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Text Problem Sets Gianeris Rivera-Marquez FIN 571 May 30, 2011 Prof. Walter A. Foggie

25. what is the current market value of a share of RHM stock if the required return on RHM common stock is 10%? Current market value = D1/(Required return – growth rate) = 5. The preferred dividends is now growing.4%.42241= 422.90| So the fair value of bond = 474.42241 PV = $1000*0.000 face value bond has a remaining maturity of 10 years and a required return of 9%.31 A10. What is the fair value of this bond? Calculating PV factor: i= required return = 9% = 0.90+422. The bond’s coupon rate is 7. (Required return for a preferred stock) James River $3.4176 So.38 preferred is selling for $45.41 = $897. What is the required return on James River preferred stock? Required Return = Dividend/Market Price . (Bond valuation) A $1.1/(1+i)^n) = 6. Cash flow= $1000 PV factor = 1/(1+i)^n = 0.60 next year and its dividends are expected to grow at a rate of 6% per year forever.4176 = 474. (Dividend discount model) Assume RHM is expected to pay a total cash dividend of $5.41 Using Coupon Rate to calculate present value of Annuity Cash flow= $1000 * 7.60/(10%-6%) = $140 A12.INDIVIDUAL ASSIGNMENT Text Problems Sets 2 Chapter 5 A1.09 n= 10 years Using Cash Flow of $1000 to calculate present value. PV = $74*6.4/100 = $74 PV factor = (1/i)*(1. Assuming annual dividend payments.

Interest-rate risk) Philadelphia Electric has many bonds trading on the New York Stock Exchange. what is the fair price of each bond? 1 Year Maturity n=1x2=2 r = 8% / 2 = 4% PV = ? PMT = 9. a.00) = $4. and the third in 15 years.010.00 / 0.(Stock Valuation) Suppose Toyota has nonmaturing (perpetual) preferred stock outstanding that pays a $1.000 PV = -$1.33 B16.38 / $45. one in 7 years.000 / 2 = $45.47% 3 A14.62 FV = $1.00 x 4.25 Required Return = $3. If the yield to maturity for all three bonds is 8%.61 7 Year Maturity .00 Annual Percentage Rate (APR) = 12% Preferred Stock Value (P0) = (D / R) (P0) = ($4.125% but that one issue matures in 1 year.00 quarterly dividend and has a required return of 12% APR (3% per quarterly). What is the stock worth? Perpetual Quarterly Preferred Dividend (D) = $1. Assume that a coupon payment was made yesterday.00 Annual Dividend ($1.12) (P0) = $33. Suppose PhilEl’s bonds have identical coupon rates of 9.INDIVIDUAL ASSIGNMENT Dividend = $3.25 Required Return = 7.125% x 1.38 Market Price = $45.

What is the fair price of each bond now? 1Year Maturity n=1x2=2 r = 7% / 2 = 3.097.000 PV = -$1.42 15 Year Maturity n = 15 x 2 = 30 r = 8% / 2 = 4% PV = ? PMT = 9.000 / 2 = $45.000 PV = -$1.000 / 2 = $45.625 FV = $1.125% x 1.625 FV = $1.125% x 1.18 7 Year Maturity .125% x 1.5% PV = n/a PMT = 9.000 / 2 = $45.27 b.000 PV = -$1.059. Suppose that the yield to maturity for all of these bonds changed instantaneously to 7%.625 FV = $1.INDIVIDUAL ASSIGNMENT 4 n = 7 x 2 = 14 r = 8% / 2 = 4% PV = ? PMT = 9.020.

000 PV = -$1.125% x 1.000 / 2 = $45. this time to 9%.001.42 c.5% PV = n/a PMT = 9.125% x 1.000 / 2 = $45.03 15 Year Maturity n = 15 x 2 = 30 r = 7% / 2 = 3.000 PV = -$1.125% x 1.INDIVIDUAL ASSIGNMENT n = 7 x 2 = 14 r = 7% / 2 = 3.5% PV = n/a PMT = 9.116.17 7 Year Maturity n = 7 x 2 = 14 5 .625 FV = $1. Suppose that the yield to maturity for all of these bonds changed instantaneously again.5% PV = n/a PMT = 9.000 PV = -$1.195.625 FV = $1.625 FV = $1. Now what is the fair price of each bond? 1 Year Maturity n=1x2=2 r = 9% / 2 = 4.000 / 2 = $45.

5% coupon and return of the $1.39 15 Year Maturity n = 15 x 2 = 30 r = 9% / 2 = 4.010.125% x 1.000 PV = -$1. You pay only $500 for the bond.000 Annual Coupon Rate 9.5% PV = n/a PMT = 9. a.00 Future Value (Parvalue of the Bond ) (FV) = -1.INDIVIDUAL ASSIGNMENT 6 r = 9% / 2 = 4.5 years.00 Par Value of the Bond $1. (Default risk) You buy a very risky bond that promises a 9.625 FV = $1.006.5 Present Value of the Bond (PV) =500.18 B18.50% Number of years to Maturity =3.625 FV = $1. After liquidating the firm.000 / 2 = $45.5% PV = n/a PMT = 9.125% x 1.000 PV = -$1. You receive the coupon payments for three years and the bond defaults. What is the realized return on your investment? Calculating Realized Return on Investment Rate: Present Value of the Bond $500.000 principal in 10 years.000 / 2 = $45.000 . the bondholders receive a distribution of $150 per bond at the end of 3.

believes that Medtrans will begin paying a $1. What is the realized return on your investment? Calculating Realized Return on Investment Rate: Present Value of the Bond = $500.00. G. James and Bret agree that the required return for Medtrans is 13%.50%) =-95 Present Value of the Bond (PV) =500.50% Number of years to Maturity =10 Annual Coupon Payment (PMT) ($1000 * 9. an analyst for A. and that it will grow at 4% annually. one of James’ colleagues at the same firm.06) / 0.0.13 .42% B20.00 per share dividend in two years and that the dividend will increase 6% annually thereafter.06) (P2) = $1. (Constant growth model) Medtrans is a profitable firm that is not paying a dividend on its common stock. Bret thinks that Medtrans will begin paying a dividend in four years. James Weber. The firm does far better than expected and bondholders receive all of the promised interest and principal payments.00 Par Value of the Bond = $1.000 Realized Rate of Return on Investment (Rate) =0.00 (1.INDIVIDUAL ASSIGNMENT Realized Return on Investment (Rate) = 37.00 Future Value (or) Parvalue of the Bond (FV) =-1. Edwards. Bret Kimes.000 Annual Coupon Rate = 9. What value would James estimate for this firm? Dividend Paid in 2 years (D2) = $1. a. that the dividend will be $1.2242 Realized Return on Investment (Rate) =22.34% 7 b. is less optimistic.g) (P2) = D2 (1+g) / (0.07 .00 Dividend growth rate (g) = 6% Required Rate of Return (R ) = 13% Medtrans Stock Value (P2) = D3 / (R .

04) / 0. a. Calculate the expected returns on the stock market and on Chicago Gear stock. Stock Market rM = Prob1*rM1 + Prob2*rM2 + Prob3*rM3 + Prob4*rM4 = 0.07 = $15.75%) (25%-15%) + 0.04 / 0.80%.04) (P4) = $1.09 (P4) = $1.14 b.06 / 0.3(15%) + 0.75)(-15-15) + 0.2(-10-9.15(35%) = 15.09 = $11.2(-10%) + 0. Chicago Gear Project rCG = Prob1*rCG1 + Prob2*rCG2 + Prob3*rCG3 + Prob4*rCG4 = 0.3(25%) + 0.35(15%) + 0. 8 .M) = 0.15(25%) = 9.35(10%-9.g) (P4) = D5 (1+g) / (0. What is Chicago Gear’s beta? COV(CG.75%)(15%-15%) + 0.75%. (Beta and required return) The riskless return is currently 6%. b.35(10%) + 0.55 Chapter 7 C1.75%)(35%-15%) = 1.13 .15(25%-9.2(-15%) + 0. and Chicago Gear has estimated the contingent returns given here.3(15%-9. What value would Bret assign to the Medtrans stock? Medtrans Stock Value (P4) = D5 / (R .INDIVIDUAL ASSIGNMENT (P2) = $1.0%.00 (1.0.

INDIVIDUAL ASSIGNMENT VAR(M) = 0.. ..3(15%-9.2(-10%-9.75% . D.75%)2 + 0.2119%.15(25%9.75%)2 + 0. R.49(9. (2007).35(10%-9. Upper Saddle River. Finnerty.80%/1.75%)2 = 1. D.59%. D. J.6%) = 11. Calculate beta CG = 1. What is Chicago Gear’s required return according to the CAPM? rCG = rf + BCG(rM . Corporate Financial Management (3rd ed.2119% = 1. J.).rf) = 6% + 1. & Stowe. c. NJ: Prentice Hall. 9 References Emery.49.75%)2 + 0.

INDIVIDUAL ASSIGNMENT 10 .

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