ACF 103 – Fundamentals of Finance

Tutorial 4 - Solutions
Chapter 4
1. How much should you pay for a zero-coupon bond with a 15-year maturity
and $1,000 face value if you want an 11% return?
Answer:
$1,000(PVIF11%,15) = ($1,000)(0.209) = $209

2. NDV Corp.'s common stock is expected to pay a $2 dividend, which will grow
at a compound rate of 4% indefinitely.
a. If the market requires a 14% return, what should be the current market price of
the stock?
b. If the current market price of the stock is $40, what rate of return is the market
requiring?
Answer:
a. D1/(ke – g) = $2/(0.14 - 0.04) = $20
b. (D1/P0) + g = ($2/$40) + 0.04 = 0.09, or 9%

3. The stock of Macbeth Cleaning Corp. is currently selling for $25 a share. The
company is expected to pay a dividend of $0.75 at the end of this year. If you
bought Macbeth stock today and sold it for $29 after receiving the dividend,
what rate of return would you earn?
Answer:
ke = (D1/PO) + g
= ($.75/$25) + ($29 - $25)/$2
= (.03) + (0.16) = 0.19 or 19%

4. You have just paid $1,063.65 for a bond with nine years remaining to
maturity. Interest on the bond is paid semiannually. If the current rate of return
for similar investments is a nominal 8%, what is this bond's coupon rate?
Round your answers to two decimal places.
Answer:
$1,063.65 = R(PVIFA4%,18) + $1,000(PVIF4%,18)
= R(12.659) + $1,000(0.494)
R = ($1,063.65 - $494)/12.659 = $44.9996 or $45.00(rounded)

Annual interest payments are $45 x 2 = $90;

Coupon rate is $90/$1,000 = 0.09 or 9%

5. Text book Ch 4 question # 1 (p.91)

Answer:
V0 = I(PVIFAkd,n) + M(PVIFkd,n)
= 100(PVIFA14%,3) + 1000(PVIF14%,3)
= 100 x 2.3216 + 1000 x 0.675
= 232.26 + 675
= $907.26

An alternative way to do this is:

End of Year Payment PV Factor (14%) Present Value

ACF 103 HAUT 2015 tutorial Solns 1

 1 $ 100 0.877 $ 87.70
2 100 0.769 76.90
3 1,100 0.675 742.50
Price per bond $ 907.10

6. Text book Ch 4 question # 2 (p.91)

Answer:
V0 = I(PVIFA7%,6) + M(PVIF7%,6)
= 50(4.7665) + 1000(0.6663)
= 238.33 + 666.3
= $904.63
or,
End of 6-month PeriodPayment PV Factor (7%) Present Value
1 $ 50 0.935 $ 46.75
2 50 0.873 43.65
3 50 0.816 40.80
4 50 0.763 38.15
5 50 0.713 35.65
6 1,050 0.666 699.30
Price per bond $ 904.30

Homework problem
7. Text book Ch 4 question # 5 (p.91)
Answer:

Phases 1 and 2: Present Value of Dividends to Be Received Over First 6 Years

End of Present Value Calculation Present Value

Year (Dividend × PVIF18%,t) of Dividend
1 $2.00 (1.15)1 = $2.30 × 0.847 = $ 1.95
2
2 2.00 (1.15) = 2.65 × 0.718 = 1.90
3 2.00 (1.15)3 = 3.04 × 0.609 = 1.85

Phase 2
4 3.04(1.10)1 = 3.34 × 0.516 = 1.72
5 3.04(1.10)2 = 3.68 × 0.437 = 1.61
6 3.04(1.10)3 = 4.05 × 0.370 = 1.50

= $10.53

Phase 3: Present Value of Constant Growth Component

Dividend at the end of year 7 = $4.05(1.05) = $4.25

Value of stock at the end of year 6 = D7/(ke + g) = $ 4.25/( 0.18 – 0.05) =

$32.69

Present value of $32.69 at end of year 6= ($32.69) (PVIF18%,6)

= ($32.69)(0.370) = $12.10

ACF 103 HAUT 2015 tutorial Solns 2

 Present Value of Stock
V = $10.53 + $12.10 = $22.63

8. Text book Ch 4 question # 6 (p.91)

Answer:
a. P0 = D1/(ke – g)
= ($1.50)/(0.13 – 0.09) = $37.50
b. P0 = D1/(ke – g)
= ($1.50)/(0.16 – 0.11) = $30.00
c. P0 = D1/(ke – g)
= ($1.50)/(0.14 – 0.10) = $37.50
Either the present strategy (a) or strategy (c). Both result in the same market
price per share.

9. Text book Ch 4 question # 9 (p.92)

Answer:
V = (I/2)(PVIFA7%, 30) + $1,000(PVIF7%, 30)
= $45(12.409) + $1,000(0.131)
= $558.41 + $131 = $689.41

ACF 103 HAUT 2015 tutorial Solns 3