Share Valuation & Bond Valuation

1. A share is currently selling for Rs. 65. The company is expected to pay a dividend of Rs.
2.50 on the share at the end of the year. It is reliably estimated that the share will sell for
Rs. 78 at the end of the year.
 Assuming that the dividend and price forecasts are accurate, would you buy the
share to hold it for one year, if your required rate of return were 12 percent?
 Given the current market price Rs. 65 and the expected dividend of Rs. 2.50, what
would the price have to be at the end of one year to justify purchase of share
today, if your required rate of return were 15 percent?
2. You have decided to buy 500 shares of an IT company with the intention of selling out at
the end of five years. You estimate that the company will pay Rs. 3.50 per share as
dividends for the first two years and Rs. 4.50 per share for the next three years. Your
further estimate that, at the end of the five year holding period, the shares can be sold for
Rs. 85. What would you be willing to pay today for these shares if your required rate of
return is 12 percent?
3. A company paid a cash dividend of Rs. 4 per share on its stock during the current year.
The earnings and dividends of the company and expected to grow at an annual rate of 8
percent indefinitely. Investors expect a rate of return of 14 percent on the company's
share. What is a fair price for this company shares?
4. A company paid dividends amounting to Rs. 0.75 per share during the last year. The
company is expected to pay Rs. 2 per share during the next year. Investors forecast a
dividend of Rs. 3 per share in the year after that. Thereafter, it is expected that dividends
will grow at 10 percent per year into an indefinite future. Would you buy/sell the share if
the current market price of the share is Rs. 54? Investors required rate of return is 15
percent.
5. A chemical company paid a dividend off Rs. 2.75 during the current year. Forecasts
suggest that earnings and dividends of the company are likely to grow at the rate of 8
percent over the next five years and at the rate of 5 percent thereafter. Investors have
traditionally required a rate of return of 20 percent on these shares. What is the present
value of the stock?
6. Cement products Ltd currently pays a dividend of Rs. 4 per share on its equity shares.
a. If the company plans to increase its dividend at the rate of 8 percent per year
indefinitely, what will be the dividend per share in 10 years?
b. If the company’s dividend per share is expected to be Rs. 7.05 per share at the end
of five years, at what annual rate is the dividend expected to grow?
1. Jaya ltd. Has a 14 percent debenture with a face value of Rs. 100 that matures at par in 15
years. The debenture is callable in five years at Rs. 114. It currently sells for Rs. 105.
Calculate each of the following for this debenture:
a. Current yield
b. Yield to call
c. Yield to maturity
2. A person owns a Rs. 1000 face value bond with five years to maturity. The bond makes
annual interest payments of Rs. 80. The bond is currently priced at Rs. 960. Given that the
market interest rate is 10 percent, should the investor hold or sell the bond?
3. An investor purchases for Rs. 5555 a zero coupon bond whose face value is Rs. 7000 and
maturity period is 3 years. Calculate the spot interest rate of the bond.
4. A bond pays interest annually and sells for Rs. 835. It has six years left to maturity and a
par value of Rs. 1000. What is its coupon rate if its promised YTM is 12 percent?
5. Globe Ltd has tk. 2,000 Face Value bond at coupon rate of 15% for 10 years with
redeemable 10% premium. The flotation cost is tk. 55 per bond incurred in this process? If the
tax rate is 40% what is the cost of the bond?
6. An investor has analysed a stock for a one – year holding period. There is fifty – fifty
chance that the stock currently selling a tk. 60 will sell for tk. 55 or tk. 70 by the year end. The
investor can borrow on 40% margin from his band at 10% p.a.
a. What are the investor’s expected holding period yield and risk if he buys 100 shares
and does not borrow?
b. What would be his expected yield and risk if he buys 200 shares paying 60% of the
cost with borrowed funds?
7. Finance.com has an opportunity to invest in a new high-speed computer that costs $50,000.
The computer will generate cash flows (from cost savings) of $25,000 one year from now,
$20,000 two years from now, and $15,000 three years from now. The computer will be
worthless after three years, and no additional cash flows will occur. Finance.com has
determined that the appropriate discount rate is 7 percent for this investment. Should
Finance.com make this investment in a new high-speed computer? What is the present value
of the investment?
8. Harry DeAngelo is investing $5,000 at a stated annual interest rate of 12 percent per year,
compounded quarterly, for five years. What is his wealth at the end of five years?
9. Mark Young has just won the state lottery, paying $50,000 a year for 20 years. He is to
receive his first payment a year from now. The state advertises this as the Million Dollar
Lottery because $1,000,000 = $50,000 * 20. If the interest rate is 8 percent, what is the true
value of the lottery?
10. Suppose an investor is considering the purchase of a share of the Utah Mining Company. The
stock will pay a $3 dividend a year from today. This dividend is expected to grow at 10
percent per year (g =10%) for the foreseeable future. The investor thinks that the required
return (r) on this stock is 15 percent, given her assessment of Utah Mining’s risk. (We also
 refer to r as the discount rate of the stock.) What is the value of a share of Utah Mining
Company’s stock?
11. Consider the stock of Elixir Drug Company, which has a new back-rub ointment and is
enjoying rapid growth. The dividend for a share of stock a year from today will be $1.15.
During the next four years, the dividend will grow at 15 percent per year (g1 = 15%). After
that, growth (g2) will be equal to 10 percent per year. Can you calculate the present value of
the stock if the required return (r) is 15 percent?
12. Consider two bonds, bond A and bond B, with equal rates of 10 percent and the same face
values of $1,000. The coupons are paid annually for both bonds. Bond A has 20 years to
maturity while bond B has 10 years to maturity.
a. What are the prices of the two bonds if the relevant market interest rate is 10 percent?
b. If the market interest rate increases to 12 percent, what will be the prices of the two
bonds?
c. If the market interest rate decreases to 8 percent, what will be the prices of the two
bonds?
13. A common stock pays a current dividend of $2. The dividend is expected to grow at an 8-
percent annual rate for the next three years; then it will grow at 4 percent in perpetuity. The
appropriate discount rate is 12 percent. What is the price of this stock?
14. Consider the stock of Davidson Company that will pay an annual dividend of $2 in the
coming year. The dividend is expected to grow at a constant rate of 5 percent permanently. The
market requires a 12-percent return on the company.
a. What is the current price of a share of the stock?
b. What will the stock price be 10 years from today?
Causes of Agency Problem:
Remedies to Agency Problem:
Several researchers have documented certain remedies to the agency problem,
which are cited below:
Managerial ownership: Granting of stocks to the agents increases their affiliation to the firm.
Jensen and Meckling (1976) described that managerial ownership makes the manager work as
the owner in the organisation and concentrate on the firm performance. By this, the interest of
the owners’ and managers’ interest aligns.
Executive compensation: An inadequate compensation package may force the managers to use
the owners’ property for their private benefit. A periodic compensation revision and proper
incentive package can motivate the managers to work harder for the better performance of the
firm (Core, Holthausen, & Larcker, 1999) and by which the owners can maximise their wealth.
Debt: Increase in the debt level in the firm discipline the managers. The periodic payment of the
debt service charges and principal amount to the creditors can make the managers more cautious
regarding taking inefficient decisions that may hamper the profitability of the firm (Frierman &
Viswanath, 1994).
Labour market: The effective managers always aspire for better opportunity and remuneration
from the market and the market estimate the manager’s ability by their previous performance
(Fama, 1980). For this reason, the managers have to prove their worth in the firm by maximising
the value of the firm and this increases the effectiveness and efficiency of the managers.
Board of directors: The inclusion of more outside and independent directors in the board
(Rosenstein & Wyatt, 1990) may diligently watch the actions of the managers and help in
making the alignment of the interest among the owners and managers.
Blockholders: A strong owner or concentrated ownership or the blockholders can closely
monitor the behaviours of the managers and can control their activities to improvise the value of
the firm (Burkart, Gromb, & Panunzi, 1997).
Dividends: The profit distribution as dividends leads to decline in the agency conflict (Park,
2009). Dividend distribution decreases the internal funds, so the firm has to attract external funds
to finance. For which, the managers need to make the firm perform better in order to allure the
market participants. Dividend payout also resolves the agency conflict between the inside and
outside shareholders (Jensen, 1986; Myers, 2000).
Market for corporate control: The poor performing firm may be taken over by an efficient
firm and the acquiring firm may eradicate the inefficient management (Kini, Kracaw, & Mian,
2004), which penetrates the managers to perform efficiently.
15. Bond Yields You’re looking at two bonds identical in every way except for their coupons
and, of course, their prices. Both have 12 years to maturity. The first bond has a 10 percent
coupon rate and sells for $935.08. The second has a 12 percent coupon rate. What do you think it
would sell for?
16. The Starr Co. just paid a dividend of $2.15 per share on its stock. The dividends are expected
to grow at a constant rate of 5 percent per year, indefinitely. If investors require a return of 11
percent on the stock, what is the current price? What will the price be in three years? In 15 years?
17. White Wedding Corporation will pay a $2.65 per share dividend next year. The company
pledges to increase its dividend by 4.75 percent per year, indefinitely. If you require a return of
11 percent on your investment, how much will you pay for the company’s stock today?
18. Gruber Corp. pays a constant $9 dividend on its stock. The company will maintain this
dividend for the next 12 years and will then cease paying dividends forever. If the required return
on this stock is 10 percent, what is the current share price?
19. Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock
over the next nine years, because the firm needs to plow back its earnings to fuel growth. The
company will pay a $15 per share dividend in 10 years and will increase the dividend by 5.5
percent per year thereafter. If the required return on this stock is 13 percent, what is the current
share price?