Tutorial 11

Corporate Finance
1. Assume that you wish to purchase a bond with a 30-year maturity, an annual
coupon rate of 10 percent, a face value of $1,000, and semiannual interest
payments. If you require a 9 percent nominal yield to maturity on this
investment, what is the maximum price you should be willing to pay for the
bond?

FV = 1000
I = 9%
N = 30
PMT = 100 (10% x 1000)
Compounded semiannually
PV = RM1103.19
2. You intend to purchase a 10-year, $1,000 face value bond that pays interest of $60
every 6 months. If your nominal annual required rate of return is 10 percent with
semiannual compounding, how much should you be willing to pay for this bond?

FV = 1000
I = 10%
N = 10
PMT = 120 (60 x 2)
Compounded semiannually
PV = RM1124.62
mature in 10 years. If your nominal annual required rate of return is 12
percent with quarterly compounding, how much should you be willing
to pay for this bond?

FV= $1,000

i/r= 12%

N= 10

PMT= 140 (35 x 4)

Compounded quarterly

PV= $1,115.57
4. A share of common stock has just paid a dividend of $3.00. If the
expected long-run growth rate for this stock is 5 percent, and if
investors require an 11 percent rate of return, what is the price of the
stock?

By using the Dividend Discount Model (DDM)

Vcs= D0 (1+g) / Kcs - g

Vcs= $3.00(1+0.05) / 0.11-0.05

= 3.15 / 0.06

= $52.5
5. The Jones Company has decided to undertake a large project.
Consequently, there is a need for additional funds. The financial
manager plans to issue preferred stock with a perpetual
annual dividend of $5 per share and a par value of $30. If the
required return on this stock is currently 20 percent, what should
be the stock‘s market value?
Stock market value

=annual dividend/required return

=$5/0.2

=$25
6. A share of preferred stock pays a quarterly dividend of $2.50.
If the price of this preferred stock is currently $50, what is the
nominal annual rate of return?
Annual dividend= $2.50*4= $10

Annual rate of return

=Annual dividend of preferred stock/ Required rate of return

=$10/$50

=0.20/20%
QUESTION 7 (common stock with perpetual constant dividend)
NoGrowth Corporation currently pays a dividend of $2 per year,
and it will continue to pay this dividend forever. What is the price
per share if its equity cost of capital is 15% per year?
g=0, D= 2 r= 15%

using dividend discount model,

P = D (1+g) / r-g = 2 (1+ 0) / 15% -0 = $ 13.33

8. DFB, Inc., expects earnings this year of $5 per share, and it plans to pay a $3
dividend to shareholders. DFB will retain $2 per share of its earnings to reinvest
in new projects with an expected return of 15% per year. Suppose DFB will
maintain the same dividend payout rate, retention rate, and return on new
investments in the future and will not change its number of outstanding shares.
(a) What growth rate of earnings would you forecast for DFB?

g = retention rate (or plowback ratio) × return on new invest

g = (2/5) × 15% = 6%
(b) If DFB’s equity cost of capital is 12%, what price would
you estimate for DFB stock?

Using Dividend Discount Model:

D1 = 3 , r = 12% , g = 6%

P = D1/ r - g

P = 3 / (12% – 6%)

= $50
(c) Suppose DFB instead paid a dividend of $4 per share this year and
retained only $1 per share in earnings. That is, it chose to pay a higher
dividend instead of reinvesting in as many new projects. If DFB maintains
this higher payout rate in the future, what stock price would you estimate
now?
Earning = $5, dividend payout = $4, retention = $1

Retention rate = 1/5 = 20%

P = D1/ r-g

D1= 4, g=3%, r = 12%

P = 4 / (12% – 3%) = $44.44