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The document Assignment #2that is attached is the assignment that is due. Page 3 shows the Grading Rubric for the assignment. All answers need to Exceed Expectations. To exceed expectations, all answers need to be an EXACT replica of the 2 sample questions & solutions provided by the professor.
You are required to use a financial calculator or spreadsheet (Excel) to solve 10 problems(provided on page 3) related to the risk and return, stocks and bonds valuation. You are requiredto show the following 3 steps for each problem (sample questions and solutions are provided forguidance): (i) Describe and interpret the assumptions related to the problem.(ii) Apply the appropriate mathematical model to solve the problem.(iii) Calculate the correct solution to the problem. ASSIGNMENT #2
The purpose of this assignment is to solidify your understanding on the applications of the risk
and return concepts and their role in valuing financial assets. The scores of this assignment will
help in assessing the following learning goal of the course: “students successfully completing
this course will be able to Analyze risk return characteristics to assess valuation of financial
assets”.
Instructions:
You are required to use a financial calculator or spreadsheet (Excel) to solve 10 problems
(provided on page 3) related to the risk and return, stocks and bonds valuation. You are required
to show the following 3 steps for each problem (sample questions and solutions are provided for
guidance):
(i)
Describe and interpret the assumptions related to the problem.
(ii)
Apply the appropriate mathematical model to solve the problem.
(iii)
Calculate the correct solution to the problem.
Sample Questions and Solutions
Sample Question # 1:
A company has an issue of 12-year bonds that pay 5% interest, annually. Further assume that
today’s required rate of return on these bonds is 7%. How much would these bonds sell for
today? Round off to the nearest $1.
Solution
(i)
The problem assumes that the face value of the bond is $1000. The bond will pay an
annual coupon of 5% i.e., coupon or interest amount of $50 is assumed to paid every
year. It also assumes that investors currently required a return of 7% on investments
with similar risk characteristics. The use of bond valuation concept is appropriate to
calculate the true value of these bonds. The accuracy of the solution depends on the
correctness of the assumptions on face value, coupon payments and required rate of
return assumption.
(ii)
The use of bond valuation concept which suggests that the true value of a bond is the
present value of its future coupon and face value discounted at investors required rate
of return is appropriate to calculate the true value of these bonds. We are required to
compute the present value (PV) which represents the true value of the bond.
(iii)
FV= $1000; PMT=$50; Rate = 7%; N=12 years; Compute PV = ? $841.15
Value of the Bond = $841.15
1
Sample Question # 2:
A company just paid a dividend of $1, and the dividends are expected to grow at constant rate of
4% forever. If the required return of the stockholders is 12%, what is the price of this company’s
stock?
Solution
(i)
(ii)
The problem assumes the stock will have a constant growth of 4% forever. The
constant growth model is appropriate to use for this problem. The accuracy of the
solution depends on the correctness of the constant growth assumption.
The constant growth model is given as: P0 = D1/ (R-g); where
• P0 is the current price to be calculated,
• D1 is the next period’s dividend,
• R is the required return on this stock
• g is the constant growth
D1 needs to be calculated in order to apply this model.
(iii) D1= 1x(1+0.04) = 1.04
P0 = 1.04 /(0.12-0.04) = $13; the stock price should be $13 based on the constant growth
model.
2
Grading Rubric
Subcomponent
The student will
make
and evaluate
important
assumptions in
Not
Submitted
No attempt
made
Does Not
Meet
Expectations
Meets
expectations
Attempts to describe
Explicitly describes
assumptions
assumptions
identification of
appropriate asset
valuation variables
and
risk and return
measures
Exceeds
Expectations
Explicitly describes
assumptions
and provides rationale for
why
each assumption is
appropriate.
Show awareness that
confidence
in final conclusions is
limited by
the accuracy of the
assumptions (e.g., provides
The student will
convert
relevant information
into
various
mathematical
forms (e.g.,
equations,
graphs, words)
No attempt
made
The student will
calculate
risk and return
measures
and asset values
No attempt
made
Completes conversion Completes
descriptions about the
assumptions of the model
and its
limitations; lists and
describes
each variable within the
model)
Relevant information is
of information but
conversion of
expressed in an insightful
resulting
mathematical
portrayal is
inappropriate or
inaccurate
information
into
mathematical
portrayal
Calculations are
Calculations are
mathematical portrayal in
a way that contributes to a
further or deeper
understanding (e.g.,
correct variables are
selected and
the mathematical model is
portrayed with the correct
variables)
Calculations attempted are
attempted but are both attempted to solve
essentially all successful and
unsuccessful and not
the problem but not
comprehensive
comprehensive
sufficiently comprehensive
to
solve the problem.
Calculations
are also presented
elegantly (e.g., provides
insights
on the interpretation of the
calculated value of an asset
such
as the value of a stock is
valid
only within the context of
the
model and its limitations)
The above rubric will be applied to grade each question and the average score will be calculated
for each subcomponent.
3
Assignment Problems
1. Exactly one year ago, Harv bought 500 shares of Primer Corp stock for $20.75 per share. He plans
on selling all of the shares today at the current market price of $22.50 per share. Over the last year,
Primer Corp. paid out dividends of $0.75 per share on its common stock. What is Harv’s holding
period return for the year on Primer Corp. stock? Submit your answer as a percentage and round to
two decimal places.
2. Analysts predict that over the next year, Thete, Inc.’s common stock has a 30% chance of returning
20%, a 40% chance of returning 12%, and a 30% chance of returning 8%. What is the expected
rate of return on Thete, Inc.’s common stock? Submit your answer as a percentage and round to
two decimal places.
3. Analysts predict that over the next year, Thete, Inc.’s common stock has a 30% chance of returning
20%, a 40% chance of returning 12%, and a 30% chance of returning 8%. What is the standard
deviation of returns on Thete, Inc.’s common stock? Submit your answer as a percentage and round
to two decimal places.
4. Han Corporation issues a bond which has a coupon rate of 8.6%, a yield to maturity of 10.4%, a
face value of $1,000, and a market price of $990. What is the semiannual interest payment? Round
to two decimal places.
5. A shipping company sold an issue of 20-year $1,000 par bonds to build new ships. The bonds pay
6% interest, compounded semiannually. Today’s required rate of return is 8.5%. How much should
these bonds sell for today? Round to two decimal places.
6. Atlantis Company issued bonds on January 1, 2006. The bonds had a coupon rate of 5.0%, with
interest paid semiannually. The face value of the bonds is $1,000 and the bonds mature on January
1, 2028. What is the yield to maturity for these bonds on January 1, 2020 if the market price of the
bond on that date is $960? Submit your answer as a percentage and round to two decimal places.
7. Consider a 12-year bond with face value $1,000 that pays an 8.6% coupon semi-annually and has a
yield-to-maturity of 7.7%. What is the approximate percentage change in the price of bond if interest
rates in the economy are expected to decrease by 0.60% per year? Submit your answer as a
percentage and round to two decimal places. (Hint: What is the expected price of the bond before
and after the change in interest rates?)
8. Hackworth Company’s common stock is expected to pay a $7.40 dividend in the coming year. If
investors require a 19% return and the growth rate in dividends is expected to be 7%, what should
the market price of the stock be? Round to two decimal places.
9. Nell Corporation stock is currently selling for $18.50. The stock is expected to pay a dividend of
$1.75 at the end of the year. Dividends are expected to grow at a constant rate of 4% indefinitely.
Compute the expected rate of return on Nell Corporation stock. Submit your answer as a percentage
and round to two decimal places.
10. Finkle-McGraw Corp. just paid a dividend today of $3.80 per share. The dividend is expected to
grow at a constant rate of 5% per year. If Finkle-McGraw Corp. stock is selling for $56.00 per share,
what is the stockholders’ expected rate of return? Submit your answer as a percentage and round to
two decimal places.
4
10/5/2020
INTRODUCTION
Chapter 07
A BOND is a type of debt or long-term
Part One
promissory note, issued by a borrower, promising
Valuation and Characteristics of Bond
to its holder A PREDETERMINED and FIXED
AMOUNT OF INTEREST per year and
repayment of PRINCIPAL AT MATURITY
P R E PA R E D B Y D R . R A H U L V E R M A F O R F I N 3 3 0 2
1
2
INTRODUCTION
CHARACTERISTICS
Investors who buy bonds are LENDING a specific
sum of money to a corporation, government, or
Par value (face value)
Maturity
Coupon rate
Bond Value
Coupon payment
Yield
some other borrowing institution
Bonds are often referred to as
FIXED-INCOME investments
Bonds have seniority in claims: in the case of
insolvency, claims of bonds, are generally
honored before those of stocks
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PAR VALUE
C O U P O N RATE & COUPON AMOUNT
PAR VALUE is the face value of the bond,
COUPON RATE is the stated interest rate
returned to the bondholder at maturity
(generally fixed rate) paid by the issuer
In general, corporate bonds are issued at
COUPON AMOUNT is the periodic
denominations or par value of $1,000
interest payment in dollar terms;
Bonds owners are expected to receive the PAR
multiply coupon rate with the par value
VALUE AT MATURITY, regardless of the price
to get coupon amount
paid at the time of purchase
5
6
C O U P O N RATE & COUPON AMOUNT
M AT U R I T Y
E X A M P L E : A bond with a $1,000 par value and
5% annual coupon rate will pay $50 annually as
M AT U R I T Y of bond refers to the remaining
coupon (interest)
length of time until the bond issuer returns
What will be the coupon amount of a
semi-annual bond with annual
coupon rate of 7%?
the par value ($1000) to the bondholder and
redeems the bond
$70 is paid annually i.e.,
$35 every half year (semi-annually)
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A S S E T V A L U AT I O N C O N C E P T
M AT U R I T Y
The intrinsic, or true value of any asset (such as stocks, bonds) is equal to
the present value of its expected future cash flows at investor’s required
rate of return
E X A M P L E : A bond with remaining maturity of
12 years and 5% annual coupon rate will pay $50
annually as coupon (interest) for the next 12
years and return the principal (par value of
$1000) at the end of the 12th year.
VALUE OF ANY ASSET IS AFFECTED BY THREE ELEMENTS:
ONE
Amount and timing of
the asset’s expected
future cash flows
For how many periods a bond with remaining
maturity of 12 years and 7% semi-annual
coupon rate will make interest payment?
TWO
Riskiness of the
cash flows
THREE
Investor’s required rate
of return for undertaking
the investment
$35 for the next 24 half years
This valuation concept is applied in this course for valuing bonds (in this chapter) and
stocks (in chapter 8)
9
10
B O N D VA LU E
B O N D VA LU E
B O N D is an asset for investors or holders.
What are the future cash flows generated
The concept of asset valuation (presented in the
by Bonds?
Expected Coupon Amount
(Interest amount) every period or year
previous slide) is applied in bond valuation.
The value of a bond (V) is the present value of
Face Value ($1000) at the end
i.e., at maturity
Future Cash Flows which bond generates
discounted at investors required rate of return
11
12
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PROBLEMS
PROBLEMS
Problem 7-2
Problem 7-1
FV
= 1000
N
= 20
PMT
= 80
I/Y
=7
PV
=?
In this case we have semi-annual
Price = $1,105.94
coupon. So we divide the PMT and
FV
= 1000
I/Y by 2 and multiply N with 2
N
=7
FV
= 1000
PMT
= 40
N
= 7*2 (i.e., 14 half-years)
I/Y
=5
PMT
= 40/2
PV
=?
$942.14
(i.e., $20 semi-annual coupons)
13
I/Y
= 5/2 (i.e., 2.5% per half-year)
PV
=?
$941.55
Solve Problems 7-4,7-6,7-14,7-15
14
CURRENT YIELD
BOND YIELDS
Yields are the expected returns for making investment in bonds
C U R R E N T Y I E L D indicates the cash income that results
from holding a bond in a given year
WE MAY HAVE TO CALCULATE
THREE VERSIONS OF YIELDS
CURRENT YIELD = Annual Coupon / Market Price
CURRENT YIELD
Captures the Short term return
based on Coupon Payments
(Interest) and Market Price of
the bond
15
What will be the price if coupon is paid annually?
(Do not divide or multiply with 2)
YIELD TO MATURITY
(YTM) Captures the long
term return if bond is held
till maturity
C U R R E N T Y I E L D is a short term return
measurement as it only includes the interest
income into the calculation
T O TA L Y I E L D
Captures the return if bond
is sold before maturity
It provides incomplete picture as it does not take
into account the capital gain or loss if the bond is
held till maturity or sold earlier than its maturity
16
10/5/2020
CURRENT YIELD
EXAMPLE: A bond which pays
coupon at 8% is currently
bought for $700. Calculate its
C URRE NT YI E L D.
Y I E L D T O M AT U R I T Y
PROBLEM 7-23
Semi-annual coupon = $35
Market Price
= $780
Y T M refers to the rate of return
Here, we ignore the face value ($1000) in the
calculation. The formula is:
is bought at the market price and
the investor will earn if the bond
To find YTM, we need to know:
(a) current price (PV)
(b) remaining life (N)
held to maturity
C U RRE N T Y I E LD
C U RRE N T Y IE LD
= Annual Coupon / Market Price
= Annual Coupon / Market Price
= $80 / 700
= 11.4%
Y T M is also known as
(d) coupon (PMT)
bondholder’s expected rate
= $35*2 / $780
= 8.97%
of return
17
18
T I M E L I N E T O C A L C U L AT E Y T M
T I M E L I N E T O C A L C U L AT E Y T M
If we buy a 5 year bond in 2017 at the market price (P) and hold it till
maturity (till 2022) then we can expect to receive annual coupon of C
Here we plug the following information
in financial calculator or Excel:
for the next 5 years and par value ($1000) at the end of the 5th year.
PV = – Price;
2017
0
2018
2019
2020
1
2
3
4
C
C
C
Market Price (P)
19
(c) par value (FV)
C
YTM
(Rate)
2021
N = remaining life;
2022
PMT = Coupon;
5
FV = 1000 and
C
Compute I/Y or Rate
Par
20
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PROBLEMS
PROBLEMS
Problem 7-17
Problem 7-8
This is a problem of annual coupon payments
FV
N
PMT
PV
I/Y
In this problem we have semi-annual
coupon payments. So we multiply N
= 1000
= 20
= 60
= – 945
=?
with 2 and divide coupon rate by 2 to
get the semi-annual coupon.
However, note that the computed I/Y
will be for half year. So we multiply with
YTM = 6.5%
2 to get the annual YTM (YTM means
FV
N
PMT
PV
I/Y
YTM
= 1000
= 10*2
= 60/2
= – 900
= ? 3.72%
= 3.72%*2 = 7.44%
(This is a very important step)
SOLVE PROBLEMS
7-3,7-16, 7-18, 7-21, 7-22, 7-24, 7-26, 7-27
annual rate of return)
21
22
RELATIONSHIP BETWEEN PRICE AND YTM
RELATIONSHIP BETWEEN PRICE AND YTM
If
YTM (EXPECTED RETURN) =
COUPON RATE
then
BOND PRICE =
PAR VALUE OR $1000
Bond Price and YTM move in
the opposite direction
Greater the expected rate of
return, lower is the bond price
and vice-versa.
Y-axis is Bond Price and X-axis is
expected rate of return or YTM.
23
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RELATIONSHIP BETWEEN PRICE AND YTM
RELATIONSHIP BETWEEN PRICE AND YTM
If
YTM < COUPON RATE,
then
BOND PRICE > PAR VALUE
If
YTM > COUPON RATE,
then
BOND PRICE < PAR VALUE
This means bond is selling at a discount,
called a discount bond
This means bond is selling at a premium,
called a premium bond
Greater the investor's required rate of
return above that of the coupon rate, the
greater will be discount on the bond
Lower the investor’s required rate of
return below that of the coupon rate, the
greater will be the premium on the bond
25
26
IMPORTANT QUESTIONS & PROBLEMS
Review Questions
Study Problems
27
7.4 – 7.10
7.1-7.4,7.6,7.8,7.16-7.18,7.21-7.24,7.26, 7.27
10/5/2020
INTRODUCTION
In the previous chapter on Bond Valuation, we
mainly calculated:
Chapter 08
1. Expected Rate of Return (also called
Yield to Maturity)
Valuation and Characteristics of Stocks
2. Bond Value (or, the Present Value of expected
cash flow from a bond)
Similarly, in this chapter, we are going to calculate
P R E PA R E D B Y D R . R A H U L V E R M A F O R F I N 3 3 0 2
1. Expected Rate of Return for Stocks
2. Stock Value
1
2
INTRODUCTION
STOCKS
In case of bonds, the future cash flow was due to
COMMON STOCK is a certificate that indicates
(i) Coupons and (ii) Par Value ($1000). Both
ownership in a corporation
these two amounts are known in advance
When you buy a share, you buy a “part/share”
of the company and attain ownership rights in
In case of stocks, the future cash flow arises
proportion to your “share” of the company
from DIVIDENDS and unlike the case of bonds,
this is not known in advance since companies
Common stockholders are the true owners of the
pays dividend based on the profits
firm. Bondholders and preferred stock holders
can be viewed as creditors
3
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STOCK VALUATION
STOCKS
VALUE OF ANY ASSET IS AFFECTED BY THREE ELEMENTS:
Common shareholders have the right
ONE
Amount and timing of
the asset’s expected
future cash flows
to the following:
Residual income of the company
Residual claim on Assets of the company
Limited Liability
TWO
Riskiness of the
cash flows
THREE
Investor’s required rate
of return for undertaking
the investment
SO, WHAT ARE THE FUTURE CASH FLOWS IN CASE OF STOCKS?
Voting Rights
Expected Dividends every year (this is the only cash flow expected from stocks);
Preemptive Rights
however it is not fixed and uncertain as it depends on the company’s profits
and dividend policy
5
6
STOCK VALUATION
STOCK VALUATION
The value of a common stock (Vcs) is the Present
Value of EXPECTED FUTURE DIVIDENDS
We can observe the market price of a stock
discounted at investors REQUIRED (EXPECTED)
but the “True Value” is a calculated number
and not observable
RATE OF RETURN
Different analysts will calculate the “True Value”
This value is also called the “True Value”,
of a stock differently based on their assumption
“Fundamental Value” or, “Intrinsic Value”. This is
about the expected future dividends and
not the same the price at which the company’s
required rate of return
stock trades in the market.
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STOCK VALUATION
EXPECTED RATE OF RETURN (YIELD)
Theoretically speaking, when the market price of
Note that the True Value of stock is the present
a stock is greater than its True Value, the stock is
value of expected dividends discounted at
considered overvalued
investors EXPECTED RATE OF RETURN
Similarly, when the market price of a stock is less
In order to calculate the true value we need the
than its True Value, it is considered undervalued
expected rate of return
This is the main purpose of STOCK VALUATION
Alternatively, we can calculate the expected rate
– to identify how much a stock is overvalued
of return of a stock when its market price is given
or undervalued
9
10
TIMELINE FOR BOND VALUATION - RECAP
2013
2014
2015
2016
2017
2018
0
1
2
3
4
5
C
C
C
C
C
Market
Price
YTM
TIMELINE FOR STOCK VALUATION – COMPARE WITH BONDS
2013
2014
2015
2016
2017
2018
0
1
2
3
4
5
D1
D2
D3
D4
D5
Stock
Value(Vcs)
E X P EC T E D RE T U RN
Par
Vcs= PV of ALL expected dividends discounted at investor’s required rate of return
Investors do not know the values of D1, D2, .... , D∞ and must be estimated
There is no Coupon or Par Value amounts which is known in advance
11
12
D
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CONSTANT GROWTH DIVIDEND MODEL
FORMULAS FOR STOCK VALUATION
(Discounted Cash Flow Technique)
We use a formula to CALCULATE THE TRUE VALUE OF A STOCK
Assumption is that dividends grow at a constant rate (g)
We need the following information to calculate TRUE VALUE
If we know current year’s dividend (D0) and expected growth rate in dividends
(g), then we can calculate the future dividends (D1, D2, D3, D4…. and so on)
D1, D2, D3, D4…. are expected dividends in years 1,2,3,4 and so on
0
1
D0
D1=D0 (1+g)
2
D2=D1 (1+g)
D3=D2(1+g)
Dividend in current year (D0) or expected dividend in year 1 (D1)
ii.
Expected growth rate in dividends (g)
iii. Investors Expected or Required Rate of Return (kcs)
3
i.
Each of these information is based on assumptions and for this reason the TRUE VALUE
D=D0 (1+g)
13
calculated by different investors will be different
14
FORMULAS FOR STOCK VALUATION
FORMULAS FOR STOCK VALUATION
We can use one of the two formulas to calculate the Intrinsic Value (True Value;
Here a common problem is identify whether the information provided is about D0 or
Fundamental Value) of Stock (Vcs):
D1 – this is one place where you should be careful as your formula will be different
depending on whether you have assumed the given dividend to be D0 or D1
When information on D1 IS GIVEN, WE USE THE FIRST FORMULA and when
D0 IS KNOWN WE USE THE SECOND FORMULA
Note that we need the values of Required Rate of Return (kcs) and growth rate
in dividends (g)
15
16
When you see terms like “EXPECTED”,
Anytime the information is about PAST
“FORECASTED”, “PROJECTED” use D1
or CURRENT year’s dividend use D0
10/5/2020
PROBLEMS
PROBLEM 8-8
D0
PROBLEMS
Since D0 is given, we can use the 2nd formula for stock valuation
= $1.32
= 7%
kcs
= 11%
Vcs
=?
use the 1st formula of stock valuation
D1
= $1.32
g
= 7%
= 1.32*1.07/0.04
kcs
= 11%
=1.4124/0.04
Vcs
=?
= 1.32*(1+7%)/(11%-7%)
= $35.31
17
= 1.32 / (11%-7%)
= $33
Solve Problems 13 & 19
18
KEY RELATIONSHIPS
The TRUE VALUE of a stock will INCREASE
The TRUE VALUE of a stock will DECREASE
due to the following:
due to the following:
i.
An increase in the expected
i.
ii.
An increase in the expected
growth rate in dividends
iii. A decrease in investors’ expected
rate of return
KEY RELATIONSHIPS
Required rate of return depends on the risk –
A decrease in the expected
GREATER the risk, HIGHER is the expected
future dividends
future dividends
19
In such cases the dividend will be D1 and not D0 and we
EXPECTED to be received
next year?
(The dividend was paid last year, so it is D0)
g
What if this dividend was
ii.
A decrease in the expected
rate of return
growth rate in dividends
iii. An increase in investors’ expected
rate of return
20
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Expected Rate of Return (Yield)
Expected Rate of Return (Yield)
Note that to calculate Vcs, we needed this
Now, the current market price would be given and we have to calculate kcs;
information:
(i)
We will use the notation P0 instead of Vcs for market price
Dividend in current year (D0) or
Accordingly, to calculate k we need the
expected dividend in year 1 (D1)
following information:
(ii) Expected growth rate in dividends (g)
(i)
(iii) Investors Expected or Required Rate of
Dividend in current year (D0) or expected
dividend in year 1 (D1)
Return (k)
(ii) Expected growth rate in dividends (g)
(iii) Current market price of the stock (P0)
Here the value of kcs was given and we
calculated the value of Vcs
21
22
Formulas for Expected Return
Problems
Expected Rate of Return or Required rate of return) (k) when stock is bought at
Problem 8-16 (Part a)
current market price (P0) and expected growth rate in dividends (g) is known is
D0 = $1.32
calculated as follows:
(Here the dividend was paid last year, so it is D0)
And we use the following formula:
= 1.32*(1+8%)/23.5 + 8%
= 1.32*1.08/23.5 + 0.08
g = 8%
When information on D0 is given, we use the first formula and when
P0= 23.50
D1 is known we use the second formula; again be careful when to
kcs = ?
use D0 or, D1 and which formula to use
23
24
= 0.0607 + 0.08
= 0.1407
= 14.07%
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Problems
Problems
What if the dividend was expected to be
Problem 8-16 (Part b)
paid next year.
In this part, we have to calculate P0
In such cases, it will be D1 = $1.32;
when k=10.5% is given.
And we use the following formula:
= 1.32/23.5 + 8%
= 0.0562 + 0.08
= 0.1362
g = 8%
= 13.62%
P0= 23.50
D0
= $1.32
g
= 8%
kcs
= 10.5%
Vcs
=?
= 1.32*1.08 / (10.5% - 8%)
= 1.4256 / 2.5%
Vcs
= $57.02
kcs = ?
25
26
Problems
Problems
Problem 8-16 (part c)
Problem 8-28 (Part a)
Should you make an investment in this stock? One can get the same
D1 = $2.50
answer by analyzing either the true value or expected rate of return
(Here the dividend is anticipated to be paid at
the end of year)
B A S E D O N T R U E VA LU E :
BA SED ON EXP ECT ED RETURN :
We calculated True Value as $57.02.
We calculated Expected return as 14.07%
However, the market price of
However, our required rate of return is 10.5%
the stock is $23.50
Therefore the stock is undervalued
i.e., we should make this investment
27
The stock is expected to give return greater
g
= 10.5%
P0
= 23
kcs
=?
= 2.5/23 + 10.5%
= 10.87% + 10.5%
= 21.37%
Part b: If we require 17% return, then we should
make this investment; the expected return is
than what we require; therefore we should
higher than what we require
make this investment
28
10/5/2020
IMPORTANT QUESTIONS & PROBLEMS
Problems
Review Questions
Problem 8-28 (Part b)
What is the true value of this stock at
required rate of return of 17%?
D1
= $2.50
g
= 10.5%
kcs
= 17%
P0
=?
(
Study Problems
)
= 2.5 / (17% - 10.5%)
= 2.5 / 6.5%
= $38.46
The true value is greater than the current market
price of $23; therefore it is a good investment
Solve Problems 29, 30, 32 and 33
29
30
8.6, 8.7, 8.8
8.8, 8.13, 8.16, 8.19, 8.28
