=r=D/Po

=3.38/45.25

=7.47%

A 14; Stock valuation) Suppose Toyota has non maturing (perpetual) preferred stock outstanding that pays a $1.00 quarterly dividend and has a required return of 12% APR (3% per quarter). What is the stock worth?

Quarterly dividend=D=$1.00

Required rate of return=r=3% per quarter

Value of stock=Po=D/r=1/3%=$33.33

B 16; (Interest-rate risk) Philadelphia Electric has many bonds trading on the New York Stock Exchange. Suppose Phil El’s bonds have identical coupon rates of 9.125% but that one issue matures...