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# Problem 25 from chapter 5 Valuing Bonds The Morgan Corporation has two different bonds currently outstanding.

. Bond M has a face value of \$20,000 and matures in 20 years. The bond makes no payments for the first six years, then pays \$800 every six months over the subsequent eight years, and finally pays \$1,000 every six months over the last six years. Bond N also has a face value of \$20,000 and a maturity of 20 year; it makes no coupon payments over the life of the bond. If the required return on both these bond is 8 percent compounded semiannually, what is the current price of Bond M? Of Bond N? Answer: Bond M: Face Value: \$20,000Year to Maturity: 20 years Amount of first round interest payment: 800 Years to first round of interest payments: 6 Amount of Second round: 1000 Years to second round of interest payments: 14 Bond N: Face Value: \$ 20,000 Years to Maturity: 20 Required return on both Bond: 8% Bond M has three terms. No payment for first 6 years, Pays \$800 every six months for eight years, and pays \$1000 every six months for six years.

The price of any bond ( or financial instrument) is the PV of the future cash flows. Even though bond M makes different coupons payments, to find the price of the bond, we just find the PV of the cash flows. The PV of the cash flows for bond M is: Present value of first round: C=800 r= 4% t = 16 periods Step I:

\$800(PVIFA4%,16)(PVIF4%,12)= =5,822.35 \$1000(PVIFA4%,12)(PVIF4%,28) =3,129.71 \$20,000 (PVIF4%,40) = 4,165.78 PM = \$800(PVIFA4%,16)(PVIF4%,12) + \$1000(PVIFA4%,12)(PVIF4%,28) + \$20,000 (PVIF4%,40) PM = \$ 13,117.88 Notice that for the coupon payments of \$800, we found the PVA for the coupon payments, and then discounted the lump sum back today. Bond N is a zero coupon bond with a \$20,000 par value; therefore, the price of the bond is the PV of the par, or: PN = \$20,000 (PVIF4%,40) = \$4,165.78

= 4,165.78

\$20,000 (PVIF4%,40)

## Problem 31 from chapter 6

Stock Valuation Most corporations pay quarterly dividends on their common stock rather than annual dividends. Barring any unusual circumstances during the year, the board raises, lowers, or maintains the current dividend once a year and then pays this dividend out in equal quarterly installments to its shareholders. a. Suppose a company currently pays a \$2.80 annual dividend on its common stock in a single annual installment, and management plans on raising this dividend by 5 percent per year, indefinitely. If the required return on this stock is 13 percent, what is the current share price? Po=D (1+g) /(R-g) = 2.80 (1+0.05) / (0.13-0.05) =\$2.80 x 1.05 /0.07= \$ 36.75 b. Now suppose that the company in (a) actually pays its annual dividend in equal quarterly installments; thus, this company has just paid a \$.70 dividend per share, as it has for the previous three quarters. What is your value for the current share price now? (Hint: Find the equivalent annual end-of year dividend for each year.) Comment on whether or not you think that this model of stock valuation is appropriate.