1. You intend to buy a bond issued by ABC Inc. The bond has 15 years remaining t
ID: 2718254 • Letter: 1
Question
1. You intend to buy a bond issued by ABC Inc. The bond has 15 years remaining to maturity, $1,000 par value and is paying 8% annual coupon.
(a) How much will you pay for the bond if its YTM is currently 7%?
(b) One year later, the bond’s YTM has risen to 10%. What are the current yield, capital gains yield and total yield of your bond investment?
2. Which of the following statements is true or false? Briefly explain your answer.
(a) “Accept the project when its IRR is greater than zero because it is creating value”
(b) “NPV of the project being negative implies that the project is loss-making.”
3. (a) Stock A just paid a dividend of $2 and its management has also announced that it will pay a dividend of $2.12 in the coming year. If you expect the dividend growth of Stock A will remain in the current level forever, how much should Stock A worth today if the required rate of return is 10%?
(b) Alice has just paid a dividend of $30 per share and the management has indicated that it will increase the dividend payments by 20%, 18% and 15% in each of the coming three years, and 10% per year thereafter. Alice’s cost of equity is 17.5%. Estimate the intrinsic value of Alice share.
Explanation / Answer
1.a- we will pay the present value of bond discounted at YTM.
year cash flow discounting factor(7%) discounted cash flow
1-15 80 9.108 726.84
5 1000 0.362 362
total=(726.84+362) 1088.84
1.b- current yeild= next intrest/market price
= 80/1000
=8%
2.a- “Accept the project when its IRR is greater than zero because it is creating value” is TRUE . IRR is the internal rate of return which the project ll earn throught out the life of the project. IRR>0 means the project ll earn something more then keeping the money idle. so if the IRR is greater then 0 the project can be acceptable provided there is no other project available withe greater IRR.
2.b- “NPV of the project being negative implies that the project is loss-making.”. TRUE NPV is the net present value of a investment/project calculated by discounting the future cash flow in the applicable discounting rate. When the future discounted cah flow which the project is going to earn in future is less then the current investment value of the project then project will give a negative NPV, which simply means future earning is less then the current investment, so the project is not acceptable.
3.a- value of stock A= Dividend of next year /Required return-growth
Dividend next yera=2.12
required return= 10%
Growth= next yr dividend - current yr dividend/ current yr divedend * 100
2.12-2.00/2.00*100= 6%
value of stock= 2.12/10%-6%
=53
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