Financial Management 2019

TUTORIAL – Lecture 3
1. Textbook, Chapter 6: 2, 3, 5, 7, 9, 16, 17, 19, 20, 21, 25, 32
2. Textbook, Chapter 7: 5, 13, 17, 19, 21, 22, 23, 27, 29, 37, 38, 41

3. A 12% Government bond with $100 face value pay interest twice yearly and matures in 5 years. The
current market yield on the bond is 10% p.a. compounded semi-annually. If the coupon payment has just
been made, what is the current price of the bond?

4. A government bond with a face value of $100 and the coupon rate of 11%p.a. mature in 3 years. Coupon
payments occur twice each year. If the current market yield of the bond is 13% p.a., what is the current
price of the bond?

5. A company intends to raise fund by selling bonds. The face value is $1,000, interest is paid semi-annually
in arrears at the coupon rate of 10% p.a., and the maturity is 2 years.
a. Draw a time line scheduling the cash flows to the buyer of the bond
b. What price will the bond sell for, if the yield for 2-year bond is 8% p.a. compounded semi-annually?
c. Complete the following table:
Yield to maturity Value of bond
8% p.a.
10% p.a.
12% p.a.
If you were to plot the value of the bond against the yield, you will see an inverse relationship – as the
yield to maturity goes up, the value of the bond goes down.

6. A three-year bond with a face value of $50,000 is selling at $47,291. Interest is paid semi-annually in
arrears at the coupon rate of 4% p.a., semi-annual compound.
Without any calculation, is the yield of the bond greater or less than the 4% coupon bond?

7. Consider 2 government bonds, both have $1000 face value and have a coupon rate of 8% p.a. with
coupon paid semi-annually. Bond A has 2 year to maturity, and bond B has 10 years to maturity.
a. If the yield to maturity for two bonds is 10% p.a., calculate the market price of each bond
b. Assume that the market yield to maturity for bonds of this risk increases to 12% p.a. Given the
inverse relationship between yield and bond price, the rise in yield will price to decrease. Before
doing any calculation, predict whether bond A or bond B will have greater fall in value?
c. Now calculate the market price of each bond and see whether your prediction in (b) was correct?
8. Red Frog Brewery has $1,000-par-value bonds outstanding with the following characteristics: currently
selling at par; 5 years until final maturity; and a 9% coupon rate (with interest paid semi-annually)
Interestingly, Old Chicago Brewery has a very similar bond issue outstanding. In fact, every bond feature is
the same as for the Red Frog bonds, except that Old Chicago’s bonds mature in exactly 15 years.
Assume that the market’s required rate of return for both bond issues suddenly fell from 9% to 8%

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a. Which bond could show the greatest price change? Why?

b. Determine the per bond price for each brewery’s bonds at the new market required rate of return.
Which bond’s price fell the most, and by how much?

9. The required rate of return (the market capitalization rate) on the shares in the company identified from
(a) to (c) is 15% p.a. Calculate the current share price in each case. Assume that all companies pay one
dividend per year
a. The most recent dividend (paid yesterday) of Lara Ltd. is $1.50. The company expects the dividend to
remain constant for a foreseeable future
b. Waught’s Ltd current dividend per share is 80cent, paid yesterday. This dividend is expected to grow
at a constant rate of 5% p.a. forever
c. Akgram Ltd’s current dividend per share is 60 cent (paid yesterday). The dividend of the company has
been growing at 12% p.a. in recent years, a rate expected to be maintained for a further 3 years. It is
then envisaged that the growth rate will decline to 5% p.a. and remain at that level infinitely.

10. Tendulkar Co. pays annual dividends on its ordinary share. The last dividend of 75 cents per share was
paid yesterday. The dividends are expected to grow at 8% p.a. for the next 2 years, after which a growth
rate of 4% p.a. is expected to be maintained indefinitely. Estimate the value of one share if the required
rate of return is 14% p.a.

11. A company has issued preferred shares promising a constant dollar dividend of $3 per year in perpetuity.

12. What’s the stock price if the required rate of return is 10% p.a.?

13. Company XYZ has just paid a dividend of $1.20. In doing so, they maintained their historical dividend
payout ratio of 40%. If the company expects to earn 13% on its new investments, what can we expect the
next year’s earnings per share to be?

14. A company has just paid (yesterday) a dividend of $2 per share. The dividend is expected to grow at a rate
of 4% p.a. indefinitely. What’s the stock price if the required rate of return is 12% p.a. and the company
makes one dividend payment per year?

15. JAH Ltd does not currently pay a dividend, but you expect that it will begin paying a $0.50 per share
dividend at the end of year 2. The dividend is expected to grow at 20% per year for 3 years, and then slow
to a sustained growth rate of 4% per year thereafter. The market opportunity rate for investors in JAH
chares is 13% p.a. What is the price per share today that you expect JAH shares to sell at?

16. Willmott Forest Ltd has recently paid a dividend of $2 per share, and trades at 70 cents per share. If
required of return is 7.57%, what is the growth rate priced into the shares?

17. It is now 31 December, 2006. Wayne-Martin Electric Inc. (WME) has just developed a solar panel capable
of generating 200 percent more electricity than any solar panel currently on the market. As a result, you
expect that WME will experience a 20% annual growth rate of earnings for the next 2 years and 15% for

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the subsequent 3 years. By the end of 5 years, you believe that other firms will have developed
comparable technology, and WME’s growth rate will slow to 5% per year indefinitely. You estimate that
the required return on WME’s shares is 12%. WME just reported its annual earnings of $10.00 per share.
WME follows a policy of maintaining constant dividend payout ratio of 20% and pays dividends on the last
day of each year based on reported earnings.
a. What is WME’s dividend per share for 2006?
b. Using a dividend growth model, estimate the value of one WME share today?
c. After calculate the intrinsic value of WME’s share in (c), you observe that WME’s shares are currently
selling at a price that is $3 lower than your calculated intrinsic value. If you believe that the market is
efficient, what factors may have contributed to this remarkable difference between the current price
and your calculated value of WME’s shares?

18. N&M Ltd. has just paid the dividend of 6 cent per share.
a. What is the dividend per share 10 year later if the growth rate of dividend is 8% p.a. for the next 10
years?
b. What is the growth rate of dividend if DPS at the year of fifth is 9 cent per share?
c. What is the stock price if dividend is expected to grow indefinitely at a rate of 10% p.a. and the
required rate of return is 15% p.a.?

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