Current Yield and stock valuation
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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 Summary
The solution explains how to calculate the current yield on a bond and price of a common stock
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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 ...
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