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# Security Valuation Models

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Problem 1: Watters Umbrella Corp issed 15 yr bonds 2 yrs ago at a coupon rate of 7.8%. The bonds make semiannual payments. If these bonds currently sell for 105% of par value, what is the YTM?

Problem 2: The next dividend payment by ZYX, Inc., will be \$2.85 per share. The dividends are anticipated to maintain a 4.5% growth rate, forever. If ZYX stock currently sells for \$84 per share, what is the required return?

Problem 3: Mickelson Corporation will pay a \$2.90 per share dividend next year. The company pledges to increases its duvudebd by 4.75 percent per year, indefinitely. If you require an 11 percent return on your investment, how much will you pay for the company's stock?

#### Solution Preview

Please refer attached file for better understanding of formulas in MS Excel.

Problem 1

Settlement 1/1/13 (Think of Settlement as the beginning of the duration of the bond)
Maturity 1/1/26 (Think of Maturity as the end of the duration ...

#### Solution Summary

There are 3 problems. Solution to first problem depicts the methodology to find the YTM of a given bond. Solution to second problem calculates the required return in case of a stock. Solution to third problem describes the steps to estimate the price of a stock. Calculations are carried out with the help of suitable formulas in MS Excel.

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## Finance Management

1. (Bond valuation) National Steel 15-year, \$1,000 par value bonds pay 8 percent interest annually. The market price of the bonds is \$1,085, and your required rate of return is 10 percent.
a. Compute the bond's expected rate of return.
b. Determine the value of the bond to you, given your required rate of return.
c. Should you purchase the bond?

2. (Preferred stock expected return) You are planning to purchase 100 shares of preferred stock and must choose between Stock A and Stock B. stock A pays an annual dividend of \$4.25 and is selling for \$36. If your required return is 12 percent, which stock should you choose?

3. (Common stock valuation) Dalton Inc. has an 11.5 percent return on equity and retains 55 percent of its earnings for reinvestment purposes. It recently paid a dividend of \$3.25 and the stock is currently selling for \$40.
a. What is the growth rate for Dalton Inc.?
b. What is the expected return for Dalton's stock?
c. If you required a 13 percent return, should you invest in the firm?

4. (Common stock valuation) Bates Inc. pays a dividend of \$1 and is currently selling for \$32.50. If investors require a 12 percent return on their investment from buying Bates stock, what growth rate would Bates Inc. have to provide the investors?

5. (Preferred stock valuation) What is the value of a preferred stock when the dividend rate is 14 percent on a \$100 par value? The appropriate discount rate for a stock of this risk level is 12 percent.

6. (Common stock valuation) You intend to purchase Marigo common stock at \$50 per share, hold it 1 year, and then sell it after a dividend of \$6 is paid. How much will the stock price have to appreciate for you to satisfy your required rate of return of 15 percent?

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