Group8 Chapter 7 8 Exercises

AIMST UNIVERSITY
FACULTY OF BUSINESS AND MANAGEMENT

PRINCIPLES OF CORPORATE FINANCE
CHAPTER EXERCISES
Chapter 7: Interest Rates and Bond Valuation
1. Madura Corporation has 9 percent coupon bonds on the market that have 8 years left to
maturity. The bonds make annual payments. If the YTM on these bonds is 7 percent, what
is the current bond price?
1−1 /(1+r )
t
FV
BV= C [ r ] +
(1+r )
t
1−1 /(1+0.07)
8
1000
= (0.09 × 1000) [ 0.07 ] +
(1+0.07)8
= 90(5.9713) + (582.01)
= RM 1119.427
2. The Permai Timber Wordrobe Co. has 8 percent coupon bonds on the market with nine
years left to maturity. The bonds make annual payments. If the bond currently sells for
RM1047.50, what is its YTM?
YTM = C + (F – P / N) / (F + P / 2 )
= 80 + [(1000 – 1047.50) / 9 ] / [ (1000 + 1047.50) / 2 ]
= 74.7222/1023.75
= 7.3%
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3. If Treasury bills are currently paying 8 percent and the inflation rate is 4.7 percent,
what is the approximate real rate of interest? The exact real rate?
Approximate real rate of interest = Nominal interest rate – inflation rate

= 0.08 – 0.047
= 0.033
= 3.3%
Real interest rate = [(1+ Nominal Interest Rate) / (1 + Inflation Rate)] – 1
= [(1+ 0.08) / (1 + 0.04) ] – 1
= 0.0315
= 3.15%
4. Bond J is a 4 percent coupon bond. Bond S is a 10 percent coupon bond. Both bonds
have eight years to maturity, make semiannual payments, and have a YTM of 7 percent.
If interest rates suddenly rise by 2 percent, what is the percentage price change of these
bonds? What if rates suddenly fall by 2 percent instead? What does this problem tell you
about the interest rate risk of lower-coupon bonds?
1−1 /(1+r )t FV
BV = C [ r ] +
(1+r )t
(0.04 × 1000) 1−1/(1+0.07 /2)

8 ×2
1000
=
2 [
0.07/ 2 ] +
(1+0.07 /2 )8 ×2
= RM 818.59
Rise by 2%
1−1 /(1+r )t FV
BV = C [ r ] +
(1+r )t
(40) 1−1/(1+0.09/ 2)
8 ×2
1000
=
2 [ 0.09/2 ] +
(1+0.09 /2 )8× 2
= RM 719.15
RM 818.59 – RM 719.15
= RM 99.44 / RM 818.59
= 12.15%
Fall by 2%
1−1 /(1+r )t FV
BV = C [ r ] +
(1+r )t
(40) 1−1/(1+0.05/ 2)
8 ×2
1000
=
2 [ 0.05/ 2 ] +
(1+0.05 /2 )8 ×2
= RM 934.72
RM 818.59 – RM 934.72
= RM -116.13 / RM 818.59
= -14.19%
Bond S
1−1 /(1+r )t FV
BV = C [ r ] +
(1+r )t
(100) 1−1/(1+ 0.07/2)

8×2
1000
=
2 [ 0.07 /2 ] +
(1+0.07 /2 )8 ×2
Rise by 2%
1−1 /(1+r )t FV
BV = C [ r ] +
(1+r )t
(100) 1−1/(1+ 0.09/ 2)

8×2
1000
=
2 [ 0.09/ 2 ] +
(1+0.09 /2 )8× 2
= RM 1056.17
RM 1181.41 – RM 1056.17
= RM 125.24 / RM 1181.41
= 10.60%
Fall by 2%
1−1 /(1+r )t FV
BV = C [ r ] +
(1+r )t
(100) 1−1/(1+ 0.05/2)

8×2
1000
=
2 [ 0.05/ 2 ] +
(1+0.05 /2 )8 ×2
= RM 1326.38
RM 1181.41 – RM 1326.38
= RM -144.97 / RM 1181.41
= -12.27%
Chapter 8: Stock Valuation
1. You are interested in buying stock in Premier Corporation. You believe that dividends
will grow at 15 percent for the next four years and level off at 6 percent thereafter.
The company just paid RM2.15 dividend. The required rate of return is 12 percent.
What is the current share price?
D1 = RM 2.15
g = 0.06
r = 0.12
P=?
P = D1
r–g
= 2.15
0.12 – 0.06
= 2.15
0.06
= RM 35.83
2. The next dividend payment by Hot Wings Inc will be $2.10 per share. the dividend is
anticipated to maintain a 5% growth rate forever. If the stock currently sells for $48
per share, what is the required return?
D1 = $ 2.10
g = 0.05
P = $ 48
r=?
r= D1
+g
P0
= 2.10
+ 0.05
48
= $ 0.04375 + 0.05
= 0.0938 or 9.38%
3. Jackson Timberlake Wardrobe Co. just paid a dividend of $1.95 per share on its stock.
The dividend is expected to grow at a constant rate of 5% per year indefinitely. If
investors require 11% on Jackson Timberlake Wardrobe Co. stock, what is the current
price? What the price be in 3 years and in 15 years?
Current dividend (Do) = $1.95
Growth rate (g) = 5%

= 0.05
Expected next dividend D1= D0 × (1+g)

= 1.95 × (1+0.05)
= $2.0475
Required rate of return (r) = 11%

= 0.11
Current price = D1
(r-g)
= 2.0475
(0.11 - 0.05)
= $34.125
Expected dividend at the end of 4 years:

D4 = Do × (1+g)^4
= 1.95× (1+0.05)^4
=$2.370237
Expected price in 3 years = D4

(r-g)
= 2.370237
(0.11-0.05)
= $39.50
Expected dividend at the end of 16 years = Do × (1+g)^16

= 1.95 × (1+0.05)^16
= $4.256605
Expected price at the end of 15 years = D16

(r-g)
= 4.256605
(0.11 - 0.05)
= $70.94
4. The common stock of Dalton Corporation paid RM1.35 in dividends last year.
Dividends are expected to grow at an 8percent annual rate for an indefinite number of
years.
(i) If Dalton's current market price is RM24.50 per share compute the stock's expected
rate of return?
D1 = 1.35 (1 + g)
= 1.35 (1 + 0.08)
= 1.458
P0 = D1 / (R - g)
24.50 = 1.458 / (R – 0.08)

24.50R – 1.96 = 1.458
24.50R = 3.418
R = 0.1395
- The expected rate of return is 13.95%.
(ii) If your required rate of return is 10.5 percent, compute the value of the stock for you?
D1 = 1.35 (1 + g)
= 1.35 (1 + 0.08)
= 1.458
P0 = D1 / (R - g)
P0 = 1.458 / (0.105 – 0.08)
P0 = 1.458 / 0.025
P0 = 58.32
- The value of stock is RM 58.32.
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AIMST UNIVERSITY

FACULTY OF BUSINESS AND MANAGEMENT

Chapter 7: Interest Rates and Bond Valuation

Approximate real rate of interest = Nominal interest rate – inflation rate

(0.04 × 1000) 1−1/(1+0.07 /2)

(100) 1−1/(1+ 0.07/2)

(100) 1−1/(1+ 0.09/ 2)

(100) 1−1/(1+ 0.05/2)

Current dividend (Do) = $1.95

Growth rate (g) = 5%

Expected next dividend D1= D0 × (1+g)

Required rate of return (r) = 11%

Expected dividend at the end of 4 years:

Expected price in 3 years = D4

Expected dividend at the end of 16 years = Do × (1+g)^16

Expected price at the end of 15 years = D16

24.50 = 1.458 / (R – 0.08)

- The expected rate of return is 13.95%.

- The value of stock is RM 58.32.

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