Finance: BOND VALUATION

Finance: BOND VALUATION

Subject: Business    / Finance
Question

I. BOND VALUATION

Question 1

Consider a 4%-annual coupon bond, with a 30-year time-to-maturity and a face value of $1,000 that you buy right now. At the time of the purchase the YTM is 10%. Your plan is to sell the bond immediately after you receive the 25th coupon payment. If the YTM is expected to remain constant, what is the minimum selling price for the bond and what is the duration and modified duration at the time of the sale?

Question 2

Consider a $1,000 face value zero-coupon bond with a time to maturity of 5 years (YTM = 8%).

a. Calculate price of the bond

b. Calculate the duration of the bond

c. Calculate the duration of a portfolio that contains two of the above zero-coupon bonds and one 3-year, $1,000 face value, 4% coupon bond (YTM = 6%).

II. EQUITY VALUATION

Question 3

The current stock price (year 0) of the Sizzling Sausage Corporation is $21. According to your information and analysis, you expect this company to pay its first dividend of $2.50 in year 2, and from year 3 on, you expect to see a steady growth in dividends. Specifically, you figure out that the dividends in year 3 will be $2.75 and will then continue to grow for another 15 years at 3% per year, after which it will grow 2% per year forever. The appropriate discount rate is 13%.

Calculate the value of this stock.

Question 4

The Moooh-Milk Corporation (MMC) currently operates as a cash cow, i.e., it pays out all its earnings as dividends. Based on your expectation that MMC has good investment opportunities, allowing the firm to earn a 12% return on retained earnings every year, you suggest the firm should reduce its dividend pay-out ratio to a new level of 60% starting at t=1. Current earnings (t=0) are $240,000 and the corporation has 60,000 shares outstanding. If the required rate of return on the stock is 10%, what is the net present value of the growth opportunities (NPVGO) for Moooh-Milk?

Question 5

Consider the following three stocks. Stock A is expected to provide a dividend of $10 per share forever. Stock B is expected to pay a dividend of $5 next year, after which dividends are expected to grow forever at 4.5%. Finally, Stock C is expected to pay a dividend of $6 next year after which dividend growth is expected to be 18% per year for 5 years and no further growth thereafter.

If the required rate of return (r) for each stock is 10%, which stock is the most valuable?

Question 6

Penn Central Electricity has existing assets that generate $5 in earnings per share. If the firm does not invest except to maintain existing assets, EPS is expected to remain constant at $5 a year. However, Penn Central can start next year with investing $1 per share a year in developing a newly discovered source for electricity generation. Each investment is expected to generate a permanent 20% return. However, the source will 5 be fully developed by the fifth year of investing in it, so no more investments are possible from year 6 onwards. Investors require an 18% rate of return.

a. What is the stock price and price-earnings (P/E) ratio?

b. What is the stock price if the firm could continue to invest $1 per year forever?

c. Calculate the NPVGO if the firm would have had the same investment opportunity for 5 years maintaining an 80% dividend payout ratio.

d. Calculate the NPVGO if the firm has the investment opportunity in perpetuity maintaining an 80% retention ratio.