Solutions Manual

to accompany

Introducing
Corporate Finance 2e
Diana Beal, Michelle Goyen,
Abul Shamsuddin

Prepared by

Michelle Goyen

© John Wiley & Sons Australia, Ltd 2008

Chapter 6: Valuation of bonds and shares

End of Chapter Questions

6.1 What is the difference between price and value?

Price represents the amount of money needed to acquire an asset. Value is the worth
of an asset to an individual. Consider a pedigree cat that has a price of $900. A person
interested in that breed might think that it was well worth paying $900 for the cat,
given its colouring and sunny disposition. This cat fancier would give the cat a higher
value than the price that is asked for the cat. Another person might not like cats at all
– this dog lover might give the cat a value of zero because he would not be willing to
pay anything to take it home with him.

6.2 What is meant by the terms ‘bid’ and ‘offer’?

A bid indicates the price a trader is willing to pay for a security. A bid is made by the
prospective buyer. An offer is the price a trader is willing to accept to sell a security.
An offer is made by someone with a security to sell.

6.3 Describe how prices are set for listed securities.

A trader who wants to purchase a security will bid for it to give an indication of what
she is willing to pay. Another trader who wants to sell that security will make an offer
for it to give an indication of what he is willing to sell for. The traders will make an
exchange when a bid and an offer match up. The highest bid orders will be filled first.
When the highest bids have resulted in exchanges, sellers will then accept the next
highest bid. This process continues until sellers think the remaining bid orders are too
low. Bidders will have to increase bids and sellers decrease offers until a bid and offer
are found for the same amount. This is a continuing process.

6.4 What is book value and how does it relate to the cash flows of a security?

Book value is the accounting measure of an asset’s worth. The book value of a share
is measured by the accounting amounts for total assets minus total liabilities (this
equals total equity), all divided by the number of ordinary shares issued. Book value
does not provide us with a good representation of future cash flows. The cash flows of
a security can come from dividends, coupon payments, redemption by the issuer or
from the sale of the security on the secondary market. None of these measures of cash
flow are closely related to the book value per share.
Introducing Corporate Finance 2e Solution Manual

6.5 What is the intrinsic value of a security and why do we focus on intrinsic
values in finance?

The intrinsic value of a security is the present value of expected future cash flows.
Cash flows are forecast and then discounted at the investor’s required return. Intrinsic
value is the appropriate value for finance because it applies the principles of the time
value of money.

6.6 Describe the variables that are used to determine a security’s intrinsic
value and explain the role of each variable.

The basic security valuation equation is:

n
CFt
V 
t 1 (1  r )
t

It states that the intrinsic value of a security is a function of the size and timing of the
cash flows that will be generated by the security. The cash flows are discounted to
reflect the time value of money. The discount rate used is the investor’s required
return. If the security can be purchased for less than its intrinsic value, the investor
will earn more than his required return.

6.7 Do analysts and traders all have the same intrinsic value for a security?
Why?

The intrinsic value of a security is the present value of the expected future cash flows
of the security discounted at the investor’s required rate of return. Different analysts
and traders form different expectations about a security’s future cash flows. They also
have different risk preferences that are used to determine their required returns for the
security. Intrinsic value is the value to an individual and this value varies between
individuals.

6.8 Explain what is meant by the term ‘coupon’ and describe how the coupon
payment is calculated for a fixed interest bond.

A coupon is the regular interest payments received by the holder of a bond. For a
fixed interest bond, the coupon rate is specified when the bond is first issued. The
coupon payment is calculated as the coupon rate times the face value of the bond.

6.9 What are the 3 main types of long-term debt securities? What cash flows
does an investor receive from a coupon bond?

The three main types of long-term debt securities are debentures, unsecured notes and
corporate bonds. These are collectively referred to as coupon bonds. After making the
initial payment to purchase the bond, the investor will receive a regular payment as
the interest component on the bond. These payments normally occur every six
months. The investor receives the ‘face value’ of the bond when the security reaches
the end of its life.

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 Chapter 6: Valuation of bonds and shares

6.10 What is a zero coupon bond? Is the calculation of the intrinsic value of a
zero coupon bond different from that for a coupon bond? Explain.

A zero coupon bond does not have any coupon payments over its term to maturity.
This means that interest is paid via the difference between the purchase price and the
maturity value of the bond. Coupon bonds do receive regular interest payments over
their lives plus the payment of face value at maturity. The implication for valuation is
that the intrinsic value of a zero coupon bond is the PV of its face value. The intrinsic
value of a coupon bond, on the other hand, is the present value of the face value plus
the present value of the coupon payments over the bond’s life.

6.11 What do preference shares have in common with bonds and ordinary
shares? How is the valuation of a typical preference share different from
the valuation of a coupon bond or an ordinary share?

Preference shares, as hybrid securities, have features of both debt and equity
securities. The similarity to debt is that they normally have a fixed coupon based on a
face value. The similarity to equity is that they don’t usually have a maturity date –
dividend payments will continue to be made while the company issuing the shares is
solvent.

The dividends on a ‘typical’ preference share form a perpetuity and we use the
perpetuity equation to calculate the present value of the infinite stream of future
dividends. This is different to the valuation of a bond, because a bond’s cash flows
have a finite life, at which point the face value is returned. While we can assume that
the cash flows for an ordinary share will continue to infinity, we don’t usually assume
that the dividend will remain constant for this entire period because dividend
payments are based on profit and we can rarely assume that profit remains constant to
infinity. While the constant growth model for valuing ordinary shares looks a bit like
a perpetuity, a perpetuity is defined as a series of equal periodic payments that
continue forever. If dividends are expected to grow (even at a very small rate) forever,
the cash flows are not equal, so cannot form a perpetuity.

6.12 If dividends are paid semi-annually on a preference share and we adjust

the required return to reflect this, is the intrinsic value any different to a
share with the same total dividend paid annually and an annual required
return? Use an annual dividend of $1 and a required return of 9% to
demonstrate your understanding.

The cash flows of a preference share form a perpetuity. As shown by the following
calculations, there is no difference in the intrinsic value of a preference share paying
and annual dividend of $1 compared to a semi-annual dividend of $0.50 for a given
investor.
1 0.50
Vp   $11 .11 Vp   $11 .11
0.09 0.045
If we were looking at a security with a finite life, we would find that the security with
more frequent cash inflows would have a higher intrinsic value.

© John Wiley and Sons Australia, Ltd 2008 6.3

Introducing Corporate Finance 2e Solution Manual

6.13 How are redeemable preference shares and convertible preference shares
different to ‘normal’ preference shares? Can redeemable or convertible
preference shares be valued with equation 6.5?

Redeemable preference shares are repurchased by the issuing company at some time
in the future. Normal preference shares have an infinite life and are not repurchased
by the issuer. Convertible preference shares can convert to the ordinary shares of the
issuer. Normal preference shares remain as preference shares. We cannot value
redeemable or convertible preference shares with equation 6.5. Equation 6.5 is only
appropriate for a security with an infinite life (and redeemable and convertible
preference shares do not have the same sized cash flows continuing forever). We
would need to find a way to approximate the timing of a redemption or conversion to
value these types of securities. We would also need to estimate the cash flow for
redemption or the future cash flows of any ordinary shares received on conversion.

6.14 How are participating preference shares and reset preference shares
different to ‘normal’ preference shares? Can participating or reset
preference shares be valued with equation 6.5?

Participating preference shares usually receive a minimum dividend amount but can
participate in additional dividends (as ordinary shareholders do) when company
profits reach some pre-specified level. We cannot use equation 6.5 to value
participating preference shares because the level of dividend can vary over time. Reset
preference shares have their dividends adjusted if and when some future event
happens. Again, the cash flows on this type of preference share do not form a
perpetuity (i.e. equal cash flows) so we cannot use equation 6.5 for these.

6.15 Are people likely to be able to forecast a constant growth rate to infinity
with any degree of accuracy? Is this important in the discounting process
over long periods of time? Why?

No, it is not possible to make an ‘accurate’ forecast of a growth rate that will apply to
every future period. Growth rates change with conditions within the firm and in the
economy in which the firm operates. The further into the future cash flows occur, the
greater the uncertainty about their size. The lack of an accurate forecast growth rate
does not mean we cannot apply the constant growth model. The discounting process
reflects future uncertainty by heavily penalising cash flows that occur later in the
future stream of cash flows. This means that the further into the future a cash flow
occurs, the less it adds to the present value so distant cash flows are relatively
unimportant.

6.16 Not all companies pay stable or growing dividends and not all investors
want to purchase companies that pay dividends. Explain why these
behaviours are observed.

Investors who have a preference for receiving cash flows further into the future will
not want to purchase companies that pay dividends. Investors might want to delay the
receipt of cash flow until they retire and have a lower marginal tax rate. If the

© John Wiley and Sons Australia, Ltd 2008 6.4

 Chapter 6: Valuation of bonds and shares

company reinvests the money it could have paid as dividends into new projects, the
value of the share will increase (we will see why later in the book) and the investor
can defer all of the cash flow from the share by selling the share when the cash is
needed.

6.17 Explain the difference between the dividend discount model and the
constant growth model. Why do we have two models?

The dividend discount model calculates intrinsic value using forecasts of the
dividends we will receive and the forecast price we expect to get when we sell the
share. We need to know how long we will hold the share and have an idea about the
selling price in order to use the model.

The constant growth model also values ordinary shares by discounting the future
dividends. It gets around the problem of having to forecast your holding period and
the selling price of the share by using the assumption that dividends will grow at some
constant rate to infinity. The catch is that we need to make a good forecast of the
dividend growth rate that will occur for many periods into the future.

Both models should calculate the same intrinsic value if the same growth rate is
applied to dividends. If we estimate the selling price in the dividend discount model as
the present value of the shares future cash flows, then the value of that security in,
say, a year’s time will be the present value of the future cash flows occurring after one
year’s time. If an investor thinks that the market price will be very different to the
intrinsic value of the share at some point in future, then he would not use the constant
growth model to calculate intrinsic value. Further, the constant growth model cannot
be used for companies when specific circumstances make the assumption of a
constant dividend growth rate implausible. Neither the constant growth model nor the
dividend discount model can be used for companies that do not pay (and do not expect
to be paying) dividends.

6.18 What is the most difficult aspect of valuing ordinary shares?

The most difficult aspect of valuing ordinary shares is making reliable forecasts for
dividends over the infinite life of the security. While it is not too difficult make
reasonable (i.e. fairly accurate) forecasting in the shorter term (say one to two years),
analysts don’t always get it right. Forecasting in the longer term (over two years) with
much degree of accuracy is extremely difficult. Most analysts confine their earnings
and dividend forecasts to a two-year horizon.

6.19 Explain why you should not use a PE multiple from the financial press to
value a share.

The PE multiples in the financial press are calculated as the most recent price divided
by the last period reported earnings per share for the company. Our definition of the
PE ratio is the relationship of price to forecast earnings. Unless the past EPS is a
perfect predictor of next period’s EPS, we would not find that the PE ratios in the
newspaper are able to help us ascertain the intrinsic value of the share. As with all of

© John Wiley and Sons Australia, Ltd 2008 6.5

Introducing Corporate Finance 2e Solution Manual

our valuation models, the intrinsic value you calculate from them is only as good as
the forecasts you put into them!

6.20 Is there a theoretical relationship between the constant growth model and
the PE method of valuation? What does the relationship depend on?

The theoretical relationship between the constant growth model and the PE method of
valuation is that both will give the same valuation for a share when you use the same
assumptions in your forecasts of dividends and earnings.

Financial Problems

6.1 You have been offered an investment with the following cash flows:
End year $
1 50
2 80
3 300
If you have a discount rate of 7% p.a., how much is this investment worth
to you?

n
CFt
V 
t 1 (1  r ) n
50 80 300
V   
1  0.07  1  0.07  1  0.07 3
1 2

V  46.73  69.88  244.89  $361.49

6.2 You expect Japonica Ltd to pay the following annual dividends for the
next 3 years.
Year Dividend

Dividends will be paid in two equal parts semi-annually. You also expect
to be able to sell the share for $9.75 right after you receive the final year 3
dividend. If your required return is 8% annually, how much would you
be willing to pay for the share?

© John Wiley and Sons Australia, Ltd 2008 6.6

 Chapter 6: Valuation of bonds and shares

n
Dt Pn
Using equation Ve   
t 1 1  rs  1  rs  n
t

D1 D2 D3 D4 D5 D P
Ve       6 66
(1  r ) (1  r )
1 2
(1  r ) (1  r )
3 4
(1.04) 5
(1.04)

0.30 0.30 0.40 0.40 0.45 0.45  9.75

 1
 2
 3
 4
 5

(1.04) (1.04) (1.04) (1.04) (1.04) (1.04) 6

= 0.2885 + 0.2774 + 0.3556 + 0.3419 + 0.3699 + 8.0612

= $9.69

6.3 Hakka Ltd zero coupon bonds have a face value of $100 000 and 5 years
to maturity. Your nominal required return is 10% p.a., compounded
semi-annually. What is the intrinsic value of the bond?

Using equation 6.3

F
Vb 
1  rb  n
100,000
Vb  5*2
 0.1 
1  
 2 
100,000

1.6289
= $61 391.12

6.4 Zed Ltd zero coupon bonds have a face value of $500 000 and 2 years to
maturity. Your nominal required return is 7% p.a., compounded semi-
annually. What is the intrinsic value of the bond?

500,000
Vb  2*2
 0.07 
1  
 2 
500,000

1.1475
= $435 729.80

6.5 A zero coupon bond has a face value of $100 000 and 5 years to maturity.
Interest accrues on the bond quarterly (4 times a year). If you required
return is 8% p.a., what is the value of the bond?

© John Wiley and Sons Australia, Ltd 2008 6.7

Introducing Corporate Finance 2e Solution Manual

F
Vb 
(1  rb ) n
100,000
Vb  5 4
 0.08 
1  
 4 
Vb  $67,297.13

6.6 Crown Ltd bonds have 4 years to maturity, coupons of 9.5% and a face
value of $100. Coupons are paid semi-annually. If your required return is
8% p.a., what is the intrinsic value of a Crown bond?

n
Ct F
Using equation 6.4 Vb   
t 1 1  rb  t 1  rb  n
0.095 0.08
Ct   100  4.75 rb   0.04
2 2

As the stream of coupon payments forms an annuity with a term of 8 periods and a
discount rate of 4%:

1  (1  rb )  n  F
Vb  C  
 (1  rb )
n
 rb
1  (1  0.04) 8  100
 4.75 
 (1  0.04)
8
 0.04
= 4.75 (6.7327) + 100 (1.3686)
= 31.98 + 73.07
= $105.05

6.7 Vision Systems bonds have a face value of $500 000, a coupon of 7.75%
and 7 years to maturity. Coupons are paid semi-annually. If your
required return is 11% p.a., what is the intrinsic value of this bond?

0.0775 0.11
Ct   500,000  19,375 rb   0.055
2 2
1  (1  rb )  n  F
Vb  C  
 (1  rb )
n
 rb
1  (1  0.055) 14  500,000
 19,375  
 (1  0.055)
14
 0.055
500000
 19375  9.5897 
2.1161
= 185 799.43 + 236 283.73
= $422 083.16

© John Wiley and Sons Australia, Ltd 2008 6.8

 Chapter 6: Valuation of bonds and shares

6.8 Cowcall Ltd bonds have 3 years to maturity. They pay an 8% p.a. coupon
and the payments are made semi-annually. The face value of the bond is
$1000. If your required return is 10% p.a., what is the intrinsic value of a
Cowcall bond?

0.08 0.10
Ct   1,000  40 rb   0.05
2 2

1  (1  rb )  n  F
Vb  C  
 (1  rb )
n
 rb
1  (1  0.05) 6  1,000
 40   
 (1  0.05)
6
 0.05
1,000
 40  5.0757 
1.3401
= 203.03 + 746.21
= $949.24

6.9 A bond with 5 years to maturity has a coupon of 6% p.a. paid quarterly.
The face value is $100 000. If your required return is 8%, what is the
value of the bond?

n
Ct F
Vb   
t 1 (1  rb ) (1  rb ) n
t

100,000
Vb  1,500(16.3514)  45
 0.08 
1  
 4 
Vb  24,527.1  67,300  $91,827.1

6.10 Amcor Ltd preference shares pay a dividend of $0.65 p.a. If your
required return is 8% p.a., what is the intrinsic value of an Amcor
preference share?

D
Using equation 6.5 Vp 
rp
0.65
Vp 
0.08
= $8.13

6.11 Croesus Mining NL preference shares pay an annual dividend of 8 cents.

Two equal sized dividend payments are made each year. If your required
return is 15% p.a., what is the intrinsic value of a Croesus preference
share?

Here, the annual dividend and required return are divided by two to reflect the semi-
annual payments.

© John Wiley and Sons Australia, Ltd 2008 6.9

Introducing Corporate Finance 2e Solution Manual

0.04
Vp 
0.075
= $0.53

However, leaving the dividend and required return at the annual rates does not have
an impact on the intrinsic value of a preference share. Try this question, as an annual
calculation to convince yourself this is true!

6.12 Preference shares issued by Sydney Gas Ltd have a dividend of 11% p.a.
based on a face value of 50 cents. Equal sized dividend payments are
made twice a year. What is the intrinsic value of this share if your
required return is 9% p.a.?

0.0275
Vp 
0.045
= $0.61

6.13 A preference share pays an annual dividend of $0.50. If your discount

rate is 12% p.a., what is the present value of the preference share’s
dividends?

D
Vp 
rp
0.50
Vp   $4.17
0.12

6.14 XYZ pays semi-annual dividends. The last dividend was 50c and was paid
yesterday. Your forecast growth rate is 3% p.a. Forecast the dividends for
the next 4 years.

D1 = D0(1 + g)
= 0.50(1 + 0.015) = 0.5075

D2 = D0(1+g)2
= 0.50 (1 + 0.015)2 = 0.5151

D3 = D0(1+g)3
= 0.50 (1 + 0.015)3 = 0.5228

D4 = D0(1+g)4
= 0.50 (1 + 0.015)4 = 0.5307

D5 = D0(1+g)5
= 0.50 (1 + 0.015)5 = 0.5386

D6 = D0(1+g)6

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 Chapter 6: Valuation of bonds and shares

= 0.50 (1 + 0.015)6 = 0.5467

D7 = D0(1+g)7
= 0.50 (1 + 0.015)7 = 0.5549

D8 = D0(1+g)8
= 0.50 (1 + 0.015)8 = 0.5633

6.15 You are considering the purchase of some shares. The shares pay semi-
annual dividends and you have forecast the next four dividends to be 20c,
22c, 28c and 31c. You expect to sell the share for $6.75 right after you
receive the fourth dividend. If your required return is 12% p.a., what is
the value of the share?

n
Dt Pn
Ve   
t 1 (1  rb ) (1  re ) n

0.20 0.22 0.28 0.31  6.75

Ve  1
 2
 3
 4
 0.12   0.12   0.12   0.12 
1   1   1   1  
 2   2   2   2 
Ve  0.19  0.20  0.24  5.59  $6.22

6.16 As part of your retirement funding strategy, you are considering the
purchase of ordinary shares in Australian Ethical Investments Ltd.
Dividends are paid semi-annually and you have forecast the next six. The
first of these dividends will be received in 6 months’ time.
Dividend

You are planning to sell the shares when you have received the final
dividend and you expect to get $14 for each share. If your required rate of
return is 6% p.a., what is the intrinsic value of a share?

n
Dt Pn
Using equation 6.6 Ve   
t 1 1  rs  1  rs  n
t

D1 D2 D3 D4 D5 D P
Ve       6 66
(1  r ) (1  r )
1 2
(1  r ) (1  r )
3 4
(1.04) 5
(1.04)

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Introducing Corporate Finance 2e Solution Manual

0.20 0.20 0.27 0.30 0.32 0.35  14

 1
 2
 3
 4
 5

(1.03) (1.03) (1.03) (1.03) (1.03) (1.03) 6

= 0.1942 + 0.1885 + 0.2471 + 0.2665 + 0.2760 + 12.0174

= $13.19

6.17 Calliope Ltd has been listed for the last 20 years. Over this time, investors
have enjoyed a steady stream of dividends. You expect the current annual
growth rate of about 1% to be maintained into the foreseeable future.
Dividends are paid semi-annually and the dividend paid last week was 13c
per share. If your required return for Calliope is 5% p.a., what is the
intrinsic value of a share?

D1
Using equation 6.7 Ve 
re  g
D (1  g )
Ve 
re  g
0.13(1  0.005)

0.025  0.005

The last dividend would have been a semi-annual one. The growth rate and required
return, however, are annual so need to be divided by two.

0.13065
 = $6.53
0.02

6.18 You have forecast an annual growth rate of 3% for MOP Ltd. Dividends
are paid annually and the last dividend was 50c. If your required return is
12% p.a., what is the value of an MOP share?

D1
Ve  0.50(1  0.03)
re  g Ve   $5.72
0.12  0.03

6.19 You have forecast the next annual dividend of Topboy Ltd at $1. You
expect that the following dividends show a 5% increase for each of the
next 2 years. After that, you forecast a growth rate of 1% p.a. and expect
this growth to continue indefinitely. If your required return is 10% p.a.,
what is the value of a Topboy share?

D1 D2 D3 D4
Ve     1  re  n
1  re  1
1  re  2
(1  re ) re  g
3

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 Chapter 6: Valuation of bonds and shares

1 1(1  0.05) 1(1  0.05) 2 1(1  0.05) 2 (1  0.01)

Ve     1  0.10 3
1  0.10 1 1  0.10 2 (1  0.1) 3
0.10  0.01
Ve  0.9091  0.8678  0.8283  9.2956  $11 .90

© John Wiley and Sons Australia, Ltd 2008 6.13

6.20 Shares in Cochlear Ltd have been trading on the ASX for about 12 years. Over that time, the company has experienced
a phenomenal growth rate in dividends of about 25% p.a. This growth has been achieved by expanding into overseas
markets and, to a lesser extent, by new product development. You expect that growth in US sales will support the
current growth in dividends for a further 5 years. After that time, you expect dividend growth to slow to about 10%
p.a. and the new growth rate to be maintained for many years to come. Total dividends last year were 51 cents. The
next dividend payment is due 6 months from now and dividends are paid semi-annually. What is the intrinsic value of a
Cochlear share if your required rate of return is 16% p.a.?

D(1  g1 ) D(1  g1 ) 2 D(1  g1 )10 D(1  g1 )10 (1  g 2 ) 1

Ve    .....   
(1  re ) (1  re ) 2
(1  re )10
re  g (1  re )10

0.255(1  0.125) 0.255(1  0.125) 2 0.255(1  0.125)10 0.255(1  0.125)10 (1  0.05) 1

   .....   
(1  0.08) (1  0.08) 2
(1  0.08)10
0.08  0.05 (1  0.08)10

0.2869 0.3227 0.3631 0.4085 0.4595 0.517 0.5816 0.6543 0.7361 0.8281 0.86947  1 
            
1.08 1.1664 1.2597 1.3605 1.4693 1.5869 1.7138 1.8509 1.999 2.1589 .03  2.1589 

= 0.2656 + 0.2767 + 0.2882 + 0.3003 + 0.3127 + 0.3258 + 0.3393 + 0.3535 + 0.3682 + 0.3836 + 13.4244

= $16.64
6.21 Calliope Ltd (CLL) currently has a PE of 25 times. If CLL ordinary shares
are selling at $6.82, what earnings per share does the market expect for the
next period?

P0
Using equation 6.8 PE 
EPS
6.82
25 
EPS

EPS  PE  6.82
6.82
EPS   0.27
25

6.22 You are interested in the ordinary shares of Blackmores Ltd. Your forecast
EPS for the coming financial year is 33c and your experience tells you that
similar firms are trading at a PE of 19 times. What value would you give
Blackmores shares?

P0
19 
0.33

P0  EPS  PE
P0  0.33  19  6.27

6.23 You have forecast next year’s earnings for Rontech Ltd at $2.5 million. The
company has issued 1million shares and the PE ratio for comparable firms in
the industry is 12. Your required return is 15% p.a. What is the value of
Rontech?

EPS = 2 500 000 / 1 000 000 = $2.50

P0  PE  EPS
P0  12  2.50  $30

6.24 A bond has 10 years to maturity, a face value of $1 000 and a coupon rate of
7% p.a. paid semi-annually. What is the value of the bond if similar bonds
are yielding:
(a) 6%
n
Ct F
Vb   
t 1 (1  rb ) (1  rb ) n
t
Introducing Corporate Finance 2e Solution Manual

1,000
Vb  35(14.8775)  102
 0.06 
1  
 2 
Vb  520.71  553.70  $1,074.41

(b) 11%

1,000
Vb  35(11 .9504)  10 2
 0.11 
1  
 2 
Vb  418.26  342.70  $760.96

6.25 Longhaul Ltd has issued bonds with 25 years to maturity and a face value of
$100. The coupon rate will be 5% p.a. for the first 10 years. After that, the
coupon will change to 8% p.a. If the required rate of return is 7% p.a., what
is the value of the bond?

n
Ct F
Vb   
t 1 (1  rb ) (1  rb ) n
t

100
Vb  5(7.0236)  8(9.1079)(1.07) 10 
1  0.07  25
Vb  35.12  37.04  18.43  $90.59

6.26 A preference share is selling for $6.36. Dividends are paid annually and the
required rate of return is 5% p.a. What is the dollar amount of each
dividend payment?

D
Vp 
rp
D
6.36 
0.05
D  6.36  0.05  $0.318

6.27 (a) The last dividend on an ordinary share was $0.50. You expect the
dividends to grow at 2% per annum for the foreseeable future. What is
the value of the share if the required return is 10% p.a.?

D1
Ve 
re  g
0.50(1  0.02)
Ve   $6.38
0.10  0.02

© John Wiley and Sons Australia, Ltd 2008 6.16

 Chapter 6: Valuation of bonds and shares

(b) The next dividend on an ordinary share is expected to be $0.50. You

expect the dividends to grow at 2% per annum for the foreseeable
future. What is the value of the share if the required return is 10% p.a.?

0.50
Ve   $6.25
0.10  0.02

© John Wiley and Sons Australia, Ltd 2008 6.17