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Problems on Stocks, Bonds, Corporate Valuation

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1) Constant Growth: You are condsidering an investment in Keller Corp's stock, which is expected to pay a dividend of $2.00 a share at the end of year (D1=$2.00) and has a beta of 0.9. The risk free rate is 5.6%, and the market risk premium is 6%. Keller currently sells for $25.00 a share, and its dividend is expected to grow at some constant rate g. Assuming the market is in equilibrium, what does the market will be the stock price at the end of 3 years? (That is, what is P3?)
2) NONCONSTANT GROWTH: Microtech corporation is expanding rapidly and currently needs to retain all of its earnings, hence it does not pay dividends.However, investors expect Microtech to begin paying dividends, begining with a dividend of $1.00 coming 3 yrs from today. The dividend should grow rapidly-at a rate of 50 percent per year-during Years 4 and 5, but after Year 5 growth should be a constant 8 % per year. If the required return on Microtech is 15%,what is the value of the stock today?

3) Corporate Valuation: Dozier Corporation is a fast-growing supplier of office products. Analysys project the following free cash flow (FCFs) during the next 3 years, after which FCF is expected to grow at a constant 7% rate. Dozier's WACC is 13%.

Year FCF($ millions)
0 $0
1 -$20
2 $30
3 $40

a) What is Dozier's terminal, or horizon value?
b) What is the firm's value today?
c) Suppose Dozier has $ 100 million of debt and 10 million shares of stock outstanding. What is your estimate of the current price per share?
4) Corporate Valuation: Barrett Industries invests a large sum of money in R &D; as a result, it retains and reinvests all of its earnings. In other words, Barrett does not pay any dividends and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing Barrett's stock. The pension fund manager has estimated Barrett's free cash flows for the next 4 years as follows: $ 3 million, $ 6 million, $10 million and $ 15 million. After the fourth year, free cash flow is projected to grow at a constant 7%. Barrett's WACC is 12%, its debt and preferred stock total $ 60 million, and it has 10 million shares of common stock outstanding.

a) What is the present value of the free cash flows projected during the next 4 years
b) What is the firm's terminal value?
c) What is the firm's total value today?
d) What is an estimate of Barrett's price per share?
5) 7.5) An investor has two bonds in his portfolio that have a face value of $1,000 and pay a 10% annual coupon. Bond L matures in 15 years, while Bond S matures in 1 year.
a. What will be the value of each of these bonds when the going rate of interest is (1) 5 percent, (2) 8 percent, and (3) 12 percent? Assume that there is only one more interest payment to be made on Bond S at its maturity and 15 more payments to be made on bond L.
b. Why does the longer-term (15-year) bond's price vary more than the price of the shorter-term bond (1-year) when interest rates change?

6) Yield to Call: Six years ago Singleton Company issued 20-years bonds with a 14% annual coupon rate at their $100 par value. The bonds had a 9% call premium, with 5 years of call protection. Today Singleton call the bonds. Compute the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called. Explain why the investor should or should not be happy that Singleton called them.
7) The Heymann Company's bonds have 4 years left to maturity. Interest is paid annually; the bonds have a $1000 par value and a coupon rate of 9%.
a) What is the yield to maturity at a current market price of (1) $829 or (2) $1,104?
b) Would you pay $829 for each bond if you thought that a "fair" market interest rate for such bonds was 12%-that is, if rd=12%? Explain your answer.

8) Yield to maturity and Yield to Call. Kaufman Enterprises has bonds outstanding with a $100 face value and 10 years left until maturity. They have an 11% annual coupon payment, and their current price is $1175. The bonds may be called in 5 years at 10(% of face value (Call price= $1090).

a) What is the yield to maturity?
b) What is the yield to call if they are called in 5 years?
c) Which yield might investors expect to earn on these bonds? Why?
d) The bond's indenture indicates that the call provision gives the firm the right to call the bonds at the end of each year beginning in year 5. In year 5, the bonds may be called at 109% of face value; but in each subsequent year, the call percentage will decline by 1%. Thus in year 6 they may be called at 108% of face value; in year 7, they may be called at 107% of face value; and so forth. If the yield curve is horizontal and interest rate remains at their current level, when is the latest that investors might expect the firm to call the bonds?

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Solution Summary

Answers on questions pertaining to stock, corporate and bond valuation.

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Corporate Finance (Problem Set)

(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?
(Dividend discount model) Assume RHM is expected to pay a total cash dividend of $5.60 next year and its dividends are expected to grow at a rate of 6% per year forever. Assuming annual dividend payments, what is the current market value of a share of RHM stock if the required return on RHM common stock is 10%?
(Required return for a preferred stock) James River $3.38 preferred is selling for $45.25. The preferred dividend is nongrowing. What is the required return on James River preferred stock?
(Stock valuation) Suppose Toyota has nonmaturing (perpetual) preferred stock outstanding that pays a $1.00 quarterly dividend and has a required return of 12% APR (3% per quarter). What is the stock worth?
"(Interest-rate risk) Philadelphia Electric has many bonds trading on the New York Stock
Exchange. Suppose PhilEl's bonds have identical coupon rates of 9.125% but that one issue
matures in 1 year, one in 7 years, and the third in 15 years. Assume that a coupon payment
was made yesterday." (a-d)

"(Default risk) You buy a very risky bond that promises a 9.5% coupon and return of the
$1,000 principal in 10 years. You pay only $500 for the bond." (a-b)

(Constant growth model) Medtrans is a profitable firm that is not paying a dividend on its common stock. James Weber, an analyst for A. G. Edwards, believes that Medtrans will begin paying a $1.00 per share dividend in two years and that the dividend will increase 6% annually thereafter. 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%.
(Beta and required return) The riskless return is currently 6%, and Chicago Gear has estimated the contingent returns given here.

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