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Smith's Clothing Store

1. You are called in as a financial analyst to appraise the bonds of Smith's Clothing Store. The $1000 par valuebonds have a quoted annual intgerest rate of 13 percent, which is paid semiannually. The yield to maturity on the bonds is 10 percent annual interest. There are 25 years to maturity.
a. Compute the price of the bonds based on semiannual analysis.
b. With 20 years to maturity, if yield to maturity goes down substantially to 8 percent, what will be the new price of the bonds?

2. Gates Inc,. has preferred stock outstanding that pays an annual dividend of $9.80. Its price is $110.00. What is the required rate of return (yield) on the preferred stock?

3. Common Stock value under different market conditions.
Walmert Inc. will pay a dividend of $3 per share in the next 12 months(D1). The required rate of return (Ke) is 10 percent and the constant growth rate is 5 percent.
a. Compute Po
(For parts b, c, and d in this problem, all variables remain tghe same except the one specifically changed. Each question is independentof the others)
b. Assume Ke, the required rate of return, goes up to 12 percent: what will be the new value of Po ?
c. Assume the growth rate (g) goes up to 7 percent; what will be the new value of Po? Ke goes back to its original value of 10 percent.
d. Assume D1 is $3.50; what will be the new value of Po? Assume Ke is at its original value of 10 percent and g goes back to its original value of 5 percent.

4. Oleo Corporation paid a $2 dividend last year. The dividend is expected to grow at a constant rate of 5 percent over the next 3 years.
The required rate of return is 12 percent (this will also serve as the discount rate in this problem). Round all values to 3 places to the righ of the decimal point where appropriate.

a. Compare the anticipated value of the dividends for the next 3 years. That is, compute D1, D2, and D3; for example, D1 is $2.10 ($2.00 x 1.05).
b. Discount each of these dividends back to the present at a discount of 12 percent and then sum them.
c. Compute the price of the stock as tthe end of the third year (P3).
P3 = D4/Ke-g
(D4 is equal to D3 times 1.05)
d. After you have computed P3, discount it back to the present at a discount rate of 12 percent for 3 years.
e. Add together the answers in part b and part d to get Po, the current valueof the stock. This answer represents the present value of the first 3 periods of dividends, plust the present value of the price of the stock after 3 periods (which, in turn, represents the value of all future dividends).
f.
Use this formula to show that it will provide approximately the same answer as part e. Po = D1 / Ke-g
For this formula use D1 = $2.10, Ke = 12 percent, and g = 5 percent. (The slight difference between teh answers to part e and part f is due to rounding).

Solution Preview

1. You are called in as a financial analyst to appraise the bonds of Smith's Clothing Store. The $1000 par value bonds have a quoted annual interest rate of 13 percent, which is paid semiannually. The yield to maturity on the bonds is 10 percent annual interest. There are 25 years to maturity.

a. Compute the price of the bonds based on semiannual analysis.

We need to calculate how much is the bond's price by using the formula as follows: -

where B is the issued price/current price
C is the coupon payment
r is the current interest rate
n is the period

B = 65 x [1 - 1 ] + 1,000
(1 + 0.05)50 (1 + 0.05)50
0.05

B = $1,273.84

b. With 20 years to maturity, if yield to maturity goes down substantially to 8 percent, what will be the new price of the bonds?

B = 65 x [1 - 1 ] + 1,000
(1 + 0.04)40 (1 + ...

Solution Summary

This solution is comprised of a detailed explanation to compute the price of the bonds based on semiannual analysis.

$2.19