Chapter 6: Valuation of bonds and shares

End of Chapter Questions:

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

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.

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

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

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

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?

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?

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?

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?
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.?

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.?

(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.?