Question No. 01 Given the following information for the stock of Foster Company,

Question

Question No. 01
Given the following information for the stock of Foster Company,calculate its beta.

Current price per share of common

Rs. 80.00

Expected dividend per share next year

Rs. 5.00

Constant annual dividend growth rate

7%

Risk free rate of return

6%

Return on market portfolio

10%

Question 2:

ABC Company is considering investing in either of the twooutstanding bonds. Both bonds have Rs.2,000 par values and 10%coupon interest rates and pay annual interests. Bond A has exactly3 years to maturity, and bond B has 5 years tomaturity.
a) Calculate the value of bond A if the required rate ofreturn is 14%.
b) Calculate the value of bond B if the required rate ofreturn is 14%.
c) If ABC wants to minimize the Interest Rate Risk, whichbond should be purchased? Why.

Current price per share of common

Rs. 80.00

Expected dividend per share next year

Rs. 5.00

Constant annual dividend growth rate

7%

Risk free rate of return

6%

Return on market portfolio

10%

Explanation / Answer

Question stock beta#1 Average Required ROR for all rational investors in an Efficient Market can be estimated using the CAPM Theory: Beta and Risk Free Rate of Return. Total Rate of Return (ROR) for Single Stock = Dividend Yield + Capital Gain. GORDON’S FORMULA FOR COMMON STOCK PRICING OR VALUATION USES REQUIRED RETURN r = DIV/Po + g. In Efficient Markets, Price of Stocks is based on Market Risk (or Beta). We can formulate the required rate of return in terms of Beta risk so how can we use beta coefficient to calculate the required rate of return for the average investor in the market. The answer to it is the Vu handout page # 114 Po* = DIV1 / [ (rRF + (rM - rRF ) ßA ) - g] Where Po*=80 DIV1=5 g= 7% rRF=6% rM =10% ßA=? Now put the values and get answer which is = ßA 1.8125 Question#2 Bond valuation Bond Pricing Equation: vu handout page#123 Bond Price = PV = C1/ (1+rD) + C2/ (1+rD) t2+ C3 / (1+rD)t3 + ….. + PAR / (1+rD)n3 Where Pv = bound value C= coupon payment Pa = 2000*10.100= 200 rD= required rate of return = 14%=0.14 PAR = par value or face value= 2000 Maturity period Bound A = t3 n3 Bound B = t5 n5 Answer: (a)Bond A = value Rs: 1967 (b)Bound B= value Rs: 1928

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