Answered: MLC Fund Management is considering the…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 23P

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Question

MLC Fund Management is considering the following three (3) options for their new investment portfolio:

Option 1 - A non-callable corporate bond that pays a coupon rate of 8% annually. The bond will mature in 30 years. The yield-to-maturity (YTM) of the bond is 7.5% and the face value of the bond is $1 000.

Option 2 - An ordinary share which just paid a dividend of $6.00 with a constant dividend growth rate of 5% each year. The current market price of this share is $85.

Option 3 - A $100 par value preference-share which pays a fixed dividend of 6%. The required rate of return for the preference shares with the same risk is 8%.

Required:

a) How much should MLC pay for the corporate bond that pays the coupon annually? If the coupon is paid quarterly, what is the new bond value?
b) Calculate the market required rate of return for the ordinary share.
c) Compute the value of the preference share.
d) Explain why a preference share is considered a hybrid between an equity and a debt instrument.

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