# Current Yield and stock valuation

1. Consider a $1,000 par value bond with a 7% annual coupon. The bond pays interest annually. There are 9 years remaining until maturity. What is the current yield on the bond assuming that the required return on the bond is 10%?

2. Assume that you plan to buy a share of XYZ stock today and to hold it for 2 years. Your expectations are that you will not receive a dividend at the end of Year 1, but that you will receive a dividend of $9.25 at the end of Year 2. In addition, you expect to sell the stock for $150 at the end of Year 2. If your expected rate of return is 16%, how much should you be willing to pay for this stock today?

3. Womack Toy Company's stock is currently trading at $25 per share. The stock's dividend is projected to increase at a constant rate of 7% per year. The required rate of return on the stock is 10%. What is the expected price of the stock 4 years from today?

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#### Solution Preview

1. Consider a $1,000 par value bond with a 7% annual coupon. The bond pays interest annually. There are 9 years remaining until maturity. What is the current yield on the bond assuming that the required return on the bond is 10%?

Current Yield is found by dividing the interest amount by the market price. First we need to calculate the market price. The market price of a bond is the sum of discounted cash flows from a bond i.e, the interest and the principal. The discounting rate is the required return. The present bond has 9 years to maturity. The interest amount each year is 1000X7%=$70. The interest amount is an annuity and we can find the PV of an annuity by using the PVIFA table to get the annuity factor. For 9 years and 10%, the annuity factor is 5.759. The PV of the interest amount is ...

#### Solution Summary

The solution explains how to calculate the current yield on a bond and price of a common stock

Computation of Bond prices and yields;Basic bond valuation & Common stock value - Constant Growth

1. Bond prices and yields.

Assume that the Christianson Corp. $1,000-par-value bond has a 5.700% coupon, matured on May 15, 2017, had a current price quote of 97.708, and had a yield to maturity (YTM) of 6.034%.

Given this information, answer the following questions:

a. What was the dollar price of the bond?

b. What is the bond's current yield?

c. Is the bond selling at par, at a discount, or at a premium? Why?

d. Compare the bond's current yield calculated in part b to it's YTM and explain why they differ.

2. Basic bond valuation.

JD Designs Inc. has an outstanding issue of $1,000-par-value bonds with a 12% coupon interest rate. The issue pays interest annually and has 16 years remaining to its maturity date.

a. If bonds of similar risk are currently earning a 10% rate of return, how much should JD Designs Inc. bond sell for today?

b. Describe the two possible reasons why the rate on similar-risk bonds is below the coupon interest rate on the JD Designs Inc bond.

c. If the required return were at 12% instead of 10%, what would the current value of JD Designs' bonds be? Contrast this finding with your findings in part a and discuss.

3. Common stock value - Constant Growth

Darlington Inc. common stock paid a dividend of $1.20 per share last year. The company expects earnings and dividends to grow at a rate of 5% per year for the foreseeable future.

a. What required rate of return for this stock would result in a price per share of $28?

b. If Darlington Inc. expects both earnings and dividends to grow at an annual rate of 10%, what required rate of return would result in a price per share of $28?

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