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Various Security Valuation Models

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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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There are 6 problems. Solution to each problem depict the methodology to calculate the value of desired parameter/s.

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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.
Interest =C=1000*8%=$80
Price=$1085
Number of coupon payments left=n=15
Bond's expected rate of return=YTM=7.06% (Please refer attached Excel file for workings)
Let us study the cash flows associated with the given bond

Year End Cash flow
0 -$1,085
1 $80
2 $80
3 $80
4 $80
5 $80
6 $80
7 $80
8 $80
9 $80
10 $80
11 $80
12 $80
13 $80
14 $80
15 $1,080 Maturity amount+Coupon

We can use IRR funtion to find YTM.
YTM=7.06%

b. Determine the value of the bond to you, given your ...

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  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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