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Valuation Problems With Hints

This document provides 10 problems related to bond and stock valuation. The problems require using formulas to calculate bond and stock prices given information like face value, coupon rate, yield to maturity, required rate of return, dividend growth rates and payouts. The answers involve using formulas for bond valuation, stock valuation under the Gordon and variable growth models, and comparing calculated prices to stated prices to determine if bonds should be purchased.

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Kawsar Ahmed
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65 views2 pages

Valuation Problems With Hints

This document provides 10 problems related to bond and stock valuation. The problems require using formulas to calculate bond and stock prices given information like face value, coupon rate, yield to maturity, required rate of return, dividend growth rates and payouts. The answers involve using formulas for bond valuation, stock valuation under the Gordon and variable growth models, and comparing calculated prices to stated prices to determine if bonds should be purchased.

Uploaded by

Kawsar Ahmed
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Problems

1. A bond has a face value of $1000 with a time to maturity ten years from now. The yield
to maturity of the bond now is 10%.
a) What is the price of the bond today, if it pays no coupons?
b) What is the price of the bond if it pays annual coupons of 10%?
c) What is the price today if pays 8% coupon rate semi-annually?
Ans: Use bond valuation formula.
2. What is the value today of a $1000 bond, 8% coupon with annual coupon payments if
the time to mature is 2 years and YTM is 4%?
Ans: Use bond valuation formula.
3. An investor wants to buy a bond with face value $1,000 and coupon rate 12%. It pays
interest semiannually and it will mature after 5 years. If her required rate of return is
18%, how much should she pay for the bond?
Ans: Use bond valuation formula.
4. American Airlines bonds pay interest on January 15 and July 15, and they will mature on
July 15, 2017. Their coupon rate is 11%. Because of the risk characteristics of American
Airlines, you require a return of 15% annually on these bonds. How much should you pay
for a $1,000 bond on January 16, 2011?
Ans: Use bond valuation formula. (where n= 13)
5. A zero-coupon bond with face value $1,000 and 6.25 years until maturity is available in
the market. Because of its risk characteristics, you require a 11.5% return, compounded
annually, on this bond. How much should you pay for it?
Ans: Use bond valuation formula.

6. The common stock of Steerforth Inc has just paid a dividend of $2.00. The dividends are
expected to grow at the rate of 10% for the next three years, and then at the rate of 5%
forever. Find the price of this stock, assuming the required rate of return is 20%.
Ans: Use the formula of Stock Valuation of Variable growth model.

7. Philadelphia Electric Co. (now Exelon) bonds were once selling at 120.25, with 27 years
to maturity and semiannual interest payments. The coupon rate was 18%. If your required
rate of return were 16% at the time, would you have bought these bonds?
Ans: Use the formula of Bond Valuation and compare the result with the selling price of
bond and then take your decision (purchase or not).
8. You just bought IBM bonds that mature in twenty years. You paid $1,000 (par
value). The bonds have a coupon rate of 8 percent. If interest rates fall and the required
return on your bond is now 6 percent, what is the value of your bond?

Ans: Use the formula of Bond Valuation and compare the result with the selling price of
bond and then take your decision (purchase or not).

9. Using the Gordon Model, calculate the value of the following stock. Use CAPM to
determine the required rate of return (Risk free = 5%, Market Return = 10%, Beta =
.9). The dividend growth rate = 7%. The dividend one period out is $2.76.

10. Pery Motors’ common stock just paid its annual dividend of $1.80 per share. The
required return on the common stock is 12%. Estimate the value of the common stock
under each of the following assumptions about the dividend:
I. Dividend expected to grow at an annual rate of 0% to infinity.
II. Dividend expected to grow at a constant annual rate of 5% to infinity.
III. Dividend expected to grow at an annual rate of 5% for each of the next 3
years, followed by a constant annual growth rate of 4% in years 4 to infinity.
Ans: use all equation for stock valuation and this is the review problem of stock valuation
chapter and answer is provided in the appendix part.

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