Fin 571- Week Two Problems

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Individual Text Problem Sets - Week Two

CHAPTER 5
A1. (Bond valuation) A $1,000 face value bond has a remaining maturity of 10 years and a required return of 9%. The bond’s coupon rate is 7.4%. What is the fair value of this bond?

“The value of a bond, its fair price, is the present value of its promised future payments for coupon and principal.” So we are solving for PV

FV= $1,000

N= 10

I= 9%

Pmt = 7.4% of $1,000 = $74

|Future Value |$1,000|

|Years |10 |

|Rate |9% |

|PMT |$74|

|Present Value |($897.32)| INCORRECT Correct answer PV = -$895.94

A10. (Dividend discount model) Assume RHM is expected to pay a total cash dividend
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Bret Kimes, one of James’ colleagues at the same firm, is less optimistic.

Bret thinks that Medtrans will begin paying a dividend in four years, that the dividend will be $1.00, and that it will grow at 4% annually. James and Bret agree that the required return for Medtrans is 13%.

a. What value would James estimate for this firm?

Fair price = starting dividend/ (required return - growth rate)

Fair price = $1.00 / (13-6) % = 1/7%= 1/0.07 = $14.29 INCORRECT

CORRECT ANSWER B20. a. P1 = D2 / (r - g) = $1.00 / (0.13 - 0.06) = $14.29

P0 = $14.29 / (1 + 0.13)1 = $12.64

Now using calc functions from book N=2

b. What value would Bret assign to the Medtrans stock?

Fair price = starting dividend/ (required return - growth rate)

Fair price = $1.00 / (13-4) %= 1/9%= 1/0.09 = $11.11 INCORRECT

CORRECT ANSWER b. P3 = D4 / (r - g) = $1.00 / (0.13 - 0.04) = $11.11

P0 = $11.11 / (1 + 0.13)3 = $7.70

CHAPTER 7

C1. (Beta and required return) The riskless return is currently 6%, and Chicago Gear has estimated the contingent returns given here.

| | |REALIZED RETURN |

|State of Market |Probability that |Stock Market |Chicago Gear |

| |state occurs | | |

|Stagnant |0.2

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