• Author / Uploaded
• Muhammad Awais

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Problems 1. 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? 2. What would be the price per bond in Problem 1 if interest payments were made semiannually? 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? 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? 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? 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? 7. A share of preferred stock for the Buford Pusser Baseball Bat Company just sold for $100 and carries an $8 annual dividend. a. What is the yield on this stock? b. Now assume that this stock has a call price of $110 in five years, when the company intends to call the issue. (Note: The preferred stock in this case should not be treated as a perpetual – it will be bought back in five years for $110.) What is this preferred stock’s yield to call? 8. Wayne’s Steaks, Inc., has a 9 percent, noncallable, $100-par-value preferred stock issue outstanding. On January 1 the market price per share is $73. Dividends are paid annually on December 31. If you require a 12 percent annual return on this investment, what is this stock’s intrinsic value to you (on a per share basis) on January 1? 9. The 9-percent-coupon-rate bonds of the Melbourne Mining Company have exactly 15 years remaining to maturity. The current market value of one of these $1,000-parvalue bonds is $700. Interest is paid semiannually. Melanie Gibson places a nominal annual required rate of return of 14 percent on these bonds. What dollar intrinsic value should Melanie place on one of these bonds (assuming semiannual discounting)? 10. Just today, Fawlty Foods, Inc.’s common stock paid a $1.40 annual dividend per share and had a closing price of $21. Assume that the market’s

required return, or capitalization rate, for this investment is 12 percent and that dividends are expected to grow at a constant rate forever. a. Calculate the implied growth rate in dividends. b. What is the expected dividend yield? c. What is the expected capital gains yield? 11. The Great Northern Specific Railway has non-callable, perpetual bonds outstanding. When originally issued, the perpetual bonds sold for $955 per bond; today (January 1) their current market price is $1,120 per bond. The company pays a semiannual interest payment of $45 per bond on June 30 and December 31 each year. a. As of today (January 1), what is the implied semiannual yield on these bonds? b. Using your answer to Part (a), what is the (nominal annual) yield on these bonds? The (effective annual) yield on these bonds? 12. Assume that everything stated in Problem 11 remains the same except that the bonds are not perpetual. Instead, they have a $1,000 par value and mature in 10 years. a. Determine the implied semiannual yield to maturity (YTM) on these bonds. (Tip: If all you have to work with are present value tables, you can still determine an approximation of the semiannual YTM by making use of a trial-and-error procedure coupled with interpolation. In fact, the answer to Problem 11, Part (a) – rounded to the nearest percent – gives you a good starting point for a trial-and-error approach.) b. Using your answer to Part (a), what is the (nominal annual) YTM on these bonds? The (effective annual) YTM on these bonds? 13. Red Frog Brewery has $1,000-par-value bonds outstanding with the following characteristics: currently selling at par; 5 years until final maturity; and a 9 percent coupon rate (with interest paid semiannually). Interestingly, Old Chicago Brewery has a very similar bond issue outstanding. In fact, every

bond feature is the same as for the Red Frog bonds, except that Old Chicago’s bonds mature in exactly 15 years. Now, assume that the market’s nominal annual required rate of return for both bond issues suddenly fell from 9 percent to 8 percent. a. Which brewery’s bonds would show the greatest price change? Why? b. At the market’s new, lower required rate of return for these bonds, determine the per bond price for each brewery’s bonds. Which bond’s price increased the most, and by how much? 14. Burp-Cola Company just finished making an annual dividend payment of $2 per share on its common stock. Its common stock dividend has been growing at an annual rate of 10 percent. Kelly Scott requires a 16 percent annual return on this stock. What intrinsic value should Kelly place on one share of Burp-Cola common stock under the following three situations? a. Dividends are expected to continue growing at a constant 10 percent annual rate. b. The annual dividend growth rate is expected to decrease to 9 percent and to remain constant at that level. c. The annual dividend growth rate is expected to increase to 11 percent and to remain constant at the level.