CH05-06 Problem Set Solutions Problem 1 a. Refer to text or slides b. 9 (69) = $621 Annual coupon 9 (34.50) = $310.50 Semi-annual coupon c. 98.375 asked price = $983.75 price x 7 bonds = $6,886.25 d. Refer to text or slides e. Maturity = 10 years N Coupon = 69.00 PMT Principal = 1,000 FV YTM = 7.125% (0.07125) I Value = $984.29 f. Discount to par g. No, market yield already incorporates credit quality h. Refer to text or slides i. Refer to text or slides j. Maturity = 4 years Coupon = 69.00 Principal = 1,035.00 (incorporate 3.5% call premium) Value = 984.29 (from e, above) YTC = 8.15% CH05-06 Problem Set Solutions Problem 2 a. Expected (CAPM) return = 4.5 + 1.25 (8.0) = 14.5% Sustainable growth rate = 30 (1 ? 0.60) = 12.0% Stock value = (1.07) 2.95 / (0.145 ? 0.12) = $126.26 (1) No, the shares are overpriced. Why pay 1.20 (126.26) = $151.51 for stock which is worth only $126.26 per share at your required return? (2) Markets are not perfect. Some investors trade on bad information. Others trade on incomplete information. This behavior can cause a stock to trade at prices different from its fair market value, if only for a very short period of time. (3) No, an inefficient market is one in which investors can earn superior returns (if only for a very short period of time). Investors can have access to all the information possible about a stock, but if the information is not employed in the right way (to earn superior returns), the stock can still be mispriced. b. The company?s equity cannot grow faster than the sustainable rate of growth. c. See (a). Using CAPM and the sustainable growth rate yields the highest possible value for a stock; the value associated with the fastest possible growth, given the required return. d. The stock?s value with forecasted dividend growth is $126.26, from part (a). The stock?s value with equity growth eliminated (all earnings distributed) is: = [ 2.95 / 0.60] / 0.145 = $33.91 where [2.95 / 0.60] is the (constant) earnings per share ( = $4.92). The difference between these two values is $92.35. This is the stock?s PVGO. rives_4 Microsoft Word - BFIN 620 Problem Set CH05-06 Answers.doc
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