FIN/571 WK2 Problems A1.

(Bond Valuation) A $1000 face value bond has a remaining maturity of 10 years and a required return of 9%. The bonds coupon rate is 7.4%. What is the fair value/present value of this bond? A1. N= 10x2 r=9%/2 PMT=7.4% x 1,000/2= 37 FV=1,000 PV= -$895

A10. (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% A10 P0= D1/(r-g) = 5.60/ (.10 - .6) = $140

A12. (Req. Return for a preferred stock) James River $3.38 preferred is selling for $45.25. The preferred dividend is nongrowing. What is the req. return on James River preferred stock? A12. PV perpetuity= D/r=D/PV=$3.38/$45.25= 7.47%

A14 (Stock valuation) Suppose Toyota has nonmaturing (perpetual) preferred stock outstanding that pays a $1 quarterly dividend and has a required return of 12% APR(3% per qtr) A14 PV perpetuity = D/r = $1/.03=$33.33 B18. (Default risk) You buy a very risky bond that promises a 9.5% coupon and return of the $1,000 principal in 10 years. You pay only $500 for the bond. 1. You receive the coupon payments for three years and the bond defaults. After liquidating the firm, the bondholders receive a distribution of $150 per bond at the end of 3.5 years. What is the realized return on your investment? a. 3.5x 2=7 PV=$500 PMT= 9.5% x 1,000/2= $47.50 FV=$150 - $47.50 = $102.50 R= -2.874% b. 10x 2= 20 PV=$500 PMT= 9.5% x 1,000/2 = $47.50 FV=$1000 r= 11.048% APY= (1 + r)m 1= (1+ 11.048%)2 1= 23.318% YTM= 2 x 11.048 = 22.097% APR

C1. (Beta and required return) The riskless return is currently 6%, and Chicago Gear has estimated the contingent returns given here. 1. Calculate the expected returns on the stock market and on Chicago Gear stock. N=1x2=2 r=7%/2=3.5% PMT=9.12% X 1000/2=$46.62 FV=$1000 PV= - $1001.17 2. What is Chicago Gears beta? N= 7 X 2= 14 r=7%/2=3.5% PMT=9.12% X 1000/2=$46.62 FV=$1000 PV= -$1006.39 3. What is Chicago Gears required return according to the CAPM? N= 15 X 2 = 30 r=7%/2=3.5% PMT=9.12% X 1000/2=$46.62 FV=$1000 PV= -$1010.18