Here is data for an issuer who has not issued preferred stock: bond’s par value

Question

Here is data for an issuer who has not issued preferred stock:

            bond’s par value          $1,000

            bond’s market price    $1,125

            bond’ coupon                      5% (paid semi-annually)

            bonds maturity date    8 years from today

            stock’s par value         $1.00

            stock’s market value   $10.00

           dividend expected 1 year from now               $0.40

           dividend growth rate                                      3%

Use the dividend discount model (either Equation 9-2 or 9-3 on p. 307) to determine the required rate of return on this stock.

2%

Explanation / Answer

Option B

Stock Price=D1/(r-g)

=0.4/(r-0.03)

Given, price=10

So,

10=0.4/(r-0.03)

Hence, r=0.4/10+0.03=0.07=7%

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