Chapter

10
Valuation and Rates
of Return

Anwar Zahid
Independent University, Bangladesh
 Bond valuation
Introduction of formula

FV = Face value
i = interest rate
A = Annuity
Ytm = Yield to maturity
n = no. of periods
Pg 321/ 1 The Lone Star Company has $1,000 par value bonds outstanding at
101.percent
Answer:interest. The bonds will mature in 20 years. Compute the current
price of the bonds if the present.
A) yield to maturity (YTM) is 6%.

Coupon rate for bond (A) = 10%

A = Annuity = ($1000* 0.10)
  = $100
YTM = yield to maturity = 6%
n = no. of periods = 20 years

Bond value = ( $100 * 11.47 ) + $311.80

Bond value = $ 1,459

Pg 321/2; Midland Oil has $1,000 par value bonds outstanding at 8 percent
interest. The bonds will mature in 25 years. Compute the current price of the
1. Answer:
bonds if the present yield to maturity is
A) yield to maturity (YTM) is 7%. B) yield to maturity (YTM) is 10%.

 
A)
Coupon rate for bond
(A) = 8%
  A = Annuity = ($1000*
0.08) = $80
YTM = yield to maturity
= 7%
Bond value = ( $80 * 11.65 ) + $ 184.25 n = no. of periods = 25
years
Bond value = $ 1,116 Ans
Pg 321/2; Midland Oil has $1,000 par value bonds outstanding at 8 percent
interest. The bonds will mature in 25 years. Compute the current price of the
1. Answer:
bonds if the present yield to maturity is
B) yield to maturity (YTM) is 10%.
 
B)
Coupon rate for bond
(A) = 8%
  A = Annuity = ($1000*
0.08) = $80
YTM = yield to maturity
= 10 %
Bond value = ( $80 * 9.08 ) + $ 92.26
n = no. of periods = 25
Bond value = $ 818 Ans years

Higher the YTM lower the bond current value/price and Vice versa
Pg 323/12; Jim Busby calls his broker to inquire about purchasing a bond of Disk Storage
Systems. His broker quotes a price of $1,180. Jim is concerned that the bond might be
1. Answer:
overpriced based on the facts involved. The $1,000 par value bond pays 14 percent interest,
and it has 25 years remaining until maturity. The current yield to maturity on similar bonds is
12 percent. Compute the new price of the bond and comment on whether you think it is
overpriced in the marketplace.
 
Coupon rate for bond
(A) = 14 %
  A = Annuity = ($1000*
0.14) = $140
YTM = yield to maturity
= 12 %
Bond value = ( $140 * 7.84 ) + $ 58.83
n = no. of periods = 25
Bond value = $ 1156 Ans years

Comment : Broker’s price is at $1,180 is too high compared to

$1,156 value. It is overpriced, Jim Busby should not buy
13. Tom Cruise Lines, Inc., issued bonds five years ago at $1,000 per bond. These bonds had
a 25-year life when issued and the annual interest payment was then 15 percent. This return
was in line with the required returns by bondholders at that point as described next:
 
Real rate of return 4%
Real rate of return 4%
Inflation premium 3
Inflation premium 6 Risk premium 5__
Risk premium 5__ New Total return/YTM 12%
Total return/YTM 15%
 
Assume that five years later the inflation premium is only 3 percent and is appropriately
reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years
remaining until maturity.
New “n “ = 20 years

Compute the new price of the bond.

 Pg 323/13; Tom Cruise Lines, Inc., issued bonds five years ago at $1,000 per bond. These
1. Answer:
bonds had a 25-year life when issued and the annual interest payment was then 15 percent.
This return was in line with the required returns by bondholders at that point as described
next: which is calculated 12% (YTM).

 
Coupon rate for bond
(A) = 15 %
A = Annuity = ($1000*
  0.15) = $150
YTM = yield to maturity
= 12 %

Bond value = ( $150 * 7.47 ) + $ 103.67 n = no. of periods = 20

years
Bond value = $ 1,224 Ans
Pg, 324/21. Heather Smith is considering a bond investment in Locklear Airlines. The $1,000
par value bonds have a quoted annual interest rate of 11 percent and the interest is paid
semiannually. The yield to maturity on the bonds is 14 percent annual interest. There are 7
years to maturity. Compute the price of the bonds based on semiannual analysis.
Semiannual interest rate = 11% interest / 2 = 5.5% (.055)
A = Semiannual interest = .055 × $1,000 = $55
Number of periods (n) = 7 × 2 = 14
Yield to maturity (on a semiannual basis) = 14% / 2 = 7%

Bond value = $481.01 + $387.82 H.W 22

Bond value = $ 869 Ans

18. Bonds issued by the Coleman Manufacturing Company have a par value of $1,000,
which of course is also the amount of principal to be paid at maturity. The bonds are
currently selling for $690. They have 10 years remaining to maturity. The annual interest
payment is 13 percent ($130). Compute the yield to maturity (YTM).
Answer:
18.

Answer: Yield to maturity (YTM) is 20.76%

Stock valuation

- Preferred Stock

- Common Stock
Pg 325,/ 23. The preferred stock of Denver Savings and Loan pays an annual dividend
of $5.70. It has a required rate of return of 6%. Compute the price of the preferred
stock.

Here,
Pp= Price of pref. stock
 
Dp= Dividend of pref. stock; $5.70
Kp= Cost of pref. stock; 6%
 

Preferred Stock
Pg 325,/ 25. X-Tech Company issued preferred stock many years ago. It carries a
fixed dividend of $12 per share. With the passage of time, yields have soared from the
original 10% to 17% (yield is the same as required rate of return).

a) What was the original issue price?

b) What is the current value of the preferred stock?
 

H.W

 
Pg 325; /26. Analogue Technology has preferred stock outstanding that pays
a $9 annual dividend. It has a price of $76. What is the required rate of
return (yield) on the preferred stock?

 
27. Stagnant Iron and steel currently pays a $12.25 annual cash dividend (D0). The
company plans to maintain the dividend at this level for the foreseeable future as no future
growth is anticipated. If the required rate of return by common stock holders (Ke) is 18%,
what is the price of the common stock?

 
Here,
Po = price of com. Stock
  Do = Dividend of Com. Stock
Ke = Cost of Com. Stock
NO growth rate

Po = $ 68.05

- Common Stock
28. BioScience Inc. will pay a common stock dividend of $3.20 at the end of
the year (D1). The required rate of return on common stock (Ke) is 14%. The
firm has a constant growth rate (g) of 9%. Compute the current price of the
stock (P0).
 

Here,
  Po = ?
D1 = $ 3.20
Ke = 14%
g = 9%
Po = $64 Ans
Do (present)= Last year dividend / Dividend paid / Current dividend

D1 (future)= Next year dividend / Dividend will be paid / expected

dividend

Assume dividend paid is $100 and growth is 5%.

Do /(pv) = $ 100 and g = 5%, D1 / (fv) = ?
D1(Fv) = Do(pv) * (1 + g ) ^1
= 100 * ( 1 + 0.05 )^1
D1 = 105 ans
30. Maxwell Communications paid a dividend of $3 last year. Over the next
12 months, the dividend is expected to grow at 8 percent, which is the
constant growth rate for the firm (g). The new dividend after 12 months will
represent D1. The required rate of return (Ke) is 14 percent.
Compute the price of the stock (P0).

  So, D1 = D0(1+g) = $3 (1+0.08) = $3.24

Here,
 
Po = ?
Do = $ 3
D1 = 3.24
Po = $54 Ans Ke = 14%
g=8%
 31. Justine Cement Company has had the following patter of earnings
per share over the last five years:

Year EPS
20X1 $5.00
20X2 5.30
20X3 5.62
20X4 5.96
20X5 6.32
The earnings per share have grown at a constant rate and will continue to do so
in the future. Dividends represent 40 percent of earnings. Project earnings and
dividends for the next year (20X6).
If the required rate of return (Ke) is 13 percent, what is the anticipated stock
price (P0) at the beginning of 20X6?
 Year EPS Div = EPS*40%
Ans: As Dividend is 40% of Earnings 20X1 $5.00
20X2 5.30
20X3 5.62
20X4 5.96
Lets calculate the growth rate (g) of EPS 20X5 6.32
20x6 ?
$6.70 ?
$2.68

g = (Change / Basic Year ) * 100  

= ($5.00 - $5.30) / 5 = 0.06= 6%
So, EPS of 20x6 will be = (6.32* 1.06%)= 6.70  

20x6 Dividend will be = 6.70 * 40% = $2.68

Po (20X6) = $ 38.29 Ans

The End