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Stock/bond valuation

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Mark Goldsmith's broker has shown him two bonds. Each hasa maturity of 5 years, a par value of \$1,000.00, and a yield rate
to maturity of 12%. Bond A has coupon interest rate of 6% paid annually. Bond B has a coupon interest rate of 14% paid
annually.

A. Calculate the selling price for each of the bonds.

B. Mark has \$20,000 to invest. Judging on the basis of the price of the bonds, how many of either could
Mark purchase if he were to choose it over the other? ( Mark cannot really purchase a fraction of a bond, but for purposes
of this question pretend he can.)

C. Calcualte the yearly interest income of each bond on the basis of its coupon rate and the number of bonds that Mark
could buy with his \$20,000.

D. Assume that Mark will reinvest the interest payments as they are paid ( at the end of each year) and that his rate of return
on the reinvestment is only 10%. For each bond, calculate the value of the principal payment plus the value of Mark's
reinvesment account at the end of the 5 years.

E. Why are the two values calculated in part d different? If Mark were worried that he would earn less than the 12% yield to maturity
on the reinvested interest payments, which of these two bonds would be a better choice?
Giant Enterprises has a beta of 1.20, the risk-free rate of return is currently 10%, and the market return is 14%. The company
which plans to pay a dividend of \$2.60 per share in the coming year, anticipates that its future dividends will increase at an
annual rate consistent with that experienced over the 2003-2009 period, when following dividends were paid:

Year Dividend Per Share
2009 \$2.45
2008 \$2.28
2007 \$2.10
2006 \$1.95
2005 \$1.82
2004 \$1.80
2003 \$1.73

A. Use the capital asset pricing model (CAPM) to determine the required return on Giant't stock.

B. Using the constant growth model and your findings in part a, estimate the value of Giant's stock.

C. Explain what effect, if any , a decrease in beta would have on the value of Gian'ts stock.
Melissa is trying to value Generic Utility, Inc.'s stock, which is clearly not growing at all. Generic declared and paid a \$5 dividend
last year. The required rate of return for utility stocks is 11%, but Melissa is unsure about the financial reporting integrity of
Generic's financial team. She decides to add an extra 1% "credibility" risk premium to the required return as part of her
valuation analysis.

A. What is the value of Generic's stock, assuming that the financials are trustworthy?

B. What is the value of Generic's stock, assuming that Melissa includes the extra 1% "credibility" risk premium?

C. What is the difference between the values found in part a and b, and how might one interpret the difference?

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Solution Summary

The solution explains how to determine the value of a bond and a stock

\$2.19