Suppose you want to invest in a corporate bond which currently has 7 years until
ID: 2629696 • Letter: S
Question
Suppose you want to invest in a corporate bond which currently has 7 years until maturity. The bond carries a coupon (legal) rate of 5.75 percent, payable annually, and has a maturity value of $1,000. If you require a 10.5 percent yield to maturity , what price should you expect to pay for the bond today ? Also, if the yield to maturity holds constant over the next year and you think you might sell your investment at that point, what price would you expect to receive for this bond next year ? Bond Price Today (VB(2013)) = ______________________. Bond Price Next Year (VB(2014)) = ______________________. 7b. (10 Points). Weaver Chocolate Co. expects to earn $3.50 per share during the current year, its expected dividend payout ratio is 65%, its expected constant dividend growth rate (g) is 6.0%, and its common stock currently sells for $32.50 per share. New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred (F = 0.05). What would be the cost of retained earnings common equity (rs) for Weaver Chocolate Co.? What would be the cost of equity from new common stock (re)? Cost of Retained Earnings Common Equity (rs) = ____________________. Cost of Newly Issued Common Stock (re) = ____________________.
Explanation / Answer
Suppose you want to invest in a corporate bond which currently has 7 years until maturity. The bond carries a coupon (legal) rate of 5.75 percent, payable annually, and has a maturity value of $1,000. If you require a 10.5 percent yield to maturity , what price should you expect to pay for the bond today ? Also, if the yield to maturity holds constant over the next year and you think you might sell your investment at that point, what price would you expect to receive for this bond next year ?
Working
rate (YTM) = 10.5%
nper (No of year left to maturity) = 7
PMT (Annual Coupon) = 1000*5.75% = $ 57.50
FV (Maturity Value) = 1000
Bond Price Today = pv(10.5%,7,57.50,1000)
Bond Price Today = 772.51
rate (YTM) = 10.5%
nper (No of year left to maturity) = 6
PMT (Annual Coupon) = 1000*5.75% = $ 57.50
FV (Maturity Value) = 1000
Bond Price Next Year = pv(10.5%,6,57.50,1000)
Bond Price Next Year = 796.12
Answer
Bond Price Today (VB(2013)) = $ 772.51
Bond Price Next Year (VB(2014)) = $ 796.12
7b. (10 Points). Weaver Chocolate Co. expects to earn $3.50 per share during the current year, its expected dividend payout ratio is 65%, its expected constant dividend growth rate (g) is 6.0%, and its common stock currently sells for $32.50 per share. New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred (F = 0.05). What would be the cost of retained earnings common equity (rs) for Weaver Chocolate Co.? What would be the cost of equity from new common stock (re)?
Working
As per Dividend Discount Model
Current price (Po) = Expected Dividend/(Cost of Retained Earning - growth rate)
Expected Dividend = 3.50*65%*1.06 = 2.4115
Current price = 32.50
growth rate = 6%
Cost of Retained Earning = 2.4115/32.50 + 0.06
Cost of Retained Earning = 0.1342 or 13.42%
Current price after floatation Cost (Po) = Expected Dividend/(Cost of Newly Issued Common Stock - growth rate)
Expected Dividend = 3.50*65%*1.06 = 2.4115
Current price after floatation Cost = 32.50 - 5%*32.50 = $ 30.875
growth rate = 6%
Cost of Newly Issued Common Stock= 2.4115/30.875 + 0.06
Cost of Newly Issued Common Stock = 0.1381 or 13.81%
Answer
Cost of Retained Earnings Common Equity (rs) =13.42%
Cost of Newly Issued Common Stock (re) = 13.81%
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